Union Pacific Corp (UNP) — Q4 2018 Earnings Call Transcript

Thank you, Rob, and good morning, everybody, and welcome to Union Pacific's fourth quarter earnings conference call. With me here today in Omaha are Jim Vena, our new Chief Operating Officer; 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 record 2018 fourth quarter net income of $1.6 billion or $2.12 per share. This represents an increase of 29% in net income and 39% in earnings per share when compared to adjusted results for 2017. Total volume increased 3% in the quarter compared to last year. Industrial and premium carloadings grew 6% and 9%, respectively, while Agricultural products declined 2% and Energy volumes were down 9%. The quarterly operating ratio came in at 61.6%, which improved 1.1 percentage points compared to the fourth quarter of 2017. Strong topline growth and improved operating performance drove the year-over-year improvement during the quarter. We launched the Unified Plan 2020 on October 1 of last year to help drive improved safety, service, and operations. And I'm pleased to report that we're ahead of our initial schedule and seeing meaningful gains in on-time performance, productivity, and financial results. The network design changes we implemented over the past few months have already had a measurable impact. We've eliminated the excess network cost that we previously discussed. Cost savings are being realized by parking excess freight cars and locomotives, by cycling cars faster in our network and by reducing the size of our workforce. We're seeing steady improvement in the key performance indicators we use to gauge progress. As a result, we announced late last year that we're accelerating implementation of Unified Plan 2020, which we now expect to be complete by the middle of the year. Shortly, you'll hear from the team on our fourth quarter results and the status of the Unified Plan 2020 initiative. But first, I'd like to introduce Jim Vena, an old friend, who we just appointed Chief Operating Officer effective last week. Jim's leadership abilities and accomplishments over a 40-year career at Canadian National Railway are well known in the rail industry. Jim will have full authority over all aspects of Union Pacific's operations to implement Precision Scheduled Railroading principles as he leads the next stages of our Unified Plan 2020. We're fortunate to have him as the newest member of our leadership team. I'll now turn it over to Jim for a few remarks.

Thank you, Lance, and good morning. First, I'd like to say how pleased I am to return again to the railroad industry. Union Pacific is a great company with a storied history and an impressive track record of financial success. I'm proud to be part of it. While I arrived only last week, it is apparent to me that Union Pacific is committed to changing its operating model in pursuit of running a safe, more reliable and highly efficient network. I've also observed that there are a lot of talented people here working hard to move the company ahead. There has been good progress made in recent months, improving the number of key service metrics, but we have a long way to go. I plan to spend time right away out on the railroad interacting with employees. In fact, I've already visited the field, and I can tell you, there's a lot of opportunity out there. I'm assessing the status of Unified Plan 2020, both in terms of progress made to date and initiatives that are currently underway. I believe that Union Pacific can become the industry leader in safety, operating efficiency, customer service and financial performance. I know the railroad has a vision in place to get to a 55 operating ratio already, and we will be working aggressively towards that goal. But first things first, Lance, let's break 60. I'm excited about the opportunities and challenges that lie ahead. And with that, Kenny, I'll turn it over to you.

Thank you, Jim, and good morning. For the fourth quarter, our volume was up 3%, driven by solid growth in our Premium and Industrial business groups, with a partial offset in Energy and Ag. We generated positive net core pricing of 2.5% in the quarter. The increase in volume and a 2% improvement in the average revenue per car drove a 6% increase in revenue. Let's take a closer look at the performance of each business team. Ag Products revenue was up 5% on a 2% decrease in volume and a 7% increase in average revenue per car. Grain carloads were down 10%, driven by reduced soybean shipment to China. This was partially offset by growth in other feed grain shipment, predominantly to the Mid-South and Mexico. Grain products carloads were up 2% as the same demand for biofuels drove increases in biodiesel, renewable diesel fuel and soybean oil markets. This was partially offset by tariff-related challenges in mills and slowing ethanol growth year-over-year. Fertilizer and soil for carloads increased 18% due to a prolonged fall application, coupled with continued strength in export potash. Energy revenue decreased 8% for the quarter on a 9% decrease in volume, while the average revenue per car remained flat. Coal and coke volume was down 6%, primarily driven by contract changes and retirement. While natural gas prices were higher, it was not enough to offset the volume decline. Sand carloads were down 47%, largely due to the impact of regional sand within the Permian Basin. Furthermore, favorable crude oil price spreads drove an increase in crude oil shipments, which were the primary driver for the 25% increase in petroleum, LPG and renewable carloads for the quarter. Industrial revenue was up 10% on a 6% increase in volume and a 3% increase in average revenue per car during the quarter. Construction carloads increased 10%, primarily driven by increased market demand for rock shipment. Metals and ores volumes increased 19% due to strength in energy, construction and manufacturing markets. Plastics carloads increased 10%, driven by higher production, coupled with new plant start-ups. Premium revenue was up 15%, with a 9% increase in volume and a 6% increase in average revenue per car. Domestic intermodal volume increased 3%, driven by back-to-back strong peak seasons, continued demand for tight truck capacity and strength in parcel and LTL shipments. Auto parts volume growth was driven by over-the-road conversions and production growth at key locations. International intermodal volume was up 21% as the new ocean carrier business continued in the fourth quarter, coupled with a strong pull ahead of shipments due to the 2019 tariff implementation. Finished vehicle shipments were flat. Fourth quarter U.S. auto sales were down approximately 1% from the fourth quarter of 2017. However, the shift in consumer preference from sedans to light trucks and SUVs, coupled with stronger shipment levels out of Mexico and growth with winning new customers, enabled UP to overcome declines in the overall market. For 2019, our Ag Product groups expect uncertainty to continue in the grain market due to foreign tariffs. We anticipate continued strength in biodiesel and renewable diesel fuel shipments due to an increase in market demand for renewable fuels that will offset headwinds within the ethanol marketplace. We also expect the tight truck capacity, combined with the value of rail, to support long-term penetration growth across multiple segments in our food and refrigerated business. For Energy, we expect favorable crude oil price spreads to drive positive results for petroleum products. Local sand supply and softer market conditions will continue to negatively impact sand volumes. We also expect coal to experience continued headwinds throughout 2019, and as always with coal, weather conditions will be a key factor for demand. For Industrial, we anticipate an increase in plastic shipments, driven largely by additional plant expansions coming online in 2019. In addition, we anticipate continued strength in Industrial production, which drives growth in several commodities. For Premium, over-the-road conversion from continued tight truck capacity, as mentioned with Ag, will present new opportunities for domestic and auto parts growth. The U.S. light vehicle sales forecast for 2019 is 16.8 million units, down about 2% from 2018. We will continue to watch the OEMs as they implement their rationalization plans. Consumer preferences driving production shifts and new business wins will create some opportunity to offset the weaker market demand. Furthermore, uncertainty in the international trade and the potential for slower growth in the U.S. economy could also present headwinds as 2019 progresses. Before I turn it over to Tom for his operations update, I'd like to share that we continue to work closely with the operating department as we implement service changes with the Unified Plan 2020. Moreover, our commercial team is diligently engaged with customers to educate them on ways to better manage their railcar inventories and help them grow their business. With that, I'll turn it over to Tom.

Thank you, Kenny, and good morning. I'd like to get started with a quick update on our safety performance for 2018. Our reportable injury rate was 0.82, an increase of 4% as compared to last year. The reportable rate for our rail equipment incidents or derailments was 3.28, an increase of 12%. In Public Safety, our grade crossing incident rate was 2.69, an increase of 5%. Safety remains our number one priority, and the entire Union Pacific team is committed and aligned to improving these metrics in 2019. Now I'd like to share an update on our Unified Plan 2020 progress so far. Implementation of Unified Plan 2020 began in October. On our Mid-American Corridor, we initiated and cut over approximately 160 changes to our transportation plan, and the results, thus far, are very encouraging. In this corridor, car inventory was down almost 16,000 cars. Car dwell was down almost 4 hours, driving reduction on our total daily crew starts. Other operating measures, such as car trip plan compliance, train departure and arrival performance and car connection performance have also improved. Furthermore, we are well underway with implementing our Phase 2, our Sunset Route, which is L.A. and Chicago, and L.A. to our southeast corridors. This phase includes over 200 network T-Plan changes, and over half of these are already cut over. Next week, we will begin on our third and final phase, addressing the PNW in our Northern California corridors. Our goal is to complete the initial implementation of all 3 phases by the middle of this year, which is 6 months faster than we originally planned. Work continues on our efforts to rationalize switching yards, and we will share the results of these initiatives later this year. As Unified Plan 2020 continues to evolve, we expect to see further gains in labor productivity, which will be reflected in train crew and mechanical and engineering workforces. Our - the culture of our workforce is changing as our employees are actively engaged in both generating new ideas and implementing those ideas to our transportation plan. I am pleased with the progress we have made so far, not only the results but the process we are following. Last quarter, we introduced 6 key performance indicators that we believe are appropriate measures to gauge our Unified Plan 2020 progress over time. These KPIs align our operating goals with our financial targets. Today, we have updated each KPI chart with the current results for the week ending January 22. The chart shows the pre-Unified Plan values from September of last year and the gold bar representing the range of expectations for our performance levels at year-end 2019. The year-end goals coincide with the data that we showed you last October. As you can see, we have made steady improvement. Freight car velocity has improved 9% since September. Operating inventory and cars per carload continued to improve due to faster car cycle time and the reduction in freight car dwell. Moving on to locomotives. Locomotive productivity increased 7% as we consolidated train operations and parked excess power. We have stored over 1,200 locomotives since August, and we expect units in storage to continue to increase. The results of these improvements are a more fluid and reliable service product. Car trip plan compliance increased 14 percentage points, and daily manifest service issues decreased 35% since September. As a reminder, the 2019 year-end goals are interim goals as we implement the Unified Plan 2020 across our network this year and beyond. Also, keep in mind the seasonality. Weather events and periodic service interruptions will drive variability in our KPI results. The results for workforce productivity in December are down from September, due primarily to the seasonality of carloads, but we expect large gains over the course of this year. Overall, we are pleased with the performance of our KPIs, and we expect continued improvement in our operations this year. So turning to capital. In 2018, we invested $3.2 billion in our capital program. In 2019, we are also targeting around $3.2 billion pending final approval of our Board of Directors. Seventy percent of our planned 2019 capital allocation is replacement spending to harden our infrastructure, replace older assets and to improve our safety and resiliency of the network. We will purchase no new locomotives in 2019, although we will continue to modernize our existing fleet. Freight car acquisitions will support both replacement and growth opportunities. We will continue to invest in our capacity projects on our network where constraints and productivity opportunities exist. We also plan expansions at intermodal ramps and other commercial facilities to accommodate expected growth. Planned investment in positive train control is $115 million, and that's down $43 million from 2018. To wrap up, Unified Plan 2020 is off to a great start, and I'm very proud of the team's efforts. We have made excellent progress in a short amount of time, but we are just getting started. 2019 will be a year full of change, and the results will be a safer, more reliable and more efficient network. So with that, I'll turn it over to Rob.

Thanks, and good morning. Before I get started, as a reminder, our results for the fourth quarter of 2017 were impacted by two adjustments that we made associated with the Tax Cuts and Jobs Act, which was passed in late December of '17. These adjustments included a $5.9 billion reduction in income tax expense and an approximately $200 million reduction in equipment rents expense, driven primarily by our equity ownership in TTX. Comparisons that I make today to 2017's financial results exclude the impact of these adjustments. With that introduction, here's a recap of our fourth quarter results. Operating revenue was $5.8 billion in the quarter, up 6% versus last year. Positive core price, increased fuel surcharge revenue and a 3% increase in volume were the primary drivers of revenue growth for the quarter. Operating expense totaled $3.5 billion, up 4% from 2017. Operating income totaled $2.2 billion, a 9% increase from last year. Below the line, other income was $46 million compared to $33 million in 2017. The year-over-year increase was driven primarily by additional real estate gains. Interest expense of $240 million was up 28% compared to the previous year. This reflects the impact of higher total debt balance, partially offset by a lower effective interest rate. Income tax expense decreased 32% to $462 million. The decrease was primarily driven by a lower tax rate as a result of corporate tax reform, partially offset by higher pretax earnings. Our effective tax rate for the fourth quarter was 22.9%. For 2019, we expect our annual effective tax rate to be around 24%. Net income totaled $1.6 billion, up 29% versus last year, while the outstanding share balance decreased 7% as a result of our continued share repurchase activity. These results combined to produce a fourth quarter record earnings per share of $2.12. Our operating ratio of 61.6% was an improvement of 1.1 points compared to the fourth quarter of last year. The combined impact of fuel price and our fuel surcharge lag had a 0.5 point favorable impact on the operating ratio in the quarter compared to 2017. Freight revenue of $5.4 billion was up 6% versus last year. Fuel surcharge revenue totaled $488 million, up $195 million compared to 2017 and up $6 million versus the third quarter of 2018. Business mix had a negative impact of 3.5 points on freight revenue for the fourth quarter. Decreased sand volumes and an increase of lower average revenue per car intermodal shipments drove the negative change in mix. And as Kenny already stated, core price was 2.5% in the fourth quarter, which represents a three-quarters-of-a-point sequential improvement compared to the third quarter. We realized solid pricing gains across most business segments during the quarter. For the full year, as we expected, total dollars generated from our pricing actions well exceeded our rail inflation costs. Now turning to operating expense. Slide 21 provides a summary of our operating expenses for the quarter. Compensation and benefits expense increased 4% to $1.3 billion versus 2017. The increase was driven primarily by employee severance costs related to our recent workforce reduction, volume costs and wage inflation, partially offset by lower management labor costs. Total workforce levels were approximately flat in the fourth quarter versus last year. Employees not associated with capital projects were also unchanged year-over-year. Our TE&Y workforce was up 4% due to higher carload volume and more employees in the training pipeline. Offsetting this increase was a 1% reduction in management employees and a 2% reduction in our mechanical and engineering workforces. Fuel expense totaled $640 million, up 17% compared to last year. Higher diesel fuel prices were the primary driver of the increase in fuel expense for the quarter. Compared to the fourth quarter of last year, our average fuel price increased 15% to $2.33 per gallon. Our fuel consumption rate increased about 1% during the quarter, primarily due to mix. Purchase services and materials expense was down 1% compared to the fourth quarter of 2017 at $582 million. Higher intermodal contract services were more than offset by lower mechanical repair costs and joint facility expenses. Turning to Slide 22. Depreciation expense was $555 million, up 4% compared to 2017. The increase was primarily driven by a higher depreciable asset base. For the full year of 2019, we estimate that depreciation expense will increase about 3%. Moving to equipment and other rents. This expense totaled $269 million in the quarter, which is down 3% when compared to 2017. The decrease was primarily driven by lower freight car and locomotive lease expense, partially offset by increased volume-related costs. Other expenses came in at $221 million, down 8% versus last year. Increased casualty costs were more than offset by insurance proceeds related to Hurricane Harvey and other items during the quarter. For the full year 2019, we expect other expenses to be up in the 5% to 10% range compared to 2018. Productivity savings yielded from our 'G55 + 0' initiatives totaled $65 million during the quarter, which was partially offset by additional costs associated with operational inefficiencies. The impact of these operational challenges totaled just under $20 million in the quarter, which is down from the $50 million that we reported in the third quarter. The additional costs were primarily in the compensation and benefits cost category. Full year productivity totaled $265 million, which was partially offset by $175 million of additional costs related to network inefficiencies. Net productivity savings for the year was $90 million. Railroad operations improved steadily throughout the quarter. And as Lance mentioned earlier, we are pleased to report that we are no longer experiencing the failure cost associated with the inefficient network operations. Slide 24 provides the summary of our 2018 earnings with a full year income statement. Operating revenue increased about $1.9 billion or 7% to $22.8 billion. Operating income totaled $8.5 billion, an increase of 8% compared to 2017. Net income was approximately $6 billion, while earnings per share increased 37% to a record $7.91 per share. Looking at our cash flow. Cash from operations for the full year totaled $8.7 billion, up about 20% when compared to last year, due primarily to higher net income. As expected, capital spending in 2018 totaled $3.2 billion or about 14% of revenue. Return on invested capital was 15.1% in 2018, up from 13.7% in 2017, driven primarily by higher earnings. Taking a look at adjusted debt levels. The all-in adjusted debt balance totaled $25.1 billion at year-end 2018, up $5.6 billion since year-end 2017. This includes the $6 billion debt offering that we completed in early June, partially offset by repayments of debt maturities. We finished the fourth quarter with an adjusted debt-to-EBITDA ratio of 2.3 times, up from 1.9 times in 2017. As we have previously mentioned, our target for debt-to-EBITDA is up to 2.7 times, which we will achieve over time. Dividend payments for the year totaled $2.3 billion, up from $2 billion in 2017. This includes the effect of 2 10% dividend increases in 2018. During the fourth quarter, we repurchased 8 million shares at a cost of $1.2 billion. Additionally, we received 4.5 million shares in the fourth quarter associated with our $3.6 billion accelerated share repurchase program that we initiated in June. In total for the year, we repurchased 57.2 million shares at a cost of $8.2 billion. These repurchases reduced our full year average share balance by 6% compared to 2017. Between dividend payments and share repurchases, we returned $10.5 billion to our shareholders in 2018. Free cash flow before dividends totaled nearly $5.3 billion, resulting in a free cash flow conversion rate equal to 88% of net income for 2018. Looking at 2019, we expect volumes for the full year to increase in the low single-digit range. And as Kenny mentioned earlier, we should see strength in several business categories, along with uncertainty in others. We will price our service product to the value it represents in the marketplace while ensuring that it generates an appropriate return for our shareholders. We are confident the dollars we yield from our pricing initiatives should again well exceed our rail inflation cost in 2019. For full year 2019, we expect overall inflation to be about 2%, with labor inflation in the 2.5% range. On the productivity side, we plan to yield at least $500 million of savings this year. We will see productivity in the form of lower compensation expense, enabled by a more efficient workforce. Labor savings and lower purchase services and materials expense will result from operating smaller locomotive and freight car fleets. Faster asset turns should reduce equipment rents and improve fuel consumption. Regarding our operating ratio, we are pleased with the recent progress that we have made in eliminating operational inefficiencies and accelerating the Unified Plan 2020. These accomplishments, along with the expectation of low single-digit volume growth in 2019, gives us increased confidence that we will reduce our operating ratio more quickly in the near term. Therefore, assuming the economy cooperates, we are setting new operating ratio guidance for 2019 of a sub 61%, and we expect to be below 60% by the year 2020. The plans and guidance that we established last year for capital spending, capital structure, and use of free cash flow remain essentially unchanged. We will continue to appropriately reinvest in the business to maintain and improve the condition of our infrastructure. We will invest capital to support growth and productivity initiatives that meet our cost of capital threshold, and we expect return on invested capital to grow. As Tom mentioned earlier, we plan to spend around $3.2 billion in 2019 on capital expenditures, which is flat with 2018. Longer term, we expect capital investments to continue to be less than 15% of revenue. After capital expenditures, we will continue returning cash to shareholders in the form of dividends, maintaining our target payout range of 40% to 45% of earnings. We expect to take another step forward to increase our debt-to-EBITDA ratio towards our ultimate goal of up to 2.7 times while maintaining a minimum credit rating of BBB+ and Baa1. The amount by which we increase our debt-to-EBITDA ratio in 2019 will depend on the strength and stability of both the economic and financial markets. We will continue with our previously announced 3-year plan to repurchase approximately $20 billion of shares by 2020. This plan is now over 40% complete with the $8.2 billion of share repurchases that we completed in 2018. So to wrap up. Positive full year volume, core pricing dollars in excess of inflation dollars and significant productivity benefits will all contribute to another year of strong cash generation and an improved full year operating ratio in 2019. In the longer term, we remain firmly committed to reaching our goal of a 55% operating ratio beyond 2020. So with that, I'll turn it back to Lance.

Thank you, Rob. As discussed today, we delivered record fourth quarter financial results, driven by strong volumes, solid topline revenue growth, and improved operating performance. Looking ahead to 2019, we're going to build on the momentum achieved during the past quarter as we continue implementation of Unified Plan 2020 under the guidance of a leader with extensive Precision Scheduled Railroad experience. We'll continue to pursue other 'G55 + 0' initiatives as well as we make further gains in safety, service, and efficiency. We're optimistic that the economy, the strength of our diverse rail network, and improved service performance will drive positive volume growth this year and provide further price improvement opportunity. We remain focused on increasing shareholder returns by making appropriate capital investments and returning excess cash to shareholders through growing dividends and share repurchases. I am confident that we have the right organization in place, with an appropriate mix of UP veterans and new thought leaders, to achieve our goals for the year. With that, let's open up the line for your questions.

Thank you and good morning, gentlemen. I wanted to touch on a few things. One, if we look at your outlook on the pricing side, you said - Rob, I think you said the pricing would well exceed your inflation rate. And you said your inflation rate was going to be about 2%. Do you consider the fourth quarter number well exceeding the rate of inflation that you guys posted?

Jason, yes. I think I'll repeat for everybody else's benefit how we calculate price. It is an all-in yield number. It's not a same-store sales type of calculation. It's the dollars that we generated across our entire book of business. And so when we say well exceed inflation dollars, we're comparing that dollar, if you will, that we generate across the entire book of business from pricing actions against the dollars that we incurred as a result of inflation. So yes, we did well exceed inflation dollars in the fourth quarter. And we expect to continue to do that again in 2019.

Okay. Fantastic. And the next one, shocking, was going to be on PSR. Can we talk a little bit about the pace of improvement? And maybe compare UP's network to some of the other networks that have seen PSR implemented? And is there anything at UP that would cause it to go slower or cause it to go faster?

I'll start it out, and then I'd like to turn it over to Jim for his perspective and then Tom as well. So the bottom line is we're focused on implementing the principles through Unified Plan 2020 on our railroad. And we see lots of opportunity to improve our car dwell, to decrease inventory, to improve cars per carload, to improve labor productivity across the board. We have benchmarked other railroads that implemented Precision Scheduled Railroading. And with puts and takes, we understand what they're achieving, and some of them are setting up some pretty strong benchmarks for us to pursue. But our focus is getting the efficiencies and the improvement here. Jim?

Lance, so all I can really add is a question. Is there any real difference in the speed? No. There is no real difference. And we're going to do it as quickly as possible to be able to look at every piece of the company to see how we get it to be as efficient as any other railroad in North America.

Thank you very gentlemen. Jim, welcome aboard.

Hey, thanks, good morning. I appreciate you taking the questions. So Lance and Kenny, obviously, the regulators have been a bit active here with some increase before the government shutdown. So maybe you can just give your perspective. It seems like they have appreciated the communication that you've had with them and with other stakeholders, but it didn't stop them from launching the inquiry into some of the accessorials and demurrage fees. So maybe just give us an update on that. And whether or not you think, when they come back, if adding two new board members will change how this might play out?

Brian, this is Lance. So you're absolutely right. The STB has expressed interest in understanding our implementation of Precision Scheduled Railroading in the form of Unified Plan 2020 and also our approach to customers and helping them change behavior. We've been crystal clear with the STB in terms of what our efforts are, what our approach is and what the endgame is. And I'll leave it to Kenny to dive a little deeper. He has done a tremendous job being in front of the STB, explaining what we're doing, and then being in front of our customers, explaining what we're doing and why. Now I'll touch just one last base, and that is there are incremental members of the STB being named and now sworn in. And the STB has a very big docket in front of it of proposed rule changes. So we're working very diligently to help the STB members understand, from our perspective, the potential impacts of some of what has been proposed, what better alternatives exist and helping them work through that docket in a good, swift logical fashion. So Kenny?

Yes. So Brian, thanks for the question. I say this humbly, but we've done a really good job of being proactive and communicating and being engaged with the STB. I can tell you that engagement has been very consistent. Lance sent out a letter that will be public on the accessorials. He said that, Monday, we'll be sending out something later this week here in the near term, really just updating the STB on where we are on the accessorials and how Unified Plan 2020 is going.

All right. Thanks. I appreciate that. Just as a follow-up, maybe on the headcount and the productivity side. Maybe this is for Tom. The KPIs are great. I appreciate the updates, but it looks like there is some seasonality given that the daily car miles per FTE hasn't moved up. You gave the average for December. They're the ones who were kind of the last 7-day moving average. Can you just give us some context as to where these were in the fourth quarter? And how you would expect, especially the productivity, how big of a factor is that in the $500 million of targets - target savings rather you're expecting this year? That would be helpful.

On the TE&Y side, our training pipeline contributed to some discrepancies compared to the actual workforce figures. Sequentially, the numbers are declining as we approach the fourth quarter, which is wrapping up well in December. This trend is expected to continue. We're in the early stages regarding labor productivity and I'm eager to see how things develop. In terms of our engineering and mechanical areas, we've made necessary adjustments to labor productivity, such as with locomotive production. However, we are still in the early phases of this and anticipate further improvements moving forward.

Right. This is Rob. If I can just add on to your point on the $500 million or at least number of productivity we expect to generate in 2019. Recall, the goal that we put on that particular KPI of a 10%-ish improvement is what we're focused on. And yes, to get $500 million-plus productivity, you can assume - without precise numbers, you can assume that labor productivity across the board is going to be a significant part of that.

Okay. Thanks for all the details. I appreciate it.

Hey, thanks. Good morning. And welcome back, Jim. Glad to have you back. I wanted to touch base - just to follow-up on that comment, Rob, maybe on the efficiencies for $500 million, if you can get a little bit more granular and sort of give us a sense of maybe how you think about the net benefit of that as we move into '19. So it sounds like you're lapping some service issues, that $175 million of service from 2018. I'm not sure how we think about that in 2019. And then how we think about the $500 million in the context of inflation and the pricing that you're able to get? So I guess, maybe in other words, how much of that $500 million do you think really is net that drops to the bottom line as you run through the PSR initiatives?

Yes, Chris, I get your question, and I'll probably frustrate you because I won't give as much detail around that, that you're asking. But I do get it. And yes, we are lapping some of those inefficiency costs. And that's why we have the at least $500 million figure out there. So yes, there is some so-called low hanging fruit of some - we won't reincur some of the inefficiency costs that we had primarily earlier in the year. So that's a good guide. But we are where we are. I mean, so we're going to improve $500 million at least off of where we ended the year on a full year basis. And it's going to come across the board. It's largely driven by the efficiencies that we've been talking through the Unified Plan 2020, but it's - every stone is going to be turned over in the organization, not just within operations. So all of that contributes. And yes, we have the headwind of the, call it, 2% inflation in there, but $500 million to the bottom line of productivity is what we're striving to get at least.

I appreciate the information. Regarding volume, there have been some updates related to the intermodal business. You mentioned implementing some of the PSR work in the Sunset Corridor. I'm curious about how intermodal fits into the 2019 volume guidance. Is there a possibility of reducing some less profitable business reflected in that projection? Could this factor influence the outcome as we progress through 2019?

Yes, so I'll take that. Thanks for that question. First of all, we have a very positive outlook on our intermodal franchise, both as we parse out the intermodal and the domestic side. We're still in the early innings on what all we want to do with the network. Jim, Tom, and myself would be working out the team as we look for more productivity and make sure that we have the most reliable, consistent service product out there.

Yes. I want to circle back, Chris, on overall volumes. So if you look around the globe, you can certainly find spots that cause you concern, right? Europe's slowing down. You can even read some reports that maybe it's ebbing into negative growth territory. Clearly, we've got trade potential impacts with China, both real now and future potential. So those are clear overhangs that we're keeping an eye on. Having said that, we have touched base with our customers and continue to do so. And as we look at the economic indicators in the United States, we still see support for what we consider low single-digit volume growth. And we're poised to be agile if that doesn't happen, but it feels like the U.S. continues to plug along. And so we're prepared for that.

Okay. Thanks very much for the color. I appreciate it.

Thanks and good morning. So I would guess the productivity guidance you've provided for this year is more back-half weighted as you'll have PSR fully rolled out on the network. So is it possible to help us understand the productivity gains you're assuming in the first half of the year versus the second half of the year? I just wanted to get a better sense of the second-half run rate co PSR.

Rob?

Yes, Justin. I mean, we aren't detailing it quarterly, the way you're asking. But I can just tell you that we're not sitting around waiting for the back half of the year to come. We're going after it. As you heard both Jim and Tom and Kenny talk about earlier, we're going after it now. And we feel like we finished 2018 with pretty good momentum. So without giving details of precisely how much it's going to show up in each quarter, I can tell you that I don't view it that way. I look at it as an opportunity in front us. We're going to go after as much opportunity on the productivity front as we can.

Yes. You've seen the numbers, whether it's year-over-year or what we talked about middle of the year to now, locomotives, year-over-year, that number is down 1,200. A number like that from peak to now is down about a couple of thousand. I mean, we are entering the year on pretty good front-forward posture.

Okay. That's helpful. And just to clarify on the guidance for a sub-61 OR this year. Does that assume $500 million of productivity? Or does it assume something higher than that?

Yes, Justin, this is Rob. It relies on the economy being favorable. It relies on us generating and seeing positive volume, although we won't attribute lack of volume as an excuse. Our expectation is for positive volume on the low single-digit side. It relies on pricing growth exceeding inflation increases. Additionally, it relies on achieving at least $500 million in productivity. So all of those factors are what we are counting on. We are focused on each of those elements.

Okay. And I guess, lastly, for Jim. Congrats on the new role. And I wanted to circle back to some of the longer-term OR commentary. I'm guessing, given your limited time at the company, your input on the targets, thus far, has been pretty limited. So is it reasonable to expect that after a quarter or two of getting out on the network, seeing the railroad, we could potentially revisit this 2020 target and maybe put some numbers around the timing of getting to that 55 longer term?

Well, thanks for welcoming me, Justin. But you knew I was not going to answer that question. I've been here for 10 days. It's pretty hard to say how much of the railroad I've seen have been out in the field. I'll tell you this much. There's opportunity out there. There's opportunity in how fast we turn the assets from locomotive cars. There's impacts to engineering. But what I'm really happy to see is the whole team, before I showed up, was working towards an improved service, improved assets, improved speed, all the things that count. So we're going to do, as a team, everything we can to do it as fast as possible without truly affecting service to the point where we're affecting the customers that pay the bill every day.

Hey, thanks. Morning, guys.

Morning.

Before I really get going, Rob, can you just quickly quantify the insurance and severance items in the quarter?

Yes. The insurance recovery that I called out was in the neighborhood of $15 million, call it, $0.01 EPS. And the severance was roughly $25 million.

Okay. Helpful. So Jim, welcome. And I'm not sure exactly how you're going to answer this based on how you just answered that last question. But UP has told us that they think structurally, they should have the best margin of any railroad. Given sort of your background and history, do you agree with that?

Thanks, Rob. We fully acknowledge that we are the best in the industry. Scott, there are no obstacles I have observed from my visits to the franchise regarding our capabilities. We can implement some quick solutions short-term, while others will require targeted capital investments to operate the trains and cars as efficiently as possible, and we will proceed with that. However, I don't see any reason for us to shy away from competing with the top players in the industry. I understand that the competition is tough, and I know key individuals at other railroads, so I expect significant effort from them. We will strive to ensure we can compete effectively and be on par with the other players.

And when we've seen precision railroading at past railroads, it has been associated with closing hump yards and yard rationalization. Do you think we'll start to see that from UP?

Everything is on the table. So I visited a hump yard last week, and there is no ifs, ands or buts. We have opportunity. So everything. Flat yards, hump yards, there is nothing that's not on the table. And I'd be remiss to say, listen, we're going to shut down x amount of yards with 10 days on the job. But we're going to spend a lot of time to make sure we get the plant set up to handle the business as efficiently as possible with great service. So that's where we're headed.

Okay. Thanks, guys.

Thanks, Scott.

Great. Great job on a solid performance in accelerating the plan, Lance. But Kenny, maybe you can delve into kind of what kind of changes have you already launched with customers in changing how the business is run. Can - any examples you can give us on things that have changed as you roll out PSR?

Sure. Thanks for that question, Ken. So first of all, what we've done is we've been very proactive with our customers and we've been very granular with them on the changes that we want to make. So specifically, we tell them exactly what will happen. We talk to them about when and then we talk to them about what they can expect. And so we've done that at every turn. We've also sat down with our customers and talked to them about how to have the most efficient supply chain in terms of what we're trying to accomplish from a rail perspective. As Tom mentioned earlier, we've had quite a bit of a decrease in our rail inventory. A significant part of that is on the private cars fleet, and a lot of that is because our commercial team has been proactive in working with the customer to let them know how to run an efficient rail service with us.

Yes. And Kenny, those conversations haven't been easy, right? So customers aren't just immediately embracing the conversations you're earning with them. But your team is doing a tremendous job helping them understand how they can change their operating processes so that they receive better service net-net overall.

Great. Appreciate that. And then if I can get one in for Jim as well. And Jim, welcome. But what - from your perspective so far and kind of how Lance has described, he stressed a lot about what fits our railroad in precision railroading principles. And given your background at your prior firm, what is different? Maybe you can explain to us from your perspective in the way Union Pacific has previously talked about PSR principles versus the precision railroading we saw. And then your thoughts on how that relates maybe to headcount reduction or timing of that?

It's great to hear from you again, Ken. I appreciate the warm welcome back. I don’t think there are any major changes. The network and the customers may have slight variations, but the goal for PSR remains straightforward: delivering excellent service. I acknowledge upfront that there will always be some challenges along the way. As you improve efficiency in operating the locomotives, you require fewer of them and need fewer employees to maintain them. While I could elaborate on various aspects, I don't see any significant differences. However, I’ll let Lance discuss any structural differences in depth. Overall, we are somewhat different from the railroad I previously worked at, but the core principle is to operate a highly efficient railroad. In the long run, this efficiency will allow us to attract new business that we currently can’t. We aim to be more competitive, not only against other railroads but also trucks. This is a positive development, and the faster we achieve this efficiency, the more it will enhance our company’s profitability. That’s our focus.

Amen, Jim. Ken, I think you shouldn't read too much into - and I've said this over and over. When I talk precision scheduled railroad principles, it's Precision Scheduled Railroading. It's all the things that build it done the UP way, which just means at right speed, engaged with customers, and you're seeing how we implement it in full. So it's not like a piece here, a piece there, and I think we've been crystal clear about that as well.

Appreciate that and the time. Thanks, guys.

Yes.

Good morning. Thanks. I wanted to, Jim, ask you, in previous iterations of PSR, the shedding of marginal traffic across the entire book not just intermodal. The resulting disruption of traffic flow seemed to allow Hunter to halt the system and redesign it very quickly, like we saw at CSX and CP. And it doesn't seem like we've really seen that so far at UMP, and I'm not hearing that from you guys today. Maybe that's due to the fact that the STB is keeping a pretty close eye out on the customer impact. But in your experience, is shedding business a necessary part of this process in order to fully realize the benefits of PSR implementation? And if you don't think so, I'd be curious to hear any thoughts on why maybe Hunter did it that way?

Well, Allison, thanks for the question. First of all, too early for me to say what impacts and what the efficiency will do to the business that's out there right now. I'd be truly guessing, and I don't like to guess. But if you have everything on the table, you need to deal with the flows of traffic, how well it fits into the plan to be efficient. And other places that have done PSR or scheduled railroad before, there has been some impact. But it's a logical decision to go through. You try to do it as little as possible. But at the end of the day, you got to be smart enough to move ahead and operate the railroad in a very efficient manner. So Allison, sorry, I just can't give you any more than that. I'd be guessing, and that's not what I'm doing.

And then, Allison, this is Kenny. I just want to say we're working together as a team, Tom, Jim and I, to really educate the customer on how to fit in our network. I can tell you, we're not going in this thing looking to say, hey, we may lose this business because we're shipping. We're going in to win and grow our franchise.

Yes, thanks. Maybe, Kenny, just a follow-up on the inbound ocean freight situation. Could you provide a little bit of context as to what the present environment is? We're hearing a lot about, obviously, pull forward. You mentioned that in your remarks, the inbound ocean freight. Data into the West Coast has been strong here. Warehouse capacity is tight. So any sort of perspective, particularly post Chinese New Year, as we get into March and the spring ramp what type of activity do we see? Do we see transloading activity and domestic intermodal pick up in a low and - on the international intermodal side? And how much of a volume risk do you see post Chinese New Year given the pull forward that we are seeing at the present time? Thanks.

Yes. So thanks for that. We definitely saw it in the fourth quarter, as I alluded to in my earlier comments. As we're talking to our largest customers now and as you probably have read in the press release, there's still some strong volume out there, and we do see that. Based on the pull ahead, there's also some of that with the spring deal on the retail side. And we're going to just continue to stay close to our customers to see how volume shakes out.

Hey, thanks everyone for getting my question here. I know it's been a long call, so I'll just keep to one. But Lance, I guess, if we look back at the recent history at Union Pacific, your other West Coast rail peers have really outgrown, and specifically CN. So I guess - and I feel like Union Pacific has always had more of a balanced plan on margins, pricing and volume. With the transition to more of a scheduled railroad, does this create a lot of opportunities to maybe have targeted expansion with your customers? Or should we be thinking volume is more in the cars looking ahead?

Yes. Thank you for the question, Brandon. So the way we think about it is our Unified Plan 2020 is all about consistent, reliable service, better service, which our customers are starting to see and we're going to grow on that. And the most efficient service, generating the best returns because we do think we should be in the lead or with the leaders of the pack in that sense. I anticipate that customer service product, coupled with the work that Lynden's team and IT have been doing with sales and marketing on the experience and targeted technology investments towards an enhanced customer experience, that makes us more attractive than competition in the marketplace, whether it's truck or another railroad. So I do think, over time, we should have growth opportunity that presents itself to us that we don't have right now. But that's yet to be seen. That's the strategy, and we're intent on pulling that off on implementing that.

Well, thank you. Welcome back, Jim.

Thank you for taking my question. Jim, welcome back. Firstly, you're stepping into a significant role in a large organization, and your extensive experience suggests that this will be a successful endeavor, similar to your previous ones. However, some decisions may be unpopular, and there will likely be objections from many at UP. How did you gain the confidence that you had the support you needed from the management team and the board to make the difficult choices that you will face in the coming years? It would be helpful if you could share a bit about that process and how you attained your comfort level with this role. Thank you.

Thank you for the question, Bascome, it's great to hear from you again. When I decided to return to work, Lance and I, along with Rob and Tom, spent a significant amount of time ensuring that our vision was aligned with our goals for the company's future. I wouldn't have joined if I wasn't confident that everyone was on the same page regarding our objectives and the steps needed to achieve them. That was the straightforward part, as we communicated openly about our goals. I have no concerns about decision-making with the board, Lance, or anyone else in the company; otherwise, I would have chosen to stay away and pursue other opportunities. This was the process we followed, Bascome.

Thank you. Welcome back.

Thank you, Rob and thank you all for your questions. We're looking forward to talking with you again in April and going over what our progress is at that point.