Greetings, and welcome to the Uni Pacific Third Quarter 2017 Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded and the slides for today's presentation are available on Union Pacific's website. It is now my pleasure to introduce your host, Mr.
Lance Fritz, Chairman, President and CEO for Union Pacific. Thank you, Mr. Fritz. You may now begin.
Good morning, everybody, and welcome to Union Pacific's 3rd quarter earnings conference call. With me here today in Omaha are Beth Whited, our Chief Marketing Officer Cameron Scott, our Chief Operating Officer and Rob Knight, our Chief Financial Officer. This morning, Union Pacific is reporting net income of 1 point $2,000,000,000 for the Q3 of 2017. This equates to $1.50 per share, which is up 10% over last year. Total volume decreased 1% in the quarter compared to 2016.
Carload volume decreased in 4 of our 6 commodity groups, driven primarily by a 10% decrease in agricultural products and associated grain carloadings. Partially offsetting this volume decrease was a 15% increase in Industrial Products with particular strength in frac sand shipments. The quarterly operating ratio came in at 62.8%, which was up 0.7 points from the Q3 of 2016. During the quarter, our company faced the unprecedented challenge of Hurricane Harvey. I want to thank the men and women of Union Pacific who worked tirelessly and heroically to quickly and safely restore our network and our operations from the storm and the related flooding.
Given these challenges, I'm pleased with our results and look forward continuing to build on the foundation provided by our 6 track value strategy. Our team will give you more of the details on the Q3, starting with Beth.
Thanks Lance and good morning. We announced during the Q3 that effective January 1, we will transition reporting to our newly established 4 business groups, agricultural, energy, industrial and premium. Until then, we will continue to report on the 6 business teams. For the Q3, our volume was down 1% driven primarily by agricultural products, automotive and chemicals with an offset in industrial products. We generated positive net core pricing of nearly 2% in the quarter with continued coal related and intermodal pricing pressure.
Despite these challenges, we remain committed to achieving core pricing gains that offset inflation and align with our value proposition. We saw a 4% increase in freight revenue due to a 5% increase in average revenue per car with a slight offset due to decreased carloads. Let's take a closer look at the performance of each business group. Ag Products revenue was down 2% on a 10% volume decrease and a 9% increase in average revenue per car. Grain carloads were down 19%, primarily driven by a delay in harvest and lower U.
S. Exports of feed grains and wheat as a result of high global inventories. This was partially offset by domestic strength in the mid south poultry and Idaho dairy markets. Grain products carloads were down 10% predominantly due to weaker competitiveness of U. S.
Export meal shipments to the Gulf Coast. Food and refrigerated volumes were up 5%, driven by continued strength in import beer with strong summer demand. Domestic sugar shipments also remained strong with the movement of surplus inventory to accommodate new crop production. Looking at the rest of the year, we may see some benefit from the delayed harvest. However, high global production of both feed grains and wheat coupled with a lower quality domestic wheat harvest will continue to create headwinds in our export markets.
Domestic business is expected to remain stable. We expect food and refrigerated shipments will see growth driven by cold connect penetration, weather recovery and tightening truck capacity. We also anticipate sustained strength in sugar and import beer trending with consumer demand. Automotive revenue was down 3% in the quarter on a 5% decrease in volume and a 1% increase in average revenue per car. Finished vehicle shipments decreased 9% as a result of lower production levels in response to softer vehicle sales coupled with high inventories as well as planned outages for model changeovers.
These reductions were partially offset by new West Coast import traffic and production growth in Mexico. The seasonally adjusted average rate of sales was 17,100,000 vehicles in the 3rd quarter, down 3% from Q3 2016. On the parts side, over the road conversions and growth in light truck demand maintained our parts volume despite lower overall production levels. The U. S.
Light vehicle sales forecast for full year 2017 is 17,000,000 units, down almost 3% from the 2016 record rate of 17,500,000. For the rest of the year, we remain cautious with respect to auto sales due to current sales trends, high inventory and rising incentives. Hurricane replacements may provide some short term opportunity. Chemicals revenue was up 2% for the quarter on a 5% decrease in volume and 8% increase in average revenue per car. Petroleum and LPG shipments declined 17% as we continue to see headwinds on crude oil shipments, which were down 82% to about 2,000 carloads due to the lower crude oil prices and available pipeline capacity.
Chemicals volume, excluding crude oil, was down 2% in the quarter. Plastics carloads were down 6% with 7 plastics plants impacted by Hurricane Harvey. Fertilizer was up 6% driven by continued strength in potash exports. For the Q4 of 2017, our chemicals franchise is expected to grow modestly. We are back to normal pre hurricane levels.
In addition, we anticipate strength in plastics with continued domestic and export demand coupled with the new facilities and expansions coming online. Coal revenue decreased 2% for the quarter on a 3% decrease in volume and flat average revenue per car. On a tonnage basis, Powder River Basin was down 4%, while other regions were up 6% as coal unit and unloading outages reduced PRV volume. Colorado, Utah loadings benefited from strong export shipments to the West Coast and to the Gulf Coast. Natural gas prices were similar to a year ago and coal stockpiles have been below normal for the majority of the year.
Looking forward to the 4th quarter, coal volumes are expected to be flat versus Q4 2016 due to normalized demand. As always, weather conditions will be a key factor of demand. Industrial Products revenue was up 26% on a 15% increase in volume and a 10% increase in average revenue per car during the quarter. Minerals volume increased 80% in the quarter driven by a 120% increase in sand shipments due to improving well completions and increased proppant intensity per well. Specialized markets volume increased 23% in the quarter driven by a 22% increase in waste as a result of West Coast remediation projects and a 130% increase in military shipments due to increased deployments and rotations.
Looking forward, we anticipate proppant intensity, well completions and business development to drive continued growth through the Q4. We see growth in military and waste shipments with an offset in rock volumes due to less project work in the South. Intermodal revenue was up 3% on flat volume and a 2% increase in average revenue per car. Domestic volume was down 1% due to a challenging competitive environment offset by parcel growth. International volume was up 1% in the quarter from stronger westbound shipments.
Excluding the Hanjin impact in 2016, international volume would have been up 5 percent. We expect international intermodal volume to hover around 2016 levels for the remainder of the year. We have now lapped the effects of the Hanjin bankruptcy, creating easier comps. However, we expect slowing from normal seasonality as well as headwinds from ocean carrier industry consolidation and increasing overcapacity in Q4 resulting in lower ocean rates. For the domestic market, we remain optimistic that truck capacity will tighten further in the 4th quarter, providing an opportunity to drive higher levels of over the road conversions.
We are also well positioned for holiday sales growth later in the quarter. To wrap up, this slide recaps our outlook for the remainder of 2017 mentioned in the previous slides. We anticipate continued progress in our food and refrigerated, plastics, fertilizer and sand markets. Over the road conversions in both automotive and intermodal will also continue to present opportunities for growth. Our diverse franchise remains well positioned for growth for the remainder of the year as the U.
S. Economy continues to build momentum in the face of a number of uncertainties in the worldwide economy. Our team remains fully committed to developing new business opportunities and strengthening our overall customer value proposition. With that, I'll turn it over to Cameron for an update on our operating performance.
Thanks, Beth, and good morning. Starting with safety performance, our reportable personal injury rate was 0.78, almost even with the year to date record of 0.77 achieved in 2016. Although we continue generating near record safety results, we won't be satisfied until we reach our goal of 0 incidents, getting every one of our employees home safely at the end of each day. With regards to rail equipment incidents or derailments, our reportable rate improved 5% to 2.97%. And in public safety, our Gray Crossing incident rate improved 1% versus 2016 to 2.52% as we remain focused on improving crossings where we can impact public safety the most.
Moving on to network performance. As reported to the AAR, velocity declined 2% when compared to the Q3 of 2016. As Lance mentioned, we faced a particularly tough challenge in the quarter dealing with the impact of Hurricane Harvey. The record setting rains negatively impacted Gulf Coast operations and our network fluidity system wide. In the aftermath of the storm, over 1700 miles of track were out of service and more than 2,400 route miles were affected.
The team showed tremendous dedication as they worked extremely hard around the clock, restoring operations back to normal in only 10 days. Continued implementation and testing of PTC across a growing number of routes in our network also negatively impacted velocity during the quarter. Terminal dwell increased 7% compared to last year. Whereas the effect of the hurricane did contribute to the increase during the quarter, we also see opportunities to improve car connections within our transportation plan. Looking at our resources, all in, our total operating workforce was down nearly 550 employees in the quarter when compared to last year.
Our engineering and mechanical workforce was down more than 800 employees, driven primarily by fewer employees required on capital projects as a result of the productivity initiatives implemented during our G55 and Xero efforts. While our TE and Y workforce, excluding those in training, declined with volume during the quarter, our overall TE and Y workforce increased as we began to refill the training pipeline. As always, we will continue to adjust our resources as volume and network performance dictate. Despite the challenges experienced during the quarter, the team has remained focused on generating solid productivity results. We achieved best ever train size performance in our grain and manifest categories during the Q3, marking the 9th consecutive quarter of best ever performance in our manifest network.
The team also achieved 3rd quarter records in our automotive, intermodal and coal categories. We are also able to generate productivity gains within our terminals as cars switched per employee day increased 3% during the Q3. To wrap up, looking forward, we will continue fine tuning our safety strategy to generate positive results year over year. And while we have made solid operating productivity gains throughout the year, our progress is far from over. Ultimately, running a safe, reliable and efficient railroad creates an excellent customer experience and increases returns for our shareholders.
With that, I'll turn it over to Rob.
Thanks and good morning. Let's start with a recap of our 3rd quarter results. Operating revenue was $5,400,000,000 in the quarter, up 5% versus last year. Positive core price and increased fuel surcharge revenue offset the slight decrease in volumes for the quarter. Operating expense totaled $3,400,000,000 up 6 percent from 2016.
This includes the impact from Hurricane Harvey and the one time expense associated with our workforce reduction plan. Operating income totaled $2,000,000,000 a 3% increase from last year. Below the line, other income totaled $151,000,000 up about $122,000,000 from 2016. This increase includes the impact from both a large land sale and the settlement of a previous litigation matter. Interest expense of $180,000,000 was down 2% compared to the previous year, and this reflects the impact of a lower effective interest rate offsetting a higher total debt balance.
Income tax expense increased 17% to $789,000,000 driven primarily by higher pretax earnings and the impact of the Illinois tax rate increase. Net income totaled $1,200,000,000 up 6% versus last year, while the outstanding share balance declined 4% as a result of our continued share repurchase activity. These results combined to produce 3rd quarter earnings per share of $1.50 The operating ratio was 62.8%, up 0.7 percentage points from the Q3 of last year. The combined impact of fuel price and the surcharge lag benefit had less than 0.5 point negative impact on the operating ratio and had a neutral impact on earnings per share in the Q3 versus last year. I want to take a minute to recap the one time items, which we have called out over the past few months.
Slide 20 provides a summary of these items, along with the Q3 impact on earnings per share and operating ratio. Above the line, we had the one time costs associated with our workforce reduction as well as the negative impact from Hurricane Harvey. Below the line, we had the negative impact of the Illinois state income tax adjustment, which was more than offset by the positive impact from the large land sale as well as the litigation settlement. The net impact of all these items resulted in a $0.06 headwind on our earnings per share and a negative 2.3 points on our operating ratio in the quarter. Turning now to the top line.
Freight revenue of $5,000,000,000 was up 4% versus last year despite a 1% decrease in volume. Fuel surcharge revenue totaled $227,000,000 up $54,000,000 when compared to 2016 and down slightly versus the Q2 of this year. The business mix impact on freight revenue in the 3rd quarter was a positive 2%. The primary drivers of this positive mix were year over year growth in frac sand shipments, partially offset by decreases in grain car loadings, finished vehicle volumes and chemical movements. Core price was nearly 2% in the quarter, continuing the positive trend that we have experienced throughout the year.
And as Beth previously mentioned, we are still facing some challenges with our continue to be on track with our pricing initiatives to generate a revenue benefit that exceeds our rail inflation costs. Turning now to operating expense. Slide 22 provides a summary of our operating expenses for the quarter. Compensation and benefits expense increased 9% versus 20 16, including the impact from the workforce reduction plan, which represented a majority of this increase. Excluding the workforce reduction impact, comp and benefits expense was up about 2% versus last year.
We expect full year labor inflation to be in the 4% to 5% range. Productivity gains and a smaller capital workforce resulted in total workforce levels declining just under 2% in the quarter versus last year or about 700 employees. This does not include the impact of our workforce reduction plan, which will be reflected in our 4th quarter results. Fuel expense totaled $450,000,000 up 15% when compared to last year. Higher diesel fuel prices and a 2% increase in gross ton miles drove the increase in fuel expense for the quarter.
Compared to the Q3 of last year, our fuel consumption rate improved 1%, while our average fuel price increased 13% to $1.77 per gallon. Purchased services and materials expense increased 9% to $615,000,000 The increase was primarily driven by higher freight car expense associated with lease turnbacks, subsidiary contract services and hurricane related costs. Turning to Slide 23. Depreciation expense was $528,000,000 up 3% compared to 2016. For the full year 2017, we now estimate that depreciation expense will increase around 3% to 4%.
The increase is primarily driven by a higher depreciable base, including our positive train control assets that we put in place to date. Moving to equipment and other rents. This expense totaled $275,000,000 in the quarter, which is down 2% when compared to 2016. Lower locomotive and freight car lease expense were the primary drivers. Other expenses came in at $230,000,000 down 15% versus last year.
The primary drivers were lower state and local taxes and an easier comparison in bad debt expense given the Hodgkin bankruptcy write off in 2016. For the full year 2017, we would expect other expense to decrease about 5% versus 2016. Looking at our cash flow. Cash from operations for the 1st 3 quarters of the year totaled about $5,400,000,000 down 1% compared to last year. The decrease in cash was primarily related to a lower bonus depreciation benefit in 2017 compared to 2016, which was mostly offset by the increase in net income.
Taking a look at adjusted debt levels, the all in adjusted debt balance totaled about $19,400,000,000 atquarterend, up $1,600,000,000 since the start of the year. We finished the 3rd quarter with an adjusted debt to EBITDA ratio of around 1.9 times, which is close to our target ratio of just under 2 times. Dividend payments for the 1st 3 quarters totaled nearly $1,500,000,000 up from almost $1,400,000,000 last year. In addition to dividends, we also bought back 27,100,000 shares, totaling $2,900,000,000 through the end of the 3rd quarter. This represents a 34% increase over last year in terms of dollars spent.
Of the 27,100,000 shares repurchased year to date, we bought back 11,800,000 of these shares, totaling about $1,300,000,000 in the 3rd quarter. And since initiating share repurchases in 2007, we have repurchased over 32% of our outstanding shares. Between our dividend payments and our share repurchases, we returned about $4,400,000,000 to our shareholders through the 1st 3 quarters of this year, which represented 127% of net income over the same period. On the productivity side, our G55 and 0 initiatives yielded around $70,000,000 of productivity in the quarter. While this number is light relative to the first half of the year, indirect effects related to the hurricane and its impact on overall network operations likely overshadowed some additional productivity momentum.
This brings our year to date total through the 1st 3 quarters to around $270,000,000 And with these results, we continue to progress as expected, and we are on track to meet our $350,000,000 to $400,000,000 productivity goal for the full year. Looking forward to the balance of the year, we expect 4th quarter car loadings will increase slightly year over year and we still expect full year car loading growth to be up in the low single digit range. With positive full year volume, positive core price and significant productivity benefits, we are still on track to improve our full year operating ratio, including the net impact of all the one time items that I just mentioned. We are intently focusing on achieving a targeted 60% plus or minus operating ratio on a full year basis by 2019 and we remain committed to reaching our goal of a 55% operating ratio beyond 2019 as we continue the momentum of our volume, pricing and productivity initiatives. Before I turn it back to Lance, I would like to mention 2 other items.
One, I would like to announce that we will be hosting an Investor Day on May 31, 2018 in Omaha, Nebraska. More details to follow, we look forward to seeing you all here in Omaha next May. And finally, as you all know, Mary Jones has announced her retirement effective December 1. She is sitting right next to me right now. And we would like to thank her for her 37 years of service, including a record 18 years as Treasurer.
So thank you, Mary. And with that, I'll turn it back over to Lance.
Thanks, Rob, and thank you, Mary. That was a great tribute. Closing out for the last few months of the year, we expect our business to be similar to this past quarter with year over year challenges in coal and automotive somewhat offset by strength in other areas such as industrial products. As the economy continues to ebb and flow, we will focus on executing our value strategy. We'll use innovation to enhance our customer experience, while continuing to drive resource productivity throughout the organization as we progress our G55 and Xero initiatives.
Looking ahead to 2018, our Engage team is laser focused on building on our recent success. Our goal is to continue creating long term enterprise value for all 4 of our stakeholders as we improve our top line and progress toward our margin improvement targets. With that, let's open up the line for your questions.
Thank you. We'll now be conducting a question and answer And our first question comes from the line of Chris Wetherbee with Citigroup. Please proceed with your questions.
Hey, great. Thanks for taking the call. I wanted to talk
a little bit about sort of
the pricing environment as you look out into probably not the Q4, but maybe 2018, just get a rough sense of maybe how you're starting to think about as you're having discussions with customers. It looks like you had some acceleration on the core number this quarter last quarter. How should we be thinking about just roughly the sort of pricing environment as we move into next year?
Beth? Chris, we are optimistic that the trucking tightening that we're seeing right now and what may come with the ELD implementation is going to provide an environment where we'll have an opportunity for pricing as well as some volume growth. But at the same time, we still do see that other things that will impact us will be other competitive modes of transportation, what's going on with economic demand, etcetera. As you know, we're still very committed to ensuring that we have pricing in place that offsets our inflation.
Okay. All right. That's helpful. And sort of with the backdrop that we're seeing with economic growth maybe picking up a little bit, we have some tightness. I guess, coupled with the moves you've done with some headcount reductions, any sense of how we should be thinking about sort of productivity?
I know you need to get productivity every year in order to get to your longer term OR targets, but how should we be thinking about 2018 maybe in relation to 2017?
Yes, we'll let Rob take that.
Yes, Chris, I mean, as you know, as part of our G55 and 0 initiative, we're all about continuing to drive robust productivity numbers as we have this year and as we have the last several years. So without giving you a number, I would just say that the unrelenting focus on continuing to drive productivity is embedded in our organization. And as we've always said, we do find benefit in our productivity initiatives with positive volume growth. And at this point in time, we are believing and hoping that volume for 2018 will be on the positive side of the ledger.
Yes, absolutely. We would love to see some growth to help us leverage, but in the absence of it, we will continue to generate productivity.
Okay. Thanks for the time guys. Appreciate it.
Our next question comes from the line of Jason Seidl with Cowen. Please proceed with your question.
Thank you, operator and Mary congratulations. This will be your last call that you have to deal with guys like me. I wanted to focus a little bit on sort of the OR in quarter, Rob. I think you mentioned some of the puts and takes from fuel being about 0.5 percent you said and I think with the other stuff, it looks like if we would draw everything out, you guys are probably closer to a 60 OR. And Lance, I think you described the Q4 as looking very similar to the Q3.
Did I get all those puts and takes rights for looking forward?
Yes. So I'll start with Q4 looking like Q3. That was largely right. You take the unusual items out, we expect continued robust productivity. We talked about slightly positive volumes.
And so the environment as we see the Q4 looks about like the Q3. Rob, you want to talk about
Yes, Jason, I would just say you're right in terms of the way you were doing the math. Fuel was a headwind in the quarter of about 0.3 and the items that I itemized were 2.3 of headwind, that's the force reduction and the hurricane impact, which we certainly don't think those 2 are going to repeat. So if you do that math, you get down to a low-sixty core performance, which we are very proud of in the 3rd quarter. Now I wouldn't straight line, because 4th quarters are always a little bit different. You got different mix, you got different volume.
But I would just tell you that we continue to be focused on the same initiatives that drove what we think is an outstanding performance in the Q3 to repeat in the Q4, but I wouldn't straight line any of those numbers per se.
Okay. Follow-up, I guess, is going to be a little bit about the pricing side. The way I look at it is obviously you've had pressures into your bigger commodity groups, but it looks like the one commodity group is should at least start to get better here, let's say, in the next quarter or so. Is the way to think about it as more of a slow recovery in both those two groups, one of which is going to be just driven by what's going on in the truck market? And if that's correct, when do you think you'll start seeing the positive impacts from that?
So I'm assuming the 2 groups you're referencing are coal and intermodal, which we called out. And certainly, coal is more of a rail to rail competition than truck. There's not as much truck activity in that segment. And so we'll continue to price into that environment, ensuring that we're reinvestable and getting the kind of returns that we want. On the intermodal side, I agree with your assessment.
I mean, there's lots of different competitors in that space, trucks and rail, IMCs, etcetera. And the tightening of trucks should provide a tailwind, but we are also continuing to keep an eye on what's happening with our competitors in that market space. And at this point, we're pretty hopeful that we're going to see the ability to get additional pricing and volume.
Okay. Thank you for the time as always.
Our next question is from the line of Tom Wadewitz with UBS. Please proceed with your question.
Yes. Good morning. Sorry, I just kind of jumped over to the call here. So I've missed some things, I think. But how would you view the, I guess, the volume impact looking into next year as you've got the economy feels pretty good.
You've got a number of probably puts and takes in terms of maybe fracs and coal things that could be headwinds. But are you optimistic looking into 2018 that you can see, I don't know, meaningful volume growth, call it 2% type of volume growth? Or do you think that there's some headwinds that are going to make that maybe difficult to achieve?
Hey, Tom, this is Lance. I will start by kind of sharing our overall perspective and then let Beth fill in some blanks. So overall, as we look into 'eighteen, we are somewhat optimistic, right? There's a number of markers that are that look promising. 1 is the truck market.
It is becoming kind of consensus knowledge that truck capacity might very well tighten, the ELD will have an impact of some kind and that's a good environment. That's good for us when that occurs. It feels to us like the overall economy continues to move along. I'd like to see it accelerate a bit, but consumers feel to us like they are buying stuff at a reasonable pace, not a kind pre recession normal pace yet. I think that will show up in housing starts.
So there's a number of relatively positive things. There's some continued headwinds though as well, right? The coal remains somewhat of a question mark. What exactly happens in the grain markets and the worldwide feed and grain markets are still somewhat of a question mark. And of course, we continue to face a robust competitive environment, notwithstanding that environment at its base level looks like it's improving.
If you want to talk a little bit more specifically about a few markets we're pretty excited about, we continue to feel good about our ability to grow the new cold connect platform that we have focused on food and refrigerated products. Mexico remains a great opportunity for us. There's certainly uncertainty around what happens with naphtha, but we believe that market is a growth opportunity for us across a variety of submarkets. And of course, the plastics expansions will give us some opportunities in 2018 and beyond. Frac sand, as you called out, may have some headwinds, but we view it as there's more than one place that oil is being drilled for in the United States.
And certainly, in the Permian, you're going to see some in basin sand come online, but we do view the entire pie for frac sand as growing. And we think that we have opportunities in other places like the Eagle Ford and Oklahoma, possibly in the Front Range as well for frac sand shipments. So I think we feel pretty good about some potential there. And if we see housing really go up, that would be a great opportunity for us.
So I mean, if you put it without saying, oh, it's going to volumes are going to grow at a certain level, when you put the puts and takes together, do you say, yes, we ought to get volume growth next year and maybe it's a couple of points, maybe it's plus or minus, but is it reasonable to think you put them all together, it's more positive than negative?
Tom, this is Rob. As you know, we're not going to give precise numbers around what that volume all adds up to, but we are confident that you add everything that Lance and Beth just went through, it's going to be on the positive side of ledger. So we'll work to be as successful on that as we possibly can, but I would just reiterate all the things we just said are a fabulous commercial for the wonderful diversity that we have in our network and the strength that, that offers us. So we have lots of opportunities to grow our business. And at this point in time, it all adds up to a positive volume assumption.
Okay, great. And then just one quick one, I apologize if you mentioned this, but how much of your book would you touch in terms of repricing in 2018, what percent?
We're kind of typically in around the 2 thirds under contract or under letter quote environment with more of a 1 third that's quoting on either a spot basis or a tariff basis.
So the letter quote would be 1 year presumably?
Yes, sorry, I'm clear about that. Yes. So those have the potential to roll off sometime in the year next year.
Right. So how much would the letter quote be? Is that like that?
We're not going to get into those details, Tom.
Okay. It sounds like you got a lot of the book you could touch next year. So, all right. Great. Thank you for the time.
Appreciate
it. All right. Thank you.
Our next question is from the line of Justin Long with Stephens. Please proceed with your question.
Thanks and good morning. So historically, we've always heard a lot from the rails about the addressable market for highway conversions as it relates to the intermodal business. But given the tightness we've seen in truckload, I was just curious if you could speak to what the opportunity looks like within your general merchant dice network? Is there any way to frame up that addressable market or growth potential that you see from highway conversions in general merchandise?
Yes. Thanks, Justin. This is Lance. Taking at a very high level, historically, and we still believe this, we've talked about a very large addressable truck market. Our current product today takes us comfortably down into a market where if the length of haul is 500 miles plus, it's an opportunity for us.
And there's lots and lots of truck load capability there. What we're focused on is making sure that the experience with us in that journey of shipping product feels as good if not better than it feels all along the way with truck. I'll let Beth talk more specifically to the opportunities within that market.
Yes. So we do believe that the intermodal market and possibly even conversion into boxcar off the highway a big opportunity for us. And our focus is really on taking advantage of our great franchise where we offer intermodal service in many more lanes than our direct competitor, which we think gives us opportunities to grow at a decent pace as the market turns our way with truck capacity tightening.
Okay, great. And as a follow-up and maybe this one is for you, Beth. I think there's going to be a lot more focus on the chemicals business as we get into next year. Could you help us think about the potential growth in your chemicals franchise as we get into 2018 beyond? And do you think we'll be at a point where that chemicals business can start growing at a pace that's above GDP?
So there are, as you know, 100 close to $200,000,000,000 that have been put into the Gulf Coast chemical franchise to grow mostly plastics, although there are industrial chemicals investments happening as well. And while that is a very substantial investment and a wonderful opportunity for us, it certainly isn't the size of some of our other markets. We would hope to see growth in those markets in the tens of thousands of carloads, not in the hundreds of thousands of carloads. And some of the things that will be a governor for us is not all of that plastics in particular is going to want to move domestically. A lot of it will have an export solution.
A lot of it will go out of the Port of Houston, but we will do our best to participate in providing our customers with supply chain solutions should they not be able to use the Port of Houston because of capacity constraints and want to use a West Coast port where we've developed an opportunity to do that near our Dallas Intermodal facility.
The good news is, and Rob talked about this, our franchise is built for the long run and overall global economic growth for the long run. So you get that beautiful chemical franchise on the Gulf Coast and it will start out producing and shipping at certain quantity and certain direction, But really who can make the call over the course of the next 10 or 20 or 30 years other than we're pretty confident consumption is going to increase worldwide and we've got a wonderful franchise to be able to ship it.
Makes sense. Thanks for the time this morning.
Our next question is from the line of Fadi Chamoun with BMO. Please proceed with your question.
Thank you. Good morning. So if we were to think about volume being up, say, 2% next year, how should we think about the headcount? I mean, if you're sort of aiming to that kind of 60 ish operating ratio in 2019, I would think headcount would have to stay kind of flat or even down a little bit to get you to that number. I'm just trying to reconcile a little bit this sort of 2019 target with the outlook for the headcount?
Yes, Fadi, without getting into the details, we've outlined the moving parts this morning. So we're going to have a pretty substantial reduction in our general and administrative overhead, which we've already talked about. Then as we look at how we react to volume, it's the moving pieces of what we can do in productivity, so that we're not growing our headcount 1 to 1 with volume growth. That's our intent year over year. It's what we've been able to do and we're going to continue to do that next year.
Okay. Thank you.
Our next question is from the line of Allison Landry with Credit Suisse. Please proceed with your question.
Thanks. Good morning. Just following up on some of the pricing questions. Earlier in the prepared remarks, you talked about the fact that you're still seeing some pressure in intermodal and coal. But just given that the core pricing gains have accelerated for 2 consecutive quarters, is it fair to infer that some of these pressures that you've been facing have begun to ease a little bit?
And if yes, maybe if you could talk about what might be driving that?
We have maybe seen a little bit of easing in that in the competitive pressure, but it's not of those two markets. That's more like a 3%. So that's helping us to continue to put up good pricing numbers.
Okay. And then as a follow-up question, one of your competitors discussed expectations for rail inflation for 2018 and cited something around 1.9%. Is that how you're looking at it as well? And maybe you could just share your view about that. And Rob, I know you mentioned the labor inflation of 4% to 5% this year, but could you remind us what the expectation for all in inflation is for 2017?
Yes. Allison, this year you're exactly right. This year, we've said that all in inflation is in the around 3 percent with labor 4% to 5%. As we look to next year, we've finalized our numbers yet, but I would say both are going to look closer to 2% all in and labor.
Okay, excellent. Thank you.
Our next question is from the line of Brandon Oglenski with Barclays.
Lance, I guess I wanted to follow-up off of Tom's question about the volume outlook in 2018. And it's really not prescriptive for guidance next year. But when you think about your franchise and we think about railroads in North America, I mean, there's clear examples of networks that can drive a lot of growth. It does seem to be a rather robust economy, both from intermodal and industrial energy perspective. So I guess, as I look back through your slide that your last analyst means, it's always this modest volume outlook.
Is there anything structural you can do on the network that can really leverage this low cost base and really the irreplaceable assets that you have that can drive a faster growth outlook looking forward? Or are you guys really just capped with the ebbs and flows of GDP?
Yes. Thanks for the question, Brandon. I'll start backwards and go forwards in the question. We are not capped as either an industrial production growth rate, a GDP growth rate. When you think about our ability to grow, we're not behaving in a vacuum.
So part of the equation is how our franchise lays and what's happening in the underlying economies that we serve. So fundamentally, our growth is built on global trade, industrial production, the industrial economy and U. S. Consumption of stuff. In that context, then we face competition, either mobile competition or direct rail competition.
So when I build that model in my mind, when I'm setting my own expectations, potential growth. We serve Mexico, we enjoy virtually 70% of the to and from freight rail business with Mexico, virtually 40% of our business is originated or terminated outside the United States. We serve very large population and growing population centers in the western 2 thirds of the United States and we touch a lot of different pieces of the economy. So from a potential perspective, I feel pretty good about it. After that, it's all about can we find business that's reinvestable and secure it in the competitive environment.
And that's always a wild card and we're always positioning ourselves to be the high value best option with our customers and we're going to continue to do that. To your point, Brandon, nothing would please me more than to see a really strong robust growth environment because we know how to leverage that very, very effectively.
Okay. I appreciate that. And Beth, I just want to circle back to your international intermodal comments. It does seem like we're seeing peak ocean volumes right now. So can you walk us through again why you guys aren't seeing a lot of that expansion?
I think it's because you've seen some port shifts with the carrier consolidation, but could we talk through that again?
I would say, I believe we are seeing the volume. Last year, we still had some Hanjin loads, which of course they went away and their volume kind of dispersed across the other carriers. So if you took the Hanjin impact out where we are sitting at a 1%, but if you took that Hanjin out of the comparison, we'd be at 5%, which is pretty commensurate with what's actually happening in the market.
Okay. Thank you.
Our next question is from the line of Cherilyn Radbourne with TD Securities. Please go ahead with your question.
Thanks very much and good morning. I wanted to ask one on productivity. The train length question gets asked a lot, but you also had pretty good gains in terminal productivity year to date. Just wondering if you can give us some color on what's driving that?
Cameron?
Inside our terminals, volume remains very predictable and very stable and that allows you to really bear down on the productivity inside each and every terminal. So that looks very positive as you think about the year 2018. The only area of growth that we see where we might struggle a little bit is out in West Texas, as Beth mentioned. The rest of the network looks very positive.
And then just separately, I appreciate this is low value traffic, but just curious whether China's pending restrictions on scrap having an impact on international intermodal, insofar as they reduce the potential source of backhaul traffic?
Yes. It is scrap paper is a portion of the backhaul traffic and it is, I'd call it, a mild concern. We are pretty actively looking for other matchback opportunities and we've implemented some programs with our customers to and with the steamship lines to use their containers for domestic loads in places where we might not have domestic containers, which doesn't give them a match back all the way to China, but it might give them a match back to the West Coast. So we're pretty focused on helping them fill that gap and being good partners in that regard.
Cherilyn, that's something we don't talk a lot about, but that's a manifestation of kind of a granular manifestation of the value of having the franchise that we do is that we are we have a lot of exposure to match back opportunities for West Coast exports and that can be a real value add for our international steamship partners.
Thank you. That's all from me.
Next question is from the line of David Vernon with AllianceBernstein. Please proceed with your question.
Hey, good morning guys and thanks for taking the time. I wanted to ask you a question about sort of the domestic intermodal market and what you guys can maybe do to help capitalize on that conversion opportunity because the volume growth in the on a reported basis for Intermodal has always been a little bit lighter. You guys have done a great job taking up yields. I'm just wondering as you think about how you work with your channel partners, how you manage the 2 box pools that you have, how you take that intermodal product to market through Streamline? Is there something you can do that you can sort of accelerate that domestic opportunity?
And then as you think about what's happening in the Eastern market with one of your partners kind of redesigning maybe some of its intermodal services, if that's going to create some of either opportunities or challenges for you? If you could comment on that, that
would be great. Yes. So we continue to be very bullish on the opportunity that Intermodal provides domestically for Union Pacific over the long term. And we are unique, as you described, with our 2 box programs and the ability to bring assets to bear and help customers meet their supply chain needs. So we are very focused on we're always looking at opportunities to get into new markets, provide new services, provide a stronger value proposition to customers.
And with that, we work across all the channel partners. We've seen very strong parcel growth this year. But as you say, the domestic, the overall domestic has been a little weaker and that's really been more of a competitive pricing situation and we are and will continue to be focused on yield. We believe that with the tightening of the truck capacity, that's going to open up some opportunities for us. You said a little bit about the CSX's changes in their intermodal network.
At this point, I think they're rationalizing some lanes that are local to them that maybe don't make as much sense for them to stay in. And we're just staying in real close communication to make sure that we preserve the viability of that UMAX product and put it in a position where it can grow as we have opportunities.
Recall, David, that we've got those 2 branded box programs, 1 each with each of our good partners in the East, the NS and the CSX and they are both robust potential growth engines.
Okay. And maybe Rob, just thinking about the CapEx, obviously the 3Q number probably impacted a little bit by the weather and some idling of work crews. I wanted to get your thoughts on the ability to kind of keep CapEx at a little bit lower level here as some of the growth is in some of the lighter weight traffic areas and you've got some idle capacity from kind of the coal traffic coming off?
Yes, David, I would just say, I assume you're talking about looking forward 2018?
Yes, long rates. Long rates, yes, more like the way that's coming off. Yes, I mean, we
constantly, of course, as a matter of process, are always in tune to being as disciplined and wise about every capital dollar we spend and it's based on a very rigorous evaluation of what the expected returns are. But the guidance I would give you is that 15% of revenue spent. I mean, again, as you know, that's not we build our budget, but that's still the right way to look at looking forward.
One thing, David, I heard you say that I want to make sure we don't leave you with this impression and that is all the potential growth is happening in areas where we've got excess
Yes
Yes. No, I was just wondering if there was going to be any need to step up a little bit of growth CapEx to pursue the intermodal opportunity broadly or if you feel like you can kind of work that through the existing capital, obviously addressing bottlenecks as they happen?
Yes, Rob has got it right from the standpoint of long term we are comfortable with where we have guided.
Great. Thanks a lot for the color.
Our next question is from the line of Scott Group with Wolfe Research. Please proceed with your question.
Hey, thanks. Good morning. So I apologize if some of this was addressed for bouncing between a couple of calls. Hopefully, it can be coordinated better next time. Just, Beth, for you on sand, what percent of your sand business is going to Permian versus other basins?
And then what's the strategy as some of the local stuff comes online? Is it if it's going to come, there's nothing we can do about it? Or do you think about changing the pricing on the longer haul stuff to compete with the Permian sand?
Well, I don't think we've ever provided exactly what the percentage is of Permian, but we have a good sized book of business into the Permian as well as the Eagle Ford, smaller books of business into Oklahoma and the DJ Basin sort of area. And off the top of my head, I couldn't even give you the percentages if I had to. But what I would say is they all provide some growth opportunities. Permian will certainly be challenged by in basin sand coming on that's of a certain mesh type. We do believe there will be opportunities to continue to bring some of the coarser meshes in from the Wisconsin and Minnesota range and continue to compete in Permian.
And I would say the Permian overall pie, I think, is still going to continue to grow even within basin sand coming on. So we'll certainly be looking to grow there, but we'll be looking to grow in Eagle Ford, Oklahoma and Colorado as well. And as far as lowering rates to try to compete with local sand, that's a pretty tough proposition. And I think we're always going to stay very focused on being reinvestable and getting a good yield for the assets that we're employing.
Okay. That makes sense. So if I just heard you right, you think even Permian sand volumes are up next year?
I think the whole Permian sand consumption is up next year. It remains to be seen how much of that will get filled with local sand versus sand coming in from another location.
Okay. That makes sense. Okay. And then Lance, just in terms of the headcount reductions, is that I guess I'm surprised that that doesn't take up the productivity target for the year. So maybe just a thought there, but more bigger picture, do you think is this one of, hey, there's many things like this we can do?
Or is this, hey, this was one specific opportunity and we did it, but don't think that there's lots more like this? I'm just trying to understand if this was a one and done or one of many.
Yes. So Scott, I'll take your first question about productivity targets. We have not changed our productivity targets. This decrease in our overhaul general and administrative headcount is going to be absorbed into those. Our communication with you and our drive amongst ourselves has always been, we've set out our accelerate productivity as well as growth as well as price, so that we can meet or exceed the markers that we've laid out.
And in terms of this particular action, reducing our overall headcount by 800 plus or minus in this one action. Clearly, I don't think that we're going to be taking that kind of action over and over and over again. Candidly, it's something we'd prefer not to do if we don't need to. But I would say that we have many granular projects inside of Grow to 55 and 0 that have anywhere between some relatively small impact to some relatively large impact that we're pursuing and that will inform how much productivity we build into our plans in 2018 and beyond.
Okay. Thank you, guys.
Our next question is from the line of Walter Franklin with RBC. Please proceed with your questions.
Yes, thanks very much. So just clarification on the inflation for next year. I know you mentioned labor in there. Can you just break out labor as to what do you expect labor inflation to be in 2018? I know you signaled it for Q4, but just wanted to confirm on next year what you were expecting in the labor side?
Yes. Walter, I earlier said that to the question on inflation and I was talking about 2018 that we expect overall inflation and overall labor to be closer to 2 versus what they're running this year. And at this point, I'm not going to break out the labor component, but of course not only do you have wages in there, but you also have the moving part of the health and welfare.
Right. Okay. But you're not breaking that out for 2018 yet?
Not at this point, no.
Okay. And just the tax rate is still going to be steady at 37.5 percent?
Yes, that's a reasonable assumption, yes.
Right. And then the last one, the other line in your other line in operating expenses, it does tend to move around a lot. I know you've got sorry, your guidance has been kind of it was up and now it's kind of down. And just wondering whether is that a line item that we should when we look at our 20 18, look at 2017 as an exceptional year in terms of being down or is this a representative year now that we can build on some normal growth rate in line with your overall inflation going into next year? Just want to make sure because that's a lumpy line item there was something in 2017 that made it a little bit not necessarily repeatable for next year?
Yes, Walter, I would say I mean, I'm going to disappoint you because we are not going to give guidance on that number, not because we're withholding, but because there is a lot of moving parts to your point. And it can and will be lumpy. So, stay tuned, but we generally say in the 150 ish neighborhood is what it's looked like historically for other income, but it can be lumpy. I mean, you have lots of moving parts in there.
Sorry, I was referencing your other in the other expenses.
Yes, which that can be lumpy as well, not maybe as lumpy as other income, but we're not going to give guidance on that, because you're right, there are a lot of moving parts. But we've typically said in the $200,000,000 range, but I would caution you that it can move up and down with unusual items.
Got it. Okay. Thank you very much.
Our next question is from the line of Ari Rosa with Bank of America. Please proceed with your question.
Hey, good morning, guys. So I wanted to start out on the network fluidity metrics. I think we saw a couple of those tick up in the quarter. I was hoping you could just delineate what might have been due to the impact of Hurricane Harvey not only for your network but also kind of interchanges with other carriers?
Interchanges with other carriers look very fluid across the network up and down the Mississippi. No issues there. Our own velocity was greatly impacted by Hurricane Harvey. In fact, it's one of the larger events that our network has suffered from a weather perspective. The opportunity looking towards 2018 lies in our train crews becoming more familiar with the PTC technology that we've rolled out both on the West and the Northern region.
And we feel that is something that we can tackle internally. It's not a technology problem. It's our crews becoming more proficient
obviously, there was the land sale this quarter. I was hoping you could maybe discuss that a little bit in a little bit more detail and what additional opportunities there might be for additional land sales?
Yes. We did announce the land sale earlier, but we announced it because of the size of it and wanted to give some perspective on the financial impact. But I would there is no we are not going to give you any details on that specific transaction. But I would just say that we have a sophisticated professional real estate organization. So our selling real estate when we find an opportunity is something we continually do.
I mean, again, it can be lumpy as I indicated in the other income question earlier on the call. But I would say that's something our professional real estate folks are always looking at, but it will be lumpy and we're continuing looking at where there are opportunities, where it's an asset that is no longer needed long term for the benefit of the rail. And that's kind of how we approach it.
I'll tell you what, maybe if I could ask a follow-up and just ask it slightly differently.
Where are you when you
look at your network, where would you say you are in terms of resource needs versus where you'd like to be? You said some capacity tightness in Texas, but maybe some loose capacity, other areas across your network, where do you feel you are on just general resource needs?
Yes. So let's just walk you around real quick. The major east west line from the Pacific Northwest, California, NorCal that runs through Wyoming and on into Chicago. In the Wyoming, Nebraska, Iowa, Chicago areas, we've got a lot of capacity there. It was built up for our coal business and our coal business is about half of what it used to be.
If you're over on the West Coast, West Coast has good solid open capacity. We'd love to use that for more shipments up and down the I-five and growth in Las Vegas, SoCal area and Phoenix. When you move over down towards Texas and let's say north south between Chicago and Texas and just Texas and Louisiana themselves, The north south routes have good solid capacity availability. We still have capacity in certain routes in Texas and Louisiana, but that's the area where when we're focusing on new capacity, when we're focusing on significant capital spend, it is likely to occur there.
Okay, that's great color. Thank you.
Our next question is from the line of Bascome Majors with Susquehanna. Please go ahead with your question.
Yes. Thanks for taking my question here. I wanted to follow-up on a couple of earlier questions on what a tightening truckload load market means for UP. And specifically, do your contractual relationships with your key domestic intermodal partners, do they allow you the flexibility to push a bit harder on pricing next year or in tight years in general compared to the last few years that have been weaker? Or are those escalators fairly fixed and really predefined on a year to year basis?
Well, we don't typically give a lot of color on specific contractual arrangements with customers, But I would say that we have opportunities out there. Most of the bid process for domestic intermodal happens in the springtime, as you know, as they go out to bid for their whole books with beneficial cargo owners. So if truck capacity remains tight and maybe even tightens with ELD, certainly, we would hope to see some opportunity to address pricing in that bid period. And we are very hopeful that our long term partners are able to get pricing in their markets and that that will flow to us as well. And additionally, we really, really would like to see the volume growth along with it.
Yes. And I think in international intermodal, which I felt like part of your question was towards that tends to be long term contracts.
Understood. So in the domestic business, just to clarify, you should see some benefit in the parts of your business where you own the boxes and control some of the assets perhaps coincident with the bid season, but some of the longer term contracts either in international or domestic maybe kind of less flexible to the near term rise in the market. Is that a
fair way to put it or? Taking it?
Yes, I think that's a very fair characterization.
All right. Thank you for the time.
Our next question is from the line of Brian Ossenbeck with JPMorgan. Please proceed with your question.
Hey, thanks. Good morning and Just a couple of quick ones. Cam, I know you mentioned some of the rollout with PTC and had an impact on Velocity. I was wondering if you could do you have a chance to quantify that? And then also what sort of milestones you're looking at next?
It sounds like you've got a better handle on what you need to do in some of the regions, but are there any other milestones that you're looking at that could be significant, maybe not this year, but perhaps in 2018 getting to going live beyond that?
The velocity impact is somewhere between 0.5 mile an hour and mile an hour right now as we see it because we have rolled out completely on the West and on the North. The vast majority of that opportunity lies within the familiarity of the technology with our crews. So it is something we can address. Ahead of us is the Southern region implementation in 2018. We see no issues with meeting all the federal requirements in that year.
And we'll continue to problem solve
whole BTC system. Hey, Brian, giving you a little kind of color on that velocity number that Cam just shared, that's a very loosey goosey number, right? We try to parse that together as best we can. It's kind of hard to tease that out specifically. Leave it said that it's a real impact and the most important thing that Cameron has in front of them is we believe the impact is all about crew behavior.
So in your mind's eye, if you think about this, there's a screen in front of the crew and inside the PTC system, pretty much all it does is warn you when it's thinking you're going to need to take action. So half the time, the screen is flashing at you a warning. And I think human behavior is to not have the screen tell you about a warning. That's a little bit of a design issue that I think the overall industry is going to have to get into, because that drives behavior then to be more cautious than necessary and that then retards the overall velocity on the lot of But Cameron has given you a general idea of it is impactful and we've got a route forward to address.
Okay. But it sounds like it's more user interface and not something in the technology that you've encountered so far?
Yes, totally.
Okay. And then just one quick follow-up on just cross border activity into Mexico. Obviously, we saw a new agreement between a competitor and the KCS at Laredo. So wondering if you'd actually seen any sort of impact on your business through that gateway so far? Thank you.
We continue to grow through that gateway over the long run. We are familiar with all competitive products and we understand to our chagrin, we're not going to be able to handle every single carload that is made available to and from Mexico, but we are very pleased with our partners and our products and we're doing everything in our power to profitably grow those products.
Okay. Thanks for your time.
Yes. The next question is from the line of Ravi Shanker with Morgan Stanley. Please proceed with your
This is Diane on for Ravi Shanker. Just a question regarding the tentative agreement reached between a group of labor unions and the Class 1 rails. Can you share your initial thoughts on how that agreement stacks up versus your expectations? And also on the agreement, it looks like it states a 2.5% to 3% pay increase in 2018 2019. So wondering why that differs from the 2% labor inflation that you guys expect next year?
Thank you.
Thanks for the question, Diane. Not surprisingly, I'm not going to be able to make too many specific comments on either the negotiation or this specific tentative agreement. I will tell you that tentative agreement is in industry with about 60% of the industry's collectively bargained employment population and it is out for ratification as we speak.
Okay. Do you have a timeline for or what is your expected timeline for the ratification?
Well, we don't have a specific timeline for it. All I can tell you is that each committee has to ratify vote. And once that's accomplished, we can call it a done deal and start implementing. I think that's the detail I can give you.
Okay. Thank you for the time.
Our next question is from the line of Amit Mehrotra with Deutsche Bank. Please proceed with your question.
Hey, thanks. Good morning, everybody. So I joined a little late. Sorry if this question is asked and answered, but wanted to just understand the breakdown between contracted and maybe transactional business next year, especially given the expectation for what truck capacity may do next year. Just specifically, how much of next year's business is already contracted?
And maybe how should we expect if there is any lag between your ability to see core pricing growth for the overall enterprise versus maybe the backdrop of the overall market? Thanks.
Yes, we did get this one earlier. And so I'll give you the same answer, which is that we see typically that our business is about 2 thirds contracted and then about 1 third moving in any particular year.
Thank you. We've come to the end of our question and answer session. I will turn the floor back to Mr. Lance Fritz for closing remarks.
Thank you very much, Rob. For the last few months of the year, we expect our business to be similar to this past quarter with year over year challenges in coal and automotive somewhat offset by strength in other areas such as industrial products. As the economy continues to ebb and flow, we're going to focus on executing our value strategy. We'll use innovation to enhance our customer experience, while continuing to drive resource productivity throughout the organization as we progress our Grow to 55 and 0 initiatives. As we look ahead to 2018, our Engage team is laser focused on building upon our recent success.
Thank you.
With that, thanks and we look forward to the next time we have an opportunity to speak with you.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.