Union Pacific Corporation

Greetings. Welcome to Union Pacific third quarter earnings call. At this time all participants are in listen only mode. A brief question and answer session will follow the formal presentation. If anyone today should require operator assistance during the conference, please press star zero from your telephone keypad. 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.

Thank you, Rob, and good morning, and welcome to Union Pacific's third quarter earnings conference call. With me today in Omaha are Kenny Rocker, Executive Vice President of Marketing and Sales, Eric Geringer, Executive Vice President of Operations, and Jennifer Heyman, our Chief Financial Officer. Before discussing results for the quarter, I want to thank our employees for their tireless efforts over the past several months to improve service levels. I'd also note the dedicated service of our craft professionals throughout the recent, very lengthy labor negotiation. The new agreements, based on the Presidential Emergency Board recommendations, reward our employees for their hard work. And with roughly half of our union's ratifying agreements, we are looking forward to complete this process and move forward. Now, turning to our third quarter results. This morning, Union Pacific is reporting 2,022 third quarter net income of $1.9 billion or $3.05 per share. These results include the impact of a $114 million charge for prior period estimates related to the new labor agreements. Excluding that charge, adjusted net income is $2 billion or $3.19 per share. This compares to third quarter 2020 run results of $1.7 billion or $2.57 per share. Our adjusted third quarter operating ratio of 58.2% is 190 basis points higher than 2021. Costs related to higher inflation and ongoing network inefficiencies were offset by fuel surcharge revenue, volume growth, and strong core pricing gains to produce adjusted operating income growth of 13%. We made real progress during the quarter to increase network fluidity and better meet customer demands. And as you'll hear from the team, we're continuing to take steps in the fourth quarter to better meet that demand and drive costs from the network. While the year hasn't played out as originally planned, our volumes have outpaced our peers, demonstrating the growth mindset that we're instilling within our organization. So with that, let me turn it over to Kenny for an update on the business environment.

Thank you, Lance, and good morning. Third quarter volume was up 3% compared to a year ago as carloads increased across all three of our business segment. Although overall volume was up, we undoubtedly left demand on the table as we continued to improve service across the network. Freight revenue was up 18% driven by higher fuel surcharges and strong pricing gains. Let's take a closer look at each of these business groups. Starting with bulk, revenue for the quarter was up 16% compared to last year, driven by a 14% increase in average revenue per car reflecting higher fuel surcharges and solid core pricing gains. Volume was up 2% year over year. Coal and renewable car loads grew 5% year over year, driven by continued favorable natural gas prices and two contract wins that started on January 1st. Grain and grain products volume was up 3% with strong domestic feed grain and increased biofuel shipments for renewable diesel. Fertilizer car loads were down 7% year-over-year due to reduced shipments of export and domestic consumed potash. And lastly, food and refrigerated volume remained flat in the quarter. Moving on to industrial. Industrial revenue was up 15% for the quarter, driven by a 4% increase in volume and an 11% improvement in average revenue per car due to higher fuel surcharges and core pricing gains. Energy and specialized shipments were down 3% compared to 2021 driven by fewer petroleum shipments, primarily due to regulatory changes in the Mexico market. Volume for forest products was down 2% year-over-year, primarily driven by lower demand for corrugated boxes. This was partially offset by positive year-over-year lumber shipments. Industrial chemicals and plastic shipments were up 8% compared to 2021 due to new business winds, customer expansions, and market demand. Metals and minerals volumes continue to deliver robust year-over-year growth. Volume was up 7% compared to last year, primarily driven by an increase in frac sand shipments, growth in construction materials, and metals business development. Returning to premium, revenue for the quarter was up 25% on a 3% increase in volume. Average revenue per car increased 21% due primarily to higher fuel surcharge revenue and core pricing gains. Automotive volume was up 19% driven by strengthening production and inventory replenishment. Finished vehicles increased by 33% and auto parts increased by 11% against the software comparison from last year. Intermodal volume was flat. Domestic intermodal was down 3%. due to softening demand driven by a 16% decline in parcel shipment. However, international volume strengthened by 4% from ocean carriers, shifting more freight to inland terminals. Now, moving to our outlook for the rest of 2022. At a macro level, we will be closely watching our markets to see how inflation and interest rates will impact our overall volume. But here is where we sit today with our markets. Let's start out with our bulk commodities. We expect biofuel shipments for renewable diesel to continue to grow due to solid market demand and business development wins. For coal, we anticipate continued favorable natural gas prices to generate demand for both domestic and export shipments. However, the opportunity to capture demand is dependent on the available resources. And our outlook for grain is also dependent on our service recovery. But as we've mentioned before, we have a tough comp in the fourth quarter as exports were strong last year. Moving on to industrial, the forecast for industrial production is decelerating and demand is softening in forest products. However, we expect construction to be a positive due to strong project demand in the south. And lastly, for premium, we are closely monitoring domestic intermodal demand as spot truck rates fall and inventories climb. We expect parcel and truckload demand to remain soft as consumer preferences have shifted more to experiences versus goods. We're also watching the international markets closely, but we expect to be positive in the fourth quarter due to easier comps. And we expect growth in automotive to be driven by improving supply for parts and inventory replenishment. Overall, we still foresee a favorable demand environment for the fourth quarter. Crew availability continues to improve, which will help us capture more growth and support our business development wins as we had in the 2023. With that, I'll turn it over to Eric to review our operational performance.

Thanks, Kenny, and good morning. Turning to slide nine, our year-to-date safety results are demonstrating meaningful and sustained improvement compared to 2021. Safety impacts every facet of our business, our employees, our customers, and our shareholders. While our safety management system is promoting the right culture, our number one priority remains returning every employee home safely at the end of the day. Taking a look at our current network performance on slide 10, our operating metrics steadily improved through the third quarter, aided by improving crew availability from hiring initiatives, lower re-crew rates, and improved crew utilization. Our hiring and training pipeline is strong. To date, we have graduated 890 employees and have an additional 518 currently in training, all expected to graduate by January of 2023. We have now hired 1,408 new transportation employees, exceeding our goal for the year. Freight car velocity is approaching 200 miles per day, up from its low in April. Even more encouraging, the improvement came while moving 10,000 more weekly carloads. By utilizing approximately 250 borrowed out employees and adding new graduates to some of our challenged crew locations, we have been able to add more coal and grain sets back into the network. We also reduced our re-crew rates from a peak of 11% in April to now around 7%. Exiting the third quarter, the network is in a more solid and fluid state than earlier in the year. Going forward, we are building upon these improved results to drive excess costs from the network. Now let's review our key performance metrics for the quarter, starting on slide 11, which remain challenged when compared to 2021, even considering the relatively easy comparison from last year's wildfire and weather events. However, both freight car velocity and manifest and auto trip plan compliance strengthened sequentially from last quarter's results. Intermodal trip plan compliance was flat sequentially and remains impacted by persistent supply chain challenges resulting in elevated chassis street times and container ramp dwell. We continue to make progress at the West Coast ports as the number of stacked containers decline. Turning to slide 12 to review our network efficiency metrics. During the third quarter, as performance improved, we were able to remove and stage locomotives across the network to improve overall fleet utilization. As a result, locomotive productivity did improve sequentially, although remains below last year's metric. Entering the fourth quarter, as we continue to improve train speed and other measures, locomotive productivity will continue to strengthen as well. Third quarter workforce productivity was flat as both the labor force and car miles increased. Train length improved 1% compared to third quarter 2021 as the team utilized longer trains to handle increasing volumes. We now anticipate completing an additional four sightings in 2022 on top of the 20 sightings in our original plan. This will bring the total sightings completed since 2019 to 80. These sightings are a key enabler of our ability to effectively use our resources and drive productivity. Wrapping up on slide 13, I'm encouraged by the progress we've made, but our work is not yet done. Using our PSR principles, we will further improve our service product and build a more resilient network. Our trajectory to this point reflects the great team we have at Union Pacific, and my thanks goes out to everyone for their efforts and dedication. To finish 2022, we remain focused on further reducing excess inventory, safely improving operational efficiency, and using our crews and locomotives even more effectively. Ultimately, as is always the goal, We need to run the network and manage our assets in a more than volume variable manner. To that point, we are storing excess international intermodal well cars as the expected levels of volume did not materialize. While at the same time, to capture demand in other areas, we are bringing cars out of storage. Additionally, to support bulk demand, we will continue hiring programs and send additional borrowed out employees to crew challenge locations in our northern region. As we wrap up the year and I look forward, I am confident that the foundation we are building will provide a better service product for our customers. With that, I will turn it over to Jennifer to review our financial performance.

Thanks, Eric, and good morning. I'm going to start on slide 15 with a walk-down of our third quarter operating ratio and earnings per share. Our reported operating ratio of 59.9% and earnings per share of $3.05 includes a $114 million change in estimates related to the Presidential Emergency Board recommendation and subsequent ratified and tentative labor agreements. At a high level, the $114 million charge negatively impacted third quarter operating ratio by 170 basis points and reduced EPS by 14 cents. For more granular information on the charge, please refer to the appendix slide at the back of the presentation deck. It's important to note, however, that while our general wage accruals weren't far off the PEB recommendation, we did not accrue for the $1,000 annual bonus payments. Core results in the quarter continue to reflect inflation and network efficiencies, as our operating ratio was unfavorably impacted 310 basis points, but contributed 20 cents to EPS. Importantly, we did make sequential core improvement in our operating ratio of 40 basis points versus the second quarter. Decreasing fuel prices in the quarter and the roughly two-month lag in our fuel surcharge program favorably impacted our quarterly operating ratio by 70 basis points and added 37 cents to EPS. Finally, third quarter results also include the favorable comparison to last year's weather and wildfire events, which adds 50 basis points to OR and 5 cents to EPS. Looking now at our third quarter income statement on slide 16, where we provide both reported and adjusted numbers that exclude the impact of the labor charge. Throughout my remarks, I will speak to the adjusted results. Operating revenue totaled $6.6 billion, up 18% versus 2021 on 3% year-over-year volume growth. As we have seen throughout the year, higher fuel prices are the primary contributor to higher operating expenses, which increased 22% to $3.8 billion. Excluding the impact of higher fuel prices, our expenses were up 10% in the quarter. Third quarter adjusted operating income totaled $2.7 billion, a 13% increase versus 2021. Other income increased $86 million, driven by higher real estate income, including a $35 million gain on sale and pension benefit. Income tax expense increased 13% as a result of higher pre-tax income, partially offset by corporate income tax rate reductions in three of our operating states. As a result of those changes, we now expect our full-year tax rate to be around 23%. Adjusted net income of $2 billion increased 18% versus 2021, and adjusted earnings per share was up 24%, to $3.19. Operating revenue, operating income, net income, and earnings per share were all quarterly records. Looking more closely at third quarter freight revenue, slide 17 provides a breakdown, which totals $6.1 billion, up 18% versus 2021. Year-over-year volume gains, supported by our business development efforts and sequentially improving operational fluidity, increased freight revenue 325 basis points. Fuel surcharge revenue impacted revenue 13 points, reflecting the impact of higher year-over-year diesel prices and the two-month lag in our recovery programs. Total fuel surcharge revenue was $1.2 billion in the quarter. Strong pricing gains when combined with a slightly negative business mix drove 200 basis points of freight revenue growth. Lower petroleum shipments combined with higher rock and auto parts shipments contributed to the negative mix. From a price standpoint, we have now lapped the positive benefit from coal contracts indexed to natural gas prices, so the year-over-year benefit is minimal. And as we experienced in the second quarter, network fluidity limited the upside for both price and mix. Setting these headwinds aside, we are confident that we will yield price dollars that exceed inflation dollars, even with a higher inflationary hurdle than expected at the start of the year. Moving on to slide 18, which provides a summary of our third quarter adjusted operating expenses, where the primary driver again this quarter was fuel, up 71% on a 67% increase in fuel prices. While we saw fuel prices come down some in the quarter, our average quarterly fuel price was $3.96 per gallon, only 7 cents lower than second quarter's average price. Our fuel consumption rate achieved an all-time quarterly record in the quarter, improving 1% versus 2021 as a result of productivity gains and a more fuel-efficient business mix. Looking closer at the other expense lines, adjusted compensation and benefits expense was up 12% versus 2021. This includes an additional $19 million related to this quarter's accrual for wage increases and annual bonus. Total third quarter workforce levels increased 3%. Management, engineering, and mechanical workforces grew 3%, while train and engine crews were up 5%, primarily reflecting year-over-year increases in our training pipeline. As you heard from Eric, we have now exceeded our 2022 hiring goals. Cost per employee came in higher than anticipated, up 8%, primarily driven by wage inflation. We also experienced continued cost pressures related to network inefficiencies with higher overtime and borrow-out costs. For the fourth quarter, we expect the year-over-year increase to be around 7%, in line with tentative and ratified wage increases. Purchase services and materials expense remained elevated, up 23%, driven by higher costs to maintain a larger active locomotive fleet, volume-related purchase transportation expense associated with our loop subsidiary, and inflation. Equipment and other rents decreased 1%, driven by higher equity income that more than offset increased car hire expenses. Other expense grew 18% in the quarter, a bit higher than we anticipated as a result of increased casualty expenses associated with freight loss and damage and personal injury. For the fourth quarter, we expect other expense to be flat versus 2021, as we are anticipating the receipt of an insurance settlement for last year's bridge fire. Overall, inflation and cost inefficiencies offset the benefits of volume leverage and resulted in fuel-adjusted incremental margins of just 2%. Although not the results we know we can achieve, it still reflects positive progress from the second quarter and provides us with momentum as we wrap up 2022. Turning to slide 19 and our cash flows, Cash from operations through the third quarter increased 9% to $7.1 billion. Our comparable cash flow conversion rate was 80%, and free cash flow totaled $2.1 billion. Although this is a decrease of $517 million versus 2021, it includes $745 million of increased cash capital spending and $317 million in higher dividends. With the increased capital spending to date, we now expect full year 2022 capital to be around $3.4 billion, up slightly from our prior guidance, but well within our overall guidance of less than 15% of revenue. Year to date, shareholders have received $7.9 billion through dividends and share repurchases. This level of cash returns demonstrates our firm commitment to rewarding shareholders with strong returns. Related to share repurchases, we now expect to buy back roughly $6.5 billion in 2022. Although we repurchase shares at a strong pace in the third quarter and expect that to continue for the remainder of the year, we have been impacted by higher than anticipated inflationary pressures and service costs. Lastly, we finished the third quarter with a comparable adjusted debt to EBITDA ratio of 2.8 times as we continue to maintain a strong investment grade credit rating. In fact, during the quarter, we received an upgrade from Moody's to A3, and we are now A-rated across all three credit agencies. Also during the quarter, we issued $1.9 billion in debt, which included $600 million of green bonds, our first such issuance. Wrapping up on slide 20, with a little over two months left in the year, we are focused on building upon the positive momentum of the third quarter. The operating team is executing on its plan to improve operating performance and capture additional unmet customer demand. As you heard from Kenny, however, markets are softening a bit, and that is resulting in a slight reduction in our overall volume expectations, now more in the range of 3% growth for full year 2022. With more clarity on the impact from the new labor agreements, our operating ratio outlook also has changed. We now expect our reported full year operating ratio to be around 60%. As we close out 2022, attention is quickly turning to 2023. While we are not yet ready to share our outlook, it is important to reiterate our long-term view. Our focus on generating strong cash returns and improving ROIC remains unchanged, and we are firmly committed to achieving the goals established at our May 2021 Investor Day of a 55% operating ratio and incremental margins in the mid to upper 60s. Since establishing those targets and even achieving them in a few quarters, the environment has changed. With higher inflation and a weaker economic outlook, the road to achieving those milestones now is a bit longer. But our roadmap to success is still the same. Supported by our great employees and the foundation of UP's strong and diverse franchise, we will leverage volume, pricing, and productivity to achieve those goals. With that, I'll turn it now back to Lance.

Thank you, Jennifer. As you heard from Eric, our year-to-date safety metrics have shown good, sustainable improvement, which is very encouraging. However, the most important metric is for all of our employees to go home safely every day. We remain relentless in pursuit of that ultimate and most important goal. On the sustainability front, during the quarter we announced a $1 billion agreement with Wabtec to modernize 600 locomotives over the next three years. This is a key investment as we work to reduce our carbon footprint and meet our 2030 SBTI targets. This investment also supports what our customers need as each modernized locomotive is significantly more reliable. This is true game changing for Union Pacific. As we close out 2022, we look to capitalize on the demand available to us as we sequentially improve operational efficiency. And although we're still putting together our 2023 plan, We like our positioning relative to the industry, considering our great customer wins like Schneider, expected strong coal demand, and a positive impact to our construction business associated with the infrastructure bill. I also want to reiterate Jennifer's point about our long-term view. We are committed to achieving a 55% operating ratio and mid to high 60s incremental margins. These goals are achievable, and as we safely and efficiently improve operations, Our customers, our employees, our communities, and our shareholders will all win together. With that, let's open up the line for your questions.

Thank you. We'll now be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants who are using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Due to the number of analysts joining us on the call today, we will be limiting everyone to one question to accommodate as many as possible. Thank you. And our first question is from the line of Brian Ostenbeck with JPMorgan. Please receive your question.

Hey, good morning. Thanks for taking the question. So I know you said it's a little too early to talk more about 2023, but just Given the importance of volume growth and visibility to that, Kenny maybe just wanted you to go through some of the areas you have a little bit more confidence and visibility at this point. And also can you touch on the impact of the stronger dollar as it relates to the various end markets because it has been disruptive in the past for you. And then Lance, any update on the negotiation process considering one of the unions rejected the contract and I believe the National Rail Conference also rejected their counteroffer last night. An update on thoughts ahead and timing would be appreciated there. Thank you.

Thanks, Brian. I'll start with a look at the labor negotiation, and then we'll turn it over to Kenny for talking about 2023 growth potential. So when we look at the overall negotiation, we've got on UP property, five unions. On the industry, six unions that have ratified. That's about half the unions. We've got four that are out for ratification votes still, and then we've got the BMW that's rejected their ratification early and are back into negotiation. A couple of things to note. We've got an agreed upon status quo or maintained of status quo with BMW while we're negotiating out what they take back to their membership. And one of the reasons, maybe we think the predominant reason for that original vote not to be ratified is that the PEB recommended both wages and they also for the BMW e recommended a change in their compensation for travel to the work site because about 40 percent sometimes more of that work team goes to away from home work sites works for seven days and then comes back so a change in that travel allowance and a change in the per diem while they're away from home. That negotiation on UP property just finished up last week. And so as the members were ratifying the vote, there was a section of it that they really didn't have clarity to. We think that clarity makes that vote more straightforward. And so that's part of the negotiation that's happening is exactly what's going to be embedded in the agreement when it goes back out for ratification. Ultimately, I remain confident that we're going to get our temporary agreements ratified and be able to avoid a strike. That's still a possibility, but I don't think it's a probability.

So I'll start off a little backwards here and take the currency question first. Lance and I just came back from Asia here recently, and we saw the evidence of what you're talking about. We're really looking at how the consumer is going to spend their money. We're seeing some evidence that they're spending more on the services right now than the goods. We're seeing that show up in the parcel shipment. And so we're going to just watch that pretty closely week to week. So I talked a little bit about some of the markets that we feel very bullish on. Obviously, coal is one of them. Eric and his team and our commercial leaders have done a really good job of being agile and put resources, incremental resources up to capture that business. On our biofuel markets, it's an emerging market for us. We feel good about the order book of customers that are coming on. We're gonna bring on two new plants here in the next, call it three to six months, which is very encouraging for us. Grain's gonna be a tough comp, but we'll see how that plays out. On the industrial side, You know, housing markets, we're seeing our lumber shipment, you know, taper off a little bit. One of the things that I tell you about industrial is on the construction product side, our rock shipments are still relatively strong, and so that's a positive for us. Our metal business has been strong. A lot of the rebar goes into construction materials for highways and roads, so that's encouraging for us. A lot of the other sheet and coil is helping out the automotive business, which is also, I talked about that being up. Automotive is up. Dealer supply at their facilities are low. They're about 32 days. Some of the OEMs that we talk to, their dealers supply for inventory at their dealerships is in the single digits, some in the teens. That's going to be a positive for us. The rest of the quarter, I mentioned this a little bit earlier, on the international intermodal side, it'll be a positive for us. We've got an easier comp, and then we're going to keep an eye on, again, domestic as we're moving through.

All right, thank you.

Our next question is from the line of Chris Weatherby with Citi. Please proceed with your question.

Hey, thanks. Good morning. You know, I guess maybe I wanted to clarify a point on the full year operating ratio. So I just wanted to make sure, I think you said reported 60 for the full year. So does that include the $114 million? That's sort of excluded from the adjusted third quarter. I guess that's my first question. And just sort of piggybacking on that, as you think about the sequential progression, it sounds like, you know, yields probably decelerate just given what's going on with fuel. But can you talk a little bit about sort of the cost aspect dynamic, maybe moving forward, it seems like, maybe a bit bigger than normal seasonal step-up in the operating ratio in the fourth quarter versus the third quarter. So can you just sort of elaborate a little bit on that? That would be helpful.

Sure, Chris, and thanks for that question. You did hear right. So the 60% is the reported operating ratio. So that does include the impact of the PEB, the $114 million that we took the charge for relative to the change in estimates. as well as the ongoing impact, which, as I mentioned in my remarks, was $19 million in the third quarter and will be likely a similar amount in the fourth quarter. So we absolutely do have that cost inflation. You also, I think, referenced fuel. That is going to flip on us, we believe, from third quarter to fourth quarter, where it was a tailwind for us in the third quarter. That flips back to a headwind of a decent amount, we think, now in the fourth quarter. So that's going to be an impact. And, of course, mixed. You know, it was a little bit negative for us here in the third quarter. That's probably going to look a little bit worse as we move into the fourth quarter. So kind of putting all those things together cumulatively, you know, on a sequential basis, we are expecting the operating ratio to deteriorate some, even as we're bringing more volume on and still working to take costs out of the network. But we have those headwinds, and as you know, with those inflationary things in particular, While we're very confident we're going to offset that with price, there is some timing there.

Okay, that's helpful. Thank you.

Our next question is from the line of Jason Seidel with Cowen & Company. Please proceed with your question.

Thank you, Robert. Lance and team, good morning. I wanted to focus a little bit on the intermodal side and break it up between both domestic and international. On the domestic side, you obviously called out sort of weakening truck market going to be a little bit of a challenge. How should we think about that going forward in terms of the yields? And on the international side, how should we think about what we've seen as a big shift from the West Coast to the East Coast? How much of that traffic shift do you think will be permanent in the long term?

Denny? Yeah, I'll start off with the international and just kind of walk you through it. First of all, one of the things that is encouraging to us is that we're seeing the percentage of traffic that goes onto the West Coast and moves to our inland facilities increase. And so again, that means that less of that product is being transloaded on the West Coast. So that is a positive to us. That's encouraging to us. We're pushing up, I'll call it products and solutions, up against our customers in that light. For example, our KTN Dallas to Dock facility last quarter had its highest volume of westbound traffic there. Also, we opened up our Global 4 ag reload facility in August. So those are things that we're doing to make the product a lot more encouraging. So keep that in mind as you're thinking about the west coast versus the east coast. Then on the domestic side, again, I mentioned and called out the fact that On our parcel business, we're looking at that fairly closely as we're heading into the last part of the year. We have seen the inventories rise a little bit. That is reflected in some of our inland terminals to a very small degree. We've seen the spot rates lower, but we haven't seen that in the contract rates. We'll know more about that as we head into a bid season. which is then call it December 4th.

Yeah, and Jason, I'd just add one thing, and that is we're encouraged by the movement of the international boxes between ports and inland, right? That's fluid, looks pretty good. We've taken some of the box count down off of the ports. That's approaching back to normal. We still have an issue with trying to get boxes off the inland ramps and process through warehouses. There's a lot of inventory sitting in warehouses right now, and the U.S. consumer is going to have to chew through that for us to be able to get street times and boxed well on the destination side back to normal.

Okay. And the comments that I made about yields, if we do see a bleed in the contract rates and the truckload side, Kenny, how should we think about pressure on intermodal yields as we look to 2023?

So, you know, first of all, I think, again, it's just a little too soon to tell. Hey, I'm not ready to concede that all the tightness that Lance just talked about might not show up in firming prices on the contract side. So it's just a little too soon to call that out.

Okay, fair enough. Doubtless there's a headwind there through the bid season, and we'll have to just see how it plays out.

Okay, appreciate the time as always, gentlemen.

Thanks, Jason.

Our next question is from the line of John Chappelle with Evercore ASI. Pleased to see you with your question.

Thank you. Good morning. Eric, you spent most of this year, probably even much of last year, trying to bring on resources, mostly labor, but all these resources that you needed for fluidity and productivity, et cetera, and now it feels like you're getting close. if not there, into a slowing demand backdrop. So as you look about going forward, do you have the flexibility and the nimbleness that you've had in prior cycles to maybe manage some of those resources down if demand's weaker than you expect, or do you need to keep the network a bit more over-resourced in the short term given these challenges that you've had and maybe even more intense scrutiny from the regulator?

Yeah, I appreciate that question, John. Without a doubt, as we've demonstrated and multiple times, unfortunately, we have the ability to bring down our resources in line with volume. You know, my prepared comments, I made a point to point out that we want to be more than volume variable. So that playbook is known and we've demonstrated an efficiency and being able to do that. Now, as we think about that and we think about the last year and a half to your point, there are three things that we continue to be focused on. Our ability to hire no matter what the market is remains critical. As part of that, we continue to work on how we think about making our jobs even more attractive to the population. So no matter what the market is, we can attract the talent that we need. At the same time, as we look at resources and continue to be able to balance them, to your point, you will see us, as we've had in the past, reestablish AWATS, which is a way for us to have a little bit of a buffer. It's not thousands of people. It's a couple hundred people to be able to react both on the upside and the downside. So we have that playbook. We clearly have demonstrated our ability to execute it, yet we continue to take lessons we're learning to make that playbook even stronger.

Great. Thanks, Eric. Next question is from the line of David Vernon with Bernstein. Please just share with your question.

Hey, good morning, guys. Thanks for taking the time. Eric, you know, you mentioned in the slides that you're getting ahead of your 1,400 hiring goals for T&E this year. Can you help us think about how much more hiring we need to do to kind of maintain the service levels that you need to be? What are you thinking about in terms of headcount for next year? Obviously, you don't have the volume plans and everything else, but are we still in the process of catching up from a headcount perspective for where you need to resource the network? Or if it gets to 1,400, are we there? Sure.

Yeah, David, great question. So, you know, to reiterate, we set out for the year to start hiring 1,400 people. You heard in my prepared comments that we've done that. Now, admittedly, a third of that 1,400 have been hired, and they're in the training pipeline. So we won't see the benefit of having them until the end of the year, between now and the end of the year, really. As we think about looking out at our hiring demands, as you pointed out and as Kenny highlighted, there are obviously questions about the markets. We'll stay close to those. We'll use the same process that we've employed in the past to ensure that we don't fall short of hiring. And at the same time, as we look, we're really focused on attrition. You have a couple questions that are outstanding with regards to the implications of the ratification with some population of our employees, and we're gonna react to that accordingly. So it's really about the markets, what do we need to be staffed to for that, and contending with attrition.

And is it right to think that there's a little bit of a buffer you need to add in there for some of those agreements around, you know, extra paid time off, just having some people, more people on staff? Is that something that's also sort of contemplated in your hiring outlook, or is that – how do we think about that from a productivity standpoint?

It's contemplated and always has been contemplated, certainly inside – the agreements that are still out for ratification, there are questions around additional time off and we'll adjust accordingly for that. I think the more important part of that is how do we think about that AWATS program and making sure that, again, it's a couple hundred people and it's viable and it's something that we can rely on.

But David, I think it's important to remember, and Eric said this, we still expect that we can be volume variable even with those agreements. So we're going to see volumes exceed whichever, you know, what happens in the economy. You won't see headcount grow to the same extent.

Yep, 100%. One last thing to note, David. We've got to step a little carefully here. We've committed and we've started and been in negotiation with some of our crafts, the unscheduled jobs specifically, to try to find ways to get scheduled time off, Part of the PEB and this negotiation address that, but it's a far bigger issue that needs to be addressed on property in job design. That's underway. We think there's a path to do that without a substantial or kind of meaningful impact on overall headcount requirement, because what we're trying to do is we're trying to make availability of employees flat across the week, right? So you don't get spikes in in crew availability and layoffs. And the way you do that is you make time off predictable. And we think that tradeoff is feasible. We think it's absolutely going to be happening. We don't think there's a large impact on employment through that.

And it could actually give us better crew availability. That gives us opportunities.

All right. Thanks a lot for the added color, guys.

Yep. Thank you.

Our next question is from the line of Ravi Shankar with Morgan Stanley. Please proceed with your question.

Thanks morning, everyone. So I get that you're obviously it's too early to give us 2023 guidance and everything. And then you did reiterate your commitment to the long-term targets. But I just wanted to get a sense of with all of the moving parts you see right now, are you confident that you guys can get pricing over inflation next year with kind of higher inflation inputs and pressure on the top line from what's going on in the macro?

Yeah, Ravi, short answer, yes. A longer answer, there are a lot of moving parts. There are going to be some headwinds into next year. Inflation is quite real. But as we look at rolling up a budget and starting or really at the tail end of putting our plan together, for sure we are confident we can get pricing above inflation.

Great. Thank you.

Our next question comes from the line of Allison Polonyak with Wells Fargo. Please proceed with your question.

Hi, good morning. Kenny, I want to go back to your comment that you put out there about leaving demand on the table. Can you maybe help us understand or quantify what you think that headwind was? And then, you know, as you're talking to potential new customers, you know, has the service challenges that you guys faced this year impacted some of that conversion to new accounts? Just any thoughts there?

Yeah, a couple things. One is, I tell you, Allison, that's hard to quantify. Clearly, we saw, you know, second week of September, mid-September, and it probably lasted for a couple weeks to dip in our carloads, probably more noticeable in our premium network than it was in our carload network. So, you know, Allison, I can't give you a number.

Yeah, but we can tell her where it's at, right? Most likely we left stuff on the table in coal. There's probably some left on the table in grain. I think that's where Allison's looking for.

Yeah, I'd say mostly in our bulk markets, I mean, or unit train markets. So if you look at our coal business, a little bit in our grain business, probably some on our fertilizer business, and there was a little bit more demand in our rock network. primarily associated with our unit train business, which consumes quite a bit of crews and resources.

And Allison, I think it's safe to say that there was less in the third quarter than the second quarter. And as we're entering in the fourth quarter, there's less again. So the whole idea isn't for all unmet demand to go away, right? There's at some point when you're running the business, it's good to have people want you that you don't have resources for. The issue is making sure that's not performance-based, that we're not leaving demand on the table because we weren't performing.

So the thing I'm encouraged by, and Eric talked about this, is that we did add more resources in. We have added more sets in. We are putting more resources up against it. We do have more crews coming on. So I'm more encouraged now. We're in a better place. Lance, you talked about it second and third, but we're in a better place today, and we're working closely together. That's on the unit train network. What you don't see is that our commercial team is working closely with operating on the carload side. So if we are seeing a little bit of softening on the lumber side, we're supplementing a little bit of boxcar and cover hoppers to capture areas where we do see the demand. The other part of that, I think you talked about just overall new customers coming into the network. Our customer base faced some of the same challenges that we did in terms of hiring and getting some of the resources so they understand that. They realize that that was a, I call it a short-term challenge for us. We're bringing on more resources to give them confidence. We're putting more capital for the growth. And so that gives us a lot of good things to articulate to our customers as we're talking about our preparedness in the future.

Great. Thank you.

Our next question is coming from the line of Ken Hexter with Bank of America. Please proceed with your question.

Hey, great. Good morning. It looks like we're opening up a little rough morning here. But, you know, thinking about your volume outlook with falling demand but improving fluidity, you know, how do you win share in that environment, particularly given the rapidly loosening trucking environment? I guess I'm more speaking on intermodal, Kenny. You know, it looks like your volume target for the fourth quarter is down to maybe 7%, given that full year 3% target. And then how do you win share if your trip plan compliance is still 58% to 62%? I mean, it just seems like after PSR, we should have been able to bounce back. I get the employees are still coming on, but, you know, just given that differential. And then, Jen, can you just clarify some comments you made on the real estate gain and pension, just to clarify what was maybe one time versus ongoing? Sure.

Yeah, Ken, let me start with that, and then we'll give it to Kenny. So on the real estate side, we called out that we had a sale with, I don't think I said this in my remarks, but that we had a real estate sale that impacted other income. We said that that real estate income was $35 million. The pension benefit, that was actually probably about, call it $14, $15 million higher year over year. That's something that we have seen through most of the year and may, you know, maybe not quite to that magnitude but should continue into the fourth quarter to a degree. But the real estate piece is the one that I would consider more one-time-ish.

Yeah, so, you know, I mentioned this a little bit earlier on our premium side. It really is a mixed bag as we look at it. We expect our international intermodal business to be up in the fourth quarter. domestic, intermodal, we're going to be looking at that closely. I talked about the shift in preferences. Now, I want to mix up fourth quarter in 2023. Looking into 2023, we've made it clear we've got another large private asset customer coming on base, which is a positive for us. How do you win in this type of market? It's all the investments that we're making. We feel good about the increased ramp capacity that we're putting on. We feel great about the tech that we're pushing up against the intermodal network in terms of precision gate technology, which will be great for the driver experience. There's quite a bit of investment, both line of road that's over there in terms of sidings that will be lengthened. We are putting quite a bit of investment up against that intermodal network to be prepared to compete and grow with it.

we look into the future and part of can your question is as predicated hey I expect you to snap back quicker given PSR why isn't your trip plan compliance better on premium and on your manifest side and the short answer is they continue to improve as we see car velocity which is now approaching the 200 number last couple of days that continues to improve and what you saw posted for Second queue and three queue is much better now in print as we're entering four queue.

But is that what gets you to the 80s from the 50s, 60s? Is it the employees? Is it the speed? What gets you back to where you were running?

So the biggest opportunity we have is really the congestion that we saw and been working through. Lance pointed out earlier in the conversation regarding the West Ports and the fluidity there. That translates. If you look into our velocity gains throughout this quarter, a big portion of that has been on the intermodal side. When I look on a daily basis at our arrival performance at terminals as well as our departure, those are both improving. Those are contributors to increased TPC. Yes, additional people are helping in certain particular markets, but it really is about the fundamentals, and I see them improving week over week.

Great stuff. Appreciate the time. Thanks, guys.

Thank you, Ken.

Our next question is coming from the line of Scott Group with Wolf Research. Please proceed with your question.

Hey, thanks. Good morning. Jennifer, the 3Q to 4Q OR deterioration, is that relative to the reported or the adjusted? And then just, you know, bigger picture, you reiterated, you know, this year pricing in excess of inflation. But with that positive price and positive volume, margins are going to be down about, you know, 300 basis points this year. So maybe just sort of help connect those two comments and then maybe more importantly just, you know, what's your confidence of improving the OR next year relative to this 60 OR we're seeing in 2022?

Yeah, Ken. So, when the comments about fourth quarter is really talking about the adjusted. So, adjusted you're at a 58.2. we see some sequential deterioration on that adjusted basis, not on the reported basis. So that's a good clarification. Thanks for that. In terms of 2023, again, still putting the plan together and a lot of moving pieces and parts. Probably the biggest part of that is really what's the economy going to be doing. But we know that we have opportunities to grow. You've heard Kenny talk about that. You've heard Lance mention that. We also know that we have continued price opportunities and we feel very confident in our ability to price above the inflation dollars. And Eric talked about the fact that we have certainly the opportunities to improve our overall efficiency. So putting all of those things together as we sit here today, not going to give you obviously any numbers, but we are confident that we will be able to achieve margin improvement going from 2022 to 2023.

Maybe just to ask it differently, like if we got positive price and positive volume this year and we're giving up three points of margin, what were the causes of that three points that maybe could go away next year? Or maybe not, I don't know.

Well, I mean, you know, just in this quarter, we'll just talk about this quarter, we had 310 basis points of margin deterioration in terms of the service inefficiencies and the inflation. So that right there is your 300 points. And so to the extent that we can do better offsetting that, don't have an inflation number for next year yet, certainly going to be impacted by the higher wages. This year's inflation, while we came into the year thinking inflation was probably going to be around 3%, and that'd be higher than what we've seen historically, it's probably going to be closer to 5%. And it's accelerated, obviously, as we've gotten here in the back half of the year and had some of these wage settlements. So it takes a bit to catch up to that with some of our pricing and as we're approaching the market, but we are confident in our ability to do that.

Okay. Thank you, guys.

Thank you.

The next question is from the line of Sherilyn Radborn with TD Securities. Please proceed with your question.

Thanks very much, and good morning. In terms of the intermodal business, I was hoping you could give us some perspective on how the onboarding of KnightSwift has progressed year to date, the extent to which both partners may have left opportunities on the table in the first year based on supply chain congestion, and whether you think that represents a tailwind as you look ahead to 2023. Thanks.

We have been very encouraged. I think KnightSwift would also agree. The onboarding has gone very well. Both companies have stayed very close to each other. Sure, there have been some supply chain challenges, but chassis dwell is not where it should be. It's actually stayed pretty elevated for some time now. So there could be some volume tailwind as that kind of loosens up as we move into the future. I can tell you that onboarding them has gone very well, and I'd use the word seamless.

Thank you.

Yep, thank you, Sherilyn.

Our next question comes from the line of Ari Rosa with Credit Suisse. Please proceed with your question.

Great, good morning. So Lance, you talked about the path to getting to a 55 OR. I was hoping you could just elaborate on that a little bit. And do you think that's primarily driven by price or are there further efficiency gains that you guys think you can realize to get there? And then on the pricing point, obviously the labor negotiations have been very public. I wanted to know to what extent that's kind of influenced discussions with customers on how much yield you might be able to get as you think about 2023.

Yeah, OK Ari. So the path to 55 is is really pretty plain. It hasn't changed this year. We ran into a rough patch. We ran the network tight. We got into trouble on our crew availability and we're digging out of that. We've made progress in the third quarter and will make another strong step to normal in the fourth quarter. I anticipate we enter into the back half of 2022. You know, in the 200-plus car velocity, we're essentially there at this point and need to grow from there and then be normal going into 2023, which I anticipate is going to be the case. As we do that, there is for sure an opportunity to take excess cost out of the network. Now, having said that, we're fighting against pretty significant inflation. You see it in the PEB, but it's across the board on our services and our inputs. We're going to have to overcome that with price. And we anticipate we will. We're confident we will. But that's not helpful on the OR side, right? So you've got to create margin somewhere. For us, that's got to be incremental volume. At this point, incremental volume is going to be a more important part of the three-legged stool into the future years. We're set up well to exceed what the industry is going to do. We're doing that this year. I think we're going to do that again next year. and we're going to have to make hay with it. And that's what gives us confidence that we're going to be able to improve margins going into next year. That's the clear path to a 55 operating ratio. And, again, I don't think we said it yet today, but reiterating leading the industry in terms of our margins. So, Kenny?

Yeah, I mean, we said it as a management team. We're going to cover inflation with price. But just to get a little granular here, our commercial leaders have done a really good job sitting down with customers, making adjustments to the rates real-time, again, real-time discussions to reflect the inflationary environment that we're seeing today. And so we're articulating the why behind the need for those adjustments with rates, especially in light of the capital that we're expending, and then also the fact that sequentially our service is improving.

Okay, thanks for your thoughts.

Yep, thank you, Ari.

Next question is coming from the line of Amit Mahatra with Deutsche Bank. Please just use your question.

Thanks. Hi, everyone. Jennifer, excuse me, I just wanted to understand with respect to the walk from 22 to 23, I understand there's a lot of macro and uncertainty, but you have the tentative agreement, so you should be able to obviously at least help us a little bit on what the incremental headwind is from the tentative agreement in 2023. It looks like, I mean, the slide was very helpful in the back. It looks like it's like $44 million a year. Is that the right way to think about kind of on day one, the incremental headwind in 2023? And then, Kenny, I just want to understand, so Lance just talked about getting to 200 car miles per day. There's still a huge gap given where fuel is, obviously, on the economics of moving something by rail. Is As we think about kind of the near-term volume the weekly volume trends. It's kind of stuck in this low to mid 160,000 if the if the asset if you know if the cycle times get better because You know you're able to get to 200 or X teams people get to 200 plus is there more volume for you to move in the near term like can we see a a corresponding step up immediately if we start getting to that 200 plus car miles per day because of where the economics of fuel are today. Thank you.

Okay, thanks for that. Let me start and then we'll turn it over. So the 22 you referenced is for the first quarter and second quarter. That was before the wage increase that became effective July 1. And so the thing you have to remember is the way that the wage accruals or the wages work is it's a July 1 increase. So effective July 1, we went from I think it was 3.5% to a 7% increase. And so when I referenced in my comments $19 million was the wage impact inflation, that's the third quarter impact, similar amount in the fourth quarter. those two impacts will carry into first and second quarter of next year, and then July of 2023, it goes to a 4% increase. So that's how you need to think about that. So 7% increase first half, 4% increase in the second half in terms of just the wage inflation piece relative to that. Does that make sense?

Yeah, it makes sense, but I'm just trying to – I'm just – maybe I'm lazy. I just wanted to – see if you can give us a number I mean it looks like if it's 20 million bucks third quarter and fourth quarter and then and then another incremental I'm just it doesn't see it looks like it's kind of like 50 to 60 million on a net incremental next year versus 2022.

Yeah, I mean, it's another, call it 36 to 38 million in the first half, and then something a little bit less than that in the second half of it going to 4%. So you're thinking about it the right way. But that's, again, that's wage inflation. We know that there continues to be inflationary pressures, particularly in our purchase services category, when you think about the labor that, you know, is contracted labor. So don't have the full year inflation number, not ready to share that. But You know, there's certainly wage inflation, PEB inflation, but there will be inflation above that. Again, 5% for this year. I don't know that we'll be quite that next year, but it's going to be much higher than our normal, or higher than what we saw kind of back at our May analyst day, which was 2.25%. We're well beyond that now.

Yeah. Oh, yeah.

And there was a question in there about... So, yeah, Amit, as you can imagine, we're looking at the economy, and we're looking at our carloads, daily, weekly, monthly. But as the velocity improves, there are some areas that we see demand out there. I mentioned coal. I mentioned rock. Autos, finished vehicles, auto parts is another area where we see quite a bit of demand that's out there. And so, yeah, I think that there's still an opportunity for us to capture more volume in the near term.

Okay, all right, very good. Thank you very much, everybody.

Yep, thank you. Our next question is from the line of Jordan Alger with Goldman Sachs. Let's just see if there are questions. Hi, Jordan, your line is open for questions. Our next question will be from the line of Ben Nolan with Stifel. Please receive your question.

Yeah, thanks. Hey, guys. Actually, just to follow a little bit on the latter part of Amit's question there, just thinking about areas of the market where you could pick up volume that maybe are underserved at the moment. Thinking about the fourth quarter specifically, we've heard a lot about how there's water level problems in the Mississippi and the barges can't move around. Is it possible or do you have the capacity in the fourth quarter to maybe make up for that at all? Is that something that could in the immediate term be a little bit of a tailwind for you?

Yeah. I tell you, we've been working with customers. We've been working closely with Eric's team. The short answer is yes. We've been talking to our customers. As you know, this would be incremental volume to what we have today. So based on that, we're working with our customers to make sure that the rates reflect this incremental volume. But yes, I don't want to say that this is going to be a large amount of volume for us that we're going to take. But what you need to hear is that we're working with customers. I'm looking at Eric. We have a good plan to go out and capture some of that business. But again, that barge, Mark, it's a huge amount of product that seems to be kind of misplaced right now.

Yeah, and Kenny, helping our owners understand this, we ship in a normal year grain to the river, up north on the river, and then it heads down the river. That's a carload. What's going to happen is the flow of those carloads is going to go all the way down to the Gulf. And so it's a car load, but it's a longer haul, and for sure we see that demand showing up right now.

Great. I appreciate it. Thanks.

Yep.

Our next question comes from the line of Brendan Oglinski with Barclays. Pleased to see you with your question.

Hey, good morning, everyone, and thanks for taking my question. I guess, Lance, you know the 55OR target has proved pretty elusive for most carriers when they put it out there. And, you know, just in hindsight here looking at what's happened the last couple years, you know, as you try to get resources out, you know, service falters and you can't move the volume that's out there. Is that the right metric we should be focusing on anymore? I mean, does it even make sense to target a 55 OR, maybe something higher with more resources but better asset turns? I mean, Jennifer did mention, you know, focusing on ROIC. So I guess can you speak to that, you know, over the longer term?

Yeah, Brandon, and that's a fair question, but here's how we think about it. We do believe that that 55 is achievable. We don't think it sacrifices the service product for a number of different reasons. You look backward in the last two years. As you know, there's just a lot of moving parts there that created unique headwinds that bit us pretty hard. This year, it was about us getting our resources wrong in terms of crew availability. and for a number of reasons, the pandemic being one of them early on. It's a distant memory now because we're kind of living as if life is normal, but that had a real live impact on us from 21 heading into 22 when we first got behind. Now, setting that aside, your fundamental question is absolutely spot on, and we talked about this at Investor Day. We said, You know, just merely focusing on an operating ratio number, that isn't the right way to think about our business. We think more important to our business is long-term sustainable incremental margins, being the railroad with a leading margin. We think we can do that. Our franchise sets us up for that. And then growth, right? And that's what we fundamentally focused on at Investor Day. The reason why we have to speak to the 55 right now is, candidly, it was a target we put out for this year. We thought it was quite achievable this year, and then a whole lot of stuff happened that made it difficult. The other thing to note is we've achieved it in a couple of handful of quarters, and that's not the goal is to nail it once and be done with it, right? The goal is we think that the business is set long-term to be able to handle that. Now, things could change, and you're pointing that out, Brandon, but they haven't changed yet to make us believe it's unachievable. More important to us right now is continued progress, get back on track of improving our margins, and grow. And that's what we're focused on when we go into next year.

Yeah, and we really think about it, too, in terms of setting us up to be competitive in the marketplace and win. that's what having that very solid competitive cost structure does for us, and that gives Kenny and his team the ability to go out there and win new business to leverage the cost of that very efficient franchise.

And, again, I think we've got to point this out. We are performing best at the top of the heap amongst our peers today, and I think we're going to repeat that again next year in terms of growth.

Thank you, Lance. Thank you, Jennifer.

Yeah, thank you, Brandon. That's a good question.

The next question is from the line of Walter Spracklin with RBC Capital Markets. Pleased to see your question.

Thanks very much. Just keeping on the OR focus here, I know you underlined reported on that guidance, and I can understand you kind of adjusting it for the third quarter given that you're putting in some prior period adjustments, but isn't a 60 OR, I mean, that's taking to effect prior period under accounting for labor, so isn't 60 the right number for this year? It shouldn't be reported or Or, you know, it's not a number we should adjust. I know I'm going to get that confusion, and I know it's going to, so I want to nip that in the bud now. Isn't that the right way to look at this? The 60 OR is the real number for this year and shouldn't be adjusted. Is that right?

No, I wouldn't agree with that because the 60 OR includes, call it 92 million, and that's what's shown on that appendix slide for 2020 and 2021. And so that is Those are dollars that really pertain to prior years where, and again, it's primarily due to this bonus that we were under accrued. So while I wouldn't take the whole $114 million out, maybe that's to your point, I do think $92 million is the piece that you need to think about when you're thinking about repeatable OR. Okay, got it.

And then for next year, I heard the word confident a lot. I heard confident about price, confident about efficiency, but not confident enough to give the OR guide for next year 55. And what I didn't hear you say confident about was the volume outlook for next year, given the uncertainty of the macro. Is that the only thing that's keeping you back from giving a 55? In other words, if we see even modest growth next year, is 55 achievable for next year?

No, hopefully what you heard from us is say that while we still absolutely have that goal, the road to getting there is longer. And it would be a pretty big stretch for us to go from, again, something less than a 60, you know, when you take out the 92 million, but call it a high 59 kind of OR to get into that 55 range next year. that's not where we think that we can get to. We certainly believe that we can get improvement, and the level of that really is going to be dependent on how we see the macro environment shape up to a degree, and that's where we're still putting the plan together. But that was what we were intending to communicate is we can still get to a 55, but we're not going to be able to snap back into that range we don't believe in 2023.

And that's the swing factor. You feel confident enough that network fluidity and all those issues will be kind of resolved next year, that that won't be a significantly constraining factor. Is that right?

Yeah, running the railroad normally, quote-unquote, being a normal kind of operation next year, that's not a constraint. The constraints are lots of incremental inflation, volume that's a question mark as to exactly what it's going to look like, So you've got that right. Next year is a normal railroad and basically back to squeezing out, you know, incremental efficiencies with a lot of inflation that we're going to have to find to overcome. Okay.

Yeah, I was just going to say, as you know, we don't have the access to reprice 100% of our contracts next year. So there is a bit of some timing there as we catch up on some of those contracts as they roll.

Makes sense. Okay. Thank you very much. Appreciate the time.

Our next question is from the line of Jeff Kaufman with Vertical Research Partners. Please proceed with your question.

Thank you very much for squeezing me in. Jen, just a quick question. That $114 million, does that represent an accrual on all outstanding labor contracts, including the ones not yet ratified, or is that only for the agreements that have been ratified to this point?

Yeah, thanks for that clarification. It is for all of the agreements, both ratified and tentative at this point, because those are the deals that are literally on the table and that are awaiting ratification. So that's what we know to be able to take the accrual for.

Okay, that's my one. Thank you.

All right. Thank you.

The next question is from the line of Bascom Majors with Susquehanna. Please proceed with your question.

Jennifer, when you look at the cost per employee trends, the 8% in the third quarter and the 7%, I think you implied, for the fourth quarter are pretty close to the union wage increase for the second half of this year that started on July 1st. As we look into next year with 7% union wage increases continuing in the first half and 4% in the second half, is there anything that you can do to maybe get the the realized cost per employee below that, or is that actually kind of a decent proxy for the kind of inflation that you'll feel per head next year? Thank you.

Yeah, thanks for that question. I mean, certainly that's the starting point, but as you heard us talk today, where we will look to end out would be something less than that because we know there's inefficiencies in that and that we're working to squeeze that out. I referenced, you know, overtime and borrow-out costs, Those are real headwinds to the overall cost structure relative to our employee costs. While we'll probably have borrow-outs for a while as we're working to catch up in some of these hard-to-hire areas, we would hope to be in a position to certainly slim that down and then ultimately eliminate that, as well as be able to manage the overtime better.

Thank you.

Our next question is from the line of Justin Long with Stevens. Please proceed with your question.

Thanks and good morning. Just to clarify that 2023 commentary, are you still assuming that you'll be able to grow volumes next year? And as we think about your comment around improving the OR in 2023, Is that predicated on that volume growth, or do you feel like even if volumes are flat or maybe even down a little bit, that you can still improve the OR from the cost takeout as network inefficiencies improve?

Yeah, thanks for that question, Justin. I mean, again, no numbers being given here today, but we have some good tailwinds, as I think both Lance and Kenny have talked to you about, in terms of volume. We've got Schneider coming on, you know, large piece of business. We have demand that we know we didn't move today on the coal market, some of our bulk markets. We know good construction demand going into next year from a rock standpoint. So our expectation is to be able to outperform the market, as we said back at our investor day. And so you look at industrial production now, I think forecasts for 2023 are in the negative range. But even outperforming that could put us on the positive side of the ledger a bit. So that's how we're shaping things up right now. Not going to give you degrees. And obviously it's going to depend on what really ultimately happens. You know, my crystal ball isn't quite that good yet to know exactly how the economy is going to fare next year. But we do like our setup going into the year, and that's how we're thinking about that at the moment.

Okay. Thanks.

Yep. Thank you, Justin.

The next question is from the line of Tom Watowitz with UBS. Please proceed with your question.

Yeah, good morning. I wanted to ask you a bit about truckload pricing sensitivity. I think there's generally a sense that, you know, given enough time, railroads can recover inflation with price. But, you know, you are looking to do that against a market where the truckload market is a lot more loose. So, you know, kind of how much of a barrier is that to accelerating your price And how much of the book do you think really is sensitive to the truck market in terms of pricing? I guess the second one would just be on imports. Do you think, I mean, it seems reasonable to think that import container imports might be down next year. If they're down meaningfully, can you still grow your intermodal or is that a pretty tight link just in terms of import activity and in UNP intermodal?

Yeah, so just, again, just trying to differentiate the two. On the domestic side, you're right. There are still a few more question marks there. As I stated a little bit earlier, we're going to get into our bid season here in December. We'll find out a little bit more about where the markets are. As I stated, there's still enough capacity constraints that are out there in the supply chain on the domestic side that could firm up some of the prices. We just have to see how that plays out. On the international intermodal side, it's still too soon to tell what will happen there. I wanted to make sure that I really highlighted the fact that regardless of what's happening with the actual volume, the percentage of international rail volume has increased this coming into the port. So again, last year, we talked a little bit about the fact that we had a larger percentage of our customers transloading on the West Coast port. Today, as we stand, we can see that our customers are now moving more of that via rail. So that's a positive for us.

Yeah, those moving parts, Kenny and Tom, are hard to discern exactly how they're going to play out. It sure does look like inbound port container volume is going to be down in certainly the early part of next year. I mean, we're hearing enough markers of that. But depending on what happens with our percentage that's coming inland depends on what exactly we see, right?

Right.

Okay. Thank you. Thank you. Our final question comes from the line of Jordan Allinger with Goldman Sachs. Please receive your question.

Yeah, hi. Sorry, I had some technical issues before. But just a quick question. On the auto sector, is that something that could deviate from the economy, just given dealer inventories at the lot as we think through to next year? I mean, will there need to be fill regardless to what happens to the consumer outlook? Thanks.

Yeah, we certainly believe so. There are just a number of markers that point to it. I talked about the supply to dealerships is very low, much lower than the OEMs want it to be. The average age of a car out there now is 13 years old. There's just a lot of pent-up demand in terms of shippables, non-shippables, meaning the OEMs have actually produced the cars and they haven't moved via rail yet. And then just the fact that, again, the parts, the ply, the semiconductor chip. I think that's going to improve here. So based on those things, we feel very bullish on that auto parts and the finished vehicle side.

Thank you.

Thank you, Jordan.

Thank you. 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 joining us this morning and for your questions. We look forward to talking with you again in January to discuss our fourth quarter and full year results. Until then, please take care.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.