Union Pacific Corp (UNP) — Q4 2015 Earnings Call Transcript

Good morning everybody and welcome to Union Pacific's fourth quarter earnings conference call. With me here today in Omaha are Eric Butler, Executive Vice President of Marketing and Sales; Cameron Scott, our Executive Vice President of Operations; and Rob Knight, Chief Financial Officer. This morning, Union Pacific is reporting net income of $1.1 billion for the fourth quarter of 2015. This equates to $1.31 per share, which compares to $1.61 in the fourth quarter of 2014. Another quarter of solid pricing gains were not enough to offset the 9% decrease in total volumes. Carload volume declined in five of our six commodity groups with coal and industrial products down 22% and 16% respectively. Automotive continued to be a bright spot for us in the quarter with the volume up 8% versus 2014. On the cost side, we continued to adjust resources throughout the quarter and also made solid progress with our productivity initiatives. We will hear the team talk about some of the highlights here this morning. As a result of these efforts we achieved a quarterly operating ratio of 63.2%. We continue to be laser focused on running a fluid and efficient network while safely providing value added service to our customers and delivering solid returns for our shareholders. So with that I’ll turn it over to Eric.

Thanks, Lance and good morning. In the fourth quarter, our volume was down 9%, with continued gains in automotive more than offset by declines in the other business groups. While we generated core pricing gains of 3.5%, this was not enough to offset decreased fuel surcharge and significant mix headwinds as average revenue per car declined 8% in the quarter. Overall, the decline in volume and lower average revenue per car drove a 16% reduction in freight revenue. Let's take a closer look at each of the six business groups. Ag products revenue was down 12% on a 5% reduction and a 7% decrease in average revenue per car. Grain was down 12% in the fourth quarter. High worldwide production and a strong U.S. dollar reduced grain exports by 23%. Solid growth in domestic grain shipments partially offset the export decline. Grain products decreased 4% for the quarter driven primarily by softer export of soybean meal and dry distillers grains demand. Ethanol shipments were down 3% driven by lower exports. These declines more than offset a 14% increase that canola meal shipments due to another strong canola crop. Food and refrigerator product volumes were down 1% for the quarter as strength in the year was offset by declines in fresh and frozen food shipments. Automotive revenue was up 1% in the fourth quarter as an 8% increase in volume was largely offset by a 6% reduction in average revenue per car. Finished vehicle shipments were up 8% this quarter, driven by continued strength in consumer demand. 2015 annual sales in the U.S. were 17.5 million vehicles, a level last reached 15 years ago. This seasonally adjusted annual rate for the fourth quarter was 17.8 million vehicles, the fourth highest quarterly sales pace on record. On the parts side, strong vehicle production increases and a continued focus on over-the-road conversions led to an 8% increase in volume. Chemicals revenue was down 7% for the quarter on a 2% reduction in volume and a 5% decrease in average revenue per car. Lower crude oil prices and unfavorable price spreads continued to impact our crude oil shipments, which were down 42% in the fourth quarter. Partially offsetting this decline was continued strength in the LPG markets including propylene, propane, and butane demand. Finally, petroleum products volume was down 6% primarily due to weaker residual fuel oil shipments as a result of a slowing in China’s production and export sectors. Coal revenue declined 31% in the fourth quarter on a 22% volume decline and 11% decrease in average revenue per car. Southern Powder River Basin tonnage was down 24% in the quarter as mild weather and low natural gas prices dampened coal demand. Temperatures in the fall were 3.3 degrees warmer than average and set a record for the lower 48 states. Coal inventory levels were 105 days through December, 39 days above normal, and 43 days above last December. Colorado, Utah tonnage was down 40%, driven again by soft domestic demand and reduced export shipments. Nationwide electricity generation by coal dropped from 37% market share in the fourth quarter of 2014 to 32% in 2015 as natural gas captured share lost from coal. Industrial products revenue was down 23% and a 16% decline in volume and an 8% decrease in average revenue per car during the quarter. Reduced rig counts and shale drilling resulted in a 42% decline in minerals volume, primarily driven by a 52% decrease in frac sand car loadings. Metal shipments were down 27% from softening industrial production, reduced drilling activity, and a strong U.S. dollar. Specialized markets were up 7% in the quarter driven by increased waste shipments. Intermodal revenue was down 14% in the fourth quarter, with a 7% lower volume and an 8% decrease in average revenue per unit. Full year 2015 domestic intermodal achieved its seventh consecutive year of record volume. However, our fourth quarter results were down slightly as continued highway conversions were offset by the discontinuation of Triple Crown business and sourcing shifts. International intermodal volume was down 12% in the quarter in a challenging market environment, primarily due to market volume headwinds for several of our ocean carrier customers. Imports in the Trans Pacific strait remained sluggish due to weaker than expected domestic U.S. retail sales. Let's move to how we see our business shaping up for 2016. In Ag products we expect high global grain inventories and the strong U.S. dollar to have a continued impact on the export environment. Food and refrigerator should continue to see growth in imports. We expect soybean meal to have another strong export year but likely will fall short of the record level reached in 2015. Turning to autos, we expect low interest rates and gasoline prices to continue to positively impact demand, driving both finished vehicle and parts shipments. However, we are cautious regarding auto sales sustaining these record levels. We expect the coal market will continue to be dampened by low natural gas prices and high inventory levels. As always, weather conditions will continue to influence demand. In chemicals, we expect most of our markets to remain solid in 2016 with particular strength in LPG markets. Low crude oil prices and unfavorable spreads will continue to present significant headwinds for crude by rail shipments. Fertilizer shipments will also be impacted by grain export headwinds. In industrial products, low crude oil prices will also challenge our minerals and metals volumes. We expect our lumber franchise to grow with demand from the slowly strengthening housing market and demand for construction products in specialized markets should be solid. In intermodal, we anticipate highway conversions will continue to drive domestic intermodal volumes. However, high retail inventories and sluggish retail demand are expected to mute growth in our international intermodal volumes. Wrapping up, while the strong U.S. dollar, low energy prices, and sluggish retail sales will continue to drive headwinds and uncertainty in some of our markets, we are optimistic in others. Mexico continues to be an opportunity driven by energy reform and Mexico's auto manufacturing market. With our growth depending on both the national and global economy we will continue to strengthen our customer value proposition and develop new business opportunities across our diverse franchise.

Thanks Eric and good morning. Starting with our safety performance, our full-year reportable personal injury rate improved 11% versus 2014 to a record low of 0.87. Successfully finding and addressing risk in the workplace is clearly having a positive impact as we achieve annual records on our way to an incident-free environment. With respect to rail equipment incidents or derailments, our reportable rate increased 14% to 3.42, driven by an increase in yard and industrial reportables. While our reportable rate took a step backward in 2015, we are confident that our strategy aimed at eliminating human factor incidents and hardening our infrastructure will lead to improved results going forward. In public safety, our grade crossing incident rate improved 3% versus 2014 to 2.28. We continue to focus on reinforcing public awareness through community partnerships and public safety campaigns to drive improvements in the future. Moving onto network performance, after making a step function improvement in our operating metrics during the third quarter, we have continued to make solid incremental progress. As reported to the AAR, velocity and terminal dwell improved 13% and 5% respectively when compared to the fourth quarter of 2014. Record fourth quarter velocity of 27 miles per hour was the best ever at the level of volume handled during the quarter. In fact, the last quarter we ran at this velocity was six years ago when our network was handling 7% fewer car loads. The strength and resiliency of our network allowed us to mitigate the impact from flooding events in the Eastern portion of our network during late December, thereby minimizing service delays to our customers. But while we have made significant improvement in our metrics, we know there is still more work to do as the team continues a relentless approach to further improve service and reduce costs. While we noted back in October that our resources were more closely in line with demand at that time, further declines in volume prompted us to make additional resource adjustments in the fourth quarter. In addition to adjusting to lower volumes, our improvement in network performance has translated into fewer recruits, lessening resource demands of our network. By the end of the year, we had around 3,900 TE&Y employees either furloughed or in alternative work status compared with 2,700 at the end of the third quarter. Overall, our total TE&Y workforce was down 18% in the fourth quarter versus the same period in 2014. Around half of this decrease was driven by fewer employees in the training pipeline. Our active locomotive fleet was down 13% from the fourth quarter of 2014. As always, we'll continue to adjust our workforce levels and equipment fleet as volume and network performance dictates. In addition to efficiently rightsizing our resource base, we also realized gains on other productivity initiatives such as train length. While we are unable to overcome the volume decline within intermodal, we ran record train lengths in all other major categories. We were also able to generate efficiency gains within terminals as productivity initiatives led to record terminal productivity, even with an 8% decline in the number of cars switched. In addition to process improvements, capital investments have also enhanced our ability to generate productivity and increased the fluid capabilities of our network. In total, we invested $4.3 billion in our 2015 capital program. For 2016, we are targeting around $3.75 billion pending final approval by our Board of Directors. More than half of our planned 2016 capital investment is replacement spending to harden our infrastructure, replace older assets, and to improve the safety and resiliency of the network. The plan includes 230 locomotives as part of a previous purchase commitment. This commitment wraps up with the acquisition of an additional 70 units in 2017. We also plan to invest an additional $375 million in positive train control during 2016. In summary, we finished 2015 on a solid note. In 2016 we are carrying that momentum forward as we continue to focus on those critical initiatives that would drive future improvement. Above all, this includes safety, where we expect once again to yield record results on a way towards zero incidents. In the face of an uncertain volume environment, we will continue to adjust our resources to demand while also focusing on other productivity initiatives to further reduce costs. And where growth opportunities arise, we will leverage that growth to the bottom line to increase utilization of existing assets. As a result, we will create value for our customers with an excellent customer experience.

Thanks and good morning. Let's start with a recap of our fourth quarter results. Operating revenue was just over $5.2 billion in the quarter, down 15% versus last year. Significantly lower volumes and an even more challenging business mix and a negative fuel comparison more than offset solid core pricing gains achieved in the quarter. Operating expenses totaled just under $3.3 billion, decreasing 13% compared to last year. Significantly lower fuel expense, along with volume-related reductions and productivity improvements drove the expense reduction. The net result was a 19% decrease in operating income to $1.9 billion. Below the line, other income totaled $28 million, down $43 million versus the previous year, primarily driven by 2014's real estate gains. Interest expense of $164 million was up 12% compared to the previous year, driven by increased debt issuance during the year. Income tax expense decreased 23% to $665 million, driven primarily by lower pretax earnings. Net income decreased 22% versus 2014 while the outstanding share balance declined 4% as a result of our continued share repurchase activity. These results combined to produce quarterly earnings of $1.31 per share, which fell well short of last year's record $1.61 per share. Now turning to our top line, freight revenue of approximately $4.9 billion was down 16% versus last year. Volume declined 9% and fuel surcharge revenue was down $438 million when compared to 2014. All in, we estimate the net impact of lower fuel price was a $0.11 headwind to earnings in the fourth quarter versus last year. And keep in mind we did report a $0.05 positive fuel benefit in the fourth quarter of 2014. This includes the net impact from both fuel surcharges and lower diesel fuel costs. As we expected, a challenging business mix did have a negative impact on freight revenue in the fourth quarter. The primary drivers of this mix shift were significant declines in frac sand, steel shipments, and bulk grains partially offset by a decline in international intermodal volumes. A 3.5% core price increase was a positive contributor to freight revenue in the quarter. Pricing continued to be solid throughout 2015 and represents the strong value proposition that we provide our customers in the marketplace. Of the 3.5% this quarter, about 0.5% can be attributed to the benefit of the legacy business that we renewed in 2015. With the exception of a few smaller contracts in the out years, 2015 marks an end to any further legacy re-pricing opportunities. Moving on to the expense side, we provided a summary of our compensation and benefits expense, which decreased 5% versus 2014. The decrease was primarily driven by lower volumes and improved labor efficiencies. Labor inflation was around 4% in the fourth quarter driven primarily by agreement wage inflation. Looking at our total workforce levels, our employee headcount declined 7% when compared to 2014. Reductions in TE&Y, training-related activities, as well as employees associated with capital projects all contributed to the workforce decline. At this point in time, given current volume levels, we are being very cautious with our hiring plans for 2016. On average for the year, we would expect overall force levels to be down somewhat depending, of course, on how volume ultimately plays out for the year. Labor inflation is expected to come in around 2% for the full year. This is driven primarily by agreement wage inflation, partially offset by lower pension expense. This is also consistent with our all-in inflation expectations in the 2% range for the full year. Turning to the next slide, fuel expense totaled $424 million, down 48% when compared to 2014. Lower diesel fuel prices along with a 14% decline in gross ton miles drove the decrease in fuel expense for the quarter. Compared to the fourth quarter of last year, our fuel consumption rate increased 1% driven by negative mix while our average diesel price declined 39% to $1.61 per gallon. Moving onto our other expense categories, purchase services and material expense decreased 11% to $589 million. The reduction was primarily driven by lower volume-related expense and reduced repair costs associated with our locomotive and car fleets. Depreciation expense was $517 million, up 6% compared to 2014. In 2016 depreciation expense is expected to increase slightly compared to last year. Other expenses came in at $235 million, up 3% versus last year. Higher state and local taxes and increased personal injury expense were partially offset by a reduction in general expenses. Other expenses for the full year were flat when compared to 2014, consistent with our full-year guidance. For 2016, we expect the other expense line to increase between 5% and 10% excluding any large unusual items. Turning to our operating ratio performance, the fourth quarter operating ratio came in at 63.2% and 1.8 points unfavorable when compared to the fourth quarter of 2014. For the full year, I am pleased to report an operating ratio of 63.1, which is a 0.4 points improvement from 2014. Even with the sharp decline in volumes, right-sizing our resources to current demand, ongoing productivity initiatives, and solid core pricing have all been key drivers to improving our overall margins. Operating revenue declined about $2.2 billion to $21.8 billion. Operating income totaled almost $8.1 billion, a decrease of 8% compared to 2014. And net income was just under $4.8 billion while earnings per share were down 5% to $5.49 per share. In 2015, cash from operations totaled more than $7.3 billion down slightly when compared to 2014. After dividends, our free cash flow totaled $524 million for the year. This was down just under $1 billion from 2014, primarily driven by lower earnings along with higher cash capital and dividend payments. This includes the two dividends that we incurred in the first quarter of 2015 resulting from the timing change in our dividend payments. As expected, the net impact of bonus depreciation on 2015 cash flow was close to neutral as the benefit from 2014 bonus depreciation offset cash tax payments associated with prior years. Taking a closer look at 2016, we will see the benefit from both 2015 and 2016 bonus depreciation since the legislation was passed just before year-end. We are factoring in the two years' worth of benefit in 2016 against payments from prior years, the expected net impact from bonus depreciation will be a tailwind of roughly $400 million on this year’s cash flow. For 2016, this would be a reduction of over $500 million from last year’s capital program. We are continuing to work towards a debt to EBITDA ratio of less than 2 times. While we did increase our debt levels to reward shareholders, we also maintained a strong balance sheet which is a valuable asset particularly in the face of economic and strategic uncertainties. In 2015 share repurchases exceeded 35 million shares and totaled about $3.5 billion up 7% from 2014. Over the past five years, we have repurchased 15% of our outstanding shares. Adding our dividend payments and our share repurchases we returned more than $5.8 billion to our shareholders in 2015. This represents roughly a 20% increase over 2014, continuing our strong commitment to shareholder value. So that’s a recap of our fourth quarter and full-year results. Looking ahead to 2016, we do have some significant hurdles. Our energy-related volumes will continue to be a challenge. Compared to last year's strong first quarter, we expect this year's first-quarter coal volumes to decline around 20% or so. And given the headwind we currently see with coal, it is likely that total volumes for the first quarter will be down in the mid-single digits. For the full year we currently expect total volumes to be slightly negative depending on coal and the strength of the overall economy as the year plays out. Fuel prices will have a negative impact on earnings at least in the first quarter given the $0.08 positive fuel benefit that we reported in the first quarter of 2015. We are counting on record productivity and solid pricing to drive an improved operating ratio again this year as we work towards our longer-term operating ratio target of 60% plus or minus on a full-year basis by 2019. And as always, no matter what the environment we remain committed to running a safe, efficient, productive railroad for our customers while generating strong returns for our shareholders. So with that I will turn it back over to Lance.

Thanks Rob, and as we discussed today, this past year was a difficult one in many respects. But our team did outstanding work in the face of dramatic declines in volumes and shifts in our business mix. Overall economic conditions, uncertainty in the energy markets, commodity prices, and the strength of the U.S. dollar will continue to have a major impact on our business this year. However, our velocity is at an all-time best for the current level of demand. The network is fluid, and we are driving towards further improvement. We are well positioned to efficiently serve customers in existing markets as they rebound. The strength and the diversity of the Union Pacific franchise also will provide tremendous opportunities for new business development as both domestic and global markets evolve. When combined with our unrelenting focus on safety, productivity, and service, these opportunities will translate into an excellent experience for our customers and strong value for our shareholders in the years ahead. So with that, let's open up the line for your questions.

Hey good morning and thanks for taking the question. Rob, with regard to your comments about the legacy pricing, further we saw about half a point in the fourth quarter. When you re-priced some of the legacy contracts, you had pulled forward some from 2016, should we still be considering some sort of incremental benefit in 2016 to the core pricing metric as we look out or should that effectively be zero for next year?

Yeah, I would say, basically, effectively zero. I mean, there might be a tad bit of little carryover, but I think for your modeling purposes, those are pretty much behind us.

Got it. And then I guess shifting gears Eric to the intermodal segment, you had called out some headwinds in the fourth quarter related to Triple Crown and some sourcing shifts. Can you kind of quantify how we should be thinking about that Triple Crown headwind for 2016 or your quad specifically, the volume challenge that you guys saw and should those sourcing shifts that we saw in the fourth quarter continue to weigh on intermodal load growth for the domestic volumes as we look out?

Yeah, Rob. As we indicated, we still always expect our highway conversion strategy, which we are firmly focused on, to drive growing domestic intermodal volumes. And so, we continue to see growing domestic intermodal volumes despite headwinds from Triple Crown and other things that occur all the time. We do expect, as I called out, to see headwinds on the international intermodal side, just because of all of what's going on with the trends in simple trade in the China markets. But on the domestic intermodal side, we continue to see our strategy working, which is growing volumes through highway conversions.

Yeah, good morning everyone and thanks for taking my question. Lance or Eric, I mean, can you guys just give us some context here because I have only been covering the industry for about a decade, but the volumes seem pretty bad right now. I mean, maybe not quite as bad as 2009, and yet we are still getting jobs growth in the U.S. So how do you look at the environment right now? Is the U.S. headed into a broader recession or is this just limited to energy, industrial, and other specifics in your business that maybe look worse than the broader economy?

Brandon, this is Lance. The impact on all railroads has been acute as you point out in energy, in commodities affected by the strong dollar like export grains, steel markets, and those are not necessarily indicative of a broader U.S. reality. I will share with you though there are also questions that we have about U.S. consumers. There are indicators that consumers are healthy like the unemployment rate is at a comfortable 5% level, consumers are buying automobiles as Eric outlined. But the labor participation rate isn’t that great and fourth-quarter retail sales for goods was not that great. So I will let Eric give you a little more technicolor.

Yes, I am not sure there is much else I would add to that. I would say the consumer is spending, there is consumer confidence, household income is going up. There appears to be a shift between consuming on products or goods, spending on services. There does appear to be that shift so it does some of the changes is impacting our business and the industrial space.

Yes, Brandon one last thing, early in the year we talked about the impact on energy from low natural gas prices and the effect on coal, the effect on crude oil and natural gas exploration and development, and we said ultimately that should be a benefit to other industries we serve like plastics manufacturing and consumers. And we just haven't seen yet the offset, the positive offset from the headwinds that we’ve experienced.

Well I know it’s difficult for a lot of investors on the line here too. Well Rob can you talk a little bit about the outlook for an improving operating ratio? What are the big drivers here especially with the uncertainty in volume?

Yes, the big driver, I mean volume obviously is our friend. And I guided, as you picked up, that we expect full-year volume to be slightly down. We’d obviously like to see that improve from there, but given that slightly down sort of view of the world and a positive improving operating ratio is our conviction around our ability and our focus on continuing to drive productivity and our ability to continue to provide quality service to our customers enables us to get price in the marketplace.

Hi there, good morning. Want to touch a little bit on the outlook or stay on the outlook for 2016. Rob, I know you don’t give earnings guidance specifically but if you can get sort of slightly down volumes, you have an improving OR, mix is going to be negative certainly in the first quarter or so of the year, I mean how do we think about the other puts and takes that potentially sort of impact that whether you are sort of flat to down or flat to up, I am just trying to make sure I understand how much you can control on the expense side to maybe offset some of this negative mix that we are expecting?

Chris, I mean and the reason that I am not giving earnings guidance is because of all those unknowns. We are confident we can control what we can control which again is the productivity and quality of service, continue to drive positive price but there is so much uncertainty at this point in time in terms of what the absolute volumes will be and what the mix of those volumes will play out. So, that’s why we are not at a position right now to give earnings guidance but I assure you we are focused on driving improvement on every aspect that we can and we certainly would like to see as positive results as we can drive.

Okay and then maybe just to follow up on that, in terms of the expense side what you can control you talked about headcount a little bit in the outlook and I think you said it would be down a bit, I guess you are entering the year with it down little bit more than that and kind of trying to chase that volume number down, I mean how do we think about sort of headcount for the full year in a little bit more detail?

I mean Chris, as we’ve said all along and I’ll say it here again for 2016 is that volume will drive what our headcount ultimately is although there is still productivity. So volumes are slightly down. I would expect that we would have down headcount driven by volume and layering on our expectation of driving further productivity. So it will flow with directionally with what volume is but we are very focused getting to see what the mix actually plays out, very focused on driving productivity in those numbers and being as efficient as we can.

Chris we outlined for you the expectations for volumes in the first quarter in a few specific areas. I would say we are in a much better posture entering 2016 from a realizing productivity in a headcount perspective, getting the resources right for the volumes than we were entering 2015. We are just in a very different place.

Good morning, thanks. So following up on the previous question, how much of a volume decline do you think that you can handle while still generating positive earnings growth? You did mention expectations for a slight decline but if car load has tracked down 5%, 6%, 7% is that sort of where you are thinking about the tipping point?

Allison, this is Rob. I can't provide guidance on the earnings. I understand your question, but the key factor will be the mix and the actual volumes that change. I can assure you there is a point where if things go too negative, it would shift our performance. However, we will focus on enhancing productivity and increasing prices where possible. I can't give you a specific answer on where that tipping point lies, but we are committed to controlling what we can and driving positive operating results and earnings, regardless of the volume changes.

Understood, thanks. And then my second question would be what your expectations for overall cost inflation are for 2016? Thank you.

Yeah, as I said Allison, overall inflation assumptions for us in 2016 are around 2%.

Hey, thanks, good morning guys.

Good morning Scott.

Rob, just wanted to clarify a few things that you said. In terms of headcount down slightly or something like that, I mean, we're going to be starting the year down 9% or so year-over-year. Are we talking about down slightly from kind of where you are ending the year at that 44, 45 level?

Basically that guidance or that view of the world Scott, that where I say it’s slightly down is a year-over-year assumption at this point in time. And again full year. And again, what will drive that is what the ultimate volumes end up being.

Scott, just a little point of detail. At the tail end of many years, there are a lot of moving parts that affect headcount, the absolute headcount number. But the average is the one that’s most useful.

Are you thinking about adding headcount from where you are right now because if you take where you are right now, I mean it should imply pretty meaningful drop in headcount?

We are going to continue to match headcount to whatever the volume situation is. The other thing to note is headcount comes in and out on capital programs as, for instance, in the winter time we start shutting down capital spend because of the weather and spool it back up in the spring. There are just a lot of moving parts quarter-to-quarter sequentially.

In terms of pricing, I wanted to ask if you are doing anything similar to what BN has mentioned about reducing prices to encourage coal demand. Could you discuss the overall pricing situation? It appears you anticipate strong pricing in 2016. Is it reasonable to expect a slowdown in the pricing environment given the current volume trends, or do you believe we can maintain this around a 3% range for legacy pricing?

Hey Scott, this is Eric. So I cannot speak to what the BN does with its pricing strategy. They do their own independent strategy and I cannot speak to what they do. We continue to hold on our strategy of pricing for our value. We are driving a value proposition that we want to be an industry superior value proposition and we are going to price accordingly for that. We do think that there are places in the market and the economy that are growing and we think that those provide value for us to continue to price according to our long-held strategy.

Okay, alright. Thank you, guys.

Good morning and thanks for taking the questions. Rob, I know you didn’t give explicit earnings guidance, but in the past two years you had noted in your slide deck record earnings and that was notably absent this time around. So I just want to confirm that we should interpret the lack of that expectation for record earnings to be what it is, that you won’t at this point, you do not expect to achieve at least the $5.75 in earnings per share that you achieved in 2014, which was the last record. I just want to confirm, you are essentially expecting this year to be below that figure?

That is correct. Now nothing would please us more than to see the economy turn and things are going to go favorable. So we are going to fight like heck to do the best we can. But yes, you are correct. At this point in time, we do not see record earnings.

Okay, that’s helpful. And then, just to touch back on the pricing discussion, you noted that you expect inflation to be 2% in 2016. In the past, you've always kind of suggested nominal pricing, above inflation. Is that still your expectation for 2016 to achieve pricing above that 2% inflation level?

Yes. But as you know, we don’t set our prices based on what current year inflation numbers are. And as has been pointed out we’ve discussed here today, we price the market. Every market is a little bit different. We clearly don’t have the benefit of the calling half-point legacy renewal that we’d enjoyed in 2016, but having said all of that, yes, we are still focused on pricing above inflation.

Good morning. I wanted to inquire about the volume aspect. You mentioned the first quarter, and Eric provided insight into the 2016 outlook by segment. Upon reviewing that segmentation, it appears to be split between positive and negative, although coal seems to be entirely negative. While the segment analysis looks quite unfavorable, you're indicating a slight decline overall for the year. I gather that a slight decline likely means a decrease of 1 or 2 rather than 3 or 4. How do you reconcile these two viewpoints? Is it simply that the comparisons become easier in the second quarter, or do you anticipate an improvement in demand later in the year, possibly adjusted for seasonality? It seems that the segment analysis appears more negative compared to the overall indication of a slight annual decline.

Let me just start off and Eric may want to comment further and to maybe more specific, but this is Rob. I would just say that Tom to your point we clearly are highlighting and as you know that the comps particularly, the first quarter is particularly challenging and that’s why we are calling out the down volume in the first quarter in coal clearly 20% or so range. So the comps do change throughout the year but our view of the world right now is that the energy environment which impacts our coal, impacts our shale, impacts our metals. It supports the shale activity on top of the continuing strong dollar. Those are going to continue to be hurdles and pressures for us. But the comps do change as the year plays out and I think that’s what's driving sort of maybe the math that you are wrestling with.

Eric you got anything else to add?

No, that’s it.

So you would say it is more comps than anticipation of improved market later in the year?

I’d say that’s a bigger driver.

Okay, I appreciate that. What about mix? If I look at your slides in the third-quarter mix I think it was a 1% year-over-year headwind and that got a lot more challenging in fourth quarter which I think was the big thing we missed in our assumptions for fourth quarter with that 4% mix headwind. I know it’s a tough one to forecast but do you think mix in 2016 is more like the 4% or more like 1%, that’s a pretty material consideration?

Tom, this is Rob again. I would say again as you know we don’t and is very difficult, in fact frankly impossible to precisely predict exactly what mix is going to be. But I would say just sort of directionally if you look at the full-year mix impact in 2015 it was about 1.5 negative and you are right, the fourth quarter was particularly bad at down at 4. We do expect to still see mix headwinds as 2016 plays out. I don’t anticipate that it would be for the full year as bad as we saw in the fourth quarter. We do have a comp challenge in the first quarter but as the year plays out things should get easier and while mix will be headwinds for the full year it should sort of get better than what we saw in the first quarter, we’ll see in the first quarter and what we saw in the fourth quarter of last year.

Recall Tom first quarter of 2015, we grew frac sand shipments, coal was still relatively healthy, grain was healthier than what we saw as the year progressed into later quarters. So markets have really changed pretty dramatically from the first quarter of 2015.

So the mix comps might be similar to the volume comps that they get to be used your beyond first quarter. Maybe what…

We’ll see.

Thank you, hey Lance, Rob, Eric, Cameron how is everyone doing.

Jason.

I want to go back on the pricing side and focus on intermodal and any of the truck competitive merchandise traffic that you are hauling. Clearly right now it seems that there is excess trucking capacity and all the data points at least we track are pointing to truck pricing going down both contractually and on the spot basis, how should we look at your ability to not only price but grow the intermodal business ex under the headwinds that we talked about with Triple Crown as we move throughout 2016?

Yes, this Eric, Jason. So, a big reason as you know for kind of the shrinkage in truck pricing is fuel is coming down which is a major cause. So, our customers are also seeing a cost reduction benefit as fuel goes down because of the fuel surcharge going down. So they are seeing that natural cost reduction benefit. So the gap, if you will, between the value proposition for intermodal rail service versus truck I think that, that gap is still there in terms of intermodal providing a value proposition to manufacturers. We have talked in the past about just by laws of physics steel wheel on steel rail is a lower costing, rubber tire on asphalt or concrete. So there still is a value proposition there that we think gives us leverage to continue to drive highway conversions which we demonstrated in 2015 and we are going to continue to focus on in 2016.

And Eric your team continually works with trucking companies themselves in terms of helping them with their cost structures and they look at intermodal conversions as an opportunity to modify their own cost structures as they compete in that marketplace and those opportunities continue as well.

Okay, now that is good color. As I look on the Ag side, it seemed like there was a couple of puts and takes but net, net for the year, would you guys say you were positive or slightly negative for Ag?

Eric.

I am not sure I understand the question.

In terms of your outlook for 2016?

Oh, we don’t give volume guidance for 2016. I think if you look at the Ag markets overall I think the Ag producers are expecting pretty good yields for 2016 of course depending on weather and number of acres planned in all of that. Maybe not record levels but pretty good levels. I think a large factor will depend on worldwide Ag production, strong dollar, and how competitive U.S. Ag is. In worldwide market there is a lot of corn, a lot of wheat in storage right now. Presumably as U.S. Ag becomes more competitive pricing wise in worldwide markets that's got to move and when that does move, presumably we as a transportation provider will have a benefit in moving in.

Okay, gentlemen thank you for the timing as always.

Good morning, Lance. I want to revisit an earlier question regarding how to navigate market downturns and manage volumes. How do you determine the right approach to furloughing employees and reducing the number of locomotives without overreacting, so you can benefit from any rebound? How have your actions this time differed from the end of 2014 and beginning of 2015 when we perhaps increased capacity too rapidly, and how does that compare to what you experienced in 2008-2009? Could you provide some insight into how you prepared for this?

Sure Ken. We have been clear historically about time lags in decisions that are just the nature of our business in terms of hiring somebody to operate a train. That is about a six-month process. So, we have to by nature when we are planning crews look out 6, 12, 18 months. And when we are talking about capital planning or locomotive acquisitions those lead times get longer. So it all begins with our business planning process and making sure that we have tight connectivity between what Eric and the commercial team are seeing and then how we are boiling that into a transportation plan and the resources necessary to run it. Every time we see a significant shift in volume, whether it is significant growth or significant shrink we try to learn from that situation. As we are going into 2016 we think our business planning process is tighter, we think our connectivity between what Eric sees in the marketplace and secondary and tertiary indicators of demand more of that is being absorbed into our estimating process. I shouldn’t miss the opportunity to talk about also doing a better job of shrinking some of the timelines let's say in terms of hiring and bringing a crew on board or acquiring equipment. We are also better candidly at when we have to store equipment, storing it quickly and efficiently and we are also better at trying to find the right mix of the right employee base where they are located and training them for alternative jobs. So we are just getting a little better in all those ways and that adds up I think into a better posture overall.

And to clarify that you don’t see that as rounding into like 2008-2009 not that deep of a recession but into I guess so far what you seen doesn’t seem a recession environment to you?

Ken it is hard for me to speak and predict on whether the economy is going into a recession. Certainly our volume drop off as the 2015 year progressed quarter to quarter and as we are entering 2016 is dramatic and it is dramatic in historical reference but it is nothing, it is not approaching what we experienced in 2008 to 2009. I will tell you again, a 6% decrease year-over-year and a quarterly 6%, 7%, 8%, 9% decrease year-over-year is pretty dramatic volume change.

If I could follow up with a quick comment, recently one of the other companies mentioned your views on mergers and acquisitions. They noted that previously you had discussed how it has affected Union Pacific and expressed your opposition to that. Could you clarify your thoughts on industry mergers and acquisitions, why they might or might not be significant for you considering you're operating in your own region, and whether changes in the industry could affect Union Pacific?

Ken we do not support mergers or consolidation in the current environment. We think that the regulatory outcomes, the regulatory impact would be substantial. The Service Transportation Board has been clear that in the next merger that they consider it has to enhance competition not just maintain it. It has to improve operations for customers and they also have to consider downstream impacts whether one merger triggers a string of consolidations. We’ve shared with you, we are focused on safety, we are focused on efficiency, we are focused on an excellent customer experience. We don’t think a merger enhances those efforts. Matter of fact we think it would have a negative impact on service and be a headwind disincentive to capital investment.

Yes, hi good morning, thanks for taking the question. So, obviously one area of growth year-over-year looks like it is going to continue into next year, but how much of that is attributable to Mexico and what type of impact do you see when it comes to seeing it is from reported first half tooling and change over staff of the border and do you think this should really have an impact on your length of haul or mix of business in that vertical?

Brian, before I hand it over to Eric I just want to say we are very bullish on Mexico in general in the long term. It’s a vibrant economy, it has got a vibrant middle class, and our access to the six primary rail gateways to and from Mexico give us a real great opportunity to participate in that economy. Eric?

Brian historically Mexico produced about 1.7 million vehicles. I think full year 2015 the number is probably closer to about 2.9 million vehicles. I’ll call it 17.5 that were sold with all of the plant expansions and new plants I think it is on its way to 4 million or 4.5 million in the next call it year and a half to two years. As it has been said we have a great franchise for Mexico and we think that that will be a strong part of our business portfolio going into the future. As always, the issue is when the sales drive total volume and so our total volume will be aligned with whatever sales are. And our strategy is to have a franchise to move it wherever it is manufactured.

Was it about 60% of your auto production that comes from Mexico, if I remember correctly?

Historically, we've said that, yes. And that’s about what it was, yes.

Okay. And then just one other quick one on train lengths. I think in the last call, you mentioned you have about 90%, about 70,000 foot capable I guess in terms of sidings. Third quarter is around 6000 foot average train lengths. So include you are highlighting some of the best ever lengths in three of the five areas. How much further and I guess how much faster do you think you can take that up and when would you hit the upper limit? I know it's different in every market and I guess the intermodals clearly got some headwinds here. But I think that’s really the one for good economics to really work, that’s when you really need to get the longer trains, so you might be simply focused on that and just some general comments about train lengths?

Cam, you want to talk a little bit about the productivity opportunity in train lengths?

Coal is about the only program that is nearly optimized although there are opportunities still within coal. Every other commodity group has plenty of train size productivity opportunity and you will see us continuing to make progress, balancing customer needs along the way.

Okay, thanks for your time guys.

Thanks Brian.

Yeah, good morning everybody. I have a quick question about coal, specifically a lot of pushback we get from investors with respect to UNP specifically as you have a competitor who due to some service issues and perhaps much larger portfolio strategy has invested significant amount of CAPEX out West and there is concern given the structural market share loss in coal and the competitive dynamic has structurally changed in their favor.

Yeah Matt, I think if you go back historically and go back to the '80s when really the Powder River Basin franchise was developed for us certainly in addition to our competitor, I think it’s been roughly call it a 55-45 split over time and as opposed to the 50-50. But we don’t look at markets in terms of what share we have in a market. We look at it in terms of what's the value of that market, what's the value of that franchise where we think we have value, a value proposition to offer the market and we sell our value proposition and we are comfortable with the outcome in terms of the business that we win or lose based on the value proposition that we sell.

Right. So I guess, again in the context of people choosing to invest or not invest in your stock, if I look at the economy and volumes Burlington Northern positive on volumes last year in coal. Union Pacific down double-digit in coal. You are saying you are comfortable with that?

What we are comfortable with Matt, is the diversity of our franchise. Coal remains a nice book of business for us, generates an attractive return, that’s how we look at all of our book of business in terms of can we generate an attractive return and we invest for that and we price for that. And I think our track record speaks for itself. We’ve done a pretty fair job of making that happen.

Okay, understood. My quick follow up would be then if I look at down cash flow, you yourself said I mean reducing the CAPEX budget by North of 500 million you have got some other tailwind, you talked about bonus appreciations, pretty material number as in terms of incremental cash flow potential. You slowed the pacing of share repurchases in the fourth quarter. Just wondering with that excess potential cash flow in 2016, is there an opportunity to step up share repurchases, what are the guiding factors in terms of either debt ratios or what not, in terms of how aggressively you are willing to use what should be some surplus cash flow in 2016?

Rob do you want to take that.

Yes, Matt you are right. I mean our expectation coming off of certainly with last year's low number from cash flow that we will hopefully positively generate an increase in cash flow. And yes, we’ll continue our philosophy of being opportunistic in the marketplace as it relates to shares. So I would expect that we will continue to do that. And as I called out by the way in the third quarter that was a high watermark if you will that we’ve seen at least in modern times of the rate at which we were buying back shares and that clearly was not our ratable rate in terms of shares. But we were opportunistic in terms of when we buy and how much we buy and that attitude and that philosophy will continue in 2016. But if we can generate stronger levels of cash that gives us greater opportunities and as we continue to walk up our debt to EBITDA as we said and as we have, it gives us further opportunity.

Job one is generating cash from operations it all starts there and we are laser focused on that.

Understood, thank you for the time.

Hey, thank you for taking my questions. So following up on that question around cap or cash flow I hear what you are saying in terms of your opposition to M&A, but if it were to take place Burlington Northern has already said that they are going to be involved if there is a waiver consolidation. Given the cash flow that you are looking at generating in 2016 do you feel the need to maintain some of that dry powder in the event that you were forced to react to a consolidation wave in the sector?

John in addition to saying we don’t support rail mergers at this time we’ve also said we’re paying close attention to the situation, we’re monitoring it and as things evolve we’ll do what is in the best interest of our shareholders and our stakeholders. If you look at our capital structure we are in a solid position strategically if we had to do anything. But what we are focused on right now is that in the current environment we think mergers are not in the interest of our customers and just monitoring that and keeping close tabs on it.

Good morning. Rob, you mentioned a $0.11 impact from fuel in the fourth quarter. Have you considered what the fuel impact might be for next year? There are many variables involved, but if we assume that oil prices stabilize, could you provide some insight on how significant the overall steel impact could be in 2016?

Yeah, I didn’t put a number on the full year but it could well be a headwind. I did call out that the first quarter, remember that we had about $0.08 of positive last year. So, we clearly have that as a hurdle facing us as the first quarter continues to play out. Of course how fuel and the timing within a quarter will dictate exactly what that number ends up being year-over-year. But we do see that as a headwind certainly in the first quarter and could continue at some pace throughout the year.

But similar to the volume comp issue, you would say that if oil pricing were to stabilize then worst than the fuel impact would be front-end loaded?

Depending on what mix is and where the volumes actually are that's a fair assumption, yes.

Okay, and then I guess just as a general question, it seems like on some of the published surcharge tariff tables fuel prices are getting to the point where surcharges actually zero out, is that kind of a correct read to those tables, or do you think that the fuel revenue will still got to be positive as we get through most of 2016?

Rob?

Well, as I said those are publicly seen and the calculations for those you probably have an accurate calculation.

David, I am with Rob, I would just remind you and others that remember we have some 60 plus different surcharge mechanisms that have different starting points, different components, different timing mechanisms around them so it is very difficult to draw any kind of a straight line conclusion. But clearly at these low prices some of them are entirely new edge.

Alright, excellent. Well thanks a lot for your time. It has been a long call and good luck through the next couple of tough quarters on the volume side.

Thank you David.

Thank you Rob and thank you all for your questions and interest in Union Pacific. We look forward to talking with you again in April.