Thank you for accessing Union Pacific Corporation’s 2016 Fourth Quarter Earnings conference call held at 8:45 AM Eastern Time on January 19, 2017, in Omaha Nebraska. This presentation and the accompanying materials include statements that contain estimates, projections or expectations regarding the Corporation’s financial results and operations and future economic conditions. These statements are forward-looking statements as defined by the federal securities laws. Forward-looking statements are subject to risks and uncertainties that could cause actual performance and results to differ materially from those expressed in the statements. The materials accompanying this presentation include more detailed information regarding forward-looking information and these risks and uncertainties. Greetings. Welcome to the Union Pacific's fourth quarter 2016 conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded and the slides for today's presentation are available on Union Pacific's website. It is now my pleasure to introduce your host, Mr. Lance Fritz, Chairman, President, and CEO for Union Pacific. Thank you, Mr. Fritz. You may begin.

Thank you and good morning everybody and welcome to Union Pacific’s fourth quarters earnings conference call. With me here today in Omaha are Cameron Scott, our Chief Operating Officer, and Rob Knight, our Chief Financial Officer. I'd also like to introduce our new Chief Marketing Officer, Beth Whited. Some of you may recall Beth as our Investor Relations officer several years ago. Most recently, she was the leader of our chemicals group. This morning, Union Pacific is reporting net income of $1.1 billion for the fourth quarter of 2016. This equates to $1.39 per share, which compares to $1.31 in the fourth quarter of 2015. Total volume decreased 3% in the quarter compared to 2015. Carload volume declined in five of our six commodity groups, while agricultural product volumes were up 8%, as grain shipments continued to be strong in the quarter. The quarterly operating ratio came in at 62%, a 1.2 percentage point improvement from the fourth quarter of last year, and about flat with the third quarter of this year. Outstanding productivity achievements along with positive core pricing helped to partially offset the decline in total carload volumes. While full year volumes were down substantially year-over-year, we did see declines moderate in the fourth quarter. As we work through the challenges of the year, we remain focused on the strategy we live each day through our six value tracks. The first value track we show is world-class safety, and I'm very pleased to report that Union Pacific had a record safety year in 2016, with our reportable injury rate improving 14% versus 2015. Executing on these value tracks enables us to run a safe, efficient and productive railroad while providing our customers an excellent value proposition. Our team will give you more of the details on the quarter, starting with Beth.

Thank you, Lance, and good morning. In the fourth quarter our volume was down 3%, with near record agricultural product shipments more than offset by declines in each of the other business groups. We generated positive net core pricing gains of 1% in the quarter with gains offset by challenges, predominantly in our energy-related and international intermodal businesses. Despite these challenges, we remain committed to achieving core pricing gains that align with our value proposition. The decline in volume and a 2% improvement in average revenue per car drove a 1% decline in freight revenue. Let's take a closer look at the performance of each of the six business groups. Ag products revenue gained 7% on an 8% volume increase, and flat average revenue per car. Grain carloads increased 22%, as a robust US grain supply and lower commodity prices enabled the US to be more competitive worldwide, resulting in record export volumes. Grain products carloads declined 2%, as a reduction in meal shipments, was partially offset by strength in biofuels. Food and refrigerated volumes were down 1%, driven by production changes in our canned and paste market, partially offset by strength in import beer. Looking forward to 2017, we expect high global grain inventories and the strong US dollar to put some pressure on the export grain market. Weather and global crop health will also continue to be factors. We expect food and refrigerated shipments will continue to see strength from refrigerated food growth and import beer. In autos, revenue was down 6% in the quarter on a 3% decline in volume, and a 3% reduction in average revenue per car. Finished vehicle shipments decreased 6%, as a result of contract changes we have previously referenced that will continue to impact our volumes through the first part of 2017.…

Thanks Beth and good morning. Starting with our safety performance. Our full year reportable personal injury rate improved 14% versus 2015 to a record low of 0.75%. The team's commitment to successfully finding and addressing risk in the workplace continues to generate positive results, as we improve toward our goal of zero incidents. With respect to rail equipment incidents or derailments, our reportable rate of 3.02 decreased 3% versus last year. While we made only a slight improvement on the reportable rate, enhanced TE&Y training and continued infrastructure investment helped significantly reduce the absolute number of incidents, including those that did not meet the reportable threshold, generating a record low incident rate for the sixth consecutive year. At public safety, our grade crossing incident rate increased 7% versus 2015 to 2.43. Union Pacific has launched a new initiative, the crossing assessment process or CAP, to enhance grade crossing safety in our communities. CAP will couple our comprehensive safety culture with new data analysis to help focus increased attention on the crossings where we can most substantially impact public safety. This big data approach allows us to utilize predictive analysis to identify crossings where incidents may be more likely to occur. CAP will be most successful in enhancing crossing safety, with the engaged participation of roadway authorities. Communication and coordination with public agencies is critical to success. Moving on to network performance. Once again, we generated solid operating results through the fourth quarter. As reported to the AAR, velocity declined 2%, while terminal dwell improved 1% when compared to the fourth quarter of 2015. Our consistent operating performance has also translated into fewer recrews, lessening the resource demands of our network. The 2.4% recrew rate achieved in the fourth quarter matched last year's fourth quarter record. And for the year, we…

Thanks and good morning. Let’s start with a recap of our fourth quarter results. Operating revenue was about $5.2 billion in the quarter, down 1% versus last. Lower volumes and lower fuel surcharges more than offset positive core pricing achieved in the quarter. Operating expenses totaled $3.2 billion. The volume-related reductions and strong productivity improvements drove the 3% improvement compared to last year. Operating income totaled almost $2 billion, a 2% increase from last year. Below the line, other income totaled $40 million, up from $28 million in 2015. Interest expense of $174 million was up 6%, compared to the previous year. The increase was driven by additional debt issuance over the last 12 months, partially offset by a lower effective interest rate. Income tax expense increased about 3% to $687 million, driven primarily by higher pre- tax earnings. Net income totaled over $1.1 billion, up 2% versus 2015, while the outstanding share balance, declined 4% as a result of our continued share repurchase activity. These results combine to produce quarterly earnings of $1.39 per share. Now turning to the topline, fright revenue of $4.8 billion was down 1% versus last year, primarily driven by a 3% decline in volumes. Fuel surcharge revenue totaled $187 million, down $31 million when compared to 2015, but up $14 million from the third quarter. All in, we estimate a net impact of lower fuel prices was a $0.03 headwind to earnings in the fourth quarter versus last year. The business mix impact on freight revenue in the fourth quarter was a positive 1.5%. Year-over-year growth in agricultural product shipments and a reduction in international intermodal volumes were positive contributors to this mix, while more than offset declines in finished vehicles. Core price was a positive contributor to freight revenue in the quarter at…

Thank you Rob. As we discussed today, we are pleased with our fourth quarter and full year results in a difficult volume environment. Looking to 2017, we feel pretty good about some of the macro-economic indicators that drive our core business. Higher energy prices, favorable agricultural markets and improving business and consumer confidence all support a return to positive volume growth this year. As always, a new year will bring its share of change and uncertainty. We'll be closely monitoring the impacts of potential developments in areas such as corporate tax reform and commerce with our trading partners around the world, as well as the overall strength of the economy. We continue to have confidence in the strength and diversity of the Union Pacific franchise, which will position us well to safely and efficiently leverage stronger volumes as our markets begin to rebound. We will continue to execute on our strategic value tracks to provide our customers an excellent service experience while generating strong returns for our shareholders. With that, let's open up the line for your questions.

Thank you. We will now be conducting the question-and-answer session. [Operator Instructions] Thank you. And our first question comes from the line of Justin Long with Stephens. Please proceed with your question.

Thanks and good morning. I just wanted to start with a question on the OR. I know you said you expect an improvement for the full year, but is there any color you could provide on the quarterly progression of the OR? And specifically in the first quarter with a slight increase anticipated to volumes, do you believe the OR can improve in 1Q?

Rob, you want to take that?

Yes, Justin, as I said in my comments, we're confident in our ability to drive full year improvement in the operating ratio. And we haven't given specific guidance by quarter, but clearly, it can and likely will be lumpy. And one of the points that you're raising, is in the first quarter alone, remember that we did get – last year in the first quarter, a fuel – favorable fuel benefit. So just kind of looking at that alone, that by itself will present likely a challenge as it relates to the operating ratio. So it can be lumpy from quarter-to-quarter. But we're focused on the longer term improvement driving the levers that we can, in fact impact over the longer term.

Okay. Got it. And maybe one on pricing. So if I think about your commentary, it seems like the message is the pricing environment has likely bottomed in the fourth quarter, and should get incrementally better throughout 2017. So first of all, would you agree with that statement? And second of all, when you think about your guidance to price above inflation, how much visibility do you have to that today? What are – how many contracts have you already repriced for 2017?

Hey, Justin, this is Lance. So we don't give forward price guidance, so we are not going to call a bottom. You heard Beth's commentary about the markets that we compete in. There are some headwinds that continue into next year, most notably in the first half of the year. And what we're hopeful for is that as the markets firm, it creates a more attractive pricing environment for us as the year progresses. I think I'll let Rob answer the second part of the question.

Yes, Justin, I guess, I would just kind of build on Lance's point. We don't give specific guidance as Lance pointed out, but we are – take one message from us here, that while inflation's rising, while we have some challenges in the marketplace as it relates to pricing, we are still committed to pricing at reinvestable levels that are above the overall inflation costs in the year. And that could be lumpy from quarter-to-quarter certainly, but we're committed and driven just as we always have been on doing that. And I don't recall, frankly what the follow-up question was. Oh, the visibility. Yes, I mean, Justin…

The visibility, yes.

I guess, I would answer that, you've heard me say this many times. No matter what day of the week, or what day of the year you would ask, what looking forward what percentage of our business we have sort of in the book, if you will – and it's lumpy because we're negotiating deals every day of the week throughout the year, we look at somewhere in the neighborhood of 70% of our business.

Okay. Great. I'll leave it at that. Really appreciate the time.

Thanks, Justin.

Our next question is from the line of Chris Wetherbee with Citigroup. Please proceed with your questions.

Hey, thanks. Good morning, guys. Wanted to sort of think about 2017, and kind of operating leverage. You've outlined, Rob, a couple of things there, and thank you by the way for the clarification on core price versus inflation. I think it's helpful people understand that. When you think about the gap narrowing a bit, in particularly the first half of the year, but volume kind of coming back, how should we think about all of those inputs into incremental margins historically? And sort of a volume growth dynamic coming out of a downturn, you've been able to generate some pretty solid incremental margins, and to get to your long-term targets, you need solid incremental margins. Just want to get a sense, just sort of how we might be thinking about that relative to historical performance when you look at 2017?

Yes, Chris. As you probably could guess, we don't give and have never given incremental margin guidance but I would just say this. That to get from where we are today to our ultimate target, and if you know we're driving towards – the organization's driving towards a 55% OR but to get from there, to the 60% by 2019 and then beyond that to the 55%, requires that on an annualized basis you get somewhere in the neighborhood of 50% incremental margin on volume growth. So it clearly will be lumpy from quarter-to-quarter depending on other factors but that's kind of the way I think about it. We've got sort of an over the longer period of time that 50% give or take is generally speaking what it's going to take to drive to our objectives.

Okay. That's helpful. And then, just a follow-up question. From a volume standpoint, when you think about the international intermodal piece of the business just broadly speaking – and that has been a bit of a headwind from a core pricing standpoint, and volumes have been, I guess, not necessarily fantastic there. I guess, as you think about that as you look out, when maybe do we see that dynamic start to turn? Do you need to see sort of just more broadly positive volumes across the industry, to start to see that capacity kind of tighten up? But or is it something that, as you lap some of these contract losses over the course of the next several quarters, maybe you could start to see that change a bit? I guess, I just want to get an understanding of maybe how we see the international intermodal business playing out over the next several quarters?

Beth, you want to take that?

Sure. I think the alliances that are happening right now in that international intermodal space are still evolving. There's still a very significant surplus capacity in the marketplace. There's clearly some competition going on between the Panama and the Suez Canal and all of those things are going to play out over the course of the months and quarters ahead and our focus really is going to be on making sure that we have the best service product to handle that business as it comes to us.

Chris, there's a couple of moving parts there. One is the state of the Trans-Pacific industry itself, the ocean carrier market itself. The other is what's going on with U.S. consumer confidence and consumption. And both are moving parts as you look forward.

Okay, all right. That's helpful. Thanks for the time, guys. Appreciate it.

Your next question is from the line of David Vernon with Bernstein Research. Please proceed with your questions.

Hey, good morning, guys. So it seems like the mix actually started to turn a little bit positive. And I know you talked a lot about core price and not giving guidance on that. But I guess as you think about the setup for the next three, six, nine, 12 months, it does look like with growth in frac sand, maybe little bit of a less headwind in coal and maybe growth in some of the chemicals business that the mix number we should expect that to continue to be positive coming into 2017. Is that fair?

Rob, you want to take that?

Yes, David, again, If I sound like a broken record. You heard me say this many times. We would hope that all that plays out as you define. But we've given up trying to give guidance on what mix is going to be because again, I would say probably us more than most we are in so many diverse markets which is a huge strength in the. UP franchise that there's a lot of moving parts and there's a lot of mix within commodity groups. So I would be reluctant to give any kind of guidance on what mix is going to look like going forward.

Okay. And then, I guess, as you think about the upside, Beth, on the frac sand business, you mentioned the volumes are kind of trending up 10% here. We've heard some anecdotal evidence that sand prices are also rallying. Would you – should we expect some better pricing in that business as well, kind of directionally – and not looking for specific numbers or percentages, just trying to get a sense for, kind of how you guys think about your value proposition into an improving demand for drilling materials, which seem to be routed on your network from Wisconsin to the Permian?

As you know, we don't really give any sort of market specific pricing guidance. But I would say that we're pretty excited about the inflection point we saw in the rigs and them kind of coming up slowly over the second half of last year. A lot of the growth is coming in the Permian Basin which is a strength point in our franchise. So we do expect to see good year-over-year comps in frac sand as the year progresses.

All right, thanks a lot guys.

Our next question is from the line of Allison Landry with Credit Suisse Group. Please proceed with your question.

Hi, good morning. This is Danny Schuster on for Allison. Thank you for taking our question. We were hoping to dig in a little bit to the chemicals business. So Beth, I know you mentioned that you'll continue to see headwinds on the crude side. And I think your slides imply that it dipped into the mid single-digit thousand volume range this quarter. So I was just wondering first, is that kind of the right range to model going forward into next year on a quarterly basis?

On to the crude oil business will continue to move away from us. As you know, the production is down, pricing is very difficult. There's more pipeline capacity coming along and that will just continue to go away from us as we progress throughout the year, down 71% in the last quarter, probably going to continue to see it fall away.

Okay. But getting to the point where it it's almost inconsequential at this point and then on the flip side…

I would call it pretty inconsequential, yes.

And then on the flip side, you have some new facilities coming on the plastic side. I think your slides implied that you had about – you were moving about 60,000 to 70,000 carloads of plastic a year, a quarter, each quarter this year. How much could the new plastics facilities add and when should we expect to see those come online?

There's a lot of uncertainties and what's going to happen as those facilities come online. And they will start to come on let's call it second half of 2017 and kind of throughout into 2020. It's still unclear how much of that product will move domestically. How much of that product will go to export markets. As it goes to export markets will it leave directly from the Port of Houston. Will it come into an inner point for packaging and then go off to the West Coast. So I don't think we have any prediction to give you there. We're just pretty excited that our Gulf Coast franchise gives us the opportunity to reach a lot of those plastics facilities and we intend to participate to the degree that we're asked to.

Okay, great. And is the revenue per unit profile similar to kind of the overall business that you have today?

I don't think we're going to make a comment on that.

Okay. Understood. Thank you.

Our next question is from the line of Brian Ossenbeck with JPMorgan. Please proceed with your questions.

Hey, good morning. Thanks for taking my call. Rob, I can understand the challenge of forecasting mix but maybe you or Beth as you look at the high level portfolio of the business you look at, can you give a sense of what percentage of the business is really sensitive to the U.S. dollar, both on an exports and import side including metals, grain and coal you mentioned before. And if I remember from prior fact books I think you’d highlighted roughly about 15% of revenue was tied to exports. So any updated numbers there would be appreciated.

Hey, Brian. This is Lance. I'll let Beth talk specifically to our international business and what our business looks like in terms of cross-border trade. But in terms of trying to get a sense for how much of our business is sensitive to the U.S. dollar, the answer to that is there's a fair amount of our commodity mix with lots of moving parts that either benefits from a strong dollar or gets hurt by a strong dollar. So you could essentially say to the extent that a dollar and its value internationally impacts the U.S. consumer and U.S. industry, our total book has some exposure to that. But I'll let Beth talk about our international book specifically.

So I think you probably heard us quote some numbers before but just as a refresher, about 40% of our business is international with a fair portion of that being Mexico and then the rest being truly global business. And we do as you said see a lot of grain in that. Clearly there's other grain products as well as a number of our industrial products that participate in that global market. Probably a big chunk is also in the vehicles and parts, mostly going back and forth from Mexico. And so there's some puts and takes with that over time because you'll see some things that are advantaged as you're in a strong dollar position but we certainly have seen some challenges with competitive products worldwide really competing against products that are made in the United States.

Right, right. Yes, I can certainly appreciate the complexity. And I guess, to follow up with even more complexity, and when we look at the cross-border stuff you mentioned going to and from Mexico, and talk of the GOP's border adjusted taxes tied into the corporate tax reform. How do you kind of size the risk potentially, if that were to come into play, and what are you hearing from customers? Do you have any sort of scenario analysis that you're trying to work through now, if that were to come into effect as written? I know it's still early, and we hear a new thing each day, seemingly from President-elect Trump and the GOP. But just how you're thinking about that piece of the network would be helpful? Thank you.

Sure. So we are paying close attention to all of the talk about potential outcomes as we go forward in terms of impact on either NAFTA or other international trade agreements. Our perspective is that the United States is tightly woven with its trading partners and our consumers benefit greatly from free and open international trade, both from a standard of living perspective, making goods available to them at lower cost than they would be otherwise, as well as creating markets for U.S. goods to be sold into, creating a robust potential growth for U.S. jobs and typically the higher paying U.S. jobs. When we look at the cross-border trade let's say specifically with Mexico, when you really dig deep, you see that a large percentage, certainly more than half, a lion's share has value added on both sides of the border and is inextricably linked to our economy. So we've been giving that kind of feedback to our elected officials and regulators for a long time. We'll continue to give them that kind of feedback. And we are prepared and preparing for any of the potential outcomes that might occur. But bottom line, we're optimistic that those decisions ultimately will benefit U.S. trade and the U.S. economy.

Great. Thanks, Lance, appreciate the thoughts.

Sure.

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

Hey, thanks. Good morning guys. So Rob, just I apologize if I'm slow, I just want to make sure I understand what you're saying on pricing. So if I'm understanding right, you're saying that the dollars from pricing this year will be above the dollars of cost inflation, but don't necessarily expect the headline pricing number to be 3% or better? Is that is kind of what you're saying?

Look Scott, I didn't gave and we won't give the specific percentage increase guidance, but yes, our message is that with the challenges that Beth has outlined in some of our markets and favorable pricing we are still enjoying in the other markets, you combine that against a higher inflation expectation, of course that's calculated as you know on a different base, that our dollars we yield, which is how we calculate our price, the dollars we yield from pricing in 2017 we expect to be above the dollars we expend in the inflation buckets, albeit potentially and likely narrower gap than we saw in 2016.

Okay. And given that narrower gap, do you think – is the path to that 60% operating ratio, does that naturally then become more back-end loaded in 2018 and 2019, or not necessarily?

No, I wouldn't say that. Again, it will be lumpy, but I would say as we have said all along, going back even the days of Project 75, if you look at the progression that we've made, it really is the same levers that we have at our disposal and that's volume, pricing to market, and productivity. And those three levers are still the levers that we wake up every day pushing to our advantage. But they will be lumpy and sometimes markets dictate how much of that lever you're able to pull from quarter-to-quarter or year-to-year but I would not say that that changes our – certainly doesn't change our focus and our commitment to getting to that 60% but from quarter-to-quarter all of those levers can result in a lumpiness between here and there. But we are very focused on that and I would say that a big part of the success that we are enjoying, have been enjoying here of late is that turbo charged if you will productivity result.

Okay. That makes sense. And just lastly, for you, Rob or maybe Cameron, did you guys say what you think headcount is going to be in the first quarter, and the year? And do you think we need to start thinking about a more meaningful step-up in resources, as some of the service metrics start to see a little bit of pressure?

Rob, why don't you take that?

Yes, Scott. We haven't given guidance on certainly not quarterly guidance on operating ratio. But I would tell you that Cam and his team…

Sorry, headcount.

On headcount, I'm sorry, did I say…

Whatever you said, headcount.

Yes, on headcount. But I would tell you that with Cam and his team and the entire organization's continued focus and commitment on productivity we are confident in our ability as volume hopefully recovers to continue to squeeze out productivity. Having said that, I would expect that certainly for the full year 2017, as I said earlier, our headcount will move up or down with volume. We hope it's up. We hope volume's positive but not one for one because there is still an assumption of continued turbo charging our productivity. We are in a position of being very ready if you will with our resources to absorb the single-digit growth in volume that we're anticipating this year. By the way, not just headcount but that stands true for locomotives as well.

Okay. Thank you, guys.

Thank you.

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

Thanks, good morning, guys. And also, thank you for the detail on pricing versus inflation going into 2017. Just a couple of follow-ups there. So if inflation is going to go up by 150 basis points this year, and pricing is to be above inflation, that means your pricing probably goes up by something to that magnitude, although you're not formally saying that. If pricing was to improve from here, what are the end markets that will drive it? Are these the same end markets that have been driving the weakness so far?

Let’s – of course by not commenting, we're not giving guidance on your first presumptive statement. So let’s just set that aside. And then Beth, why don't you talk about what markets look like as you're moving into 2017.

Yes, as we think about 2017, we will still continue to see some challenges in places like coal and international intermodal. But we would expect to get some momentum as the markets improve with the economy growing. Additionally, as the year progresses, the trucks and our competitors are going to face some challenges with electronic logbooks and hours of service regulations coming into play, which may also provide us with an opportunity.

Ravi, if I can just – this is Rob. Just kind of back to the first part of your question, I just want to make sure I am clear on what you were suggesting. Lance is right, we're not going to give specific pricing guidance but I would just clarify. That we are not saying don't take from what I have said about our pricing plans against inflation for 2017 as being any kind of an indicator of whether that means pricing's going up or down. I mean what we're saying is that we are still committed to that pricing yield dollar being above the inflation expense but I did say we do anticipate that that gap of the yield above inflation dollars will narrow in 2017. So I didn't say what the pricing will be. And I would not take that to mean pricings going up at some X amount.

Okay. I think I understand, but I'll probably follow up offline anyway. Just one follow-up on the call though. When you consider kind of all the factors that are kind of pressuring pricing today, and also the factors driving – I don't want to say a potential rebound in 2017, but let's say that comes. Are there any UNP specific factors here, or do you think that this is an industry-wide phenomenon, in terms of what you're seeing out there?

This is Lance. I'll attempt to take that. So the factors that impact pricing are essentially the market factors that Beth had talked about. We have a market we compete in, many markets we compete in across commodity groups. And what we've said is we're fairly optimistic as we look into 2017. First and foremost, on coal, primarily because of easier comps. But there are some other market dynamics that we're going into the year with a stronger grain and ag products market than we had entering 2016. Arguably construction markets should be firming up as there's talk of infrastructure and as we see the housing markets improve. Consumer confidence and business confidence appears to be growing, so that looks like that could create some opportunity. So bottom line is as our served markets improve, that should create an environment where we have more pricing opportunity.

Great. Thank you.

Our next question is from the line of Ken Hoexter, Bank of America. Please go ahead with your questions.

Hey, great. Good morning, and great job on the performance, and the OR for the quarter. But, I guess, Beth, maybe you can just talk a little bit more about coal, given the easier comps that we're facing, particularly in the first half? Can you talk a bit about where inventories are, how much they've come down, and kind of what your view is on how pricing is right now? Are you in the money? Are you seeing demand pick up at this point?

So we have seen what I call a very modest fall-off in inventory levels. We're at around 93 days of inventory which is still call it 80 days above historical levels. So still kind of a challenging stockpile environment. We are, though, in a little different situation than we were in part – in most of 2016, where we have natural gas prices that are considerably higher, $3.40-ish, where last year we spent most of the year in the $2s and even a part of the year under $2. So that gives us some potential for our served plants to be more in the money, and able to burn coal. So the weather of course is going to play a role in it in parts of our network and served plants are experiencing some nice cold winter and we love that. So if you kind of put that all together, we've got favorable comps, a better natural gas environment, stockpiles that are still a bit high, and weather is always going to be kind of the swing factor.

Just for comparable purposes, a quarter ago, a year ago, you had mentioned that inventories had come down a bit. Can you give us, from what level, to put that in perspective?

We were over 100 days at one point and I can't recall what they were in the first quarter of last year but it's not a substantial decline and it's still well above historic levels.

Ken, bear in mind, there's two different measurements for inventory. One is an absolute measurement of how much tonnage do you have on the ground. That's moved more dramatically than what your days burn looks like and of course that's because burn has changed over time.

Okay. And I think, Beth, just keeping with you for a minute, for my follow-up on grain. Growth, I guess, decelerated here in the fourth quarter from what I guess, is still a record crop. Is there a reason why that is, and maybe your thoughts on that going forward? And then, same with yields, they were flat. Is, I guess, with demand being up, would – or I guess, printing average revenue per car, is that something, a shift between domestic export, or anything that would impact that?

We do have a pretty large carry-out in the ag markets and we still continue to see pretty strong shipments all through the fourth quarter going to export markets. So I’m not sure what data you’re referencing when you talk about it being down from third to fourth, but…

Till not down, just de-accelerating. Sorry.

Okay, sorry. Yes, it was – we had a very strong fourth quarter, huge carry-out remains in the market. I think the carry-out numbers are up something like 10% across the different grain categories versus year-ago levels. It’s going to be impacted by the same thing it’s always been impacting by, which is world grain capabilities, what kind of harvest we see in the United States this year and then of course this is an area where we do see impacts from the U.S. dollar strength. I don’t know if I got all the pieces of your question. There were multiple parts there.

No, yes, it was just on the – that was the volume side. Just on the yield side I was just wondering why they would be flat in such a strong market. Is that a shift in mix that would cause pricing to be relatively flat year-on-year in terms of average revenue per car?

Okay. Sorry. I didn’t catch that part. Yes, so our grain can move to market in a variety of different ways. It can move all the way by rail to the end destination. Sometimes we’ll see situations where the river is very competitive. So we may move to the river and so that would be a shorter length of haul for us and that might drive some mix changes in the arc. But still very positive yields for us. We wouldn’t say that moving a shorter distance necessarily changes the yield perspective.

That’s wonderful. Thank you very much for the insight. Thank you.

Our next question is from the line of Brandon Oglenski with Barclays. Please proceed with your questions.

Hey, good morning, everyone. Thanks for getting me in here. So I’m not going to ask about pricing, because I think what’s critical here is that you guys are guiding to an improved operating ratio in 2017. And Lance, I know you guys have been calling for that for the last two or three years, but it has been challenging with top line declining as much as it has. What is the confidence level in 2017 that we are in fact, going to see that improved margin? And Rob, I’m going to try it, because if I just straight line your guidance to get to a 60% OR by 2019, I think that implies about 100, 110 basis points of improvement per year. Is there any reason why we shouldn’t be thinking that’s attainable, in a stronger growth environment that we might be seeing in 2017?

So Brandon, I’ll take the confidence level and then turn it over to Rob. We are confident that we’re going to improve our operating ratio in 2017. The reason why is the three moving parts that we touch that Rob talked about; one is productivity. Rob’s already talked about another strong year of productivity in 2017 and Cameron and the rest of the team have those projects in sight and already working on. That gives us confidence there. The second is pricing. We’re going to take what the market gives in terms of pricing for the value that we represent. We’re hopeful that the markets are firming a bit, so we’re hopeful that the third element in terms of volume will cooperate a little bit more in 2017 and we’ve guided to positive volumes in 2017. So we’re confident we’re going to be able to improve the operating ratio.

Yes. Brandon, this is Rob. I would just add that we stay away from giving specific OR guidance, but your straight line math is right. But one thing we know is things aren’t going to be straight line, but we’re going to take advantage of every opportunity we have and if we can front end load that we will. If it ends up being lumpier than that or back ended because of factors in the marketplace, that’s the way it will play out.

Okay. I appreciate that feedback. And Cameron, can you just talk a little bit more about the productivity goal this year of $350 million to $400 million. I mean, is that mostly labor related as you think about volumes coming back and maybe not adding one for one?

Well, your last comment is accurate as Rob mentioned, with the amount of furloughed employees we have as Beth brings on additional volume, we have people ready to take on that volume. And there’s plenty of room on train side, so we expect to see additional volume come on the railroad without any additional starts as far as – whether it’s purely labor based or other initiatives, most of it is other initiatives.

All right. Thank you.

Our next question is from the line of Tom Wadewitz with UBS. Please proceed with your questions.

Yes, good morning. Thank you. Let’s see, Rob, at the risk of asking you something you’ve talked about quite a bit here, just to fine-tune on what you did say on inflation for 2017, did you give us a specific expectation? Or you just said, it’s going to be higher than the 1.5% inflation you had in 2016? I just want to make sure I understand that.

Yes. Tom, I actually said that we expect inflation to be in the neighborhood of 3% full year.

And that’s not just labor, that’s total inflation?

That’s total inflation, yes. Although labor, health and welfare are certainly drivers of that.

Right. Okay. So that’s 3%. In terms of intermodal, I don’t think that you’ve commented a lot on this. What’s the view on intermodal volumes in 2017? You got a lot of moving parts. Do you have confidence that you’ll see growth in the domestic piece, and is it reasonable to think the international is going to be down? Or how would you think about the two pieces, and what the outcome might be in terms of intermodal volumes, up a couple points, down a couple points, just kind of broad brush? Thank you.

Hey, Tom, it’s nice to talk to you again. I would say that we feel really good about our ability to continue seeing domestic intermodal growth. We’re very focused on highway conversions. We have an expectation that there could be some tightening truck capacity later in the year and that could be very beneficial to our intermodal market as well. On the international side, I think it’s really hard to predict what’s going to happen in international intermodal this year. As I alluded to before, there’s just a lot of moving parts in that business with the alliances evolving, all the overcapacity and what I’d call some in-fighting about which ports are the ultimate winners. We’ve seen the West Coast ports kind of bounce back from the levels that they were at during the – immediately following the ILWU issues. But the Gulf ports and the East Coast ports are still kind of duking it out. It will be on balance hard to predict what happens in international intermodal I would say.

So you think the net result is a little bit of growth in volume or is that hard to say?

Yes, I don’t think I would be willing to make a bet on that today.

Right.

Okay. Thank you Beth, I appreciate it.

Our next question comes from the line of Bascome Majors with Susquehanna. Please proceed with your questions.

Yes, thanks for fitting me in here. So Lance, I was curious if you could help us understand what drove the Board’s decision to make a leadership change in the sales and marketing team? And perhaps as a follow-up, Beth, if – can you let us know how, if at all, we can expect UNP’s approach to customers and pricing change, with you running the group there?

Yes, Bascome, this is Lance. The Board supported my decision to change our leadership team around a bit. It was really prompted by one of our executives getting close to retirement, announcing their intention to retire. That allowed me to put Eric Butler into a job that he is exceptionally well suited for. That will benefit the Corporation. That allowed us to put Beth into the Chief Marketing Officer job and she’s going to be tremendous in that role. So it had nothing to do with other than normal, customary and routine succession planning and it’s an execution of our succession plan. And I couldn’t be happier with it and the Board couldn’t be happier with it as well.

As far as I’m concerned, I think that Eric was a wonderful leader for the department. He set a lot of strategies in place that focused our entire organization on pricing and we will continue along that pricing path in the manner that Rob has laid out for you today. In terms of changes, of course we’re always going to try to evolve and change with the marketplaces but we’re going to keep our focus pretty simple. We’re going to keep trying to grow volume on a network. We’re going to try to retain the great customer base that we’ve already got. And we’re going to keep taking price in the marketplace as circumstances allow.

Thank you both for the color there.

Sure.

Our next question is from the line of Amit Mehrotra with Deutsche Bank. Please proceed with your questions.

Okay, thanks. Good morning. Thanks for taking the question. I had one question on productivity, and just trying to understand whether productivity savings are an absolute reduction in the cost base, or an effort to maybe make the cost structure a little bit more variable, where you lower the decrementals, but also lower the incrementals. If you could just sort of help us understand that a little bit better, so we can get a sense of maybe how some of the productivity actions you have taken and are taking, can maybe impact conversion of revenue growth in the future? Thanks.

I’ll start, and then if Cameron would like to add some Technicolor, he’s welcome to. So Amit, when you think about the productivity that we have, Cameron and team and the rest of the executive leadership team have removed cost from our structure. It’s come out in different ways. Our overhead, management and administrative burden has been reduced. I do not see a need to increase that as we grow into the future, so that’s fundamentally changed how we drop revenue to bottom line to some extent. From an operating perspective, Cameron and team have done a tremendous job at reducing what we’ve considered kind of structural wastes like re-crews. That’s where a crew is required to take a train to destination other than the train that originate or the crew that originated with the train. That’s pure waste. And the fact that we’re now at record low levels and intend to stay there has kind of structurally reduced our cost base. There’s hundreds of examples like that that tell us that, A, it’s real productivity, real-time, right now; and B, we don’t anticipate it growing back to the same levels it was historically. Now, clearly when our volume declined, there was some just pure volume reduction in costs because we didn’t need as many, for instance, TE&Y or as many mechanical forces to support the business. And as we grow, we expect that to grow back but not one for one as we’ve said before.

Right.

Cameron, you got anything to add to that?

Amit, I think one of my favorite productivity initiatives is train size. It might give you a sense that we have plenty of head room in productivity as Rob indicated. We’ve set all-time train size records for four years in a row. And we’re not close to optimizing our network. Coal is truly the only network that is very close to being optimized and we still have some room there. Rest of the network is wide open for opportunity, making sure we match up train size with taking good care of Beth’s customer commitment.

Okay. That’s really helpful. Thanks for that. Can I just ask one follow-up on taxes? You mentioned it very briefly in the prepared remarks, but I know corporate tax reform is a really tough question to answer today. But if you can generally talk about – if the industry, or if we do receive any major relief on corporate taxes, how that would translate to the P&L? Do you think some of it could be competed away, either through wage inflation or lower prices? And then, also, Rob, I think the Company has over $15 billion deferred tax liability. So I would expect that to be reduced pretty significantly, if we do get any relief. Does that change at all, the Company’s thinking on capital deployment strategy? Thanks.

Yes. This is Rob. Amit, as you obviously know, there’s a lot of devils in the details if you will in terms of how and when and if that will all play out. I would just say you’ve sized it right. And my expectation of any tax reduction benefit that may result would flow to the benefit of the Company. I mean, we’re not sitting here thinking about making – holding back, making capital investment decisions based on the tax rate as an example. So I would anticipate that that wouldn’t impact sort of how we treat that and I think it would be to the benefit of us and our shareholders if that played out and we would have the expectation of hanging onto it.

Yes. Just a reminder, right. So job one is create more cash from operations, so job two, we have the opportunity to use it for CapEx for rewarding our shareholders either in the form of buyback or dividend.

Right. I guess, you’re already doing that to a pretty significant degree. So to the extent that you get a windfall or maybe an increase in the book capital as a results of a reduction of deferred tax liability. You would just basically do more of what you’ve been doing, in terms of dividend, share buybacks, is that the correct read?

Let’s answer that from the perspective of would we take a windfall and some how apply it to capital projects that are not funded and the answer is no. We fund the capital projects that we think are appropriate for the business, that’s our first highest order for cash utilization and we’re very satisfied with what we’re spending in capital right now.

Okay. All right. That’s all I had. Thanks for taking the time. Congrats on the good quarter.

Our next question is from the line of Walter Spracklin with RBC Capital Markets. Please go ahead with your questions.

Thanks very much. Good morning, everyone. So I guess, if I could ask one question with regards to the competitive dynamic on the pricing side. If you were to describe your key competitors, both BN and trucking, if you were to describe their behavior in the last, call it three or four quarters, and how that might have changed as we go into 2017, would you say – I just leave it over to you – how would you describe that competitive behavior over the last little while?

Beth, you want to take that?

Sure. I guess what I would say is that we’re always in competitive marketplaces where we have trucks or other railroads who are making decisions about what makes sense for their business and our focus really is on ensuring that we’re getting reinvestable pricing that makes sense to us for our business. Now, from time to time markets change and you’ll see pricing change and we have to make decisions about whether or not we should meet the market where it is and we do that thoughtfully with the idea that our ultimate goal is to make decisions that represent our customer value proposition and what we think the value that we provide in the marketplace is.

Okay. Let me – perhaps if I get a little bit more specific, I guess. You took some actions a couple years ago when BN was struggling in a capacity environment with crude. With the crude coming off, we’ve been hearing that BN has reversed some of that with their own actions on a pricing standpoint. Is that true? And has there been any – if it is true, has there been any improvement in that dynamic in recent months?

Walter, this is Lance. I’ll take that. So if you go back to 2014, there were opportunities for us to haul business that typically we wouldn’t see for a number of reasons and we definitely took advantage of those opportunities. That was not a price based decision. That was a market offering us opportunity that we typically don’t enjoy. And we’ve already talked about that and our value proposition allowed us to have some of that be sticky and stay with us and some of it did not. Looking at today’s world, Beth’s answer is exactly as it is. There’s competitive dynamics in every commodity market that we serve. Those change over time. The environment clearly has been more difficult in 2016 than in previous years. And what will help that is if the markets themselves start improving, demand starts increasing, excess capacity gets consumed and then our pricing environment will improve.

Okay. That makes a lot of sense. I appreciate that color. Just on the second question here, and again I guess, this is for Beth, your franchise has enjoyed a nice lift in ag over the last 12 months. When you look out to 2017, are you forecasting growth on top of what should be a fairly difficult compare, or should we be building in, to be conservative, and to model an average crop year? Should we really be looking at a back half decline in your ag business in 2017?

I wouldn’t say that we still believe that we have opportunities to grow in our ag business that as I mentioned before. And there’s a lot of dynamic that’s have to happen, but the grain carry-out is strong. We don’t know what will happen with the crop yet. We have a lot of grain products, things like biodiesel and ethanol that are moving pretty solid for us and then we continue to have opportunity in our refrigerated business to grow. So I think you have to decide how you want to put that into your model. But in general, we feel pretty good about our ag business in 2017.

Okay. Thank you very much for the time.

Our next question is from the line of Cherilyn Radbourne with TD Securities. Please go ahead with your questions.

Thanks very much and good morning.

Good morning.

The call is running long, so I’ll just ask one on CapEx. Your guidance implies that you’re going to be down just over 10% year-over-year in 2017 versus 2016, and the step-down versus 2015 is obviously even much more substantial. I assume a lot of that is lower locomotive purchases, but can you just call out some of the other areas of major savings?

Yes. Rob, you want to take that?

Yes. At a high level, Cherilyn – I mean, you’re right, the big ticket items if you will, if you look at the timeframe that you’re citing would be locomotive and positive train control. I mean, those are two sizable. Beyond that, we always look at kind of a clean sheet approach if you will in terms of capital investments that we’re of confident will drive returns and remember that every year, year in, year out, we spend just north of $2 billion on replacement capital, so everything above that is driven based on commercial decisions and with an eye on returns and capacity expansion, et cetera. So but the big ticket items, I think in terms of the timeframe you’re looking at would be locomotive and positive train control.

And then, just very quickly, in terms of the freight cars that you’re adding in 2017, is that across the board, or are there particular areas where you’re renewing the fleet?

Cherilyn, when we make freight car decisions, those are very granular and targeted. Every year we look at what we think the long range plan and the closer years in that long range plan mean in terms of overall fleet. We bounce that against what’s retiring out and we make a judgment call as to what we need to purchase. So those – what gets purchased in any given year, the mix of freight cars that are being purchased and the quantities change and can change pretty dramatically. I would include that also incorporating containers and chassis.

Thank you. That’s all from me.

Our next question is from the line of Jeff Kauffman with Aegis Capital. Please go ahead with your questions.

Okay, thank you very much. Can you guys hear me?

Yes.

Okay, thank you. Just a quick question for Rob. I know it’s been a long call here. Rob, there was no discussion when you were talking about labor inflation, as to what was wage-related, what might be benefit and pension-related. And I know a number of other companies have flagged that pension goes from being more of a headwind to more of a tailwind, given what’s going on in the marketplace. When you gave the labor inflation guidance, was that all-in?

Yes, it is. And just a comment on that; yes, I’m not going to break it out but I would say that the health and welfare component of that is certainly one of the drivers. I mean, there are other drivers but that is a sizable piece of the expectation of overall labor inflation will go up in 2017.

All right. Congratulations and thank you.

Thank you, Jeff.

Our next question is from the line of Scott Schneeberger with Oppenheimer. Please go ahead with your questions.

Good morning. This is Daniel Hultberg, squeezing in for Scott here. Thank you for taking my question. Can you guys please elaborate a little bit on the end market outlook in the industrial products segment, and how we should think about the growth there, as we compare to the full year growth volume outlook for 2017? Thank you.

Beth?

Yes. For our industrial products market, there’s – as you know, it’s kind of a market basket, has a bunch of different things in it. One of the biggest growth areas we’ll see in 2017 will be frac sand and I mentioned earlier that we’ve really seen rig counts come up and fortunately for us a lot of them are in the Permian Basin and we believe that’s going to give us some opportunity to participate. But we do think that as we see the economy get some more legs and momentum, that we should have an in line opportunity to participate in that expansion in things like construction products and lumber specifically. Those are probably the key areas where we see growth. But I would say that we view that whole market basket as being pretty stable to growing in 2017.

Thank you.

Our next question is from the line of Brian Konigsberg with Vertical Research. Please go ahead with your questions.

Yes, hi, good morning. Thanks for taking my question. I’ll just be very quick. The commentary just about the contract changes relates to auto, how do we think about that, if we have a kind of a base assumption for the market this year? Should we think that you’re structurally below that because of the contract changes? Any color there would be helpful?

I would say the SAAR predicts pretty stable volumes for us into 2017, but as you suggest, we will lap that contract that we discussed in the early part of 2017 and so after that you should see us kind of participate in the market as it moves.

Don’t forget that embedded in automotive for us are automotive parts and we’ve done a really sound job. Eric and Beth’s team have done a really sound job of penetrating that market and growing it. So that’s a moving part there too.

Actually if I could sneak one last one in. I’m sorry, were you adding onto that?

No, go ahead.

I’m sorry. Just last question on inflation, just coming back to that. So 3% is a bit higher than I think some of your peers had suggested for the year. I know, before you did say that health and welfare will be a leading driver of that. I think you said that last quarter. But are other components – maybe you could talk about some of the other components that are really picking up, that are contributing as well, because I didn’t think that, in aggregate it would reach 3%. It was just kind of the outlier on health and welfare, where that doesn’t seem to be the case now.

Yes. Brian, this is Rob. I would just say that overall our overall inflation, I didn’t call out specially just labor, but labor will be a sizable piece of it, our expectation is 3%. And I would just say, that it will be what it will be. But I frankly not speaking for other railroads, but I think in terms of the labor and the health and welfare I would be surprised that if at the end of the day there’s a difference between us.

Got it. Thank you.

This concludes question-and-answer session. I will now turn the call back over to Lance Fritz for closing comments.

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

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Have a wonderful day.