聯合太平洋集團 (UNP) 2017 Q4 法說會逐字稿

Greetings, and welcome to the Union Pacific Fourth Quarter 2017 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 now begin.

Good morning, everybody, and welcome to Union Pacific's fourth 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 $7.3 billion for the fourth quarter of 2017 or $9.25 per share.

These reported numbers include the previously disclosed adjustments reflecting the impact of corporate tax reform, which Rob will discuss in more detail in a few minutes.

Excluding these adjustments, 2017 fourth quarter net income was $1.2 billion or $1.53 per share.

This represents an increase of 5% and 10%, respectively, when compared to 2016.

Total volume increased 1% in the quarter compared to 2016, driven primarily by a 17% increase in Industrial Products and a 5% increase in Chemicals.

Partially offsetting these volume increases were declines in Agricultural Products, Automotive and Coal.

Intermodal carloads were flat for the quarter.

Overall force levels decreased in the fourth quarter, both sequentially and year-over-year, as we continued to make meaningful progress on our productivity initiatives.

The quarterly adjusted operating ratio came in at 62.6%, which was up 0.6 points from the fourth quarter of 2016.

This increase was driven by an increase in fuel price.

I'm pleased with the results the men and women of Union Pacific achieved by focusing on our 6-track value strategy.

While we have room for improvement in many areas, that does not include the dedication and hard work of our employees as they build America.

Our team will give you more of the details on the fourth quarter starting with Beth.

Thank you, Lance, and good morning.

This will be our final reporting on 6 business groups as we announced during the third quarter.

Effective January 1, we will transition reporting to our newly established 4 business groups: Agricultural Products, energy, industrial and premium.

For the fourth quarter, our volume was up 1%, driven primarily by Industrial Products and Chemicals.

We generated positive net core pricing of about 1.75% in the quarter, with continued Energy and Intermodal pricing pressure.

Despite these challenges, our focus continues to be on achieving core pricing gains that counterbalance inflation and coincide with our value proposition.

The increase in volume and a 4% improvement in average revenue per car drove a 5% increase in freight revenue.

Let's take a closer look at the performance of each business group.

Ag Products revenue was down 4% on a 7% volume decrease, partially offset by a 3% increase in average revenue per car.

Grain carloads were down 19%, driven by high global supplies and reduced U.S. competitiveness in the world export market.

Grain products carloads were down 2% as growth in ethanol exports were offset by reduced meal shipments to the East.

The delayed implementation of the biodiesel tax credit also negatively impacted our oils business.

Food and Refrigerated volumes were up 2%, driven by continued strength in import beer, growth in refrigerated shipments for frozen fries and Cold Connect.

Automotive revenue was down 1% in the quarter on a 4% decrease in volume and a 3% increase in average revenue per car.

Finished vehicle shipments decreased 5% as a result of lower production levels in response to softer vehicle sales, high inventories as well as planned outages for model changeovers.

These reductions were partially offset by new West Coast import traffic and strong shipments into the Texas market for hurricane replacement.

The seasonally adjusted average rate of sales was 17.7 million vehicles in the fourth quarter, down only slightly from fourth quarter 2016.

On the parts side, over-the-road conversions and growth in light truck demand minimized the impact of lower overall production levels, resulting in a 1% reduction.

Chemicals revenue was up 7% for the quarter on a 5% increase in volume and 2% increase in average revenue per car.

Petroleum and LPG shipments increased 15%, driven by stronger diesel and crude oil shipments, coupled with strength in propane due to Mexico demand, hurricane recovery and inventory build for seasonal winter demand.

Plastic carloads were down 4% due to resin tightness and increased commodity prices as a result of residual impacts from Hurricane Harvey.

Fertilizer was up 11%, driven by continued strength in potash exports.

Coal revenue decreased 5% for the quarter on a 3% decrease in volume and a 2% decrease in average revenue per car.

On a tonnage basin -- basis, Powder River Basin was down 2% while other regions were down 1%.

Natural gas prices were down 8% from a year ago, driving the decrease in the domestic demand.

Colorado/Utah loadings benefited from strong export shipments to the West Coast and to the Gulf coast.

Coal stockpiles have been below the 5-year average for the majority of the year.

Industrial Products revenue was up 28% on a 17% increase in volume and a 10% increase in average revenue per car during the quarter.

Minerals volume increased 71% in the quarter, driven by an increase of over 100% in sand shipments due to improving well completions and increased proppant intensity per well.

Specialized markets volume increased 20% in the quarter, driven by a 15% increase in waste shipments as a result of West Coast remediation projects and a 60% increase in military shipments due to increased deployments and rotations.

Intermodal revenue was up 4% on flat volume and a 4% increase in average revenue per car.

The domestic market increased 1%, driven by strong parcel shipment.

International volume was down 2%, driven by continued headwinds from industry challenges due to overcapacity and consolidation, which resulted in increased transloading and changing vessel ports of call.

Going forward, we will begin to report on our 4 business groups: Agriculture Products, energy, industrial and premium.

For Agricultural Products, we anticipate continued strength in ethanol exports driven by demand from China, Brazil and India, continued growth in Food and Refrigerated shipments due to Cold Connect penetration, tightening truck capacity, frozen fry expansions and continued strength in import beer.

We anticipate continued uncertainty in the grain market as high global supplies and unknown wheat crop quality potentially affect our ability to participate in the export market.

For energy, we anticipate continued strength in frac sand, with more uncertainty in the second half due to the viability of local sand.

As always for coal, weather conditions will be a key factor of demand.

Industrial is expected to remain stable.

We anticipate an increase in plastics as new facilities and expansions come online and resin supply increases.

In addition, we expect to see strength in both rock and cement markets.

For premium, we expect truck capacity to continue to tighten, providing an opportunity to drive higher levels of over-the-road conversions.

Despite challenges within the international Intermodal market, we anticipate new products benefiting the supply chain will drive growth.

As for Automotive, the U.S. light vehicle sales forecast for 2018 is 16.9 million units, down 2% from 2017.

Production shifts will create some opportunity to offset the weaker market demand, and over-the-road conversions will present new opportunities for additional parts growth.

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 injury rate was 0.79, slightly higher than the full year record of 0.75 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 regard to rail equipment incidents or derailments, our reportable rate improved 3% to 2.94.

In public safety, our grade crossing incident rate increased 5% versus 2016 to 2.55 as we continued to reinforce public awareness through community partnerships and public safety campaigns.

Moving on to network performance.

As reported to the AAR, velocity declined 5% and terminal dwell increased 12% compared to the fourth quarter of 2016.

We are not satisfied with this operating performance.

Multiple factors play into network fluidity, and we are intently focused every day on improving service from these levels.

We also have the resources and capacity needed to make this happen.

In addition, as I mentioned on our last earnings call, implementation and testing of positive train control across a growing number of routes on our network continues to drive part of the negative impact on velocity.

For a quick update on PTC, at year-end, about 60% of the total route miles requiring PTC were fully implemented and operational.

The Western region has been completed.

The Northern region is near completion, and we are well underway on the Southern region.

With each new region comes a new set of challenges, both from a technological and training perspective.

The team is doing an excellent job troubleshooting and building upon the lessons learned from those locations where PTC has been implemented.

We will continue working through these challenges as we progress toward the 2018 PTC deadline.

Taking a look at our resources.

All in, our total operating workforce was down more than 200 employees in the quarter when compared to last year.

Our TE&Y workforce was up 6% when compared to the fourth quarter of 2016, primarily driven by an increase of approximately 600 employees currently in TE&Y training.

This is predominantly a timing issue.

With the 6- to 9-month lead time required for new hires to become service eligible, we have begun refilling the training pipeline to accommodate our resource needs for the coming year.

Our engineering and mechanical workforce was down more than 800 employees, driven by a smaller capital program in 2017 and because our G55 and 0 initiatives have resulted in greater labor productivity.

As always, we will continue to adjust our resources as volume and network performance dictate.

Moving on to productivity.

Although a decline in our velocity and terminal dwell metrics did negatively impact productivity in certain areas, I am pleased with the progress we experienced driving productivity elsewhere.

We achieved best-ever train size performance in our grain and manifest train categories during the fourth quarter, marking the 10th consecutive quarter of best-ever performance in our manifest network.

The team also achieved fourth quarter records in our Automotive and Intermodal train categories.

And with 2017 complete, I'm proud to announce the team achieved full year records in every single train category.

We were also able to generate productivity gains within our terminals as cars switched per employee day increased 1% during the first -- fourth quarter.

Turning to our capital investments.

In total, we invested about $3.1 billion in our 2017 capital program.

For 2018, we are targeting around $3.3 billion, pending final approval by our Board of Directors.

About 70% of our planned 2018 capital investment is replacement spending to harden our infrastructure, replace older assets and to improve the safety and resiliency of the network.

Our 2018 capital program also includes about 60 new locomotives, which will complete our multiyear purchase commitment.

We also plan to invest an additional $160 million in positive train control.

On a cumulative basis, we still expect to spend approximately $2.9 billion on PTC.

Additionally, we plan to begin construction of a new classification yard in Hearne, Texas.

This facility will be named Brazos Yard and will help support expected volume growth from our customers in the Southern region.

It will improve service by decreasing car handlings and car cycle times.

It will also be the most efficient hump yard in our rail network with the lowest operating cost.

Construction is expected to cost approximately $550 million, with operations scheduled to begin in 2020.

To wrap up, looking to 2018, we expect network fluidity to return to normalized levels as we work through PTC implementation and shifting volume growth.

We will continue to create productivity opportunities through initiatives designed to increase train length, balance resources and improve asset utilization, with the ultimate goal of enhancing the customer experience and creating value for our shareholders.

And we will continue striving for positive safety results on our way to an incident-free environment.

With that, I'll turn it over to Rob.

Thanks, and good morning.

Let's start with a recap of our fourth quarter results.

I want to first remind everyone of a couple of noncash items impacting the fourth quarter and full year 2017 as a result of the Tax Cuts and Jobs Act legislation passed prior to year-end.

As we initially disclosed back on January 9, the fourth quarter includes a noncash reduction in income tax expense resulting primarily from the revaluation of the company's deferred tax liabilities to reflect the recently enacted 21% federal corporate tax rate.

After further analysis of the effects of the tax reform, we have revised this estimate upwards to just over $5.9 billion compared to the $5.8 million that we disclosed in our 8-K filing.

In addition, we also recognized a noncash reduction to operating expense of just over $200 million related to income tax adjustments at equity-method affiliates.

This adjustment is primarily driven by our equity ownership in TTX and is reported in the equipment and other rents line of our income statement.

Slide 20 shows our adjusted results for the fourth quarter and full year 2017, reflecting the impact of these items.

With that in mind, let's take a look at our core performance in the fourth quarter, excluding the impact of the corporate tax reform.

Operating revenue was $5.5 billion in the quarter, up 5% versus last year.

Positive core price, increased fuel surcharge revenue and a 1% increase in volume were the primary drivers of the increase in revenue for the quarter.

Operating expense totaled $3.4 billion, up 6% from 2016.

Operating income totaled $2 billion, a 4% increase from last year.

Below the line, other income totaled $29 million, down $11 million from 2016.

Interest expense of $188 million was up 8% compared to the previous year, and this reflects the impact of higher total debt balance, partially offset by a lower effective interest rate.

Income tax expense decreased 2% to $676 million.

Net income totaled $1.2 billion, up 5% versus last year, while the outstanding share balance declined 4% as a result of our continued share repurchase activities.

These results combine to produce adjusted fourth quarter earnings per share of $1.53.

The adjusted operating ratio was 62.6%, up 0.6 percent points from the fourth quarter of last year.

The combined impact of fuel price and our fuel surcharge lag had a 0.6 point negative impact on the operating ratio in the quarter compared to 2016.

Fuel had a neutral impact on our earnings per share year-over-year.

Freight revenue of just under $5.1 billion was up 5% versus last year.

Fuel surcharge revenue totaled $293 million, up $106 million when compared to 2016 and up $66 million versus the third quarter of this year.

The business mix impact on freight revenue in the fourth quarter was a positive 0.5%.

The primary drivers of this positive mix were year-over-year growth in frac sand and base chemical shipments, partially offset by a decrease in grain car loadings.

Core price was about 1.75% in the fourth quarter, slightly down from the third quarter.

However, if we set Coal and Intermodal aside, our core price was around 2.75% in the quarter.

And for the full year, as we expected, the total dollars that we generated from our pricing actions exceeded our rail inflation costs.

Turning now to operating expense.

Slide 23 provides a summary of our operating expense for the quarter.

Compensation and benefits expense increased 4% to $1.2 billion versus 2016.

The increase was driven primarily by a combination of higher wage and benefit inflation, along with higher volume, and partially offset by productivity achieved in the quarter.

Full year labor inflation came in at about 4% while overall inflation was approximately 2.5%.

Productivity gains and a smaller capital workforce resulted in total workforce levels declining 1.5% in the fourth quarter versus last year or about 625 employees.

For 2018, we expect force levels to adjust with volume, especially with respect to our TE&Y workforce that Cam just mention.

But our overall workforce levels will also reflect ongoing productivity initiatives as well.

Fuel expense totaled $547 million, up 27% when compared to last year.

Higher diesel fuel prices and a 3% increase in gross ton-miles drove the increase in fuel expense for the quarter.

Compared to the fourth quarter of last year, our fuel consumption rate was flat while our average fuel price increased 23% to $2.03 per gallon.

Purchased services and materials expense increased 6% to $585 million.

The increase was primarily driven by higher costs associated with subsidiary contract services.

Turning to Slide 24.

Depreciation expense was $532 million, up 2% compared to 2016.

The increase is primarily driven by a higher depreciable asset base, including our positive train control assets.

For the full year of 2018, we estimate that depreciation expense will increase about 5%.

Moving to equipment and other rents.

This expense totaled $276 million in the quarter, which is down 1% when compared to 2016.

This excludes the equity income tax adjustment of $212 million that I mentioned earlier.

Other expenses came in at $239 million, up 3% versus last year.

The primary driver was an increase in state and local taxes and other expenses, partially offset by a decrease in personal injury expense.

For the full year 2018, we expect other expense to increase around 10% versus 2017, driven in part by the anticipation of higher state property tax expense resulting from the corporate tax reform changes.

On the productivity side, our G55 and 0 initiatives yielded about $75 million of productivity in the fourth quarter.

This brings our full year total to just under $350 million.

Slide 26 provides a summary of our 2017 earnings with the full year income statement, again excluding the impact of our corporate tax reform.

Operating revenue increased about $1.3 billion to $21.2 billion.

Adjusted operating income totaled $7.8 million, an increase of 8% compared to 2016.

And adjusted net income were just over $4.6 billion while adjusted earnings per share were up 14% to a record $5.79 per share.

Looking at our cash flow.

Cash from operations for the full year totaled about $7.2 billion, down 4% when 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.

Our capital spending program in 2017 totaled around $3.1 billion.

Adjusted return on invested capital was 13.7% in 2017, up a full point from 2016, driven by -- primarily by higher earnings.

Taking a look at adjusted debt levels.

The all-in adjusted debt balance totaled about $19.5 billion at year-end 2017, up $1.6 billion since the end of 2016.

We finished the fourth quarter with an adjusted debt-to-EBITDA ratio of around 1.9x.

Dividend payments for the full year totaled nearly $2 billion, up from just under $1.9 billion in 2016.

This includes a 10% increase in our declared dividend per share, which occurred in the fourth quarter.

In addition to dividends, we also bought back 36.4 million shares totaling $4 billion during the full year 2017.

This represents a 29% increase over 2016 in terms of dollars spent.

In the fourth quarter, we bought back 9.2 million shares at a cost of about $1.1 billion.

And since initiating share repurchases in 2007, we have repurchased over 32% of our outstanding shares.

And between our dividend payments and our share repurchases, we returned $6 billion to our shareholders in 2017, which represented 129% of adjusted net income over the same period.

I want to provide you some commentary on how we believe the new tax law changes will impact Union Pacific in 2018 and beyond.

Our federal statutory income tax rate will decline from 35% to 21%.

All in, when you include state taxes, our effective in tax -- income tax rate will be about 25%.

And from a cash perspective, we expect our 2018 cash tax rate to be between 17% and 18%.

This cash tax rate reflects the benefits from the lower federal tax rate and immediate expensing of eligible capital expenditures, partially offset by the negative impact of prior year bonus depreciation programs.

In later years, our cash tax rate will likely trend in the direction of a statutory rate.

We expect these changes will result in free cash flow by approximately $1 billion in 2018.

And we are still in the process of developing specific plans for the uses of cash in 2018.

And as you know, these plans, including our capital budget, must be reviewed and approved our board.

But for now, I can assure you that our basic philosophies and priorities regarding cash allocation and distribution have not fundamentally changed.

We will continue to employ a balanced approach to capital expenditures, dividends and share repurchases.

First and foremost, we will approximately invest in the business with an eye on earning adequate returns on capital employed.

And as Cam mentioned earlier, we plan to spend around $3.3 billion on capital in 2018, and our guidance of reinvesting around 15% of revenue remains unchanged at this time.

After capital expenditures, we will continue returning cash to shareholders in the form of dividends and share repurchases.

Looking ahead to 2018 from a fundamentals perspective, we expect volumes in the first quarter and the full year to be up in the low single-digit range.

And as Beth commented on earlier, we should see strength in several business categories, along with uncertainty in other areas.

We will price our service product to the value that it represents in the marketplace.

From an all-in pricing perspective, we are confident the dollars we generate from our pricing initiatives should well exceed our rail inflation costs in 2018.

As for inflation this year, we expect both labor inflation and overall inflation will be under 2%, driven primarily by lower expected health and welfare costs.

On the productivity side, we plan to achieve approximately $300 million to $350 million of savings this year as we continue to focus on our G55 and 0 initiatives.

To wrap it all up, in addition to the significant incremental cash benefit that we expect as a result of the corporate tax reform, positive full year volume, positive core price and a significant productivity benefit will all contribute to another year of strong cash generation and an improved full year operating ratio in 2018.

We are still focused on our targeted 60% operating ratio, plus or minus, on a full year basis by 2019, and we are confident in our plans to get there.

And longer term, we are firmly committed to reaching our goal of a 55% operating ratio beyond 2019 as we continue the momentum of our volume, pricing and productivity initiatives.

So with that, I'll turn it back over to Lance.

Thank you, Rob.

As we discussed today, we delivered solid fourth quarter and full year results, setting the table for 2018.

We're optimistic the economy will favor a number of our market segments, leading to another year of positive volume growth.

Increased unit volume, combined with inflation plus core pricing and G55 and 0 productivity initiatives should result in another year of revenue growth and improved margins.

We'll continue to execute our value-track strategy to benefit our employees, partner with the communities we serve, provide our customers with an excellent experience and generate strong returns for our shareholders.

With that, let's open up the line for your questions.

(Operator Instructions) Our first question comes from the line of Brandon Oglenski with Barclays.

This is actually Van Kegel on for Brandon.

Lance, [best] -- could you just kind of give us a postmortem on 2017?

Your volume was up around 2% versus the industry up about 4% and your competitor being up 5%.

And historically, UNP hasn't seen a lot of growth.

Could you just talk through some of the headwinds that maybe we don't appreciate from this year and some of the most compelling market opportunities going forward?

Sure, Van.

This is Lance.

I'll just start with a just very broad kind of overview of 2017 and then turn it over to Beth for a more specific market discussion.

So you're right, we had about a 2% volume growth.

You combine that with core pricing growth and our about $350 million in productivity, and it generates a record EPS of $5.79.

Now within that, there are some things that we are particularly proud of.

That is, continued productivity improvement, the ability to get price in some of our markets that are relatively difficult, having a franchise that makes us open and accessing to a number of markets that are looking pretty sharp and good.

And then there are some things that I would say I'm either not happy with or disappointed in, and that is in the second half of the year, we saw our operating kind of service product and overall operating performance slip a bit.

And that's a place that we're not comfortable in and we're working very hard to remedy as we speak.

Beth?

As Lance mentioned, we're very focused on ensuring that we're generating great value and margins for the company and we're maybe less focused on volume as the end-all, be-all.

So we had great growth and a wonderful business that we enjoyed in frac sand.

We saw Coal return in the year overall to levels that are probably a little bit more normalized.

We had really strong Ag in the first half, not so much in the second half compared to the year before, and that's really just a global markets perspective.

And then on the Intermodal side, while the -- our domestic parcel business went gangbusters, we continued to see competitive pricing scenarios in both international and domestic Intermodal for most of the year that really dampened our growth potential compared to others.

We remain really focused on improving margins in Intermodal, and so we didn't see maybe the same kind of growth that you saw from others.

Great.

And then on -- just a quick follow-up on Intermodal.

I mean, with domestic up 1% and international up 2% in kind of one of the strongest global trade environments we've seen.

Could you just give some more context around the drivers behind that and maybe your contract losses or some of the shifts that happened with the steam liners?

And then what you're doing on the sales and marketing side to maybe improve those outcomes?

So We -- as I mentioned, we were -- we had really have strong parcel growth in the last quarter, a lot of that e-commerce driven, as you would expect.

The domestic market seems to be significantly improving with the tightening of truck availability.

So I would -- we are certainly very hopeful that, that ends up being a good market for us in 2018.

On the international side, we did see some decline in the fourth quarter, and I think that, that is largely due to some shifting from the Pacific Northwest U.S. ports into some of the Canadian ports where you've seen some pretty significant capacity expansion.

Our next question comes from the line of Scott Group with Wolfe Research.

So I wanted to ask you, Rob, about the -- just the pricing metric.

I think people are surprised that it decelerated this quarter.

Even if you exclude Coal and Intermodal, it decelerated a little bit.

So maybe if you can give us some thoughts on why it decelerated.

Beth, I think last quarter, you said that the Coal and Intermodal competitive pressure may be starting to ease a little bit.

Maybe if you can give us an update there.

And then, Rob, you talked about pricing dollars well exceeding inflation.

So I think that sounds a little bit better than what you've been saying in the past.

Maybe do you have -- is that just the inflation dollar amounts falling a lot?

Or do you have confidence that the pricing dollars accelerate this year?

Yes, Scott, let me take all that in.

First of all, we -- you noticed that we changed the refined, if you will, and I would say being crystal clear in trying to be as transparent as we possibly can in trying to -- with the rounding convention the quarter points here.

I would say that if you look at the difference between the just under 2% that we reported on our pricing in the third quarter to the 1.75% that we're calling out here in the fourth quarter, the difference between the third and fourth quarter is really quite small.

So I wouldn't read that there's any pricing actions story to be told between the third and fourth quarter there.

Stepping back, though, just to remind you, and I know you know this, but to remind everybody listening how we calculate price.

And we've been doing this for the 15 years that I've been the CFO, and I'm very proud of this.

It's a very detailed, analytical approach to what did we actually yield from our pricing actions.

So it's not representative of a same-store sales that took place this quarter versus last quarter or last year.

It really is how many dollars did we yield from the pricing actions that we took since the last 12 months, and how many dollars did we yield this quarter that actually went to the bottom line.

So it's not a -- again, it's not a same-store sales-type numbers.

What did we really take to the bottom line?

And in the fourth quarter, that was 1.75% pricing.

To the -- to your point, if you exclude, as we called out in both the third quarter and now in the fourth quarter, if you exclude the Coal and Intermodal, where we continue to face some challenges, I would say -- and Beth can perhaps elaborate on the Intermodal piece of this -- I would say that in the fourth quarter, we still faced those same challenges.

Now as you look forward -- and Beth can comment on this -- as you look forward particularly in the Intermodal, we're feeling better about that, obviously, but we're still in the competitive challenges, I would say, in the Coal space.

And then there's one final comment, before I let Beth comment on Intermodal, on your question about the well exceeding comment that I made as we look to 2018.

And what I'm saying there is our expectation -- again, remember how we calculate price.

It's dollars yielded from the pricing actions that we took and comparing that to the dollars that we anticipate expending on inflation.

Both pieces, we think, are moving favorably.

Yes, we think inflation overall for 2018 will be lower than '17.

We think it's going to overall be under 2%.

And yes, we do have some optimism as we look forward to 2018 in some of our pricing opportunities.

So we believe that gap, if you will, of the pricing actions and yields from our pricing actions in '18 versus the inflation dollars will be better in 2018 than it was in '17.

Beth, do you want...

Yes, just building on what Rob said, my perspective is that our pricing in the fourth quarter versus the third quarter was no different.

We're still seeing opportunities to price and, I would say, growing opportunities to price on the domestic Intermodal side.

International Intermodal and Coal continue to be challenges for us competitively, but we definitely do see that truck availability is tightening in the spot market.

How that converts into long-term contracts, we'll get more and more opportunity to see as we have bid season coming up in domestic Intermodal, but it does feel like the pricing opportunities are firming.

Okay, that's helpful.

And then, Rob, I wanted to just ask you one about just the balance sheet and maybe the rationale for being a single-A credit.

It doesn't seem like there's any sort of meaningful reduction you're seeing in borrowing costs relative to maybe some of the other rails.

So it doesn't just feel like maybe we're optimizing the cap structure here.

And now with all the extra cash flow from tax reform, it would seem to me like there's a pretty dramatic opportunity here to ramp up leverage and then, obviously, with that, really ramp up the buybacks for your shareholders.

I know you can't give us like the specific numbers today and maybe that'll come in May, but maybe can you just -- does what I'm saying make sense to you?

Or is there a reason why you feel like you need to be a single A credit relative to what you used to be?

Yes, Scott, I mean, duly noted.

And we totally understand and -- your point and others' point on this very issue.

I would say that with the new $1 billion of cash flow opportunity we have here, it's frankly a high-class problem for us to evaluate how this is all going to play out.

And I know we and everyone, including rating agencies, are going to kind of be digesting what does all this mean.

Now we're comfortable being -- we don't -- we drive towards cash flow measures, and we've been comfortable with that A rating.

But even within that, Scott, to your point, we think there is a growing opportunity for us to both -- grow our cash flow from the fundamentals, and the benefits of the tax Reform Act give us additional opportunities.

And as I stated and I'll reiterate it, we're not changing our philosophy.

We're going to continue to be very focused on rewarding our shareholders in addition to spending capital while returns are there.

But we do believe this gives us a high-class problem as we look at dividends and share repurchases going forward.

Our next question is from the line of Ken Hoexter with Merrill Lynch.

Okay, great.

So Rob, you've been at a -- between a 63%, 64% OR for 4 years now, and you noted the workforce, I think, in your commentary will increase with volumes.

Is that a change from growing the workforce but not at a pace with volumes?

And I guess just thinking about that 60% OR, does that include the shift in pension income and with the rise in fuel prices impacting the operating ratio?

Yes, Ken.

I mean, your point is duly noted in terms of where we are, and we're proud that we've, as you know, over the years gone from high 80s to the low 60s, and we're very focused on getting to that 60% and ultimately 55%.

The math behind why it may have kind of slowed the momentum here in the last couple years, there's a lot of moving parts in there.

But rest assured we are very focused on continuing to improve year-over-year and we have to drive incremental volume -- incremental margins to get to that 60%, plus or minus, by 2019.

And what it's going to take is continue focus on our G55 and 0 initiatives, which still is turning out stellar productivity numbers.

A high-quality service product enables us to continue to get price in the marketplace.

Specifically to your point on headcount, that's not really a -- what I've said here today on headcount, and that is that it will move with volume and not 1 for 1. I don't -- that is not a change.

We've kind of had that philosophy now for several years.

And what I'm saying there is, if volume is up X percent, I would expect that, that will require us -- because we think we're right-sized right now, that will require us to bring in additional employees depending on what business it is, what mix it is, et cetera.

But it's not going to be 1 for 1 because the G55 and 0 focus on productivity, we're very confident that headcount will not grow at the same pace that hopefully volume does.

So it's really a combination of factors, but I take comfort that we are very focused and committed to continuing to drive to that 60%, plus or minus, by '19.

But that's -- okay.

And Ken, this is Lance.

Just 2 other observations.

One is that training pipeline is going to have to be filled just for attrition purposes.

We have what -- mid- to high single-digit percent attrition out of our TE&Y workforce every year.

So that's going to have to be filled for that purpose as we look forward into next year and growth.

The second thing is, growth is another of the levers that we focus on in making sure that we're able to drive a long-term margin improvement.

And we're very pleased that we got margin improvement this year.

Okay, great.

Rob, I think I was a little confused.

I thought you were shifting and saying that you were going to do it 1 for 1 in the original commentary.

So thanks for that clarification.

Oh, no, no.

But yes, thank you for the -- no, I'm not saying that, yes.

Yes.

And then my second one, I guess, Lance, maybe for you.

The -- we've heard now 3 other rails moved to kind of eliminate, seems like, almost all of their hump yards and improve operating performance.

Now you're looking to spend maybe $0.5 billion on adding another one.

Maybe can you just walk through the cost-benefit analysis so we can understand the difference of why you'd look to add one when the others seem to be cutting them?

Yes, absolutely.

So let's start from the top, Ken, right.

We use yards, whether it's flat switching yards or hump yards, to categorized cars in our manifest network.

And you know we have a very robust, large manifest network.

When we determine how we want to get that switching done, it's all about how many cars can we aggregate and how deep into the network or somebody else's network we can send them.

That informs for us the number of large network yards, which are hump yards for us, that's all driven by car count versus smaller regional or local yards, which are flat switching yards.

The reason why we're building a new hump yard in the middle of Texas is that as we look forward both from a volume that's coming out of the petrochemical complexes along the Gulf Coast, Texas itself and our overall manifest growth down in that part of our network, we see that our existing infrastructure is going to be overwhelmed at some point in the future.

We're doing everything we can to incrementally improve productivity in those areas.

You saw Cameron this morning talk about incremental productivity and car switch per employee.

We also look for incremental capital that can be spent in existing network yards.

But once that string runs out, we have to build new capacity.

When you think about this specific yard, Brazos, it will be the most productive yard on our network.

It'll be the lowest cost per car switch and the most efficient.

And what we will do is we'll utilize it again for a lot of that to-and-from business that's down in the southeast part of our network, and we're pretty confident -- I would scratch that -- very confident that now is the right time to build it and it's the right asset to build.

The next question is from the line of David Vernon with AllianceBernstein.

Rob, just real quickly in terms of that 10% growth in the other expense guidance.

Could you clarify that a little bit more?

It sounds like you guys are doing a lot of work on taking cost out, and yet this other line continues to kind of pop up a little bit.

So I'm just wondering kind of what's behind that cost increase there.

Yes, David.

I mean, that's -- there's a lot that goes into that line item, as you know, and it includes state and local taxes, equipment property damage, utilities insurance, I mean, environmental.

A lot of things go into that, so it's one of the hardest, if you will, to try to nail to the wall as to exactly what that's going to be.

Your point is duly noted.

On every cost bucket, rest assured, as part of our G55 and 0 initiative, though, we've got an eye on being as efficient and productive as we can, and we -- that includes the other expense category.

But our best thinking at this point in time, largely driven by some of the unknowns around state and local tax using that 10% category.

Okay.

And then maybe just -- you guys have done a phenomenal job in terms of managing up returns and evaluating new business opportunities based on their re-investability.

As you think about the lower tax rate sort of maybe changing the math on what is investable, what is not investable, are there any opportunities where you see you might be able to get a little bit more aggressive in terms of driving some volume growth because of a lower tax rate?

Yes, David.

This is Lance.

The lower tax rate and increased cash flow resulting from it does not change the calculus that we use for the returns that are attractive to our shareholders and for reinvesting in the railroad.

So I think the short answer is, just because we have increased cash, it doesn't increase the pool of either projects or markets that are attractive to us.

I mean, I guess, the one area that's come up in a couple conversations with some industry folks is the West Coast Intermodal trade, where obviously the U.S. rail industry is going to be getting a little bit of a tax reform benefit that maybe the Canadian rails aren't, and you've seen a bunch of freight diversion up north.

Do -- would that maybe impact some of the routing decisions on some of those moves?

Or is that just something you guys wouldn't even consider?

Well, so those routing decisions right now, as we compete for that business right now, is all about the service product, the ultimate cost to the end user and which way they want to go, what's most attractive to them.

So we compete aggressively for that today.

We'll compete aggressively for it tomorrow in the context of making sure we generate an attractive return out of it.

The next question is from the line of Fadi Chamoun with BMO.

I want to drill back into the productivity a little bit.

I mean, looking back on 2017, we had a pretty good kind of revenue environment.

You achieved $345 million of productivity savings.

The OR moved 50 basis points.

So we're starting '18 with 300 basis points to improving to your target for 2019.

If you can just kind of walk us through what is going to get better in '18 and '19 in order to kind of move the productivity momentum stronger and to get you to your target of 60%?

Let me start with that, and then I'll let both Rob and maybe Cam add technicolor as appropriate.

So Fadi, the game plan really doesn't change as we look forward.

The levers continue to be productivity.

And we've talked about the amount of productivity we think we can get in 2018, and we're just laser focused on delivering that and then moving into '19 for the same.

We see market opportunity for growth, and growth is always our friend in terms of leverage and dropping it to the bottom line, and then price, of course.

The thing that got in the way a little bit for even better results from 2017 is that in the second half of the year, the fluidity of the network eroded to a certain degree.

In some part, that's positive train control and the impact of implementing it aggressively across the network.

You heard those stats.

Part of it, candidly, was just the execution and, in certain spots around the network, that we have all hands on and attention, and I'm confident, given that we've got the resources and the capacity, that we'll remedy that.

So my expectation is 2019, 60%, plus or minus, operating ratio is still imminently achievable, and we have enough in front of us in activity and projects to make it happen.

Fadi, I would just add -- again, I'm -- don't take anything I'm about to say here as excuses, but just recall notably in the third quarter we did have the hurricane impact, we had the force reduction impact.

Fuel for the full year was a little bit of a headwind.

So not excuses, but some of those things, notably the workforce reduction, sizable, we will get the benefits of that more in 2018 where we incurred the cost in 2017.

And of course, things like the hurricane, which, frankly, we weathered extremely well.

Those are things that we don't anticipate repeating.

But other than that, it really is just the volume, productivity and pricing levers that we're going to continue to pull.

Okay, that's helpful.

And just one follow-up on the pricing side.

International Intermodal, you said that the market can -- remains very competitive.

Would you attribute that competitiveness to the Canadian ports and the Canadian kind of railroads being more aggressive on the market?

Or is it U.S. competition?

Like is it...

Well, Fadi, I would say that we see both things being pretty aggressive.

It's pretty aggressive coming out of Pacific Southwest in terms of the pricing challenges, and it's pretty aggressive coming out of the Pacific Northwest, which is U.S. railroads and Canadian railroads.

Our next question is from the line of Chris Wetherbee with Citigroup.

I wanted to come back to the OR for a second, just thinking about the fourth quarter and then maybe looking out to 2018.

But within the fourth quarter, we know fuel was a headwind, but it sounds like, ex fuel, kind of OR was flattish.

We had positive volume, positive price.

I just want to get a sense from a 4Q perspective if there's anything specific in the quarter going on from a cost standpoint that you felt like maybe was maybe a little bit onetime in nature or maybe not so recurring.

And then as you move into 2018, particularly the first half, I mean, do those things kind of -- are there other cost items that sort of drop away?

Do you think you can get OR improvement in the first half of 2018?

Just trying to get a sense of sort of how things are trending today.

Yes, Chris.

I'll let Rob speak to the details of the fourth quarter financials.

But just at a high level, I think we would have been generating a better operating ratio and overall results with a more fluid network.

Again, there's a number of reasons for that, that Rob outlined that we talked about this morning, and there's no reason to think that, that is systemic in any way.

That's a completely resolvable issue.

Yes.

And that's the only thing I would add.

And Chris, as you know, we are focused on improving our operating ratio in 2018.

We're going to stay away from breaking out by quarter or first half versus second half, but I would agree with Lance that, from my perspective, there's nothing really unusual, and you called out fuel that occurred in the fourth quarter, other than our disappointment on the cost side.

I mean, we frankly admit that, but there's opportunities, and we're very focused on doing better on that.

And that's the big delta in my mind.

Okay, all right.

No, that's helpful.

I appreciate it.

And then just in the context of sort of pricing, it seems like the industry is getting better pricing gradually in 4Q and then moving forward into 2018 with the potential of a much tighter truck market.

How much of your business is sort of available and open for repricing?

So how much, in other words, can -- do you think you can kind of capture what's going on in some of those markets with contracts that are available to being repriced?

Well, I think we've given guidance previously that roughly 2/3 of our business is under some sort of a 1-year or longer term at any given point in time, and then you have things that are under -- everything else will be kind of under tariff and available for pricing.

And then you -- of course, you get roll-offs of the 1-year deals, so.

Okay.

So somewhere in the sort of third range is kind of what the shot on goal was for 2018, maybe a little bit more than that?

No.

I -- so listen to what she was just talking -- what Beth was just saying.

At a moment in time, 1/3 is available through tariffs.

Over time, the other 2/3 -- a portion of that, maybe a fair portion of that, is in short-term contracts.

So as they expire, they become available for pricing.

Our next question is from the line of Allison Landry with Crédit Suisse.

I guess just following up on the previous question.

If we think about the bid season for trucking and assume that TL contract rates are up in the mid-single digits or high single digits during the bid season, is it fair to assume that UNP would see a step function increase in price in the second half?

Well, as you know, there definitely is a timing of the bid season on the Intermodal side in particular.

And then of course, we have other business that's truck competitive as well.

So as we go into the bid season in the second quarter, we certainly hope that, that spot high rates that are happening right now in trucks convert to longer-term contract capability.

But you're right, it won't show up until later in the year.

Okay.

And then I know that pricing has been beaten to -- upon a dead horse during the call.

But I wanted to ask about the Coal pressure.

I know that you mentioned that the pressure was similar in Q4 to what it was in Q3.

But if we think about new contracts signed in the second half of the year, was the pressure the same as it was for contracts signed in the first half of the year?

Or was there some sequential easing that happened?

I would say that we're -- the pressure in the coal markets remains some -- pretty much the same.

Okay.

So from the first half to the second half, it was the same?

Yes, but -- yes.

Our next question is from the line of Bascome Majors with Susquehanna.

I wanted to focus on a few of the CapEx budget items and how they might trend beyond 2018.

Specifically, the $460 million or so for locomotive equipment that you said this was the last year of your purchase commitment on locomotives; the $160 million for PTC, since we're at the tail end of that.

And the $445 million that you allotted to capacity investment, which seems to be up almost $200 million year-over-year, and I'm assuming that's related to the Brazos project that you talked about earlier, but can you just give a sense for how some of those moving parts might move into 2019 and beyond?

It would be helpful.

Rob?

Yes.

Bascome, I'll probably disappoint you and not get into quite the level of detail that you're asking.

And let me just start out by reiterating that our guidance over the long term is 15% of revenue.

And as I think you and everyone knows, that's not how we build our capital plan, but that still is a good way of thinking about what we are thinking here as to what the overall expenditures will be when you add it all up.

Some of the moving parts, though, that I would call out, yes, this is the last year -- as Cam pointed out, this is the last of our long-term commitment on buying locomotives, so we'll take 60 locomotives this year.

And we don't have plans at this point in time to take any more locomotives beyond that.

We will still have some capital expenditures that go into locomotive programs, et cetera, in there.

So the number will come down, but it won't go to 0 in our locomotive line.

PTC, clearly, once that's up and running and behind us, that number will change.

It'll go down to probably not 0 in the near term, but it will go down, as it has, dramatically from where it started.

And beyond that, again, so we just talked about Brazos being an opportunity where we're making that investment because we're confident the returns are there, and that's how we look at all investments.

So you're right, there are some pieces coming down, and we're -- other than Brazos, we're not saying it's necessarily going to be backfilled dollar for dollar, but our guidance at this point in time, to kind of answer your question, is still that 15% of revenue level.

I appreciate that color there.

Just one more question.

Someone earlier mentioned that the training pipeline will have to be filled to start to backfill some attrition based on the growth you expect over the next few years.

Where is the T&E (sic) [TE&Y] pipeline today?

And can you help size us up how many hires you might need to get that to where you'd like it to be?

Bascome, I don't know we'll give you exact numbers, but I think Cameron can give you a sense for how we're thinking about it.

For the attrition that Lance mentioned earlier in the meeting, we have filled the pipeline appropriately to meet that attrition and some of the growth that has been highlighted for the Southern region.

And we feel like that's timed pretty accurately.

There will be a few additional hires for attrition in the locomotive and engineering side, but we think we've got that pipeline filled appropriately.

The operating team -- and we haven't received any questions about it this morning, but it was a pretty stark number.

They've done a tremendous job on the engineering and mechanical side of achieving productivity, both in central operations and in our distributed operations that are throughout the network.

And I anticipate there's even more opportunity there as we look into 2018 and beyond.

Our next question is from the line of Tom Wadewitz with UBS.

Yes.

Look, the -- I'll start with one on the cost side.

Your -- I guess in -- when you talk about inflation, I know that probably doesn't map precisely to total operating expense growth.

But obviously, some broad relationship in the way we model that.

You're talking about 2% or less in inflation.

And on the high side, you get the 5% rise in depreciation, 10% in other expense.

So what would be the categories of operating expenses that would be less than 2% and we ought to model at kind of pulling that overall number down to 2%?

And if I'm thinking about it wrong, tell me that, but just want to know where we should model maybe favorable OpEx items on the P&L.

So, Rob?

Yes.

So again, I'll probably disappoint in terms of giving you the precise line items that you're asking.

But I would just start out by saying every cost bucket, we're looking at opportunities to squeeze out efficiency and manage the costs.

You've got your comp line, you've got -- which, again, I called out that, that line overall should be less than 2% on the inflation side of the house.

You look at rents.

I mean, that's another category where we're hopeful of continuing to manage that effectively.

But just -- and I know you know this, but just to kind of reiterate, when I -- when we say less than 2%, of course, we're talking about inflation.

The actual costs that flow through the income statement will largely be driven by what volume we actually enjoy.

And so volume costs, albeit not 1 for 1, and all the efficiencies that we expect to squeeze out of that will clearly fill up on the line items as well.

But as it relates to inflation, I called out, I guess, comp and the rents as 2 lines that might be lower than overall average.

Okay.

And then I know this has been a big topic on the call, but just I had one on pricing as well.

How do you think about -- like I think about the Eastern rails as having more sensitivity to truck market.

So their pricing is kind of probably going to move a little bit more closely related to the rise in truck.

How much of your book do you think is pretty sensitive to truck market?

And how much do you think that can flow through to help pricing?

It just seems like the truck markets are super, super tight and that it's kind of hard to resolve your cautious comments on price with that really tight truck market.

So how do we think about how much sensitivity you have to truck?

What parts of the book or how much of the book overall?

Oh, we do have several markets that are very truck competitive, Intermodal being one of them, lumber.

I think -- you probably saw the article in The Wall Street Journal yesterday that called out reefer capability as being very tight right now, and we participate, and that is a -- it's obviously a lower volume for us, but we do have exposure to that.

And then, of course, we serve a lot of bulk markets that aren't as likely to be truck competitive.

So when we put all that kind of together in the mixer and we think about what's happening there, we do see that there is a potential for us to have the opportunity to participate with some higher pricing in these markets that are truck competitive.

The caution I give you is that we are continuing to see quite a bit of competitive pressure in big books of business like international Intermodal and Coal.

Okay.

So you -- do you want to put a number around it?

Is it like 20%, 30%, 40%?

Rob will not let me tell you a number.

Well, there's still (inaudible) in various categories, but we're going to stay clear of giving a precise fine point on that.

Our next question is from the line of Jason Seidl with Cowen and Company.

Well, let me drag the horse out again, guys.

Let me look at it in a different way.

So obviously, you're saying modest sequential decline in what you report as core price or essentially the same as the previous quarter.

When you look at the contracts that you have signed this year or maybe late last year, would those be above that core rate that you posted in the fourth quarter?

So something similar to one of your competitors reported north of the border?

Yes, so we don't -- we really don't talk about individual deals when we do this.

We have a very purist mentality about how we calculate price.

We are looking at the yields.

And so one thing that you might want to think about is it really kind of depends on what's going on in your book of business, right.

So mix can be very important.

In the fourth quarter, we did virtually the same price as what we got in the third quarter, and we had a lot of changes in that mix of business.

So it just -- it matters in the way that we calculate price.

We still feel good about the pricing that we're getting.

We are going to take advantage of the opportunities we have as the spot truck rates firm, we hope, into longer-term capability to price there.

And as I've mentioned a few times, it feels like a bunch.

We still see headwinds in some of our big books, international Intermodal and Coal being 2 that we call out for you.

But your description of firming at least intrigues me to some extent because what we're seeing in the marketplace in the spot side is really strong price increases and a lot of people talking about potential contractual increases somewhere between 6% and 10% on the truckload side.

Are you guys seeing something different?

Because I would have categorized it as strong rate increase, not firming, if you will.

Jason, this is Lance.

We would love for the current truck pricing environment to continue all the way through bid season next year, and there's a potential that it does.

And it's a great environment for us to be out in the marketplace pursuing business and repricing business.

So I think that's probably the sum total of what we want to say about truck pricing.

Okay.

My follow-up is on Mexico.

Could you talk a little bit about the total exposure in terms of traffic direct from you guys and then maybe in the interchange?

As well as, do you feel that there's been any increase in shipping to and from Mexico ahead of any potential issues with NAFTA?

Yes, I'll take that, Jason.

So our Mexico businesses is about 11%, maybe a little bit more, of our overall book.

We enjoy about 70% of that business to and from Mexico that's shipped by rail.

And we have not seen anybody's behavior in our served markets changing pending NAFTA.

Now having brought up NAFTA, of course we're keeping a very close eye on current negotiations.

You know we're in the penultimate negotiation up in Montréal.

So they're down to the really difficult parts of the deal that need to be negotiated.

And while I still believe there is a good opportunity for the NAFTA agreement to be solidified, all 3 parties continue in it going forward, we've got a strong eye on all the what-ifs and contingency plans and agility to react to whatever would happen.

Our next question is from the line of Matt Reustle with Goldman Sachs.

Just going back to the productivity program and particularly in the context of the current cycle.

Is there any trade-off here where you think you'll capture less of the volume or the pricing upside in the cycle just given you have this longer-term focus on productivity?

I'll take a stab at that.

So when I -- when we think about productivity, we don't view that as a trade-off for price and volume.

Productivity, to a fairer degree, is in our control and things that we are consuming, paying for, organized for in order to provide an excellent customer service, which allows us to price in the marketplace.

So I don't think we see it as a trade-off like that.

Okay.

And just to go back to one of your follow-ups to, I think, David's question on capital investment, I would think that the return on any projects that you were considering on a previous tax reform would -- or previous tax framework would improve your tax and cash flows at a lower rate, immediate depreciation.

I guess why wouldn't that increase the pool of investments that would be attractive to you?

And is it just a factor of even after you adjust for those returns, it doesn't meet your hurdle rate?

Matt, this is Rob.

I would say clearly, yes, that's a positive.

Tax reform is a positive in that calculus.

But I think what we were say and Lance addressed earlier is that alone is not going to cause us to -- it's not like we have a bunch of pent-up capital projects that were sitting on the sidelines just waiting for that extra couple of points of improvement in the ROI.

And oh, by the way, I would remind you that we are improving -- or increasing our capital spend in 2018 versus '17.

So it's all in the mix of things, but it's not like that's opening a floodgate of additional investment that was pent up, sitting on the sideline.

But -- so let's take a step back and take a little broader perspective of this tax reform.

We do believe, and we hear from our customers and our markets, that tax reform fundamentally makes the United States more competitive, both for direct investment, whether it's foreign direct investment or domestic investment and for competing with either import goods or for export goods.

So from our perspective, we believe that tax reform will result in more opportunity for us over the longer term, which should result in more opportunity for us to invest and to grow and to hire.

But that's the string that we see happening.

Basically, it'll affect the competitiveness of the markets that we serve, and then that'll drive incremental investment opportunity and incremental hiring opportunity.

Our next question comes from the line of Ravi Shanker with Morgan Stanley.

Just one straggler here.

There's been a change in Canadian grain regulation that potentially allows U.S. rail to maybe access some of that market.

Do you see that as an opportunity for you guys?

Beth?

The change doesn't impact Union Pacific in particular.

We do participate in some of the Canadian grain market that would come out -- that would come across to us from one of the Canadian railroads and go to export.

But we don't see that -- this change in the regulation materially changing anything for us.

Got it.

And just a follow-up.

On the frac sand market, you said the second half of the year is likely to be challenging given the emergence of some local alternatives.

What's your game plan there?

Is there anything you guys can do to kind of make your business more competitive or help make white sand more competitive, or is it brown sand, to kind help defray that impact?

Well, the reason that the brown sand is really emerging is because the logistics costs are so substantial coming from Wisconsin and Minnesota.

And while there could be fringe markets that you can help make that work, it doesn't seem like that's solvable by us.

However, I do think that there are other markets, other shale plays where white sand is desirable that will continue to emerge.

So you -- it's not just the Permian.

It -- there's Eagle Ford, there's -- the Oklahoma markets are pretty hot.

You're seeing investment happening in the DJ Basin and Colorado as well.

And we're pursuing participation in the local markets to the extent that makes sense as well.

Our next question is from the line of Justin Long with Stephens.

I wanted to ask about incremental margins as the fourth quarter was lighter than what we've typically seen in this type of environment.

Was there anything outside of the fluidity issues you mentioned that drove this?

And as we look into 2018, what's your confidence incremental margins can return to levels that are 50%-plus?

Okay, Justin, you're right on.

I mean, as I pointed out earlier, we were not happy with our performance in the fourth quarter on a couple of measures, and that showed up in the incremental margins.

But it was fully explained by some of the fluidity challenges that Lance and Cam addressed earlier.

So there's nothing other behind the scenes on that.

And as we look to get to our 60%, plus or minus, by 2019, we've got to annually run in the 50% to 60% incremental margin range.

And that's our focus and we understand that.

And we're confident in our ability to get there.

That's helpful.

And Lance, you mentioned a couple times earlier that operating performance did slip in the second half.

And I wanted to ask if you could address when you think the network can get back to normal fluidity this year.

And what are the specific action items that are necessary to see this recovery?

Yes, I'll just briefly take a stab at that question and ask Cameron to provide more.

The -- we won't put a date certain on when we think the network is "back to normal." My expectation is it happens sooner as opposed to later.

This isn't something that I think we wait around and see what happens in the first and second quarter.

We -- I mean, we are actively working on the handful of issues that we need to address.

And Cameron, maybe you want to talk about those specifics?

Velocity at this particular time is being impacted as we implement PTC in Chicago and Kansas City and Houston.

That's really the last series of implementations that we have ahead of us.

There are always challenges when we implement in those big network, industrialized, heavy areas.

And we'll work our way through those.

We are shifting quickly from implementing PTC to problem solving PTC, which requires a technical team to continue to problem solve and really a human design team to help people become more familiar and try to adapt to the technology that we've asked them to use as they're running trains.

So we'll continue to work that throughout 2018 and there is -- there are really no other critical issues that's impeding velocity other than that.

Well, we've got a couple of discrete kind of execution areas that we've got to pick up on.

But the good news from my perspective is we've got all the resources we need, we've got the right team and they're focused on the right stuff.

So we -- I expect this to happen sooner, not later.

Our next question is from the line of Brian Ossenbeck with JPMorgan.

So following up on the PTC comments.

You said you're going through the big metropolitan areas.

Cam, I (inaudible) think you give us a -- I don't think you gave us a guesstimate last quarter on how much PTC implementation shaved off velocity for the network.

So that would be helpful.

And as you look ahead to -- beyond 2018 and the next couple of years, how -- what's your early sense of the other rails and interoperability?

And is it not going to be another potential challenge for rolling out this system after this first -- after the first couple of legs you're going through here now?

During the previous earnings call, we estimated 0.5 mile an hour to 1 mile an hour, and that still looks like to be a very solid estimate, somewhere in that range.

And as we mentioned, some of that, as we troubleshoot, problem-solve and train our employees, will be recovered.

You do highlight the challenge for the entire industry which is ahead of us, which is the interoperability, which we have all been working very closely with each other all along.

I don't believe there'll be any issues with executing that.

It is a little bit of an unknown.

We have yet to marry up with BNSF or Norfolk Southern or CN or CP and really run each other's products on each other's railroads.

That's ahead of us here this year.

Okay.

Is there a specific time on when you start to cross tracks or link up the system, as you mentioned?

I'll give you one example that is time certain.

If you think about Metra, Union Pacific Metro in Chicago, that cutover with each other is going to be this July.

Okay.

And Lance, just one quick one for you, if I could, on just trade flows globally.

We've seen some news on tariffs being increased.

But on the flip side, we've got the weaker dollar, which has been down, I think, 4%, 5% since you last reported earnings.

So just what are you hearing from some of the bigger customers, bigger accounts?

And what's your view on kind of the upside and downside with potentially more like tariffs, but offset by what could be a continual weaker dollar, which would be a pretty nice tailwind for you and for the industry in general?

Yes, Brian, thanks for that question.

The -- there's a lot of moving parts as regards trade, and trade is pretty important to us, of course.

First, we need consumers in the United States to feel optimistic and feel wealthy so that they consume stuff, build homes, et cetera.

And that looks like it's set up pretty well as long as the risks in the global environment don't kind of overwhelm that optimism.

Right now, consumers are saying they're pretty optimistic, and we see wages starting to increase and they feel pretty wealthy.

The second thing that needs to happen is we've got to have open markets and free and fair trade, and more open markets is better.

While there's some rhetoric that isn't helpful to that as we're negotiating NAFTA and as the administration observes other trade relationships, as of yet, I have not seen it significantly negatively impact markets that we serve, nor in conversations with my counterparts in those markets are they saying it's fundamentally changing their behavior at this point.

So there's a lot to pay attention to.

Now this -- I think the power of the tax reform is -- it almost can't be overstated to some degree.

You think about this.

Every product produced in the United States that has any kind of supply chain to it, all along the way suppliers build in a 35% tax rate historically.

That drop to the 21% fundamentally alters the landscape for cost of goods sold coming out of the United States.

And at the same time, it makes us very attractive -- more attractive for investment, capital investment.

All of that is positive for railroads.

And so I think in the net, we're very -- we're cautious and we're deliberate and diligent on all the moving parts, but I think there's a pretty fair chance that it turns out positive as opposed to negative.

Our next question is from the line of Amit Mehrotra with Deutsche Bank.

I guess you guys were saving the best for last.

First one is on the share repurchase.

The company committed to 30 million, I guess, share buyback clip through 2020 back in late 2016.

You ran a little bit above 20% that rate last year by repurchasing a little more than 36 million shares.

Now we have tax reform, the share price is up more than 50% since that target was announced.

So just given all those factors and moving parts, can we assume maybe a bit of a cooling off on the pace of buybacks given the fact -- those factors?

Or -- and also, are you still committed to repurchasing 120 million shares by 2020 from the 2017 date?

Yes, Amit, this is Rob.

We don't straight-line our repurchases.

It's -- we're opportunistic in terms of the price and the opportunity, and we will continue to operate that way.

But I wouldn't take -- I wouldn't interpret anything that we've said or what the benefits of the billion dollars of additional cash flow from the tax to imply that we will slow down the pace of share repurchases.

I wouldn't look at it that way.

We're still working through all the details of that, but we think it gives us a greater opportunity on dividends and share repurchases, frankly.

So the 120 million target in terms of shares is still very much intact, maybe even -- I don't want to put words in your mouth, but maybe even some upward bias to that given the inflows from the tax reform?

I think we're still on track.

I mean, we're still on track for that.

Okay.

Okay, one other quick one for me.

And I don't mean to nitpick on the core pricing, but I just wanted to be crystal clear on the movement as you move from 3Q to 4Q.

You did talk about rounding and then offering kind of that 1.75% number in the fourth quarter down from 2 percentage.

I just wanted to see, was that 2% rounded?

And again, I'm not trying to nitpick here, but I just want to be clear.

Was it 2.00% or 1.8% or 2.05%?

Any color there so we're just -- we're all on the same page in terms of that.

Yes, fair point, Amit.

And as I said earlier, if you recall, in the third quarter, I said our pricing, when you look at what we yielded in the third quarter, was just under 2%, and we've refined our convention in terms of the rounding.

So I would say again, the story is not the big change from the third to the fourth quarter, and it's probably in -- 0.10% or 0.2% kind of range in terms of the way the math flew.

So it's not a full quarter-point difference.

But the -- so the mix shifts that impacted the headline number, I would just imagine, would probably accelerate over the next 12 months in terms of the Coal and Intermodal volumes.

So I know you talked about, I guess, in response to one of the previous questions, that 50% to 60% is obviously the walk to get to your long-term target.

But how do incremental margins get to accelerate from kind of the back half of the year when some -- maybe some of the mix challenges accelerate in 2018?

Amit, I don't think we really talked in detail about mix challenges.

What we were referring to or trying to refer to is that mix is a significant contributor to what happens sequentially quarter-to-quarter to pricing.

And if you look at incremental margin, which we only really talk to for purposes of kind of illustrating full year last year was something like mid-60s, the fourth quarter was something like high 30s right.

So the fourth quarter from our perspective was all about fluidity and some incremental costs like a little elevated re-crews, some -- a little elevated overtime, a little elevated TE&Y force levels or more equipment that we would need normally, all adding up expense that didn't need to be there.

Our next question is from the line of Ben Hartford with Robert W. Baird.

I just want to come back to service real quick, Lance and Cameron.

When you -- what's clear is the economic outlook has improved, the truck market is tight, there were some headwinds across the rail space noted in the back half of the year that presented challenges to service.

You talked about the PTC.

And I think, Lance, you said you expect improvement for the year sooner rather than later.

But what in your mind is the biggest risk to service improvement here?

Historically, it would suggest that it's accelerating volume growth across the rail network, and I think that's clearly a bias here as we start the year, but it's also well telegraphed.

So is it the macro?

And if not, then what is in your mind the biggest risk to incremental service improvement during the course of 2018?

Sure.

I'll start and then turn it over to Cameron.

This -- the, I'll call it, a service blip that was reflected in our fourth quarter, again, is not systemic.

Historically, when we would get into really difficult times, we get behind the resource curve for locomotives, TE&Y, other later, and it's really hard to catch up in those environments.

It takes quite some time given the lead time, the kind of amount of time it takes to get incremental resources back into the network.

We're not anywhere near a place like that.

We've got 800 or 1,000 locomotives stored.

We've got a pipeline full of TE&Y that makes sense to us.

So that -- it's not that stuff.

From this point going forward, service will be about maybe some weather shocks, that's always a possibility, and making sure we navigate through positive train control effectively, that we are problem-solving things that are getting in the way of us being fluid and doing that rapidly.

Cam?

To answer your volume question, which is a good one, Northern region looks sound, Western region looks very sound.

It's really about the State of Texas and very positive growth not only this year but the next several years.

And that is what Brazos is meant to address.

Plus if you looked under the hood of where we're spending our capacity dollars, it is all pointed at Texas.

So we have the right capacity projects pointed at growth to take care of the Southern region.

Okay, that's great.

And then Rob, a quick follow-up on the other income line item as you look to 2018.

Any direction relative to '17 or on an absolute basis?

Yes, good question, Ben, because '17 was an unusually high year.

If you'll remember, in the third quarter we had a couple of large transactions, Kinder Morgan, Seabrook, which we called out.

So as we look to -- a normal year is closer to, I'll call it, $150 million range, plus or minus, rather than, call it, the $300 million that we had this year.

Our final question today is from the line of Cherilyn Radbourne with TD Securities.

I just wanted to ask a quick one on network performance.

The slide mentioned transportation plan adjustments, and I was just wondering if you could clarify whether that was intended to indicate that adjustments to the plan impacted network velocity in Q4 or that you intend to make changes to the plan to improve network velocity.

Cam?

We always take Beth's forecast and drop it into a model and take a look at a couple basic questions surrounding T-Plan, whether or not we have enough T-Plan to offload our terminals, and we make adjustments as necessary.

So, well, we'll be watching that, particularly down on the Southern region.

And again, it's not really a Western region or Northern region exercise.

It is focused on the Southern region.

Thank you.

I will now turn the floor back to Mr. Lance Fritz for closing comments.

Great.

Thank you, and thank you all for your questions and interest in Union Pacific.

We're all looking forward to talking with you again in April.

This concludes today's teleconference.

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Thank you for your participation.