聯合太平洋集團 (UNP) 2016 Q3 法說會逐字稿

Greetings, and welcome to the Union Pacific third-quarter 2016 conference call. (Operator Instructions)

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 begin.

Good morning, everybody, and welcome to Union Pacific's third-quarter earnings conference call. With me here today in Omaha are Eric Butler, Chief Marketing Officer; Cameron Scott, Chief Operating Officer; and Rob Knight, Chief Financial Officer.

This morning, Union Pacific is reporting net income of $1.1 billion for the third quarter of 2016. This equates to $1.36 per share, which compares to $1.50 in the third quarter of 2015. Total volume decreased 6% in the quarter compared to 2015.

Carload volume declined in five of our six commodity groups, with coal and industrial products both down double digits. Agricultural products volumes were up a robust 11% this quarter versus 2015, as grain shipments finally started to show some strength.

The quarterly operating ratio came in at 62.1%, which is up 1.8 percentage points from the record third quarter last year, but improved 3.1 percentage points from the second quarter of this year. Continued momentum from our productivity initiatives, as well as positive core pricing, helped partially offset the decline in total carload volumes.

While many of the same volume challenges have continued throughout the year, we are keeping a laser focus on our six value tracks. This strategy ensures we provide our customers with an excellent value proposition and service experience, while efficiently and safely managing our resources. Our team will give you more of the details, starting with Eric.

Thanks, Lance, and good morning. In the third quarter, our volume was down 6%, with near-record agricultural product shipments more than offset by declines in each of the business groups. We generated core pricing gains of 1.5% in the quarter, reflecting the impacts of competitive markets in a weak economic environment, particularly in our energy-related and international intermodal businesses.

Despite these challenges, we continue to achieve solid re-investable returns, even in these difficult markets, and we remain committed to achieving positive core pricing gains that reflect our value proposition over the long term. The decline in volume and the 2% lower average revenue per car drove a 7% reduction in freight revenue.

Let's take a closer look at the performance for each of our six business groups. Ag products revenue gained 6% on an 11% volume increase, and a 4% decrease in average revenue per car. A robust US grain supply and lower commodity prices generated export strength and lifted grain volumes 27% in the quarter.

Wheat exports rebounded in the second half of the quarter, as adverse weather in South America caused significant losses, elevating demand for the higher protein US wheat. Grain products carloads advanced 5% in the quarter, primarily due to increased ethanol exports and biodiesel shipments. Food and refrigerated carloads were flat in the quarter, as strong demand for import beer offset softness in refrigerated food shipments and import sugar.

Automotive revenue was down 8% in the quarter, driven by a 2% decrease in volume and a 6% reduction in average revenue per car. Finished vehicle shipments decreased 7% by sales, and production levels of passenger vehicles impacting key Union Pacific-served plants and contract changes we referenced last quarter that will continue to impact our volumes through the first part of 2017. In total, finished vehicle sales in the quarter were at a seasonally adjusted average rate of 17.5 million, up 2% from the second quarter, but down 2% from the 2015 third quarter. On the parts side, a continued focus on over-the-road conversions drove a 5% increase in volume.

Chemicals revenue was down 1% for the quarter on a 1% decrease in volume and a 1% increase in average revenue per car. We continued to see headwinds on crude oil shipments, which were down 48% due to lower crude oil prices, regional pricing differences and available pipeline capacity. Chemicals volume, excluding crude oil shipments, was up 2% in the quarter. Partially offsetting the declines in crude oil was strength in other areas, including industrial chemicals, which was up 3% in the quarter.

Coal revenue declined 19% for the quarter on a 14% decrease in volume and 6% decline in average revenue per car. Sequentially, however, overall coal tonnage increased 40% from the second quarter of this year. Powder River Basin and Colorado-Utah tonnage declined 17% and 16%, respectively, in the quarter, as increased demands from a warmer-than-average summer was unable to offset high coal stockpiles. PRB coal inventory levels in September were 90 days, down 13 days from June, but still 27 days above the five-year average.

Industrial products revenue was down 13% on an 11% decline in volume and the 2% decrease in average revenue per car during the quarter. Minerals volume was down 22% in the quarter, driven by a 26% decrease in frac-sand carloadings, impacted by lower crude oil prices and decreased drilling activity.

Construction products volume was down 8% due to weather-impacted construction activity in the South. The strong US dollar, weak commodity pricing and increased imports pushed metal shipments down 13% year over year. Intermodal revenue was down 9% on a 7% decline in volume and a 2% decrease in average revenue per car.

Domestic intermodal volume declined 2% in the quarter. Excluding headwinds from the previously discussed discontinuation of Triple Crown Service, domestic was nearly flat. International volumes were down 11% in the quarter, as the industry continued to face significant headwinds from weaker global trade activity, softer domestic sales, high retail inventories on the Hanjin bankruptcy.

To wrap up, let's take a look at our outlook. In ag products, we expect a healthy US harvest and strong world demand for US grain to drive favorable export trade. Grain products will continue to be strong, driven by ethanol exports. In food and refrigerated, we expect continued strength in beer imports.

Turning to autos, light vehicle sales are forecasted to finish 2016 at 17.4 million, down less than 0.5% from the 2015 record rate of 17.5 million. Although we expect sales incentives, low gasoline prices and consumer preference will continue to drive demand, we remain cautious with respect to auto sales sustaining at these levels. The continued focus on over-the-road conversions will support auto parts growth.

Our chemicals franchise is expected to remain stable, with strength in LPG and industrial chemicals offset by declines in crude oil. Coal volumes will continue to be impacted by natural gas prices, high inventory levels and export demand. As always, weather conditions will be a key factor of demand.

In industrial products, lower crude prices and reduced drilling activity are expected to continue to challenge minerals volumes. We anticipate a softer year end for metals, as imports continue to impact domestic shipments and customers manage year-end inventories. We expect lumber to be stronger in the fourth quarter as housing starts continue to expand.

Finally, in intermodal, our international volumes will continue to be adversely impacted by a strained ocean carrier industry, offset partially by over-the-road highway conversions.

In the face of a number of uncertainties in the worldwide economy, our diverse franchise remains well-positioned for growth as the economy slowly improves. We remain committed to strengthening our customer value proposition and driving new business opportunities. With that, I'll turn it over to Cameron for an update on our operating performance.

Thanks, Eric, and good morning. Starting with our safety performance, our year-to-date reportable personal injury rate improved 16% versus 2015, to a record low of 0.77. Included in this was a record-low number of severe injuries which have the greatest human and financial impact. Although we continue to make significant improvements, we won't be satisfied until we reach our goal of zero incidents, getting every one of our employees home safely at the end of each day.

With respect to rail equipment incidents or derailments, our year-to-date reportable rate of 3.13 improved 4% versus last year. While we made only a slight improvement on the reportable rate, enhanced TE&Y training and continued infrastructure investments helped significantly reduce the absolute number of incidents, including those that did not meet the reportable threshold, to a record low.

In public safety, our grade-crossing incident rate increased 13% to 2.55. We continue to focus on driving improvement by reinforcing public awareness through various channels, including public safety campaigns and community partnerships.

Moving to network performance, while the California wildfires and flooding along various parts of our network created some challenges during the quarter, our network proved resilient, as we continued to achieve solid operating performance. Effective use of our surge locomotive fleet and TE&Y workforce were critical to minimize the impact of these network challenges.

As reported to the AAR, velocity improved 2% when compared to the third quarter of 2015. Terminal dwell also improved 2%. But the benefits of a fluid network were somewhat offset by productivity gains, such as longer train lengths and other network management initiatives.

Moving on to resources, as part of our ongoing business planning process, we continue to adjust resource levels to account for volume changes and productivity gains. As a result, our total TE&Y workforce was down 14% when compared to the same quarter last year, but up 2% sequentially from the second quarter to efficiently handle the 8% volume increase experienced since the end of June.

We also continue to evaluate all other aspects of the business, with the goal of driving productivity throughout the organization. This includes the right-sizing of our engineering and mechanical workforce, which was down a combined 1,900 employees or 9% versus the third quarter of last year. Our active locomotive fleet was down 9% from the third quarter of 2015, but up 2% sequentially to handle the increase in carloads.

As you know, we've been planning for the acquisition of 230 new locomotives this year. We now expect that number to be 200 locomotives this year, with the delivery of 30 units delayed into 2017. This would add to the 70 units previously scheduled in 2017, for a total of 100 next year. We are adjusting our 2016 capital program down about $100 million to just under $3.6 billion, primarily driven by this change in locomotive deliveries.

Turning to network productivity, while we remain focused on effectively balancing our resources, we also continue to realize efficiency gains through several productivity initiatives. Train length is a significant productivity driver and a primary focus area for us. During the quarter, our manifest and grain networks ran at all-time-record train-length levels, while our automotive network set a third-quarter record.

Re-crew rate, a cost incurred when the first crew has insufficient time to complete the trip, is an indicative measure of the fluidity and productivity of our network. Our third-quarter re-crew rate was 2.3%, a near 2-point improvement from 2015, and a third-quarter record.

As we move forward, we expect our safety strategy will continue yielding positive results on our way to an incident-free environment. And where growth opportunities arise, we will leverage that growth to the bottom line through increased utilization of existing assets, while maintaining our intense focus on productivity and efficiency across the network. With that, I'll turn it over to Rob.

Thanks, and good morning. Let's start with a recap of our third-quarter results. Operating revenue was about $5.2 billion in the quarter, down 7% versus last year. Lower volumes and lower fuel surcharges more than offset positive core pricing achieved in the quarter.

Operating expenses totaled just over $3.2 billion. Lower fuel costs, volume-related reductions and strong productivity improvements drove the 4% improvement compared to last year. Operating income totaled almost $2 billion, an 11% decrease from last year. Below the line, other income totaled $29 million, roughly flat versus 2015.

Interest expense of $184 million was up 17% compared to the previous year. The increase was driven by additional debt issuance over the last 12 months, as well as about $8 million for the fees associated with our recent debt exchange transaction. This increase was partially offset by a lower effective interest rate.

Income tax expense decreased about 14% to $674 million, driven primarily by lower pretax earnings. Net income totaled just over $1.1 billion, down 13% versus 2015, while the outstanding share balance declined 4% as a result of our continued share repurchase activity. These results combined to produce quarterly earnings of $1.36 per share.

Turning now to our top line, freight revenue of $4.8 billion was down 7% versus last year, primarily driven by a 6% decline in volumes. Fuel surcharge revenue totaled $173 million, down $141 million when compared to 2015, but up $86 million from the second quarter of this year. All in, we estimate the net impact of lower fuel prices was a $0.05 headwind to earnings in the third quarter versus last year.

The business mix impact on freight revenue in the third quarter was about flat, similar to what we experienced in the second quarter. Year-over-year growth in agricultural product shipments and declines in international intermodal volumes were positive contributors to mix, which were offset by declines in industrial products and finished vehicles volumes. Core price was a positive contributor to freight revenue in the quarter at about 1.5%.

Slide 21 provides more detail on our pricing trends. As Eric just mentioned, pricing gains this quarter reflect a competitive marketplace in a soft economic environment. Going forward, we remain committed to our focus on positive return-driven core pricing which reflects the value proposition that we provide our customers.

Moving on to the expense side, slide 22 provides a summary of our compensation and benefits expense, which decreased 6% versus 2015. The decrease was primarily driven by a combination of lower volumes, improved labor efficiencies and fewer people in the training pipeline. General wage and benefit inflation partially offset these decreases.

Labor inflation was about 3% in the third quarter, driven primarily by general wage increases and health and welfare expense, which were partially offset by some favorable pension costs. We still expect full-year labor inflation to be about 2%, and overall inflation to be about 1.5% for the year.

As a result of lower volumes, solid productivity gains and a smaller capital workforce, total workforce levels declined 10% in the quarter year over year, or more than 4,700 employees. Looking sequentially, total workforce levels were down about 1% from the second quarter of this year. For the fourth quarter, we expect our force levels to be similar to the third quarter, and also down somewhat from the prior-year, as comps get little bit more difficult.

Turning to the next slide, fuel expense totaled $392 million, down 19% when compared to 2015. Lower diesel fuel prices, along with a 6% decline in gross-ton miles, drove the decrease in fuel expense for the quarter. Compared to the third quarter of last year, our fuel consumption rate improved 2% to a record 1.075, while our average fuel price declined 13% to $1.57 per gallon.

Moving on to our other expense categories, purchased services and materials expense decreased 4% to $566 million. The reduction was primarily driven by lower volume-related expense and reduced locomotive and freight car repair and maintenance costs. Depreciation expense was $512 million, up 1% compared to 2015, driven primarily by higher depreciable asset base. For the full year, we still expect depreciation expense to increase slightly compared to last year.

Slide 25 summarizes the remaining two expense categories. Equipment and other rents expense totaled $282 million, which is down 7% when compared to 2015. Lower volumes, which reduced car-hire expense, and reduced locomotive lease costs were the primary drivers of this decline. Other expenses came in at $271 million, up $66 million versus last year.

We did have a couple of one-time items impacting the other expense category in the third quarter, as well as a few favorable items that we incurred last year. As we discussed back in September, we have written off the $13 million accounts receivables associated with the Hanjin bankruptcy. In addition, we also were incurred $17 million of write-offs associated with in-progress capital projects which we are no longer pursuing.

Higher state and local taxes and increased environmental costs, partially offset by lower personal injury expense, also contributed to the negative variance in this category for the quarter. For the full-year 2016, we now expect the other expense line item to increase close to 10%, including the one-time items that I just mentioned.

Turning to our operating ratio, the third-quarter operating ratio came in at 62.1%, 1.8 points unfavorable when compared to the record third quarter of 2015. Fuel price negatively impacted the operating ratio by 0.4 points in the quarter.

Looking at cash flow, cash from operations for the first three quarters totaled about $5.5 billion, down about $160 million when compared to the same period last year. The decrease in cash was driven by lower net income, and was partially offset by the timing of tax payments, primarily related to the bonus depreciation on our capital spending. For the full-year 2016, we now expect the net impact of bonus depreciation to be a tailwind of about $350 million. After dividends, our free cash flow totaled about $1.3 billion, year to date, through the end of September.

Taking a look now at the balance sheet, our all-in adjusted debt balance increased to about $18.5 billion at quarter end. We finished the third quarter with an adjusted debt-to-EBITDA ratio of over 1.9 times, up from 1.7 at year end. This brings us close our target ratio of less than 2 times.

For the first nine months of the year, we bought back over 25 million shares totaling about $2.2 billion. Since initiating share repurchases in 2007, we have repurchased about 28% of our outstanding shares. Between our dividend payments and our share repurchases, we returned nearly $3.6 billion to our shareholders through the first three quarters of this year.

So that's a recap of the third-quarter results. Looking out to the remainder of the year, volume declines on a year-over-year basis should moderate, as the volume comparisons get easier in the fourth quarter. We would expect total fourth-quarter volumes to be down in the low single digits. And we still expect total full-year volumes to be down in the 6% to 8% range.

While we do not expect to improve the operating ratio this year, we will continue to leverage our G55 + 0 initiatives to generate positive core pricing and strong productivity, to achieve the lowest operating ratio possible. And as Cam just mentioned, we now expect 2016 capital spending to be down about $100 million to just under $3.6 billion, primarily as a result of the delay in the locomotive deliveries. While we have not yet finalized our capital plans for 2017, we still expect our capital spending to be around 15% of revenue.

From a productivity perspective, our G55 + 0 initiatives have generated significant efficiency savings for the Company thus far this year. And we are confident that we will continue to drive further improvement well into the future as we work toward our operating ratio target of 60%, plus or minus, on a full-year basis by 2019. And longer term, we are keeping our eye on the goal of a 55% operating ratio as we gain momentum with our G55 + 0 initiatives. So with that, I'll turn it back over to Lance.

Thank you, Rob. As the team has articulated here this morning, we continued to experience a difficult but improving market environment in the third quarter. While we were pleased to see improving volumes in some of our business lines such as grain and coal, many of our markets still remain at volume levels below a year ago. The macroeconomic environment still has its challenges: an unstable global economy; the relatively strong US dollar; and continued soft demand for consumer goods.

However, certain segments of the economy are showing signs of life. The recent rally in energy prices has crude oil over $50 a barrel and natural gas over $3 per million BTU, which are both encouraging for our coal- and shale-related businesses. We are also pleased to see strength in the overall grain market. With a record harvest currently underway, we are well-positioned with our network and resources to serve an increase in demand from our ag customers.

Closing out 2016 and heading into next year, we're optimistic about the opportunities that lie ahead. In the coming months, we will continue to do what Union Pacific does best, operate a safe, efficient and productive network, while providing an excellent customer experience and delivering solid shareholder returns. With that, let's open up the line for your questions.

(Operator Instructions) Ken Hoexter, Merrill Lynch.

Great, good morning. Can you, Rob, talk a little bit about the projects you're writing off? I just want to understand what kind of costs we have going forward. And it looks like, as the business comes back, you're starting to ramp up your locomotives and employees. But you notice that there are fewer people in the training pipeline. Should we see some startup costs as you start to bring people back in? Thanks.

Yes, Ken. What I commented in the quarter is, there was around $17 million of projects that were started that we've chosen to not pursue, and so we are taking an adjustment there. So I think if you look longer term, that's a number that is not going to repeat. We occasionally will have situations like that, but I think it's safe to assume that, that's a number similar to the Hanjin receivable write-off that I mentioned, that are not going to repeat in that line item.

In terms of the cost, we're confident that we are well-situated, both on locomotives and employees, to leverage the volume that we hope does materialize. So we've got fewer people in the training line because we've got so many people, if you will, in furlough status at this point. So we feel very good about our ability to -- and we would love nothing more than to see volume pick up and be able to put resources back to work.

Great, thanks.

Cherilyn Radbourne, TD Securities.

Thanks very much, and good morning.

Good morning.

With the international shipping lines under continued financial pressure, as you noted, and the prospect of a record grain crop match-backs is something that I've been hearing more about. Just curious if that's something that you're facilitating and potentially see as a means to increase market share in intermodal or grain, or both?

Eric?

Yes, as you mentioned, Cherilyn, there's significant volatility going on in the international containership business. There have been three major mergers, one bankruptcy; there are a number of other entities that are in dire or questionable financial shape.

One of the things that all of the containership companies are looking at doing is finding ways to have match-backs or exports from the US to Asia. One of the large historical exports has been grain, in particularly DDGs to China. We are continuing to look at that as an opportunity to grow our business in terms of the westbound business to Asia.

We're also real excited longer term or mid term in terms of the opportunity to ship plastics to Asia from the expanding franchise we have in the Gulf. And we think that, that's going to be an excellent opportunity for match-backs also. So we think both of those things are great opportunities.

Of course China occasionally, as they have right now, has tariffs or other governmental policy things that hinder imports like DDGs. But we think long term, that should be opportunity for us.

Cherilyn, this is Lance. What Eric just outlined is indicative of the franchise strength that the Union Pacific brings to the industry. We've got breadth and coverage in a number of markets that allow us visibility into potential match-backs.

Great. And just by the way, as a very quick follow-up, when you say medium to long term on the plastics match-backs, is that sort of 2018 and beyond?

Yes, as we've been saying for the last several quarters, we think most of the growth will happen in 2018 and beyond. There might be a tail of -- a small ramp-up toward the end of 2017, but basically 2018 and beyond.

Thank you. That's all for me.

Ravi Shanker, Morgan Stanley.

Thanks, good morning, everyone. A couple of questions on pricing. You've committed to positive core pricing. Can you also commit to pricing over inflation?

And second, can you just help us understand what the driver of the pricing, let's say, the deterioration in the gains have been? Is it mostly inter-rail competition? Is it truck competition? Or is it you guys just supporting some of your customers who may be going through a hard time, and hoping to get it back a little later on?

Eric?

Yes, Ravi. One of the things that we're real excited about is the great franchise we have, and we have a very diverse franchise. And some components of our franchise obviously -- as we've mentioned, the energy-related and the international-related -- are facing both economically weakness conditions and also some competitive conditions.

So we've been talking about the challenges in coal. Coal, as you know, has been greatly challenged not only by demand, because of weather and other usage demands, but natural gas has been a great, strong competitor to coal. The low, below-$2 natural gas prices has created a headwind for coal in the past. We are excited -- or, we think that with natural gas being above $3 now, and even some of the futures markets showing it in the mid-$3s, that, that certainly will improve the competitive condition for coal. But that has clearly had an impact.

Likewise, the three major mergers, the one large bankruptcy in the international intermodal, the volatility that we've talked about in previous earnings releases has created economic conditions and competitive conditions in international intermodal. Even despite those challenges in those markets, we still have been able to put our market price at re-investable returns.

And we think that, looking at the broadness of our portfolio, we are pretty positive in the future about our ability to price for the excellent value we provide. And we're going to price above re-invest forward terms, and we have a broad portfolio of opportunities to drive that message.

Thanks so much for that color. Can you also -- do you have the confidence that you can stay above inflation in pricing?

Ravi, this is Rob. Let me answer that. Clearly, long term, that is still our goal. The one thing with these challenges and opportunities that Eric just outlined, one of the things we haven't finalized yet, but as we look into 2017, at this stage, it looks like Global Insight's inflationary numbers are like 2.5%. And our number may well be above that from an inflationary standpoint, largely driven by the health and welfare costs on our labor line.

So still some work to play out there. But longer term, absolutely, we are as committed as ever to driving that price.

Great, thank you.

Tom Wadewitz, UBS.

Good morning. Wanted to ask a little bit more on the pricing side. You commented how the higher natural gas price is helpful for coal, so that's obviously a constructive thing. But I'm wondering if you are optimistic if that will -- that should help the coal tonnage, and obviously if you have a normal winter and so forth. But what about the pricing in coal?

If we stay at this gas price or go a little higher, do you think that you'll be able to go transition to a better competitive environment where you could raise price for coal transport? Or is that something that some of that pricing pressure would likely persist?

So Tom, you're asking a couple different things here. As you know, there are always a variety of market conditions that impact price: transportation, capacity availability and availability on transportation networks for other commodities, as you know. Competition, weather -- there are a lot of things. Natural gas prices -- that will affect coal.

We are positive that the use of coal should be increasing in the mid term. If you just look at, again, the competition against natural gas, if you look at the economic pick-up and the use of energy, we are confident that the use of coal should be picking up in the near mid term. And we saw that in the second to third quarter in terms of the sequential use of coal.

We will continue to price for re-investable returns based on the value of service that we provide. And we are confident in that strategy, we are confident in the value that we are providing, and we're going forward.

Hey, Tom, this is Lance. Clearly an environment where natural gas prices increasing -- put it north of $3.50 or so -- and where weather is favorable, and where the stockpiles have been worked down, that's a better pricing and competitive environment than not. So it helps.

Okay, I appreciate that. And then for the follow-up, I don't know if this is kind of Rob or Cameron. But you've shown nice improvement in the train length, good momentum there, so that's very favorable. I'm wondering if you look at 2017 and if you do see a volume growth as a couple things play out -- let's say you see a couple points of volume growth -- how does that translate to incremental margin?

Could you see something that's well above the kind of normal 50% incremental margin we are talking about? Could you see something 60%, 70%, as you expand train length more and see some of the benefit of cost take-out and so forth? Is that a reasonable equation, or would you be more cautious about the incrementals in 2017 if the volumes come back? Thank you.

Rob, why don't you take that.

Yes, Tom, this won't surprise you, but we won't give guidance on the actual incremental margins. But everything you said are certainly opportunities. As you know, our G55 + 0 initiatives, which are some 15 different areas, our view is, we're looking at every single cost bucket in the entire Company and attacking it aggressively with an eye on safety and efficiency, and customer value.

So I would just answer that question by saying, the scenario you outlined, where there's positive volume and a reasonably positive economic environment, would give us an outstanding opportunity to continue to drive productivity. And staying away from an actual incremental margin calculation, we would expect it to be a positive contributor.

And oh, by the way, for us to go from where we are today to our 60%, plus or minus, by 2019, and with an eye on getting to 55%, assumes we're going to have very healthy incremental margins from here to there. So we're going to certainly go after it.

Tom, as we've opened up the door now to the productivity in your question, I just want to give recognition to the entire UP team, who have done a tremendous job in a reduced-volume environment of finding ways to grow, for instance, manifest train size 5% year over year. That's a phenomenal effort, and that's just one of many in terms of finding productivity on the network. I think the team has done a tremendous job in creating productivity in a pretty difficult environment.

Yes, clearly you guys are doing a great job in that area. That's an impressive performance. Thank you for the time.

Thank you.

Jason Seidl, Cowen & Company.

Thank you, operator. Good morning, gentlemen. I'm going to stick on the price horse here for now. As we look at that 1.5%, you mentioned tough volume environment, competitive environment. Is this something that you would expect UNP to hover around for a while? Or what could break it out of that 1.5%?

I'm trying to figure out, is this near term? Are we going to see that throughout 2017 unless things recover from here?

You know, Jason, we don't give any guidance on price. Clearly as we've outlined a little bit here this morning, there are certain markers that make the competitive environment better for pricing. Any time, for instance, capacity in alternative modes tightens up, that's good. Demand for the underlying commodities, as it increases, that's good.

So you've just got to keep your eye on what's happening with, for instance, natural gas prices, and stockpiles and weather in the coal world, what's happening on import demand, and the financial health of our international intermodal ocean carriers -- that helps. What happens for industrial production in the United States -- that helps. What's happening to truck capacity, alternative modes -- that helps. So all of those are a helpful environment for our pricing.

I appreciate that. I mean, I just -- even checking my records, I can't remember the last time you guys were below what we would call your real cost inflation.

Looking at 2017, I know you guys don't provide guidance specifically, but are you pretty confident that you're going to be able to grow your volumes in 2017? Forget what percentage, but just grow the volumes?

Eric, do you want to handle that?

As we say, we don't give volume guidance. But if you look at the markets that we have out there and you look at the pick-up in different markets that we have, we feel pretty positive that as the economy continues to grow and is slowly strengthening in many of our markets, we feel pretty positive about the run rate opportunity.

The one cautionary area that we have talked about before is in automotive sales, and we continue to think those are cautionary. If you look at even our Mexico franchise, we had great growth in our Mexico franchise in the quarter. We still think that there are good opportunities to grow volume.

If I can just add to Eric's comments, Jason, just kind of remind you and everyone else, our thesis from this point over the longer period is a positive volume environment. And you look at the -- as Eric just pointed out -- you look at the unique diverse opportunities of our franchise, while Eric's right, we aren't giving precise volume guidance for next year. But we do feel there is great opportunity for us to continue to leverage and, over the longer period of time, for us to have volume on the positive side of the ledger, certainly.

Let me ask you quickly another way. If you saw negative volume next year, that would mean that something would have to decelerate from here with the trend. Is that an accurate statement?

Yes, that's an accurate statement. Generally speaking. Again, we play in multiple markets. But that's a fairly accurate statement.

Okay. Gentlemen, I appreciate the time, as always.

Thank you.

Brandon Oglenski, Barclays.

Hey, good morning, everyone, and thanks for getting me on the call here. A couple -- I think a few months into this year, we had been talking about OR improvement, even when volumes were down pretty significantly in the first quarter. And I know you guys backed off of that in 2Q. But I guess as I listen to the call here, it sounds like pricing might be in line with cost inflation, maybe even a little bit below it next year.

Let's say volumes don't come back tremendously. What can you guys do on the operating ratio that maybe we could instill some confidence again that you guys would break into lower territory?

Let me start, Brandon. This is Lance. And I will remind you that we have confidence -- extreme confidence in our ability to continually find opportunities to be more efficient, reduce waste and increase the value that were adding. I'll ask Cameron just to give us a handful of examples of things we're working on when were going into next year. But our bucket is full of opportunity to be better.

On train size, the only commodity group that is truly optimized or nearly optimized, is coal. Every single commodity that we have out there, from manifest to automotive to intermodal to grain or rock, all has tremendous opportunity for us to continue with the results that you have seen. So we feel confident that that is going to happen in 2017.

The record all-time re-crew rate, from a process perspective, we feel like we have well in hand, and we should continue to see that into 2017 and 2018.

And we work on other initiatives, like rationalizing our low-horsepower fleet. We've done a great job of moving to single-unit local operations versus two units. There's a number of initiatives that we have. Truly, we are just getting started in framing up the opportunity and getting ready to realize it as we step into the new year.

Exactly. And even little things like C-rate, that improved 2% year over year here. There's plenty of opportunity, as we look forward, to become world-class, if you will, in consumption rate for diesel. So there's just a host of issues there, Brandon, that we can continue to work on.

And I appreciate all that you guys probably have going on that we can't see from here. But I guess in retrospect, Lance, was it just that volume got a lot worse than we thought in the second quarter? Or was it competitive factors, was it market pricing? You know, what was it that led to the lack of ability to drive OR improvement this year?

Let me let Rob handle that.

Yes, Brandon, your comment is right, that we have always said and we do believe that we can make improvements in the operating ratio, in spite of a lack of volume growth. And in fact, you look out over the last decade, we've taken almost 25 points off our operating ratio without the benefit of positive volume over that time frame. I would say, you're exactly right though.

Here in the short term this year, I would say that the major driver of not likely improving the operating ratio this year is the pace of which we've been chasing volume down. We never have perfect visibility as to where that volume is going to trough, and that makes it difficult. So we are always chasing, if you will, and I think that's really the answer to what you've seen this year.

So as we look forward, I think it's still a fair assumption, and it's certainly our drive, that we expect to make improvements in our operating ratio, in spite of what the economy deals us in terms of what happens with volume. Now having said that, as we look out over the next several years, we do have volume in our thesis on the positive side of the ledger, but we're going to not use that as an excuse not to make continued productivity improvements.

Okay, thank you.

Yes.

Scott Group, Wolfe Research.

Hey, guys, morning. Wanted to follow up on pricing. Rob, your point about inflation picking up to 2.5% next year, is that to caution us that pricing could be below inflation? Or is that, you're telling us we have line-of-sight to inflation getting higher, so we have line-of-sight to our pricing accelerating too next year? I'm not sure what you're trying to tell us.

Yes, Scott, my point on the inflationary comment is, we do expect inflation to go back up, if you will, to more normal levels versus the below-normal levels that we enjoyed this year. And again, 2.5%: Global Insight. Our numbers, because of health and welfare costs, might be higher than that.

So my point on that is simply to say, not unusual against historical numbers. But we do expect inflationary pressures to be back to normal conditions, if you will.

But because you have line-of-sight to inflation picking up, do you have line-of-sight to your pricing re-accelerating too?

I would say, no. It's not mechanical, as you know, the way we price. And we play in so many different markets that it's not a cookie-cutter, it's not a one-size-fits-all. And as Eric outlined, there are opportunities for us to achieve stronger price than other areas in the short term.

But we will continue to drive service, drive value, and price at a minimum of re-investable levels, as Eric outlined, in spite of what that inflationary number turns out to be. So I would say they're disconnected, if you will, in terms of the day-to-day pricing initiatives that we take.

So maybe just bigger picture, it feels like for the long term, you guys have said: hey, we're going to get pricing no matter what -- if we get volume, okay; if we don't get volume, we don't care. And truthfully, you haven't had much volume, and you've gotten great pricing.

Is the philosophy changing, where you care more about volume now as part of G55, and so it's less clear that you necessarily always get the pricing?

Scott, our philosophy is not changing. And as a matter of fact, our top line this quarter reflects that it's not changing. We are pursuing business in the marketplace that we can price for the value that we represent and that's re-investable. If we can't find that, we walk away from it. So nothing has changed about that philosophy.

Okay. And if I can just ask one more thing on grain pricing specifically. So as the grain volumes are finally picking up, are there opportunities to start raising grain tariffs? I was a little surprised by the sequential drop in ag revenue per car this quarter. I don't know if that's mix or a lack of pricing there? Just anything specifically on grain pricing?

Yes, Scott, I think if you -- some of grain pricing, as you know, is in public tariffs, which is publicly available; and I think you would see some of that sequential increase in pricing in the publicly available tariffs that mirror kind of the demand that's picking up in grain. I think you'll also see, in some of the secondary markets, huge increases in the value in the secondary markets for equipment for grain. So some of that you have public visibility to, and I think if you look at those public things, you would see pricing going with the demand increases.

Okay. Thank you, guys.

Allison Landry, Credit Suisse.

Hi, good morning. This is Danny Schuster on for Allison. Thanks for taking my question here. So just coming back to pricing a little bit, I think investors are looking at the downward trend and wondering whether we could eventually see flat pricing at some point. I think after today, we're a little bit potentially closer to that. So what can you tell investors to alleviate the concern that flat pricing is not a possibility?

Just exactly what we've said this morning, which is, our pricing philosophy is that we're looking for markets and opportunities where we can price for the value that we represent. And if we can't find that and have it re-investable, we will keep searching.

As markets improve, as the competitive environment improves, that should translate into an environment where we have more opportunity than not. But our philosophy, our way of conducting business, is not going to change.

Okay, great, thank you. And just switching gears on the fuel side, the discount to spot diesel prices seems to have climbed a little bit this quarter, back up to around 66%, another 300 basis points up. So should we expect this trend to continue upwards, or in other words, expect the discount that you receive to spot diesel to diminish as fuel prices go up? Thank you.

Rob?

Yes, I would answer that by saying, it's hard to say. I mean, I can't give guidance as to what that gap may be. But certainly the way I would look at is, overall, as diesel fuel prices increase, we will work hard and have good mechanisms in place to continue to -- there may be a timing difference, but -- put our surcharges in place.

So from a net impact, we work hard to minimize that. But I can't predict exactly what the delta to the spot will be.

Okay, great. Thank you for taking my questions.

Justin Long, Stephens.

Thanks, and good morning. I wanted to ask about the OR. I know you've said you're not expecting improvement this year. But do you think we'll see year-over-year improvement in the OR in the fourth quarter, given what you're expecting for volumes?

Rob?

Yes, as you probably are on top of here, comps get a little bit easier, if your will, in the fourth quarter, number one. And number two, we're going to continue to drive the productivity initiatives that we've been successful with this year. And volumes get easier. And if volumes stay flattish, as I outlined in my comments, say even flattish with where they are now, we would see the fourth quarter gap over previous year narrowing.

So having said all that, again, without giving specific, precise guidance on the OR for the quarter, we certainly have an opportunity to do that.

Okay, that's really helpful. And I don't want to beat a dead horse on core price, but we did see the moderation there. And it sounded like in your prepared comments, you said it was mainly due to energy and international intermodal. I was wondering if there's any way to frame up how much of a headwind you saw from those two areas of the business? Like maybe to say, that was all 50 basis points of the sequential deceleration that we saw, or something like that?

Justin, this is Rob. We don't break it out that way. But I would just tell you, again, as you've heard me say many times, we don't have just a simple cookie-cutter one-price-fits-all. So all of our markets that we enjoy -- and again, we have more markets because of the diversity of our franchise than many -- gives us opportunities. And the pricing opportunities for us are very diverse. But having said that, we don't break out the way you're asking it.

Okay, fair enough. I'll leave it at that. Appreciate the time.

Thank you, Justin.

Chris Wetherbee, Citigroup.

Thanks, good morning. I do need to just come back to price, and I apologize, because I know it's been talked about ad nauseam this morning. But just one thought on renewals. You guys report core pricing a little bit different than some of your peers. And I just wanted to get a rough sense of the relationship between inflation and the renewal dynamic. And I know it's not mechanical, Rob, and you highlighted that.

But just generally speaking, in a higher inflationary environment, would you expect that renewals would accelerate as well? And how much maybe of a lag do you think that there is?

I guess I'm just trying to get a rough stance, regardless of the magnitude, just sort of directionally. I'm guessing they work together. I'm just want to get some color on that, would be great.

Yes, Chris, just a couple of comments I would make. Number one, as I think you and others know, we have about 25% of our business, if you will, that is affected by [ALIF]. So over a longer period of time, that mechanism sort of -- it may be lumpy from quarter to quarter, but over a longer period of time, it tends to reflect what is happening with rail inflation, number one.

But I guess I would more broadly say, and remind folks the way we calculate price. And as you all have heard me say for many years, I'm very proud of the fact that we are very conservative in terms of how we calculate price. It is not a same-store sales kind of number. It is a mathematical calculation of how many dollars we yielded in that particular quarter from our pricing actions, and the denominator is our entire book of business. So it includes contracts that perhaps we didn't touch certainly in the quarter for pricing.

So having said that, there tends to be a little bit of a lead/lag, if you will, in terms of the yield dollars that come from our pricing actions. But again, our focus is unchanged from what it's been at this point in time. We've got a couple of markets out there that are particularly challenging. But our commitment to driving value, driving quality service and driving positive price and positive volumes -- or positive margins, has not changed.

Okay, that's helpful. I appreciate that. And then switching gears, I wanted to follow up on the coal side. Eric, you had mentioned, I think, inventories are 27 days above average, I believe, is what you highlighted there. What do you think the right number is in terms of the go-forward period, where the natural gas curve is?

Weather has been a factor over the summer. We don't know what it will be like over the winter. But what do you think that right number is? How close are you guys to kind of getting towards normalized inventories, do you think?

Well, if you think about the Powder River Basin inventories, the five-year average, as I said, was the low-60s -- 63, 65. And right now we're still at 90. So that's how you get to the 27 days.

I do think that 60-ish number is probably right if we have normal weather patterns and a normal cold winter. If you look at the natural gas futures curve, I think right now it's predicting $3.40 in the early part of next year. That will drive the inventories down. That will drive usage of coal.

Coal market share in the quarter was 32% compared to like 28%, I think, in the second quarter. So coal market share has grown. I think it will be in a good place, a good position. You will see coal volumes grow, you'll see the opportunity for coal pricing to grow, you'll see inventories go down, and I think we will be in a better place.

One thing to note: you can get to that days inventory reduction adjustment a number of ways. If you think about what's happening in the coal world in a different perspective, on a stock level of, call it, 80 million tons of SPRB coal, we are about 3 million tons higher year over year. And that represents, as Eric says, about 25 days of burn. So it really doesn't take much in both how much you have in stock and how much you're burning, to affect that days ratio. You can get there a number of ways.

That's really helpful. And real quick, did you say what the coal outlook was for volume within the low single-digit decline in the fourth quarter?

We didn't, Chris, but it's, call it, in the low-teens, is probably a reasonable assumption -- down low-teens.

Okay, great. Thanks for the time, appreciate it.

Brian Ossenbeck, JPMorgan.

Hey, good morning. Thanks for getting me on the call here. Lance, just wanted to get your views on the regulatory backdrop. Obviously there's been a lot of things coming out of the STB. They had their review of the stand-alone cost test from the external consultant come out recently, we've got some news out of the GAO about the EPC brakes.

But just looking into next year, it seems like it will still be fairly busy on the docket. I just wanted to get your thoughts on if there will be any potential impact, changes in regulations in 2017 that you would be particularly focused on?

Brian, thanks for that question. We are focused on the activity at the STB, that's largely driven by their re-authorization from Congress about a year ago. In that reauthorization, Congress has essentially encouraged the STB to work through their docket. They had a backlog of a fair number of action items.

Our concern is that that's interpreted as a desire to regulate the industry further. We don't believe that is the desire of Congress. We think Congress's desire was to have the STB work through their workload.

So we've got our eyeballs and are working on different activities, things like the reciprocal switching rules, or a reduction of exemptions of different commodity groups. We're touching all the right points, and making sure our perspective is known and incorporated into the thought process. There's a lot of moving parts there, so it's taking a fair amount of work on my part, on our legal team and on our Washington team.

I would say our largest concern would be the kind of overriding overall impact of each individual regulation. If the STB takes those in isolation, we could end up in an impact that is unintended and unconsidered. And so we are also working hard to make sure that the STB takes into account the full perspective of everything they're working on, and the knock-on impacts of each as a group. Does that make sense?

Yes, it does, and it helps a lot. Because I think you see the activity, you think potentially activist. But it does seem like a docket that needed to move forward a bit.

Just one real quick question for Eric on the Hanjin impact; you mentioned the $13 million write-off. I was just curious if there's any operational issues you've been seeing as those containers come onshore, and then people don't necessarily want to move them? Anything from the chassis shortage that we've been hearing a little bit about, if that's of a concern? Clearly there's a lot of other puts and takes in the international intermodal side right now. Thank you.

Yes, Brian. So Union Pacific, I think, has weathered a lot of what I call the operational fallout from the Hanjin bankruptcy, fairly well. At a high level, on the day they went bankrupt, they roughly had about 100 ships on the inflows around the world -- 40 owned, about 60 leased. And there are lots of issues in terms of what to do with all of the in-traffic flows. There was roughly, I think, $14 billion worth of goods in traffic flows, lots of issues around what to do with that.

We had a fairly nominal number of boxes en route on our railroad, and we've been able to process all of those through. We probably have a couple dozen left to process through, from roughly, probably a little over 1,000 on the day of bankruptcy. So we navigated that fairly well.

There are issues out there in navigating the rest of that. It is an issue for the industry and supply chain, in terms of what to do with the boxes, both loaded and empty, and boxes on chassis, what to do at those. And that's something that the industry is going to be struggling with to resolve. But for the Union Pacific side, we've navigated that fairly well.

Okay. Thanks for the detail, Eric.

John Larkin, Stifel.

Thank you very much for taking my question, gentlemen. Had a question on coal. Keith, you've said it a couple times, that the stockpiles are still well-above kind of targeted levels. Yet sequentially, there was a huge step up in coal volume too -- in theory, replenished stockpiles drawn down during the hotter-than-normal summer. Was that very specific to a few different utilities, or what really drove that? It seems a little contradictory to make that comment, that coal would be up sequentially, even though stockpiles are still, on average, way above normal.

Eric, can you handle that?

Yes, the stockpiles have come down. If you look at over the second to the third quarter, the stockpiles have come down 13 days. And they came down because the burn increased. And so our volumes improved roughly 40% and the stockpiles came down because the burn increased even at a higher percent than that.

Okay. So it doesn't sound like the utilities are all that dedicated to drawing those stockpiles down that aggressively if they're replenishing still fairly aggressively there in the third quarter. Just one more question. The US dollar has been sitting at elevated levels relative to foreign currencies now for a year or longer. What is your outlook on that for the rest of this year and throughout 2017, and the impact it might have on exports which are so critical and the bulk side of your business?

Yes, John, this is Lance. You're right, the dollar has been strong. We don't make a prediction about what the dollar is going to be going forward, but you've got to believe all reasonable expectations are, it's going to continue to remain strong. In order to change that, you need real acceleration in the global market, which would enhance the strength of other currencies. And there's just not a lot of catalyst that you see for that.

To your point, a strong dollar does make exports difficult. However, even in today's world, you see, for instance, grain exporting off the Pacific Northwest and the Gulf Coast and into Mexico, despite a strong dollar. So market conditions can still prompt commodity movement in global trade.

And the other thing to note is that the US is unique in its ability for its manufacturing base to figure out how to be globally competitive over time. I think the shale energy revolution is indicative of that, where a couple years ago, people would say $70 a barrel shale oil was competitive. And in today's world, they say, no, that's maybe more like $50 a barrel.

So there's a lot of moving parts there. Clearly we would prefer an acceleration in the global economy which would prompt more global trade, which would mean more US exports. That all would be really helpful to us.

Got it. Thank s for that explanation.

David Vernon, Bernstein Research.

Hi, good morning, guys and thanks for taking the question. Rob, I know you guys don't want to get too much into predicting price. But maybe could you let us -- or clarify for us kind of what percentage of the volume right now is under contract that would have a normal inflationary escalator, versus those that are going to be subject to more of the competitive or market conditions that are out there?

Yes, David. I mean, we don't necessarily break it out exactly the way you're asking, other than I would just remind that, overall, about 25% of our book of business is touched by the ALIF index. But to your question of how much do we have under contract, or if you will, kind of sized from a pricing standpoint, it's the same answer I would have given you last quarter, and that's about 70%.

I mean, every day of every week, we are negotiating with customers and negotiating our deal. So it's not like it's done each quarter on day-one. So it's an ongoing, continuous process. And roughly speaking, any day of any week, we have about 70% of the next 12 months business under contract or sized up.

And I guess as you think about your outlook and your near-term to 60%, and then the longer-term, to achieve 55%-plus? Does the recent trend in that same-store sales price metric make you as a CFO rethink the timing of some of those targets? Or do you think that you see enough opportunity in the cost side here to keep the forward momentum on the margin side?

We haven't changed our guidance in terms of 60%, plus of minus, by 2019, and then our eyeballs on getting to a 55%. And I would say, don't read that we are like changing our longer-term view in terms of our commitment to pricing. We're not.

We've got a little bit of bump on the road because of some of the market conditions that Eric outlined. But as we look longer term, the levers that got us to where we are today, that are going to take us to the next rung on the ladder of 60% and then eventually 55%, are, certainly, we hope, positive volume. But are going to be solid value to our customers, solid core pricing at re-investable levels-plus, and solid productivity gains.

All right, well, I appreciate the color on that. It's been a long call. Thanks for your time, and we look forward to hearing more about those G55 initiatives over the coming years.

Thanks, David

Ben Hartford, Baird.

Thanks, Rob. Quick question for you. You had provided the 15%-of-revenue target that you had talked about in the past, for next year, as it relates to CapEx. Can you envision -- as you march toward the 55% OR target longer term, can you envision a situation in which CapEx does approach G&A on an absolute basis? Is that realistic for a relevant period of time, or over a relevant time horizon?

Ben, probably not. I wouldn't use that as a marker, again, because of the timing. These are long-lived assets, generally speaking. But to your broader point, I'm very proud of what the team has done to continue to make progress on tightening our capital discipline. And I think it's a significant step of getting to that 50-percentage range, if you will, from where we have historically been. There's a lot of great productivity and a lot of great work that goes into getting to that level. So we'll get to that rung next, and then we'll see where we are at that point.

Okay, that's helpful. Thanks.

Walter Spracklin, RBC.

Thanks very much. Good morning, everyone. Just on the OR long term, your targets, as you mentioned. When we started the year, we heard the entire -- all the railroads each indicate that they would be able to reduce OR despite a challenging environment. You noted the same. Most have done so, and your OR unfortunately has not followed that trend. And I'm just looking on a relative basis. When you see the improvement across the group, can you point to something that is specific to your Company that -- be it a business mix, be it some structural challenges -- that leads you to have that challenge that the others did not?

And I frame it in a relative question. I know you don't like looking at peers, but I know your investors do. So I want to be able to understand, is there something Company-specific here? Or how do I answer that question when I get that OR question?

Walter, this is Lance. Again, I won't compare ourselves to our peers. We are a unique railroad. When we began the year, we were hopeful we were going to make OR improvement. The top line went away from us, as Rob said, a little more aggressively than we had anticipated. If you think about our ability to improve OR over the long run, we're still confident that we can do it. That is shown in our maintaining the guidance for a plus/minus-60% in 2019.

We did start the year with a very low operating ratio. It's still an attractive operating ratio. We're not pleased that we didn't have the opportunity to improve it this year. And again, we are just laser-focused on all the activity necessary to continue to improve our margins for our shareholders.

So coming back to your long-term then, from where you sit today, that's a 900-basis point improvement. It's a significant improvement. Several of your peers are there already, and many investors are banking on you to achieve that. Given the trends that we're exhibiting, the reversal of those trends, I'm just trying to understand what confidence that we can put in a reasonable timeframe -- long term is a fairly vague definition -- a reasonable timeframe for evolution toward a 55% OR?

Rob, why don't you take that?

Yes, well, I guess I would remind you and everyone that we are confident in sticking with our 60% plus-or-minus target OR by full-year 2019 -- and as you've heard us talk, with eyes on where do we go beyond that to be 55%. So while we haven't put a date on the 55%, but I would just say that getting to a 60% is a very enviable spot, in my opinion. I mean, we've made great progress on that.

So I would not read that this one year of perhaps not making OR improvement is a new trend or a new objective or new signal here. It's not. To get from where we are today to that 60% is going to take all the initiatives we just talked about, and it's the same levers that got us a 25-point improvement over the last decade. So we going to continue to make a progress, and we haven't backed off our 60% OR guidance.

Okay, thank you very much.

Brian Konigsberg, Vertical Research.

Yes, hi, good morning. Thanks for taking my question. A lot of ground has already been covered. Maybe just on the bonus depreciation and moving some of the purchases on locomotives from 2016 into 2017. So should we just think those two are connected and the carryover into 2017 will show up?

I think I would stick with the guidance I gave on bonus depreciation impact this year of about $350 million. I don't think that's -- not going to move much. We haven't finalized what the number is going to look like all-in for 2017. But I think I would still just kind of use that assumption of $350 million-ish for this year.

But conceptually, a lot of that bonus depreciation is associated with the purchases of locomotives and these other things. Is that just the way to think about it, generally?

Yes, I mean, it certainly impacts that, but I would say it's still in that $350 million range for this year. And again, we will see. We will get some carryover benefit next year. But we, of course, have to start paying back previous year. So we haven't finalized or given guidance as to what the impact all-in net will be next year. But you're right. The locomotive movement will have some impact on what those numbers are.

Understood, thanks. And maybe just touch a little bit on balance sheet? So you're approaching the self-imposed leverage limits. You talked about just thought process from here. You look to maybe de-lever or actively de-lever, or will you naturally do [a 3] with that growth? How do you see that playing out?

We've made great progress on that measure over the last several years. And at this point in time, the biggest opportunity we still have in front of us, which we are laser-focused on, is driving EBITDA, driving cash flow, and that will give us additional capacity. And that's how we're approaching it. So we think we do have room as we grow our earnings and grow our cash flow.

I will leave it there. Thank you.

Scott Schneeberger, Oppenheimer.

Thanks very much for fitting me in. With regard to -- just focusing on the automotive sector, you mentioned the contract changes being a headwind into 2017. Could you just kind of compare and contrast what you think the impact will be, as it looks like over-the-road conversions are good?

And then obviously there's a lot of near-shoring and a lot of development in Mexico, with manufacturing. So just if you could compare and contrast within that sector how you think you enter next year? Is it going to be a net up or down in that category? Thanks.

You know, Scott, we love our auto franchise. We think we have the premier auto franchise. We think all the trends in terms of Mexico production is positive for us, in terms of our franchise. We think we're in a great spot for over-the-road auto parts conversions. We've had great success this year, and we think that will continue in the future.

There will always be contract changes, and it's a competitive marketplace, and we saw that this year. You said something that will happen across time. The big driver, as we've been saying, my view on the automotive side is the cautionary impact in terms of sales. Sales have been a record or near-record levels, and there's some indicators out there that should give cautionary lights. It's the amount of debt inherent in auto loans and leases. Actual sales incentives per car, we're at an all-time record level in the quarter, the highest since 2008, was the previous record. So there are some cautionary signs out there.

If auto sales they strong, we have a great franchise and we're in a great spot. I do think there are some cautionary signs out there.

All right, thanks. And just a quick follow-on at Panama Canal. Any update there, what you're hearing from customers [as though per check-out]? Thanks so much.

No, I think the Panama Canal story is what we've been saying for the last several years. And certainly, I think, the last couple of quarters we've been mentioning that the amount of traffic hitting the West Coast versus the East Coast did -- there was traffic that moved to the East Coast because of the strike and BCOs trying to diversify their risk and not be dependent upon the West Coast. We did see that phenomena.

We have seen some of that business start to come back, but it hasn't all come back from before the strike. That has probably been a larger factor than any canal opening factor, the fact that the BCOs are diversifying their flows in a lot of different ways just to not have that risk.

Having said all that, we do believe -- I do believe that the West Coast ports are the most economical, the best supply chain, in terms of transit time, to get goods from Asia to the interior of the country, and even into the East Coast. And if you look at some of the technologies that some of the West Coast ports are employing to make themselves more efficient, with autonomous vehicles and things like that, I think West Coast ports are still going to be positioned to be the best supply chain factor going into the future. Though you will see people wanting to do risk mitigation strategies.

Thank you. I would now like to turn the floor back over to Mr. Lance Fritz for closing comments.

Thank you, Rob, and thank you all for your questions and interest in Union Pacific. We're looking forward to another conversation with you in January.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.