聯合太平洋集團 (UNP) 2019 Q3 法說會逐字稿

Greetings.

Welcome to the Union Pacific Third Quarter Earnings 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.

Mr. Fritz, you may begin.

Thank you, Rob, and good morning, everybody.

And welcome to the Union Pacific's Third Quarter Earnings Conference Call.

With me today in Omaha are Kenny Rocker, Executive Vice President of Marketing and Sales; Jim Vena, Chief Operating Officer; and Rob Knight, our Chief Financial Officer.

I've also asked Jennifer Hamann, our newly appointed Chief Financial Officer, effective January 1, to join us for the Q&A portion of the call.

So before we get started today, I want to take a moment and thank Rob for his service and contributions to Union Pacific over his 40-year career, particularly the last 16 years as CFO.

Rob has been a critical member of our senior team and was instrumental in driving Union Pacific's financial success.

We wish him all of the best in his upcoming, well-deserved retirement, and thank you very much, Rob.

And I also would like to welcome Jennifer to the CFO role.

She and Rob are doing a great job working through the transition, and I'm confident that Jennifer is the right choice to lead our financial initiatives into the future.

This morning, Union Pacific is reporting 2019 third quarter net income of $1.6 billion or $2.22 a share.

This represents a 3% increase in earnings per share and a 2% decrease in net income compared to 2018.

Our quarterly operating ratio came in at 59.5%, a 2.2 percentage point improvement compared to the third quarter of 2018.

Once again, this represents an all-time record quarterly operating ratio, beating our previous low established last quarter.

That's quite an achievement when you consider the fall-off in volume during the quarter.

We are continuing to drive productivity through our G55 + 0 and Unified Plan 2020 efforts, which are also producing a safe, reliable and consistent service product for our customers.

The work our employees are doing as part of Unified Plan 2020 is foundational to the company's success and there are additional improvement opportunities going forward for both our customers and our shareholders.

With that, I'll turn it over to Kenny to provide more details on our results.

Thank you, Lance, and good morning.

For the third quarter, our volume was down 8% as gains in our industrial business group were more than offset by declines in ag products, premium and energy.

At the same time, we generated a positive net core pricing of 2.5% in the quarter as we continue to price our service product to the value it represents in the marketplace while ensuring it generates an appropriate return.

Freight revenue was down 7% driven by the decrease in volume, partially offset by a 1% improvement in average revenue per car.

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

Starting off with ag products, revenue for the quarter was down 1% on a 2% decrease in volume and a 2% improvement in average revenue per car.

Grain carloads were down 3% primarily driven by continued reduction in export grain shipments, partially offsetting feed grain declines with strength in wheat.

Volume for grain products was flat as sustained demand for biofuels and supporting products was offset by reduced exports.

Fertilizer and sulfur carloads were down 5% primarily due to soft global demand for potash.

Moving on to energy, revenue was down 20% as volumes declined 15% coupled with a 5% decrease in average revenue per car related to negative mix with the loss of long-haul sand volume.

Sand carloads were down 45%, largely due to the impact of local sand.

Coal and coke volume was down 17% due to the softer market conditions, resulting from lower natural gas prices and weak export demand.

In addition, contract changes and retirements also impacted volume in the quarter.

However, on a positive note, favorable crude oil price spreads drove an increase in crude oil shipments which was the primary driver for the 18% increase in petroleum, LPG and renewable carloads for the quarter.

Industrial revenue was down 1% on a 2% increase in volume and a 3% decrease in average revenue per car due to the negative mix with increased shorter-haul business.

Construction carloads increased 16% primarily driven by a strong market demand in the south for rock shipments.

Plastics volume increased 7% due to higher production.

Forest products volume decreased 11% driven by softness in the lumber and paper market.

Turning to premium, revenue for the quarter was down 9% on a 11% decrease in volume while average revenue per car improved by 2%.

Domestic intermodal volume declined 11% primarily driven by an abundant truck supply coupled with softer demand during the quarter.

International intermodal volume was down 12% during the quarter, reflecting weak market conditions related to trade uncertainty, escalating tariffs and challenging year-over-year comparisons driven by accelerated shipments seeking to avoid tariff in September 2018.

And finally, finished vehicle shipments were down 4% for the quarter.

Third quarter U.S. auto sales were down approximately 2% from 2018.

Strong light vehicle and SUV sales did not fully offset declining car demand.

Looking ahead for the rest of 2019, for ag products, we anticipate continued strength in advanced biofuel shipments and associated feedstock due to an increase in demand, which will help offset challenges in the ethanol marketplace.

We also expect stronger beer shipments along with long-term penetration growth across multiple segments of our food and refrigerated business.

And furthermore, with the recent outlook with China to take more ag products, we hope to see some relief as those exports resume.

However, we will continue to keep a watchful eye on foreign tariffs within our ag market.

For energy, we expect favorable crude oil price spreads to drive positive results for petroleum products.

Local sand supply will continue to impact volume although the comps should improve over the long term.

We also expect coal experience continued challenges with volume throughout the balance of the year and weather conditions will always be a key factor for coal demand.

Looking at industrial, we anticipate an increase in plastic shipments driven largely by plant expansions coming online later this year coupled with continued strength in the construction market in the south.

But we continue to watch housing starts and the projected softness in the overall market.

And lastly, for premium, the light U.S. vehicle sales forecast for 2019 is 16.8 million units, down about 2% from 2018.

Although we remain encouraged by the tentative agreement between General Motors and their autoworkers, we're still keeping a close watch on it and the associated volume impact.

Domestic intermodal volume is sequentially strengthening, but when compared to 2018, it is expected to be impacted by truck competition in the fourth quarter.

In addition, we expect international intermodal to return to its normal seasonal flow but face tough year-over-year comparisons due to accelerated shipments seeking to avoid tariff increases in 2018.

And now, I'll turn it over to Jim.

Thank you, Kenny.

Well, we finally had a clean quarter from a weather perspective, and I think our results speak volumes for what is possible.

Our operating metrics continue to improve, and as a result, we are seeing a better service product for our customers.

Furthermore, I couldn't be more proud of how the team has responded to the challenge of rightsizing our cost structure in the face of declining volumes while driving significant productivity.

For example, crude starts were down 15% in the quarter and outpaced the 8% decline in carloads we experienced.

This along with our Unified Plan 2020 actions drove an all-time best quarterly operating ratio of 59.5%, which truly was a remarkable achievement.

While we are continuing to drive productivity, these gains are overshadowed if we aren't simultaneously improving safety.

Our incident experience has not improved, but we are committed to getting better.

As always, safety remains job 1 at Union Pacific.

Let me turn over to Slide 11.

I'd now like to update you on our 6 key performance indicators.

We continue to see substantial year-over-year improvement in our metrics.

In fact, earlier this year, I said we would blow by some of our goals and we are doing just that.

So direct results of our relentless focus on improving network efficiency and service reliability is part of Unified Plan 2020.

Continued improvement in asset utilization and fewer car classifications led to a 20% improvement in freight car terminal dwell and a 10% improvement in freight car velocity compared to the third quarter of 2018.

Our train speed for the third quarter, as a whole, decreased 1% to 23.7 miles per hour compared to 2018.

We turned the corner in September and saw a year-over-year improvement, and the trend has continued into October.

As I've mentioned in the past, our train speeds continue to be affected by additional daily work events being performed as part of Unified Plan 2020.

While these work events are helping us increase train size and drive asset utilization, there is an opportunity to execute these work events even more efficiently and drive faster train speeds.

Turning to the Slide 12, continuing our trend from the second quarter, locomotive productivity improved 18% versus last year as efforts to use the fleet more efficiently enabled us to park units.

As of September 30, we had around 2600 locomotives stored.

Driven by a 13% decrease in our workforce levels, workforce productivity increased 4% year-over-year.

In addition to improving productivity, delivering on a great service product is of equal importance to the team.

Car trip plan compliance improved 10 points year-over-year driven by increased freight car velocity and lower terminal dwell.

While we are pleased with our progress, we do expect our service product to improve going forward.

In fact, we're already seeing sequential improvement in October.

Slide 13 highlights some of the recent network changes we have made as part of Unified Plan 2020.

By shifting classification work to surrounding terminals, we are able to reduce operations at our Rolesville hump yard, resulting in increased car velocity for associated manifest business.

In addition, we reduced switching operations at our yard in Alexandria, Louisiana, moved the work to a more efficient terminal in Livonia.

We also stopped humping cars at Neff Yard in Kansas City.

As a result, we will now build overhead blocks to drive cars deeper into the network and leverage existing flat switching terminal in the Kansas City complex.

Going forward, we will continue to look for ways to reduce car touches, which undoubtedly lead to additional terminal rationalization opportunities on our network.

Currently, one of our main areas of focus is to utilize our existing network capacity, and we are making excellent progress on this front, as illustrated by the train length graph on the right.

By putting more product on fewer trains, we've increased train length across our system by over 1,000 feet or 15% since January of this year.

In fact, we have specific initiatives up against the Sunset, Central and North-South corridors on our network, and they are paying big dividends.

Earlier this year, we discussed investing capital in our Sunset corridor for site extensions to support productivity initiatives.

Through a collaborative team effort, that work was completed in record time.

As a result, I am pleased to report the train length in the Sunset corridor has increased 18% since January 2019.

Furthermore, operational changes in our North-South corridor between Chicago and South Texas have driven train length up over 21% since the start of the year.

Looking forward, I expect to see continued improvement in train length through a combination of transportation plan changes and targeted capital investments.

To wrap up, on Slide 14, we've made a number of changes to our operations in the last year and the results have been outstanding.

However, there's still a lot of opportunities ahead of us to further improve safety, asset utilization and network efficiency.

As we move forward, look for us to continue pushing the envelope and taking bold steps as we transform our operation.

Running a safe, reliable and efficient railroad for both our customers and our shareholders is nonnegotiable, and our team is committed to making that happen.

And with that, I'll turn it over to Rob, for the last time.

Thanks, Jim, and good morning.

Today we're reporting third quarter earnings per share of $2.22 and a 2.2 points of year-over-year improvement in our operating ratio to 59.5%.

This represents an all-time best quarterly operating ratio for Union Pacific and the second consecutive quarter with a sub-60% operating ratio.

This is, once again, a testament to the great work that we're doing with G55 + 0 and the Unified Plan 2020.

Our quarterly results were affected by some onetimers, so before I jump into the details, let me set the stage.

An increased frequency of rail equipment incidents resulted in approximately $25 million of added operating expenses in the quarter.

These excess costs for cleanup, destroyed equipment and damaged freight resulted in a 0.5 point negative impact to our operating ratio and subtracted $0.02 of EPS compared to the third quarter of 2018.

The combined impact of lower fuel price and our fuel surcharge lag had a favorable impact for the quarter of 0.9 points on the operating ratio, adding $0.04 of EPS compared to 2018.

The good news is that despite lower volumes, we drove core margin improvement of almost 2 points compared to the third quarter of last year.

Now let's recap our third quarter results.

Operating revenue was $5.5 billion in the quarter, down 7% versus last year.

The primary driver was an 8% decrease in volume.

Operating expense totaled $3.3 billion, down 10% from 2018.

Operating income totaled $2.2 billion, a 2% decrease compared to last year.

Below the line, other income was $53 million, up 10% from 2018, driven by lower benefit plan costs and increased rental income, partially offset by higher environmental costs.

Interest expense of $266 million was up 10% compared to the previous year.

This reflects the impact of a higher total debt balance.

Income tax expense decreased 4% to $466 million.

Our effective tax rate for the third quarter was 23.1%.

And for the full year, we expect our annual effective tax rate to be around 23.5%.

Net income totaled $1.6 billion, down 2% versus last year, while the outstanding share balance decreased 5% as a result of our continued share repurchases.

As I noted earlier, these results combined to produce third quarter earnings per share of $2.22 and an operating ratio of 59.5%.

Freight revenue of $5.1 billion was down 7% versus last year.

Fuel surcharge revenue totaled $393 million, down $89 million compared to 2018.

Business mix had almost a 1 point negative impact on freight revenue in the third quarter driven by increased shorter-haul rock business and decreased agricultural product volumes along with reduced sand carloadings, somewhat offset by fewer intermodal shipments.

Core price was 2.5% in the third quarter, similar to the pricing that we achieved in the first half of 2019.

Although the reported yields are slightly lower, this is not indicative of any quarterly pricing actions.

As you've heard me say many times before, in order to get credit for price under our methodology, which we believe is the right way to calculate price, you have to move the volumes.

In the third quarter, the fall-off in volumes negatively impacted our pricing yield.

Having said that, beginning with our fourth quarter results, we will no longer report detailed pricing numbers.

We are making this change solely for commercial reasons as Union Pacific is the only Class 1 railroad to publicly report detailed pricing results, which we now believe disadvantages us in the marketplace.

This should not be read in any way as Union Pacific becoming less disciplined or less focused on pricing.

Of course, price will continue to play a key role in achieving our financial goals and our guidance is unchanged.

And rest assured, we will continue to yield pricing dollars above our rail inflation costs.

Slide 19 provides a summary of our operating expenses for the quarter.

Compensation and benefits expense decreased 10% to $1.1 billion versus 2018.

The decrease was primarily driven by a reduction in total force levels, which were down 13% or about 5700 FTEs in the third quarter versus last year.

Productivity initiatives, along with lower volumes, resulted in a 13% decrease in our TE&Y workforce while our management, engineering and mechanical workforces together declined 15%.

Fuel expense totaled $504 million, down 24% compared to 2018 due to lower diesel fuel prices and fewer gallons consumed.

Average diesel fuel prices decreased 12% versus last year to EUR 2.09 per gallon and our consumption rate improved 3% through more efficient operations.

Purchased services and material expense was down 9% compared to the third quarter of 2018 at $574 million.

The primary drivers of the decrease in the quarter were reduced mechanical repair costs and less contract services and materials, partially offset by reduced foreign car repairs.

Turning to Slide 20, depreciation expense was $557 million, up 2% compared to 2018.

For the full year 2019, we still expect the depreciation expense will be up 1% to 2%.

Moving to equipment and other rents.

This expense totaled $236 million in the quarter, which is down 13% when compared to 2018.

The decrease was primarily driven by lower equipment lease expense and less volume-related costs.

Other expense was down 3% compared to the third quarter of 2018 at $277 million driven by lower environmental expenses, partially offset by an increase in cost associated with damaged freight and destroyed equipment.

For the full year 2019, we expect other expense to be up low single digits compared to 2018.

Productivity savings yielded from our G55 + 0 initiatives and Unified Plan 2020 totaled approximately $170 million in the quarter, which was partially offset by the additional costs that I mentioned in my opening remarks.

As a result, net productivity for the third quarter was $145 million with year-to-date net productivity, now standing at $375 million.

This is a remarkable outcome when you think about the challenges that we have overcome such as unprecedented flooding and a weak volume environment.

In fact, we continue to gain traction with our productivity initiatives and are confident that we will still deliver at least $500 million of net productivity in 2019.

Looking at our cash flow, cash from operations in the first 3 quarters totaled $6.3 billion, down slightly compared to last year.

Free cash flow before dividends totaled $3.8 billion, resulting in free cash flow conversion rate equal to 83% of net income for the first 3 quarters of 2019.

Taking a look at adjusted debt levels.

The all-in adjusted debt balance totaled $28 billion at the end of the third quarter, up $2.9 billion since year-end 2018.

We finished the third quarter with an adjusted debt-to-EBITDA ratio of 2.6x.

As we have previously guided, our target for debt-to-EBITDA is up to 2.7x.

Dividend payments for the first 3 quarters totaled more than $1.9 billion, up $209 million from 2018.

This includes the effect of 10% dividend increases in both the first quarter and third quarter of this year.

During the third quarter, we repurchased 6.4 million shares at a cost of $1.1 billion.

We also received 3.2 million shares in the third quarter associated with the closeout of a $2.5 billion accelerated share repurchase program that we initiated in February.

Between dividend payments and share repurchases, we returned $7.1 billion to our shareholders in the first 3 quarters of this year.

Looking out to the remainder of 2019, with the current softness in rail volumes and the underlying economic uncertainty in the marketplace, we expect fourth quarter volumes to decline year-over-year at a similar level to what we experienced in the third quarter.

Clearly, we would love to have additional volume.

With a more consistent and reliable service product, we are poised to grow our business.

And going forward, we will continue to price our service to the value that it represents in the marketplace while ensuring that it generates an appropriate return.

We remain confident that the dollars we yield from our pricing initiatives will again well exceed our rail inflation cost in 2019.

With respect to capital investments, we now expect full year 2019 spending to be around $3.1 billion or about $100 million less than our previously announced $3.2 billion plan.

Although we are continuing to invest in projects that support the Unified Plan 2020 productivity initiatives, we've scaled back some of our growth capital spend in light of current business volumes.

As it relates to our workforce, strong productivity initiatives and, to a lesser degree, lower volumes have resulted in a 9% year-to-date reduction.

For the balance of the year, we expect continued combination of operating efficiency gains and lower business levels should result in fourth quarter force levels to be down at least 15% versus 2018.

As a result, full year force levels should be down slightly more than 10% which positions us nicely going into 2020.

Importantly, with improving margins in the second half of the year, our guidance of a sub-61% operating ratio in 2019 on a full year basis remains intact despite the fall-off in volumes.

Furthermore, an early look at next year's productivity lineup gives us confidence with our ability to achieve an operating ratio below 60% for 2020.

As you have heard me say many times before, we have to play the hand that we are dealt when it comes to volume, but let me assure you, our commitment to achieving our financial targets is unwavering, and we are moving aggressively to improve, regardless of the economic environment.

Before I turn it back to Lance, if you can indulge me for just one minute, as was said, this is my final earnings call, and I want to thank all the men and women of Union Pacific for the dramatic improvements in safety, service and financial results over the past 16 years.

I am very proud that we have improved our operating ratio 28 points, increasing our market cap by over $100 billion over that time.

And I am confident that the team will continue to drive great results as we drive to a 55% operating ratio.

I have never felt better about the path that we are on operationally.

And I also know that Jennifer will be an outstanding CFO.

And finally, I would like to thank everyone listening today for all the professionalism and support that you have given me and Union Pacific, and I wish you all the best.

With that, I'll turn it back to Lance.

Thank you, Rob.

As discussed today, we delivered solid third quarter financial results and we've made tremendous strides to improve our productivity and service product as part of Unified Plan 2020.

For the remainder of 2019, we look forward to building on our successes and we provide a highly consistent and reliable service product for our customers.

Although there are some unknowns looking ahead at the economy, confidence in our operational capabilities, as Rob just mentioned, has never been greater.

As always, we're committed to operating a safe railroad for our employees and the communities that we serve and we have some work to do there.

We remain squarely focused on driving long-term shareholder value by appropriately investing in the railroad and returning excess cash to our shareholders through dividends and share repurchases.

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

(Operator Instructions) And our first question comes from Justin Long with Stephens.

I'll start with congrats to Rob and Jennifer on the announcement.

Maybe to start on head count, if we just look at the guidance for the fourth quarter and take the exit rate this year and hold that steady, it seems to imply another 6% reduction or so in the head count in 2020, if you just hold things flat sequentially throughout next year.

I know it's somewhat volume-dependent, but should we be thinking about a 6% reduction in the head count at a minimum for next year?

And can you just speak to the opportunity beyond that level as you continue to implement PSR?

Justin, this is Rob.

We haven't finalized our 2020 plan and so volume will obviously have a role in what the head count actually ends up being, but we're confident in that and we're hopeful that volume is positive and we will grow that very efficiently from a productivity standpoint.

Having said that, you're right, we're exiting at a very efficient level, we're gaining momentum with the Precision Rail and Unified Plan 2020 initiatives that Jim talked about.

So directionally, I think you're thinking about it right.

We're not guiding to that number but that directionally is exactly what we're thinking.

Okay.

And then maybe secondly, more of a near-term question.

Last couple of years, we've seen the OR stay fairly flat sequentially third quarter to fourth quarter.

Should we be thinking about the OR staying flattish sequentially in 4Q of this year as well?

Or is there something that could cause a divergence from the trend we've seen in the past couple of years?

Yes.

We're not giving quarterly guidance on that but I think directionally also, there, you're thinking about it right, and I gave you sort of early look at what we expect to see on the volume front, which would be a similar decline in the fourth quarter that we saw in the third quarter.

So there is nothing unusual outside of that.

We're obviously going to continue to implement the Unified Plan 2020 initiatives and do as good as we can, but you're thinking about it directionally right.

The next question is from the line of Chris Wetherbee with Citi.

Congrats to Rob and Jennifer.

Rob, it's been great working with you.

Wish you all the best on your retirement.

I guess I wanted to come back to the head count dynamic.

Certainly, a 15% reduction in the fourth quarter is dramatic and a big, big number.

I guess when you think about sort of when you set the target for a 10% decline earlier this year relative to what we've seen from a volume perspective, you can make an argument that obviously volume has sort of disappointed, I guess.

So how do you feel about sort of a balance between your resources and what we're seeing from a volume perspective?

Is there opportunity -- I'm coming at this question, I guess, slightly similarly to Justin, but kind of a little bit different.

Is there an opportunity to kind of get a little bit more aggressive on the head counts as we kind of go through this 4Q, 1Q, hopefully bottoming in volume?

Yes.

Chris, this is Lance.

Without putting a really fine point on it, the short answer is largely, yes.

Right, we have been a little disappointed in the top line versus what we were hoping to see when we came into the year.

As a result, we've adjusted head count more aggressively to match that drop in volume.

You see that happening in the third quarter as we had head count lower than volume, and I expect we will continue that.

Jim, do you want to add a little technicolor in terms of some of the opportunity that you see in the operations.

So I think the numbers speak for themselves, Lance.

I think the team did a great job of taking into account where the volume ended up this quarter and what we were able to react, and we're going to do the same thing.

We're going to react to -- on any volume.

Hopefully, the volume goes up.

But at the end of it, we'll react in the right way, and we see a sequential drop in the number of people that we have as we move forward against the flat line business model.

Okay.

Okay.

That's helpful.

And I appreciate that.

Can we talk a little bit about the top line and yield specifically?

I guess from a yield standpoint, some sequential deterioration here.

Can you talk a little bit about sort of the competitive pricing environment that you're dealing with in your markets and then maybe some of the mix dynamics that are kind of working their way through?

If there's any predictability to the mix as we look out to 4Q or maybe 1Q?

Could you sort of highlight that?

But those kind of dynamics around yield would be very helpful.

Before I turn it over to Kenny, I just want to remind everybody, Rob said this, that we calculate yield in the most conservative way.

And so when you get a 10% or an 8% drop in volume in the quarter, it has a real significant impact on our ability to generate yield.

And Rob again had said very specifically that there was nothing specific in the quarter that drove yield sequentially to decline just a little bit.

But with that, Kenny, do you want to talk about the pricing environment that you're in right now?

So first of all, I just want to give a shout-out to Jim [Lish] and the operating team for creating an environment where we can price to the really strong service product out there.

So our commercial team is doing a really good job of keeping pricing discipline and aligning our price consistent with that service offering, that's improving.

Having said all of those things, there is a very competitive truck environment that's out there.

I think all of you are aware what's taking place in the marketplace and we complete -- compete daily with a number of rail carriers in North America.

But I think the important thing for you to hear is that we're going to maintain pricing discipline, especially as our service product is improving.

And as that service product improves, we also expect that to help us grow.

Rob, do you want to touch on mix?

Yes.

Chris, as you know, we don't give guidance on mix, and the reason for that is we have such a diverse product mix that we have mix within mix.

You've heard me say that many times.

Having said that, the challenges and, perhaps to some, the surprise in the third quarter mix, was I think largely explained by the increase in the shorter-haul rock shipments that we called out.

I mean intermodal, I think everybody gets that.

Most of the other moves like ag, everybody kind of gets that.

The shorter-haul rock shipments that increased, I think, were maybe perhaps a little bit of the surprise to some on the mix.

Having said that, I see no reason why the fourth quarter wouldn't -- would be materially different from what we saw in the third quarter.

Again, I'm going to stay away from specific mix guidance but directionally, I would envision it looking similar.

The next question comes from the line of Tom Wadewitz with UBS.

Rob, also congratulations.

Wish you the best.

Pleasure working with you over the years, and congratulations to you as well, Jennifer.

The -- let's see, the volume trend, I mean obviously there are a lot of moving parts and weakness in volumes but I think it's notable that there's a pretty big delta in volume performance for Union Pacific versus Burlington Northern.

And just wanted to see if you could shed some light on what might be driving that?

In particular, I'm referring to the intermodal where it looks like kind of 4-week moving average, you're down about 13%, BN is down about 2%.

And there's a pretty wide gap on the coal side as well.

So just wondered if you could offer some thoughts on what's driving that and whether you think that might change over the next couple of quarters.

Kenny?

Yes.

I'll tell you that we would've appreciated a stronger economy to help compete for more opportunities, but the fact that the service product on the intermodal side is actually strengthening is something that we appreciate.

And yes, we've seen a lot of competition out there from both the trucking side and as always, we compete with the Western rail carriers and the North American rail carriers.

So that has -- that's going to be around for us and we'll continue to compete there.

Yes.

One thing that I would add, Tom, is we are very happy with our service product and the trend that it's on.

So it's currently a very good service product and it's showing itself to be reliable and consistent and I think it's going to continue to improve.

So from that basis, we're in a great place to compete for business.

Having said that, we're also continuing to be very, very disciplined on our price.

So we're not trying to chase market share.

We're not trying to chase some market down against the loose truck, and we'll just compete based on the service that we provide, we'll price for that.

And as the economy strengthens, which it will at some point, and as truck capacity tightens up, which it will at some point, we're in a great place to take advantage of that.

Okay.

Just -- I guess to follow up on that a little bit further.

Are there contract shifts in the intermodal and coal side that might account for part of that?

And I guess, in terms of the PSR impact, sometimes you make big changes too, as an example in Chicago, the terminals you're using and you can cause some initial disruption to the customer, but then obviously you hope to run better in the future.

But is there an impact from contracts or kind of initial disruption from PSR?

Yes.

Chris, I'll take that mix of questions.

The short answer is in terms of design of our network in the intermodal space, there has been small single-digit impact on intermodal volume from rationalizing low-volume lanes, low-density lanes.

That made sense in the book of business, it still makes sense.

And when you aggregate that back up to the entire railroad, it's really largely an asterisk.

When you get into -- the other parts of your question about contracts, we don't talk specifically about customers but I -- but we did call out both in the first quarter and I think Kenny mentioned it again this quarter that we did have a coal contract change hands that's impacting this year to a degree and we haven't talked about any other contracts besides that.

The next question is from the line of Scott Group with Wolfe Research.

So I want to ask a couple on the cost side.

Comp per employee, a little higher than we thought.

Any thoughts on how to model that going forward in rail inflation next year?

And then purchased services were flat sequentially given the weak volumes and PSR -- I would've thought there would be some opportunity there.

Maybe can you just talk about the opportunity that's left on purchased services cost?

Yes.

Scott, this is Rob.

Let me take the cost per employee.

The kind of the delta, if you will, as to why it was up above what we were expecting in terms of inflation was really some of the overtime, which -- a lot of changes going on in operations but the overtime is something that did inflate that cost per employee up a little bit.

As we look to 2020, again, we haven't finalized our planning assumptions yet, but I would say it's probably overall inflation for 2020 is going to be in the neighborhood of 2% with labor probably in the 2.5%-ish range again.

And on the purchased services, I guess I wouldn't call out anything unique there.

Obviously, as we pursue the Unified Plan 2020 initiatives, there will be opportunities, we think, for us to continue to rationalize and be as efficient as we can on that line as well.

Okay.

And then we've got the sub-60% OR guidance for next year.

Rob or Jennifer or maybe Jim, if you want to comment, The Street is already well ahead of that.

Given the macro, does that seem reasonable?

And then maybe asking it a little bit differently, so when we've looked at past instances of rails doing PSR, you've seen better margin improvement in the second year than the first year.

Does that seem like a reasonable way to think about it or not?

Yes.

Let me start, Scott, and then I'll hand it over to Rob and Jim.

So the bottom line for next year is we've got guidance out there, sub-60%, but we've constantly said we're going to be a sub-sub-60% as we possibly can be.

As we enter next year, we've got good momentum, right?

If we can get a little cooperation from the economy, that would be very helpful.

We've had some puts and takes this year, we've discussed this through the quarter so we know what those are.

But we're going to get as sub of 60% as we possibly can.

And with that, I'll turn it over to Rob and Jim to fill in.

Yes.

Scott, I would just add to that, that as you know, every step on the ladder of efficiency that we've had over the years, we've always tried to get there as safely and efficiently and quickly as we can and frankly, we have.

So I would say, that's similar to the numbers that we have out there.

I feel, as I said in my comments, I feel as good as I have ever felt in my career about where we are operationally.

So the things that I feel like we can control to get to that sub-60%, I feel extremely good about.

So the variable right now, as I look to 2020, is really the economy.

And as we sit right here today, we're certainly hopeful and thinking that the volume will be on the -- maybe slightly on the positive side of the ledger but that's still an unknown at this point.

So I think that's really the big variable as to how sub, sub can be on that sub-60% guidance for next year.

Listen, the only thing I can add, I think that Lance and Rob have done a great job of giving the macro view of it.

Operationally, we're just starting.

I think there's lots to do.

I think -- I've been here for 9 months a couple of days ago.

I think what the team has been able to deliver and you see it in the metrics that are real key.

I think -- I don't think, I know, next year is going to be a great year operationally.

We'll take whatever business, hopefully it's an increase in business, and Kenny, substantial increase, and we'll show what this team can do and if not, we react to it properly.

I see lots of headway and I'm excited to what I see coming forward for the end of this year and next year.

Jim, can I just clarify one thing with you?

So you -- in the beginning of the year, you laid out a 10% labor productivity target.

We're getting a lot of head count output because volumes are down so much, we're getting maybe half of that on the labor productivity.

So does that imply that there is a big opportunity left next year?

Are we thinking about that right?

I think we're headed in the right direction where it comes to -- you're thinking right.

We are -- the more we can put less train starts, put more product on the trains, make them more efficient, adjust our yards just like we did in Kansas City, we drive productivity better.

We'll see that improve as we move ahead, Scott.

So nothing wrong with the way you're thinking.

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

Rob, good luck on retirement; and congratulations, Jen, from me as well.

So it was pretty interesting that you guys said that you're no longer going to announce a core price.

I think that now makes every Class 1 rail that doesn't disclose price.

That's a pretty dramatic change from 5 or 6 years ago where that was kind of key to the rail kind of [buy] case and investment thesis.

Why do you think that's changed?

I mean is that because it's just gotten more competitive to get price?

Is it because of a tougher regulatory environment?

Why have you seen that shift you think?

So I can't speak for other railroads.

I can speak for us, and that is by publishing a yield number every quarter, we work against ourselves commercially.

I mean in the simplest way, when Kenny is talking to a customer and trying to maximize that price discussion, our conservative yield calculation frequently works against us in that conversation.

It's as simple as that for us.

Rob?

Ravi, I would just add -- Lance nailed it, but I would add as I said in my comments, you're right, it is a shift.

But I think as I exit the company, I also have never felt better about the understanding and value of understanding the impact that the pricing has on our financials.

And you combine that with the continually improving service product, there is no doubt in my mind that Kenny and the marketing team completely understand that it's our objective to drive as positive a price and earn adequate returns that we can in the marketplace.

So rest assured, I guess the point is, rest assured that because we think commercially it's not to our advantage to be talking as precisely as we have about price, don't interpret that to mean that we're not aggressively going after pricing opportunities, which we think are still there and we're going to aggressively pursue that.

Got it.

And just a follow-up, Lance, I know you said earlier that you guys are very clear that you're not chasing share and going after volume over price.

Just given some of the volume delta this quarter between you and your chief regional competitor, do you feel like there is some of that going on in the marketplace?

Our marketplace is -- as we relay it to you every quarter, it remains very competitive and it remains competitive specifically in the intermodal space, not just against rail competition but specifically against truck competition.

Trucks are pretty darn loose right now, which means capacity is readily available and widely reported that truck pricing has been dropping.

So we're looking forward to seeing a bottom of that and then an upturn.

And I anticipate that, that will occur.

I don't know when but you see truck orders substantially down.

You see production starting to turn negative and that all bodes well for competition as we look forward.

And the best way to combat that is an improved service product and that's what we're getting right now.

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

Again, congrats, Rob and Jennifer.

Just going back to the volume side for a minute, we have easier comps here in 2020.

What do you feel, Kenny, about the absolute activity levels, maybe some of the key areas to talk about?

You just mentioned truck, but obviously a little -- given length of haul, I'm a little surprised that, that's been such a factor, so maybe you can help expand on that.

And that while we've talked about sand for a long time, as it continues to go down, just wanted to see when you mentioned the long-term comps get easier, is there still a big shift in local sand that's comping up that you think is going to be a mix headwind as well?

Yes.

So first of all, it's a little premature for us to talk about the plan for the following year but yes, I would expect that we would be on the slightly positive side of the ledger as we look towards the future, and the fact that we've got a good service product really helps us out.

When you look at the sand business, yes, that local sand penetration has been with us now for a good 18 months.

I will tell you that I would expect those comparisons to flow over time.

So maybe not the immediate near term but over the longer term, it certainly should, those comparisons should get easier for us.

And then to follow-up on the trucking side, I feel like you didn't get as much benefit when the cycle is tight.

So a little surprised to hear that it's a bit of an overhang here in some of the markets.

Yes.

We're keeping an eye on the trucking market.

Over the last couple of months and even over the last couple of weeks, we're seeing it firm up a little bit.

We're also keeping an eye on what will happen in terms of peak season out there because there is some interplay between our domestic and international business.

But right now, we'd really appreciate more help from the overall economy.

Got it.

And then just one quick one for Lance.

Could you just give us your view on regulatory environment in DC?

And it still feels like it's little more active, not necessarily [activist] from that perspective, but we're certainly seeing a lot of movement in a few different areas.

Then we have labor negotiations that's starting in Detroit.

Appreciate -- you probably can't say too much on that but just want a sense on what's coming between now and the end of year that's going to kick off here.

I just wanted to get your thoughts about this, more general.

Yes, sure.

So let's take them in two pieces.

I'll start with the regulatory environment.

So the STB is so poised to be fully staffed with 5 Board members in the not-too-distant future, and they've already started getting more active on a host of items that they're pursuing either old items on the docket that just weren't handled over the course of the last 5 years; and in some cases, new items.

Our posture is we're continually engaged with the STB to help them understand what some of the negative impacts could be of some of the regulations that are being considered and also help them understand that each regulation can't really be taken on its own.

It forms a mosaic of regulatory impact and the in-game for the railroads for the STB is to make sure that the railroads are healthy and can continue to invest capital in the railroads so that we have a robust infrastructure to support the United States.

So we constantly are having dialogue and communication about current state of the railroad, how good the service product is, what we're working on and what the risks are of some of the regulations that are being considered.

In terms of our negotiation with labor, you did see that there was a lawsuit filed against the SMART TD, that was to compel that specific union to negotiate on crew consist or at least consider that through arbitration as a negotiating item that it was a -- it's a technical matter, and I look forward to that being addressed through the courts.

The end of the current moratorium is November 1. So sometime around that time frame, unions are free to put demands on the railroad management teams and railroad management's free to put demands for negotiating on unions.

I anticipate that's going to happen.

I anticipate it's going to be a robust negotiating season, and I look forward to that and I look forward to being able to work with our unions to continue to position Union Pacific as a competitive strong supporter of the U.S. economy.

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

I just wanted to ask firstly about the profit potential as volumes and revenue get better, some of the huge progress that you've made on the cost side is obviously being masked a little bit by the revenue environment.

So just in that context when we do get back to revenue growth, hopefully, as soon as possible, probably next year, can all of that incremental revenue drop to the bottom line?

Just help us think about the cost in the business, whether it's structural or variable, and how those -- which of those would have to increase once revenue growth kind of moves from negative to positive.

Amit, this is Rob.

I think you're spot on.

We'd love nothing more than to see the volume be as positive as possible and there obviously are some direct volume variable costs that would come on board with that but at a very productive level.

But I think you hit the nail on the head and that is we are well positioned now as volume does return for the incremental margins to be impressive because there is no -- I mean we won't have to add back the costs that we've been able to rightsize and achieve through the Unified Plan 2020.

So the efficiencies and the incremental margins, to your point, from the incremental volume that comes on board should be extremely efficient.

That's -- Amit, that's where that work that the operating team has been doing on train size really pays off, and when we talk about train size opportunity into the future, volume growth is just going to be our friend.

Right.

And I -- that's a good segue into my next question or follow-up question.

On the operating stats, the train length progress has been really impressive.

I think it's like 8,000 feet or maybe a little bit more now.

What's -- I don't know if it's a question for Lance or Jim, but what's the upper limit there?

I mean can you get to 10,000?

How quickly can you increase that?

And have you made enough from that?

I know you made a bunch of investments or reallocated some capital towards extending sightings earlier this year, is that all done right now?

You can continue to grow that?

Just talk about how quickly you can continue to grow that because the progress there has obviously been impressive.

Well, thanks for the feedback, Amit.

And -- listen, the team's done a great job.

You don't change from a 7,000-foot railroad to an 8,000 foot railroad in 9 months without touching a lot of places.

We have a great network.

So that's what's nice about as business comes, which it's going to come, we drive more of it to the bottom line if the costs are not going to go up one-to-one.

In fact, I'm -- be very interested to see what happens when the business goes up next year.

Second is we will invest, we've found some places in this network that we need to invest and we'll invest to make sure -- same as we've done on the Sunset, to increase train size, can be more fluid and have less trains run on with more product on it.

The upper limit, I don't guess.

It's a traffic mix depending on what kind of traffic you have with and traffic that is very tough to build big trains with just because of origin destination, and others we have the possibility to be able to increase them.

So I continue to see improvement.

I know what other railroads have had the capability of doing, one that I worked at.

So I think we'll blow by that number that they've had and -- without an issue next year as we build this infrastructure even better and harden it.

Amit, there is one last thing to note here and it's lost on a lot of people.

It's a benefit of the train design that we've gotten in Unified Plan 2020 and that is much more of our volume is running in mixed manifest traffic now.

Kenny talks about it from the perspective of that's enabling us to win business that we used to pass on because it wasn't conducive to a unique boutique train.

Well, in the old days if 40% or 45% of our network was in the manifest world, that number is looking more like 2/3 and 3/4, which means volume can grow across different segments and we can leverage it into train size, or as that opportunity to do that, historically, was probably a little more limited.

So that's a big benefit of the Unified Plan 2020.

Our next question is from the line of Jordan Alliger with Goldman Sachs.

A question for you.

I know the network's in good shape for the incremental margin next year, volumes snap back.

Question though on the head count front, can you gear up quickly or would you need to gear up quickly given how much reduction you've had so that you can ensure the operations from that perspective will run smoothly?

Yes, I'm going to, at the highest level, say yes.

We've changed a number of things that make our ability to be more agile on both the upside and the downside but on the upside, our time to hire and train and bring out a crew, a conductor, has been cut dramatically.

We're actually looking forward to the next time we have to add conductors to exercise that new muscle.

Jim, there's some other things we've been doing.

What are your thoughts?

Lance, I think you hit it right on the nail.

Bottom line is I don't think we have to increase, we have an increase in business.

We are not going to increase on a same percentage as we go up or we're going to become more efficient.

It helps us become even more efficient.

I think we've shown what we can do this quarter.

When you have this kind of adjustment in volume and for us, that drop, 5,700 FTEs in the third quarter shows that we've got the capability that we will make the right adjustments when the business level is -- and a lot of that cut was because of the efficiencies that we've built into the system.

So I'm looking forward to what happens next few months and into the next year and I'm very excited about it.

I think the numbers will dictate a great result for this company moving forward.

And then just a quick follow-up on intermodal.

We keep hearing that service is much better from various folks that they are on the rails, you guys as well, intermodally.

So when you talk to your customers, I mean is it truly a price spread between what you offer versus trucks that's going to get the needle to move back to positive volumes?

And if so, what sort of -- pick a length of haul, what sort of spread versus trucks percentage-wise, let's say, induces a shipper to move the volume to rail especially given the service and what are the discounts narrowed to now?

If you have any input on that?

Yes.

You're right on that service has improved and our customers are realizing that.

And it'll take a while.

I mean we're talking about a few months now where our services really turned the corner from the weather event.

The spot rates have now lowered, they're less than 20% from the highs where they were over 25% last year in terms of being depressed.

In terms of where we need to be in that delta, we've always said that we'd like to be from the contracted rates, anywhere from 10% to 15% lower than the contracted rates and so we'll continue to see what happens in the marketplace going forward.

Jordan, this is Lance.

Two points, one that the truck capacity -- overcapacity of truck supply really needs to get adjusted for those spot rates and contract rates to start going back up.

And then the second thing to note is our service product consistent, reliable over a period of time.

We'll start convincing customers who have historically split their book of business but would have benefited by putting more on rail, to put more on rail.

So over time, theoretically, I think we should see more opportunity as opposed to less even in status quo, even in the status quo environment.

I think the important thing is that we're already seeing wins, the commercial team is already putting together some wins out there that are specific to UP 2020 and so we -- the expectation is that, that will continue as we move forward in the next year.

The next question is from the line of Ken Hoexter with Bank of America Merrill Lynch.

Rob, obviously congrats, and really enjoyed working with you through all the years and to Jen on your new role of finding a way to talk to analysts again.

Just a great call so far on the big picture but maybe, Kenny, if I could just drill down maybe in the little near term here, it looks like we started off the quarter even worse than the run rate that you're highlighting that the fourth quarter should look like third quarter.

Particularly at energy and premium which are down 18% and 13% with the quarter now down 11%.

So a bit worse than third quarter.

Is there anything you'd put that on, floods, snow?

Anything you look to turn around on easier comps as we move forward?

Yes, if you look at it, clearly, we have some tough comps.

I think we all remember some of the pull-aheads that we were faced on the intermodal side, especially with our international intermodal and clearly, natural gas is in a different place than it was around this same time last year.

So structurally, those are 2 fundamental issues that are there.

We'll continue to also keep an eye on what's going on in our -- in automotive industry.

Our Detroit team is working with GM, and although we didn't see a significant impact in the third quarter, we're going to be working with them and all the auto players to see the impact that it's having early on in the fourth quarter.

Okay.

But I guess just to understand that the pull-ahead would make it even tougher comps.

So you're saying that was maybe an earlier quarter event so it gets easier as the quarter rolls on?

No, what I'm saying is that those comps are impacting what you're seeing in terms of the delta that we we're down, for this quarter.

The start.

The start of the quarter.

Right.

And then Jim, great slide on kind of the newer moves and kind of continued rationalization, are there -- maybe your thoughts on additional yards or is it incremental from this point forward as you've cleaned up the humps?

Just trying to see if there are any more step function improvements that you see as you move into 2020.

I think if you look at what we're trying to do, it's a great question because I look at it holistically for the whole company and not just look at it numbers of what we're doing.

All we're trying to do is, is move cars as fast as possible, remove the touch points and give a better service product and that's what we're doing.

And this is a winning game.

So we drop our operation, we've become the most efficient railroad in North America.

We are able to then compete against everybody.

So what I see out there is we've just started, we are truly baseball season, it's a great time of the year, maybe not if you are a Yankee fan right now but that's a little tough but at the end of it, I think that we're early innings and we still have a lot to do productivity-wise in this company and stay tuned and it will move ahead and I'll announce them as we are ready to go.

All right.

Great.

I think the Yankees would say it's still early.

So...

I was waiting for that comeback.

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

Congrats to Rob and Jennifer.

Maybe Jim, just following up on your recent comments about productivity.

Could you maybe give us your initial thoughts on what this could look like in 2020 given that the improvement in the key metrics have really accelerated here recently?

And maybe without asking you to put a specific number on it, is there a reason to think, at least directionally, that it should be bigger than the $500 million or plus this year?

I'm not going to put a number on next year.

Let's wait to see what we -- where we end up with and where we want to put the place mark for next year, but operationally and what I see in this company and what I'd seen from my history is that we will continue to improve our efficiency.

We'll be able to draw more business on because we win in the marketplace with a better product.

We'll look at it end to end.

I'm going to try to make Kenny's job easier, moving forward.

So I think it's a win-win for us moving ahead and that's about as close as I'll get to giving you any numbers.

Okay.

Fair enough.

And as you go through the network rationalization process, have you seen any meaningful opportunities for line sales?

Stay tuned.

We'll just work through it as the business mix and what we look at but I think we've already got a pretty good plan of what we look at our network, but at this point, nothing to announce.

The next question comes from the line of David Vernon with Bernstein.

Kenny, wanted to ask you a longer-term question about the energy franchise.

Obviously, you've got coal and sand challenges right now.

You've got a plus sign up on petroleum products.

I'd like to understand kind of what kind of flows near term are driving you positive?

And what you think is the risk that, that positive could shift negative as you get into 2020 and the pipeline complex gets closer to the inbuilt out up in the Bakken?

Yes.

So longer term, again, we think the comps for the sand will improve.

We'll see what happens there.

On the crude oil side, we feel very optimistic about that market and we -- I look at that as a couple to a few years type of opportunity and we're gearing up and we got the resources out there and I think you've read, where the government has increased the curtailment.

So we're expecting more volume to come along.

Is that predominantly Canadian origin stuff or is there also some stuff coming out of the Bakken?

That is the Canadian origin that we're looking out into the Gulf.

So that's really what's driving the growth near term?

Correct.

Okay and then maybe, just as a quick follow up in the industrial products sort of segment, the average ARPU came in a little bit softer.

Could you talk a little bit about what the mix dynamic is going on inside of that segment and what the outlook is there in sort of the next couple of quarters?

Yes, so Rob talked about this a little bit earlier and we realized we've got some strong double-digit growth on the construction products.

Our rock shipments have a shorter length of haul, that's there.

You could possibly make the -- as you look at a lot of the petrochem business, it's also a lot that moves inside an interchange into the Gulf, so you've got a strong mix there of growth that is not as longer haul as, say, some of the other pieces of business, like our lumber that's down.

And will that -- so will those sort of mix trends sort of continue for the foreseeable future?

Do you see any sort of major shifts ahead or just kind of this shift continuing?

We'd expect both the petrochem and the Construction Products business to continue to grow.

I think the economy will help us out with the housing market right now.

It's been pretty flat.

And again, that's also truck susceptible, so a stronger economy will help us compete better in the housing market and we'd hope for a little bit more help with the overall thought there.

The next question is from the line of Brandon Oglenski with Barclays.

Rob, congrats as well.

I was going to ask one but this may be a longer-term question.

When you guys look at the intermodal business, if we comp you relative to industry growth, I think Union Pacific has probably fallen behind there over the last decade, but obviously you guys have improved returns and margins in that time period.

So I guess, looking forward, with the new operating plan, I mean, is intermodal a now more attractive business than maybe it was in the past?

Or that you guys have been calling out for a couple of years here competitive pressures.

I mean is that more competition from North of the Board that Jim might know very well?

Or how do you think about it looking forward?

Yes, so let's talk about the intermodal business broken into 2 pieces, international and domestic.

They're both attractive.

Our work on cost structure has made growth in both, attractive to us, presuming it's in the right price.

And from a domestic intermodal perspective, we've got a track record of growing domestic intermodal up until about the last, call it 18 months, and I think that has more to do with the flip on truck capacity than almost anything else.

Once overcapacity happens in trucks, there's just a lot of behavior that breaks out the marketplace that makes it difficult to grow at an attractive return.

Our current cost structure has changed the playing field for us in terms of what's an attractive piece of business.

And our current service product has changed the playing field so that customers look at us and think: Boy, they are a viable alternative to my truck network.

So both of those I think should be positives for us to get back on the path of growing domestic intermodal.

That still needs to also occur in the context of truck capacity getting rightsized.

Internationally, there is no doubt that Southern California ports have lost some market share, both the Canada and, to a smaller degree, the East Coast ports and that's troubling.

And that, I think, has less to do -- I know it has less to do with our service product from California ports to let's say places like Chicago and more to do with the overall cost and infrastructure of landing a box and paying fees at ports.

So we're really trying to help the ports in California along the West Coast of the United States understand those dynamics and understand that it's a very competitive environment and the whole supply chain has to be involved in winning that business back to the West Coast ports.

Our service product is being designed on a end-to-end game.

So it's not just the transit over the road.

We're worried about what dray looks like around our facilities in Chicago, what grounding looks like, how quickly we can turn our equipment with stripping and reloading.

All that is moving in the right direction.

I think all that is going to create opportunity in the future.

We need to do that in partnership with our ports as well and we are.

And well, I said I was only going to ask one but I guess, Lance, in that regard, I mean, have you guys changed your marketing efforts on the intermodal side to address some of these challenges?

For sure, we're having those conversations.

You've seen our product design change.

We demarcated and got out of low-density lanes.

We changed the layout of our intermodal ramps in Chicago so that they are much more focused and dedicated, for instance, G4 in Joliet on International, G2 in Proviso on domestic, G -- the Yard Center on north, south and automotive parts, and that's helping.

So yes, I would say we're addressing the marketplace in a different way to have a service product that wins and it's a good-looking service product right now, and right now, it's basically up to the marketplace and Kenny's team to make those matches happen and to get, essentially, the truck overcapacity back in to the right box.

We've turned on things like the intermodal reservation, terminal reservation so that our customers have really good visibility on which containers or which boxes are going to move on what day.

So it takes out any confusion or ambiguity there, which the customers love.

Your next question comes from the line of Walter Spracklin with RBC Capital Markets.

Congrats to Rob and Jennifer on new roles and the new retirement.

Best of luck.

I want to come back on your answer to the intermodal difference between you and BN.

What I see a company that is implementing PSR the way Jim's doing it at Union Pacific, ripping out that level of workforce and locomotives and so on, I would expect some service disruption and I would argue that these declines relative to your closest peer would be par for the course here.

Is there any of that going on?

That would suggest that the disruption and the decline is temporary and that when you are completed your PSR, you can use it as a weapon rather than a cost reduction tool, you can use it as a share gain weapon and just stay tuned for more rather than your commentary about a real competitive environment?

I mean that doesn't leave -- that's much more negative I think, if you're pointing at a more competitive or a competitor I guess, is a little less encouraging than if it was just due to temporary disruption on service.

Any comments on that?

Yes, Walter.

So let me -- let's put a little finer point on our -- on the answer that we gave a little while back.

So specific to intermodal, specific to rationalizing our lanes, that impact might be a couple of 3 percentage points.

So you're right, there's a bit of that and I would expect us to grow back through that.

But there is still a piece in that particular marketplace that's both truck overcapacity that has to get back in the box, and it will.

Those always ebb and flow over time in business cycles and I think those are the 2 big moving parts.

Okay.

And then just following up on the pace, Jim, of PSR adoption in the past, we've always noted to be very fast, very significant early on.

This quarter compared to Q2, it was effectively flattish.

Obviously, we were expecting a little bit better given you had a lot of flood impact in the second quarter, hoping for a bit more of an improved third quarter relative to the second quarter.

I don't want to answer it for you but obviously, prior PSR implementation generally has been done in a nice, strong economy and growth environment.

Is that the reason why we are seeing a bit more of a muted pace in the early execution?

Or is there another reason?

Son of a gun, I'm telling you, Walter.

So 5,700 FTEs, 13% drop versus volume, 8%.

Train length up 16%, dwell time dropped, freight car velocity up, workforce productivity on a drop and business model better.

So if that's average, son of a gun, I want average again next quarter.

That's the way I look at it.

I think we've got to be smart about it.

We don't want to blow up the place.

I could've parked 1,000 locomotives the first day I showed up.

I'm not going to do that.

I think it's a long game, and I don't mean long by years, but it's a long game.

Do it right, get the right product and this whole intermodal discussion -- it's a great question and this is where we want to be.

We want to be where we have a very efficient railroad.

We're able to open up new markets, we're able to beat the competition, which is other railroads and truck and bring more product in without dropping our price.

So that's the game we're playing.

I'm excited about it, Walter, and you are a tough -- your kids must hate coming home with your -- with their scorecards.

You are a tough marker.

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

Rob, I have to offer, one, my congratulations on your retirement.

I think sitting in my chair for as long as I have, I'm definitely jealous of seeing somebody retire.

Also, it's been a pleasure to work with you over the years.

You've been extremely generous with your time and always gracious with your responses.

Jennifer, welcome back.

All I could say, if you're going to work with us analysts, again you must be a glutton for punishment.

Two quick questions here.

One, Jim, clearly, there has been a lot of success here in PSR, but train speeds are the one thing that I would call out, that I'm a little bit surprised that I knew there were some puts and takes, but relatively flat in a declining environment.

Can you talk a little bit about that and what we should expect going forward?

And then I have one more follow-up.

Okay.

So let's talk about train speed.

People want to worry about train speed, I look at car velocity, which is the end-to-end measure that the customer looks at, it's not just a subsection.

So what we've done is, is we've taken some of our trains that used to run through and been able to not stop, and get end-to-end and we've had worked events so far.

Get them to add 3,000 or 4,000 cars instead of running extra trains.

So at this point, we're working through that.

What I see moving forward is we will have the fastest train velocity of anybody in the railroad network that we compare ourselves to.

So we're working towards that, and I expect some noise -- some more.

If I have a choice of increasing the train speed by 0.1%, and running the car velocity quicker and being able to drop the car -- the number of cars I need by 5,000, I'll take the car drop and car velocity over the train speed.

So that's where my mind is with it.

Okay.

Fair enough.

And my last question, Rob, I'm going to go to you for old times' sake.

You talked a little about rent expense drop and you mentioned volumes as one of the reasons it was off over 13% in the quarter, given that volumes are going to be down on a similar fashion in 4Q, would you expect rent expense to be about down the same in 4Q as it was in 3Q?

Yes, without a fine point on it, I can't see any reason why directionally it wouldn't look similar to third quarter.

Our next question is from the line of Fadi Chamoun with BMO capital markets.

Congratulations Rob and Jennifer on the announcements.

One question for Jim.

The operating ratio will have a pace that is also influenced by some of the top line dynamic we're seeing, but if I think in terms of actual progress on redesigning the operating plan and rationalizing the classification assets and all these kind of Unified 2020 Plan you're doing.

Does less volume help you get more things done?

And hopefully, as we come out of this volume downturn, we can see a stronger payback than we would have otherwise?

No, Fadi.

In fact, it's the other way, the way I see it.

I would love to have increase in volume, come on, volume helps us in that we're able to really run the place more efficiently and more -- some cars come on, on the same trains that we're operating on so I see volume as a helper, helps us both top line and bottom line.

But on top of that efficiency-wise, it helps us even better.

So that's exactly what we want, Fadi.

Okay.

And maybe one quick follow-up.

If we do see next year another challenging volume environment down mid-single digit, is there any constraint or any roadblocks that would prevent you from taking another 10% plus out of the head count?

I hate to be negative but the answer is no.

We'll react to what the market gives us, what the competition gives us and what's available for the economy.

So we will react in the right way, up or down.

And I'm hoping that it's up, and everything that we see is -- with the floods and everything we have, we see a good year starting next year.

So that's where we are, Fadi.

We're looking forward to volume.

Presuming the economy stays healthy, I would love to see a little bit of growth that would be welcomed.

But whatever the economy is, Rob says this, it's probably a fitting ending to the call.

Rob says that every time we get together and that is the economy is what the economy is.

We deal with the hand that we're dealt and we don't use that and as an excuse and we won't.

And this concludes the question-and-answer session.

I'll now turn the call back over to Lance Fritz for closing comments.

Thank you, Rob, and thank you all for your questions.

In closing, we have made really good progress in the third quarter, delivering a more consistent, reliable service product with a fundamentally smaller cost structure.

And although I'd much prefer a growth environment, our operating performance gives us a lot of confidence that as volume returns to the network, we're going to leverage it very efficiently and return even stronger results.

With that, I look forward to talking with you again in January to discuss our fourth quarter and full year 2019 results.

Thank you.

Ladies and gentlemen, thank you for your participation.

This does conclude today's teleconference.

You may now disconnect your lines, and have a wonderful day.