Canadian National Railway Co (CNI) 2002 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the conditional second quarter conference call. I would like to turn the meeting over to Mr. Robert Noorigian, ladies and gentlemen, Mr. Robert Noorigian.

Good morning, I would like to thank you for joining us today's and we'll begin in just a couple of minutes. If you're listening to us on our live conference call, webcast, (inaudible) are available on CN's website as well as replay should you want to review this afterwards, of the website it. I want to remind everybody that we will be making some forward-looking statements within the make of the Private Securities Litigation Reform Act of 1995 and other applicable legislate aches. I would like everyone to read this statement that was included in this presentation regarding the risks and uncertainties that may cause actual results to differ. Such forward-looking statements that are made are based on information that is available at this time and that cannot be guarantee. Please read the safe harbor statements as well as the risk details and the reports filed by CN regulated of late in both Canada and the United States. With that, would like to introduce Mr. president and Chief Executive Officer of Canadian national.

Good morning to all of you and thank you for joining us. Let me introduce my colleagues in the conference room with me. Our Chief Financial Officer (inaudible)), Jim Foote, our chief marketing officer, (inaudible) our operations and (inaudible) is here. I would like to say, inaudible was at the British open last weekend and I suggested he should take a few days off and this is where he is. We will be brief. This is not after that face-to-face presentation. And therefore to allow you to ask questions we'll be very brief. On my part, a few comments on this one. EPS went up by 15 percent in a very tough environment therefore the we tell a hell of a beating again on (inaudible) and year to date, our (inaudible) revenues are down month to month (inaudible) and final in spite of this, we did a hell of a job on the merchandise traffic in offset days of the week while sector and as a result we're able, pro forma basis to increase our revenues by more than one percent. Last quarter before I did the floor to floor to our CFO, very strong performance after it (inaudible) discount in the first half of this year, after review in excess of 350 million dollars for cash flow. Over to you.

Thank you Paul. There are many reasons to be pleased by our Q2 results. Let me mention a few. The time live WC acquisition is providing solid accretion. Of the strengths of our merchandise franchise is helping us offset a 50 pro forma decline in grain and coal and we also continue to focus on driving value below the operating income line. All of this helps us deliver $1.39 EPS which is an increase of 15 percent excluding nonmajor recurring items such a special charge for work force reduction. Reference up 11 percent. On a pro forma basis as Jim will discuss, revenues were up 1 percent driven by strong merchandise and intermodal growth. Expenses were also up by a similar percentage increase helping us keep our operating ratio to only a slight increase of 30 basis points. Below the line, other income was up to 23 million dollars. Slightly higher than our run rate guidance of 15 to 20 million dollars per quarter. That was achieved on the strength of further relation sales around the Detroit River tunnel. Our effective tax rate was down to 33.6 percent. I am comfortable with this level for the balance of the year. If we start turn to the cost side we were able to keep our expense cost pressure to deal with first our equipment ramps are up 11 percent this is for a 96 of reasons. 1 million times 4 million dollars for an increase our record results in this quarter. More broadly we also have had less locomotive leasing than prior years and this is a good news/bad news, the other railroads are improving car cycle which has us generates less offline cars. It does show up in terms of increased expense for equipment rents. For the next few quarters we should see expense goes down sequentially in terms of year-over-year increase. Casualty and other purchase services were impacted by the cost of two major derailments. This is clearly part of doing business but these accidents were lumpy and costly and the impact was slightly in excess of 10 million dollars for this quarter. Our labor increase from 12 to 4 percent. But wage increase, less insourcing to third parties and the cost of health and we will compare in the US are taking a bite. In terms of underlying productivity as Jack would report we are continuing to make steady progress. There's a lot of hard work going on and all of this will pay a dividend when volume picks up. If I turn to free cash flow this is the most positive aspect of our results. Year to date we have generated 356 million dollars cold cash. Much working capital is releasing cash, capex containment discipline is showing through and all this cash was used to improve our balance sheet according to plan. At June 30 our book debt ratio stood at 42 percent. Including all leases the ratio was IBM 47 percent. In the second half we plan to he can independent about 640 million dollars capex but the strength of our H 1 results leads me to believe we could read a record 500 million dollars free cash flow for the full year. We are very pleased with our first half performance. We record double digit EPS growth of 13 percent. This was driven by solid railroad performance in a tough environment. The WT acquisition is proving out to be a very smart investment. Looking out to the balance of the year however we remain cautious. We will need a give economy to accelerate growth in (inaudible) on the cost side as you all know, the fuel prices for the second half will be less of the benefit than in the first half. Obviously the last point is we will (inaudible) accretion in Q4. All in all, bottom line we are on track to achieve our full year target at the upper end the rang that is 10 percent reported EPS growth year-over-year. Jim over to you.

Thanks. The second quarter pro forma revenue story eggs very positive but is impacted by very weak results in two areas, Canadian grain which was down 35 percent and coal which was down 16 percent. First, services goods and continues to get percent better. That service is helping to drive market share gains. We continue to realize price increases which are reflected in our yield improvement and we are exceeding expectations based on strategic initiatives. Full year IT merger related revenues are already in the bag. Revenues are on track despite weakness. Despite the so Mexican economy and our alliances are doing very well. More specifically, merchandise, the strength of CN's franchise is up 17 percent. Petroleum and chemicals up 16 percent, due to relatively low feed stock price is in Alberta was down 4 percent. But at 4 percent increase in aluminum traffic which was offset by the loss of previous year (inaudible) spot moves. (Inaudible) products up 2 percent. (Inaudible) up 7 percent due to continue strong housing markets and we should note here the traffic remained strong since the 86 position of the US import duties. Pulp and paper up slightly in a down markets as it increased 78 percent of capacity in Q1 to 83 percent of examination in Q2. Or was up 13 percent, two-thirds of this increase driven by higher volumes in General Motors and the other third of that coming through the higher imports traffic through Vancouver. (Inaudible) down 13 percent. Canadian grain down 35 percent due to the impact of the much poor crops harvest the last year half of that decline in wheat, we are seeing similar declines in grains and. On the positive side US grain is up 7 percent. Fertilizer traffic was strong both in the US but especially strong in Canada. Coal business was down 16 percent. With a continuing soft Canadian coal metallurgical overseas shipment. And petroleum coal shipments down to lower oil and gas prices. Enter modal up 4 percent both on the international side and then on the domestic side. The next slides shows the strengths of CN's percent franchise. We have a very very strong customer base which is driving CN's car go business at about 3 times the industry growth. One of the - the next slide shows where some of that growth is coming from. The (inaudible) plan we have put in place which is allowing us to continue to take share from trucks. Areas that have been our focus have been in news print, printing paper, and aluminum where we have seen very strong shifts from truck to rail. In the second half we will want to continue to sell service. Two, have disciplined price increases unless 1 to 2 percent range that we've talked about in prior quarters, and continues to drive the merchandise franchise will allow us to overcome some of the soft bulk markets. Jack.

Thanks, Jim. It's a pleasure for me to be back with you this morning. I'll begin with service, while we continue to lead the industry in service, and that being reflected in the 7 percent increase in merchandise traffic, we did have two lengthy main line disruptions which impacted our on time performance notice quarter leaving us with 90 percent for the quarter. We have returned to the 93 percent levels for trip line compliance and we have several initial differences in place to him prevent similar problems from occurring in the future. Having said that train accident ratio continues to show improvement. We had a 13 percent improvement quarter over quarter and we're especially proud of the 35 percent improvement that we had in reportable personal injuries. Asset utilization continues to improve and we've proven in the last quarter, we have additional capacity for additional carloads and in fact when we did this additional volume it does improve our utilization. We've made substantial improvements in both locomotive and car fleet percent utilization. Record high of 271 for the quarter. And we even had 6 or 7 days during the quarter where we were over 300 GPMs per horse power and the result, we've been reduce the our fleet by 64 locomotives by the first of January. While the lease opportunities have diminished this year, much it has enabled us to take savings: Car to lot continues to improve. Average for the fleet was at a record high for us 181 miles per day versus 160 during the same period last year. For fleets like center beam where there was special live high demand for forested products we were consistently operating at over 220 and recently as high as 250 miles per car day.

Let me interrupt, we all know that we're going through a period of great uncertainty. In the business environment. There is out there at this point in time am crisis of confidence. And in that context, we believe, we strongly believe that CN is very well positioned. What you see basically is what you get. Full through and plain disclosure. For instance, a big subject these days being discussed are the cost of (inaudible). Well, in the first quarter of this year, we are reflecting the true cost of these stock options in a note to our financial statements and for instance, if these stock options had been expensed, this would on that (inaudible) we have reported, this would represent 3 cents. Across the board we are at the forefront. Since this company has begun, the publicly traded company, the CEO and the (inaudible) have been split. Only two members of management, myself and the COO are members of the board and the board of trustees. Every single director of the (inaudible) is an offsite director and therefore I think that basically in the context with so many numbers are being questioned, CN is very well positioned. So we are focused on delivering our plans. It was once again a strong quarter. And we continue to him build on our industry leading position. And I my colleagues 00:31:27 and I would like to answer your questions.

Thank you. Please note that the question period is reserved for the financial analysts only. If you wish to ask a question, please press star 1 on your telephone. You will then be in a priority sequence queue. If you're using a speaker phone, please lift the hand set and then press star 1. Should you wish to cancel the question, please press the pound key. There will be a brief pause while the participants register for their questions. Thank you for your patience. You may now proceed. Our first question is from Morgan Stanley, Mr. Chris (inaudible) you may now proceed.

Thank you. Jim Ballentine. Good quarter. Forgive me I jumped in half way through the call, by I know he guys had more than one accidents in the quarter, I'm not sure, but if you could quantify it. Just talk about philosophically where you're at in terms of safety and I know you've historically seen a big improvement. Is it really just a coins deposition we think we've seen a few of these higher profile accidents notice quarters are things you're doing to redouble your efforts. That whole topic of derailments and accidents.

I'll give the floor to Jack.

We've led the industry for the 4 and last 5 years with the lowest training accident ratio. As we said this morning we've got a further 13 percent improvement this year. There have been some high profile accidents that did occur. And while I'm not concerned that, the accidents ratio is imposing, we are doing a number of thing ensure that there is no increase the trend. You may know that one of our more serious main line accidents in Canada was caused by truck, offline crossing and we made serious effort through all the trucking associations in Canada, transport Canada as well as the Railway Association of Canada to address the heightened awareness on the part of owl of our truckers in they to ensure that we don't have serious accidents going forward. In terms of our own maintenance, we've height understand the increased the velocity, increase the frequency of ultrasonic rail testing. We've allocated some of our capital money to install an 20 miles of rail in areas that we did have some concern with. And we do have plans to increase the amount of capital spending that we have for rail and tire replacement next year. Overall,s as I say, the trend, accident statistics continue to show that we don't have a major cause for concern but we certainly don't want to have a recurrence of the two or three serious accidents that we've had so far this year.

Okay. Good. The question, same question actually if you use, Jack, in terms of productivity gains and labor costs. I think during if we take out fuel, the operating ratio did not see an improvement. And obviously you are feeling the impact of some real negative bulk commodities. The number in there that surprised us a little ability your wage per employee cost went up 9 percent. Is there anything unusual in that on a year to year basis. If not, is there some way that you can offset that level of increase or for some reason that increase rates will slow down.

This is (inaudible) we are focused on this. And at the heart of this, it our ability to continue to focus on head counted reduction. Again this quarter our head count is down and that's the good news. It's down less so than in prior year. And the issue in terms of cost increase eggs related to a few factors. First, we had less insourcing of the third-party work, so that's an expense that used to be charged do other the which we now have to carry on our P and with a given amounts of employees. Seconds usual our wage increase and the cost of health and welfare benefits in the US. You're familiar with the situation. We have less exposure to its than the other railroads but it's certainly having a pinch on our results as well. So that increase of around 3 to 4 percent on a year-over-year basis, that's not a bad run rate in terms what we're facing this year.

Okay. Great. Thanks guys.

Our following question is from Salomon Smith Barney from Mr. (inaudible), you may now speak your question.

Yeah. Good morning, all. Just a couple of quick questions. One I was wondering, this is something you didn't directly address, but what has been the progress that EW and S, just operational, I know you felt there was some quick things could help you there, track access U saw some benefits but obviously there are some changes going on in the British rail system with all the difficulties of rail trashing. I just wondered if you could give us a quick update on the financial performance of UW and S.

Yes, Scott, I'll make one comment and then I'll turn it over to (inaudible). (Inaudible) was attend ago board meeting a week ago. Good news in terms of at long last. The British government is about to resolve the rail traffic situation. You will recall that rail traffic, basically the order of the roadbed and so on. They are basically in a situation for (inaudible). A new corporate entity will be guarantee by the British government. It is in the process of being put in place called network rail. And therefore this is falling in place. Also, good news, EWS was success in negotiating a new access agreement five year access agreement, where the cost is going down. And also, we were successful in putting in place a new labor contract with the drivers, so on, again this is good news. In terms of performance, you want to comments.

Yeah. Their performance is a good and steady with these positive factors that Paul just mentioned. In terms of the he can quits contribution to our results, you may have announce noticed it's down slightly from the first quarter. Two items worth mentioning. The first is the new labor agreements involved a retroactive one time payment which had to be booked in the quarter. Second, there was a small UK to US gas reconciliation which we had not picked up in Q1 had to book for both Q1 and Q2. Their run rate of built 8 to 9 million dollars a quarter is what we're expecting out of them and their performance in the second quarter was very much in line with this except for the items I just mentioned.

Could you just give us some sense of what the retro labor payment and the GAAP reconciliations impacts on Q2 was.

That's what I'm saying. Basically the first quarter was reported at 11. Should have been 9. The second. Quarter cars reported at 5.5. If you take out those two factors it's about that in line with a 8 to 9 million dollars run rate.

Just a question quickly for Jim in this. Update us in terms of two things. One was what are you seeing as a run rate of revenues for modal conversion/new products: The incremental revenue is coming in the top of the bucket relative to the new products. Maybe a little bit more difficult to quantify or get your hands around, do you have any sense what the erosion, or run rate of erosion might be in your children of normal business? Some of the customers you had may go away for financial reasons and otherwise. I want to see how you see those two factors in your reach stream.

Sure, Scott. It would be difficult for me to put it in exact percentage off the top of my head in terms of what is accruing to us as a result of modal conversion. A large part of the merchandise growth is a direct result of our picking up market share gains at the expense of truck. Especially the - in the area of the paper and the aluminum business where we have focused on that for the last few years. If you want to say that we're growing at 3 times the rate of the industry, a certain part of that, whether that's a third or half of that additional growth would be coming at - from market share gains. And I could further quantify for you if you would like but it would take me sometime to do some work on the numbers. The other question in terms of the churn of or normal business, I can tell you that to the extent - with a few exceptions, where we have customers who clearly view transportation strictly as a commodity, and therefore are strictly interested in price only, we have very little turnover in our customer base. Our customer loyalty which we measure on a regular basis in our satisfaction survey continues to grow. As well as our market share which would be another measure I would look to in terms of customer allegiance, continues to grow as well as. They are not going to ask you back to do more work if they were dissatisfied with the work you did for them the first time around. We are not seeing - we are not seeing a lot of business or customer relationships diminish.

Thank you very much.

Thank you. Our following question is from Bear Stearns, Mr. Tom (inaudible) you may proceed.

Good morning, everybody.

Good morning, Tom.

I've got two questions, the first one I think is for Jim. Focuses also on the merchandise side and some pretty impressive growth in the merchandise area in second quarter, so you know, that's looking great. I'm wondering if you look out to second half, do you think that that's pretty sustainable at the same level of growth or do you have any concerns that the economy, there may be some double dip or there's some inventory rebuild that would not be present in the second half? Or do you think it's really strong growth us sustainable?

I would surmise that the rate of growth relative to the industry, two to 3 times what the industry growth has been is what we have achieved over the last year, year and a half or so. To the extent that I see the economy expanding so that that growth rate will still be up there in the 6, 7 percent range, I see no reason at this point in time to believe that my customers, for example, the Canadian producers, will not continue to have the advantage in the second half of the year that they've had in the first half of the year, the lower cost of production, to the lower cost natural product, and three, the advantage as a result of the Canadian dollar. So I see those as three factors which are helping to drive that economic growth at a faster rate. And I would expect those three factors to continue in the second half.

Do you think the chemicals strengths is pretty sensitive to the natural gas prices? That's an important input or not worry about that too much.

No. The natural gas price,, historically, Alberta where our significant base of customers are in the polyethylene, and all those P chemicals originate, has historically had an advantage over say the Gulf coast producers. And there was a time when there was a speculation in the market place where that advantage went away. They still continue to have the low cost production in that - during that period of time. That advantage to so-called Alberta advantage is now back in the range of, you'll measure it whatever you call it, or million BTUs, it's $2, versus $3 in the Gulf. So I expect that spread at this point in time, unless something changes that I'm not aware of, to continue.

Okay. And then one question on the cost side. Looking at the labor costs and on a per worker basis, I see it being on the order of 11 and a half percent per worker year-over-year. And that's no. factoring in the pro forma for Wisconsin central. You did very well in the head count reduction side but actual cost per worker the inflation was significant. Can you tell us, if you look out beyond the near term, 2003, given of the contracts you have in place, what is a normalized type of inflation per worker? Should we be looking at 5, 6 percent going forward? Some of the near term effects normalize?

When you look at it it's less than the numbers you were quoting. First on a pro forma basis, our head count is down us a pointed out. The run rate that you see this year in terms of labor increase is a factor of wage increase which are in the order of three percent, slightly more in the US. What is creating increase in cost per worker, couple of things. First the facts that we are doing less insourcing, so that means work that was charged out to third-party is now an expense on our P and L. There's a of slight mixed change, we have fewer employees that are not returning trade, and the running trades employees cost more per head than some other crafts in the railroads. And third, we have some increase in health and welfare as you know the prescription drugs in the US and the general medical trend is such that you have higher costs and when you deal with 60, 30 and more retirements, you have to book the expense of those employees which are no longer productive for the railroad on an actuarial basis. These things are increasing our labor expense in this quarter but more generally this year but I don't see that as an indication for a run rate in 2003 and beyond.

If you take those out in 2003, what type of number do you think is reasonable for inflation on a per worker basis.

I think it's going to come down closer to the wage rate inflation which is notice range of 3 to 4 percent at the most.

Right. Okay. Thanks very much for the time. Good quarter.

Thank you.

Thank you. Our following question is from Credit Suisse First Boston from Mr. Gary Woblin (phonetic). You may now proceed.

Hey, gentlemen, how are you?

Fine, Gary, how are you.

Couple questions for Jack. You've got a slide in here Jack talking about GTMs per available unit of horse power, you folks keep raising the much bar and exceeded the bar. A couple of years, your thoughts, some of the sensitivity work for capital avoidance as you do percent more with less, could you give us an update on that.

In terms of how far can we go on locomotive productivity?

Yes.

I made a specific point of saying that we reached seven days in the quarter where we were over 300 GTMs per horse power. This in my view is a function of the cargo traffic. If we have the success in the last quarters, 7 percent in merchandise traffic, we continues to have that type of increase in merchandise traffic there's no reason why we can't be consistently at 300 GTMs per horse power. We've proven that in this last quarter.

What kind of sensitivity, for every X percent, how does that math fall out?

Let's just say on - we've gone from 260 to 270. We've taken out roughly 60 to 75 locomotives with that improvement in GTM per horse power.

From 260 to 270.

Claude how do I think about that in captain at that time or P and L terms.

When we have the opportunity of leasing out this extra power, it was a nice benefit in terms of the expense line. We were able to lease them out last year to other railroads. We're still on the lookout for those opportunities and we may hit pay dirt. At the moment, most of those units are sitting idle. And what you see in terms of operating expense is only the cost of getting the lower fuel or the (inaudible) consumer, out from the fleet and the fact that you have less materials for the maintenance. The billing benefit is in capital expenditure going forward. Every unit its 2 million bucks or more. It's an expense you don't needs to handle a given amounts of business, that over time, 60 times 2 million that's in excess of 100 million dollars of capital that we won't have to he can independence over the next several years. That's where of the benefit is on the cash flow side.

One follow-up, if I could. This is probably for Paul and/or Claude. Talking about decides count rates. This is unfortunately all popular topic as the relates to pension costs with the market being so wonderful. Could you tell us a little bit about sensitivity you have there for every let's say 25 basis point change in assumption for returns over the longer term, how that effects you?

Your question is in terms of the rate of return on pension fund?

Correct.

Yeah. Our assumption it's obviously an area we are monitoring closely. Our assumptions for the rate of return of our pension plan is 9 percent. If you shave 25 basis points it increases our expenses on the 10 million dollars on an annual basis. The good news is, it's seen as good situation in terms of the pension plan. That we have a meaningful surplus on an actuarial basis, we are monitoring this rate of return. We are less aggressive than most US companies but I think 9 percent is an aggressive number in today's environment and we will have to assess over time whether we should gradually bring it down.

Claude, how does is that work? Is that a recommendation from an actuary, something goes to the board level, how do the mechanics work?

It is basically on the basis of the best advice from acts rears and the people in our own investment divisions and the statistics of the pension fund return on an historical basis.

A couple of words of background, Gary, that you may be aware of. As you know, our pension fund is one of the largest private sector pension fund because it is a (inaudible) given the fact that a number of pensioners, larger than the number of employees, given the age of this company a which goes back to 1919. Therefore, this is managed by an investment division which is operating completely apart from us. And to show you our how careful these managers, when we did the ITO, we took the decision is that they should not buy, with the access of the pension fund, any shares in CN. So therefore, they are totally operating on their own plain. And over the last 10 years, their performance has been very much in the top quarter tile or what have you. Every year, based on the - the situation in Canada, they have to report to the supervisor of funds institution in our department of finances. And are every year there is an actuarial values by some actuary from the bursar, and we have the choice of either filing in a new evaluation with the supervisor of financial institutions or stay with the evaluation that they have which is go for three years. This has been managed in a very conservative fashion. If you're asking me the CEO of this organization, do I worry about this? I would say, except for the two hours a month that I sit on the board of getting a progress report on their performance, I never focus on it because it is run in a very professional fashion.

Okay. Fair enough. Thank you.

Our following question is from (inaudible) Nesbitt Burns, Mr. Randy cousins, you may take your question.

Afternoon gentlemen I'll circle two questions. First off, with reference to WCX, you talked about a series of synergies, you have owned this asset for three quarters now. What's the status of those synergies, how much have you gotten and how much are you going to see over the balance of this year. The second question is probably more for Jim. Jim, in terms of pro forma. Get into a little bit more detail in what is going on in your intermodal business. Revenue ton miles are down 5 percent in terms of yield. Your revenue per car load intermodal is also down. Give us some sense as to what is going on there.

Randy, on our question about WC. We're making good progress on all counts, whether the integration of the physical operation, whether it's the changeouts of the locomotives fleet, the way that we have discussed it in the application. We are gradually integrates the - all of the corporate and overhead functions. The good news is we completed our SAT phase 3 here in Canada and we're now in the process of starting to roll out SAT on the WC over the next 6 to 8 months. So on all accounts we're making very good progress and we are still committed to achieve the three year target that we've communicated to the street previously.

Let me just add, Randy, as you may know, as far as the oversight, responsibilities (inaudible), we have to file a monthly basis a progress report. The last progress report was filed as of July 9 or July 13. And under every single item, we are - had - we had told the board when we came with - when we filed, we are at synergy that we have put in that permission.

So for the balance of the year, how much would you hope to realize in terms of additional synergies.

We have a targets of 60 million dollars over a 3 year period. So this year, with a 20 million. We're in a light lie in excess of that. you can assume that half of that women come through in our results into the latter part of the year.

Okay.

You want to comments on the better modal.

Sure our intermodal business is doing very well. We have talked in the past about some significant business that we decided not to pursue that went elsewhere based upon price. So that number was in the sec second quarter of last year on the overseas side. And it is not there this year. In addition, so therefore, from a volume perspective we were able to more than offset that on the overseas sides the business, the international steam ship sides of the business. By increasing the traffic that we had with existing customers. Principally through Vancouver, as well as bringing in some new customers as well. On the domestic side of the business, that business also is percent growing very well. But that is the side of the area where we have some haulage business in the US which again went away. And is not reflected in the numbers. So, from a volume perspective, we have grown the business in this quarter very well. Offsetting the loss of two significant pieces of business that will - for comparison purposes, won't be a problem in the second half of the year. On top of that, to address what you see as a decline in the yield in the intermodal business, while we have been focusing very hard on imposing the rate structure in that business and have been very successful in improving the rate structure and have been willing to see business go away when it could not, we had a four percent fuel surcharge in the second quarter of last year which we do not have this year. In addition to the rate increases that we have been pushing forward, it has been difficult for us to apply in across the board rate increase in addition to the fuel surcharge as well. So we have seen some decline on a total yelled basis in that. And we'll make up for that going forward with additional fuel is your charges or additional rate increase eggs where appropriate.

Thank you.

Our following question is from Deutsche Bank, Mr. (inaudible) you maim know proceed.

Yes, thank you. Paul and Claude, you talk about cash flow, could you talk about the user calf, are you going to retire that more and more or would you consider elsewhere to invest that money.

Well, let me just tell you that I'm sure you would agree with they, this a very nice (inaudible) so Claude go ahead.

Yes. We are using the catch supporting the plan. We are committed to bring back our debt ratio on an adjusted basis down to 45 percent at the end of this year, as I said we stood at 47 at 6 months, with the cash flow we expect to generate on the second half we should be on target to which bring our debts ratio around 45 percent. Going forward in terms of use of cash, we would love to have other smart investments that produce instant and solid accretion from day 1, that's up on our list, but behind, that it's a one thing you can rest assured U this company will not sit on cash and we will reward shareholders accordingly. It is too early to make decisions on how exactly we will use the cash but for next year in the November timeframe we will have a better sense of things.

Second question for Jim as to gaining market share from trucks. What more opportunity do you see, could you quantify some kind of a dollar amount or in terms of (inaudible) amount or how could you see that opportunity?

Well, the opportunity is enormous if you look at just the existing market out there. Our business, let me say, receipt me give you a good example. We have talked over the years about the new OSB plant that have been coming on line on our system. Today, if you look at those charts that you used there, our percentage of traffic as a percentage of all tons of that commodity moved in Canada, in lumber we have about 55 percent of the market are slightly higher in terms of lumber. In the OSB market that number is down around 35 percent. There is no reason in the world that the OSB market share should not be the same as the lumber share. Unfortunately some these OSB plants were built in areas and during times that were - or in areas that were not rail served, etcetera. So we need to get in there and be more aggressive and work on the origin reload side the business as well. But that's just one example of taking an existing business, existing customer, as we did on the paper side, using the (inaudible) example as the one. We've talked about. We've gone from 35 to 45 percent of the markets there. Those examples exist all across our system. And as the service levels improve, and as the productivity levels get higher, we will continue to gain market share like we have done in the past. And we're not sure what comes first, if it's the if it's bringing on the merchandise customer, which then helps drive the productivity that Jack talked about that he's able to achieve, if we get the new business, or if it's the - which then drives 86 proved productivity and improved service or improved productivity and the improved service to drive the market share gains but let me tell you, they are both intertwined and we see the benefits on either side with I'm able to achieve in growing the business or Jack is able to you chief in imposing service levels and productivity.

Okay. Thank you.

Thank you.

Our following question from J P. Morgan, Mr. or Miss Jill Evans. You may now proceed.

Thank you. On head count, Claude, do you see head count going up next year with expected increase in volumes.

No. I wouldn't see it going up. We've been as I said earlier, our rates of head count reduction has slowed down. But just a carryover impact of the reductions we're doing this year give us a platform to work with into next year. We are always working at opportunity to gain efficiency where it's through technology or just smart management of the railroad. I don't expect significant head count reduction but I don't expect increases in head count.

Okay. That's interesting you can handle the volume increases with your current labor force. And then on the other nonlabor, nonfuel items, you did have quite a bit of pressure in the second quarter, yet the second half is going to get tougher from a comp comparison. Just in general, Claude, I mean, I guess the concern is that we hear the productivity is continuing but it looks like we're seeing a lot of cost pressure kind of creeping in here. And kind of wanted to know how you would counter that assumption or just reduction from the second quarter numbers.

A lot of blocking and tackling. You're right to say in terms of expense, the second half will be a tougher comparison as compared to the first half. Just fuel which was a big benefit in the first half is expected to be either only flat or even in the first quarter fourth quarter, might be up year-over-year if the curve stays where it is. We have our work cut out in terms of managing these expense items but we are focused. I think that's - the (inaudible) were here, there are still a lot of things we can sweep in the corner and basically blocking and tackling, and maintaining a focused and disciplined approach to every expense item. That's on the cost side. We also expect on the revenue side, with bulk environment being a bit less's veer as the first half, we continue to grow on the merchandise side, we should have of a slightly accelerated revenue growth. Overall when you look at our EPS, we've achieved 13 percent for of the first half. We're committed to reaching 10 percent for the full year. There is a slowdown in the rate of EPS growth but we're certainly planning on continuing to deliver strong performance and meet all of our targets for the year.

Okay. That's all. We'll keep on 8 other than things going.

Thank you. Our following question from Goldman Sachs, Mr. (inaudible) you may take your question.

Yes, hi. Here's a question on the agricultural side. I think general production forecasts still suggests that things on the Canadian crop side may look better as we move through this year and into next year. I'm just curious your thoughts on that and sorts of comfort level in that regard.

We don't think this is a the case at all. At best, the (inaudible) this year, with crops this year, and it's not unlikely it would be worse. So therefore, year to date, Jim and I have already said that our revenues on the Canadian side are rough, by about 100 million dollars. This is going to continue to grow by maybe another 3 million dollars between now and the end the year. So therefore, we don't think that next year crop, again the crop year start on August first, is going to be any better. The Norman part of the prairies are suffering the worst drought of the last 15 years. And therefore that crop is not going to be any better.

Obviously, to the extent that the fertilizer components of the company as well as the US corn and so I bean business does well, it diminishes the negative impact of the Canadian wheat crop. But it obviously has - makes it more challenging when you start the year 120 or 130 million bucks in the hole to dry and have - to try and have significant top line growth offsetting that. To the extent that we are positive on the revenue growth with this bulk environment which is unprecedented, really shows the true strength of conditional which is the merchandise side, and the business which really plays right in the hands of the schedule the railroad and our ability to grow the top line and productivity simultaneously.

Is it possible to see improvement on the yield side in the AG sector.

Yes. To the extent that we have room on the Canadian side. As you know there are parts of that business that are regulated. We have just increased that - a certain part of that 4 percent in order to take advantage of room underneath the rate cap as the crop sizes come down. We're able to mover rates up in some areas. On the US side, obviously, we continue to push for rate increases wherever we can and have been very successful in imposing yields unless Canadian or I mean in the US corn side the business this year and would expect to do that going forward. Yes, those rate increases and yield improvements to a degree diminish the impact of the lower volume. Backup 15 to 20 year low in terms of crop sizes it's difficult to overcome.

One more question.

Thank you. Our - this last question is from RBC Capital Markets, Mr. Joseph (inaudible) you may now proceed.

Hi, gentlemen. Can you hear me?

Yes.

Just a couple ones. Autos and the lumber have been quite strong and I was wondering if you get any preliminary view as to what the third quarter, any down trend there. Just a counterbalance, are you seeing any strengths in the pulp and paper side to offset lumber?

Well,s lumber has actually been very surprising for us. Everybody had projected that the lumber traffic would soften after the quarters went into effect the lumber business has remained strong. Interested rates, as you know, interest rates have a remained low. A lot of the money that is flowing out of certain equities is flowing into real estate investments. That's driving the market. Again, our customers, principally those in the west on the lumber side of the business, have been - have benefited to a degree from having lower than average quarters so their shipments are actually up. So we see lumber in the second half being good. On the paper and pulp side, again, very very soft markets. We're seeing some production capacity come back but that's more of an indicator of lower inventories than it is in increase in consumption. We're going to have to wait until we move further into the third quarter if advertising space moves back up there. Kind of a Thanksgiving, school-back period. Paper is going to come back, see. Much a slight increase in pulp which is normally a leading indicator of that section. On the auto side, as GM goes to the extent, so does CN and the auto side. They are our largest customer. They have been doing very well. Not only have they been bring out some new products which have been doing well, gaining market share against both the US and the imported producers. So as they have aggressively with lower financing programs gone after market shares, we have benefited from that. they expect to have strong production in the second half of the year. And are having additional overtime schedules to produce models and we will benefit from them in the second half.

You still see some positive growth year-over-year in the second half.

Absolutely. The merchandise side of our business is very well positioned. And our customers and our producers are the strongest in the industry right now and I'm looking forward to a good second half in the business.

That's great. That was my last question. Thank you very much.

Well, thank you very much for all of you for joining us. We are committed to meet our commitments. I want to repeat what Claude said,, the CFO, looking forward to seeing you in New York in person at - in October. And hopefully, you'll be able to join us (inaudible). Thank you and have a good and safe week.

01:14:47 >>OPERATOR: Thank you. Have a great day.