Canadian National Railway Co (CNI) 2002 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Canadian National conference call to discuss CN's year-end and fourth quarter 2002 financial results. I would now like to turn the meeting over to Mr. Bob Noorigian, vice president, investor relations of CN.

Ladies and gentlemen, Mr. Bob Noorigian.

Good morning. Welcome to all of you today, in this lovely warm New York, especially by comparing things with Montreal, which is about, I think, 10 degrees cooler this morning. To start off this morning, I'd like to introduce the important people in the room, and I'd like to introduce my new associate, Nadine Bellani (ph), who has joined me, who you will probably be talking to over the next several months, who is replacing Mark Wallace, who is on to bigger and better things working with Hunter Harrison as his chief of staff and looking at a few expenses here and there that may be able to be reduced over the next few months.

Before we begin today, I have two cautions that I want to read to you today. The presentations that you're going to see will include non-GAAP financial measures for purposes of comparability. The GAAP financials are included in the notes in the 20-page package we gave to you today, and are part of the press release and are also available on our website, www.cn.ca. In particular, in that package, I'd like to-you to refer to note 11, the quarterly statements provides a detailed reconciliation of the items that effect the comparability of our results.

Also today, we will be making forward-looking statements under the meaning of the U.S. Private Securities Reform Act of 1995 and any other applicable legislation. There are a number of risks and uncertainties that could cause actual results to differ materially than what we present to you today. Some of those risks and uncertainties are detailed in the first slide of the presentation and also in reports filed from time to time with the SEC.

And with those warnings, and our introduction, I'd like to introduce --actually I would like to and it is my pleasure to introduce Mr. Hunter Harrison, CN's president and chief executive officer.

Thank you, Bob. Good morning to you that are here present with us in New York and also you that -- who are joining us telephonically and on the webcast. Let me set the record straight. Contrary to media reports, I love analyst meetings and quarterly earnings and there appears to be conflict there that I'm strictly railroad, but I'm delighted to be here this morning.

What I'd like to do is, before Jim and Claude kind of peel back some of the numbers for us, let me give you a little bit of my take on particularly the overall results for the year. Claude and Jim are going to focus on the fourth quarter as well as, but I would characterize it as very good, solid performance, particularly given the environment we were in with tremendous pressures on the top line based on the weakness in grain in western Canada and the drought. You're going to see numbers that we have taken $220 million top-line hit and the beginning of two phase-out and closures of two major mines in Canada. In spite of that, to be able to produce adjusted earnings growth of 6% is pretty outstanding.

We still were able to maintain an operating ratio, came in less than 70, about 69.4. If I had been asked a year ago if we could have sustained that kind of performance with that kind of pressure on the top line, I would not have been able to answer in a positive frame. But I think that if we sit back and analyze what gave us the ability to do that, it's the strength in our operating plan, it's the strength of the schedule railroading, the discipline it brings to us. You will see from Jim's remarks that we had significant market share gains and growth in petroleum and chemicals, forest products, intermodal, automotive, that to some degree are blurred by the weakness in Canadian grain.

Probably the thing I'm proudest of is we had record -- emphasize record -- free cash flow of $513 million, which is on a percentage basis, I think, probably pretty unprecedented, and to some degree as a result of that, I'm sure you saw the press release this morning that the board yesterday approved a increase in our dividend to 25 cents a quarter, an increase of 16%, which puts us a dollar for the year.

So all things - and I'll have some other remarks at the end, I think it was a pretty good performance, tough year, tough environment, and with that, Claude, would you review some of the expenses for us.

Thank you, Hunter.

Before I review the Q4 results in more detail, let me take a look at the full-year with and without the charges that we took in November in which we explain in great details in a conference call at that time. On a GAAP basis, our reported net income was $800 million for the full year, which is $3.95 -- $3.97 per share. This includes the after-tax impact of $252 million for those two charges, one for personal injury reserves and one for the workforce adjustment charge. If you exclude these charges for better comparability -- and there is a few items, both gain and losses in 2001, which we exclude as well -- adjusted results came in with an EPS of $5.22, which is a 6% increase, slightly better than the revised guidance which we offered to you when it became clear to us that grain would be a disaster in 2002. Grain indeed came in basically $220 million down year over year, so we're quite pleased to show full-year profit growth in spite of that adversity, and a lot of the reasons why we were able to show that growth is because of the successful acquisition of the WC, which provided us with meaningful accretion during the year.

If we turn to Q4 results, and look at them on an adjusted basis, our final quarter came in at $1.36 EPS. That's a 12-cent or 8% reduction from 2001. The drop reflects the impact of a very difficult bulk environment in 2002, and also a tough comparison against an exceptional fourth quarter in 2001. On the revenue side, we managed to hold the line despite a massive $70 million hit in our profitable grain and coal business, and as Jim will discuss, this hit was offset by strong merchandise growth and also by intermodal, which came in with a 15% clip in terms of growth rate for the last quarter. Overall, given cost, inflation, and the impact on mix of losing that profitable bulk business, margins suffered slightly with an increased operating ratio to 68.3.

Below the line, we continue to make progress with a 1.5 percentage point decrease in our effective tax rate, and also lower interest expense. But these improvements were more than offset by a $25 million reduction in other income. That $25 million reduction alone represented an 8-cent drop in EPS year over year. At $7 million for the quarter, we're not too far from the run rate that we've communicated to you on the order of $10 million per quarter with some volatility. The issue is last year, we had just a spectacular quarter with a large real estate gain from an initiative of coal production with CP in southwestern Ontario.

If we turn to expense, overall, our expenses increased by $41 million, of which $11 million is due to the eight days gap of the WC consolidation prior to October 9 in 2001. About half of the $30 million pro forma increase is in fuel expenses, and that really is the impact of a one-time recovery which benefited us in 2001. Prices were down slightly, and our fuel expense, other than this one-time recovery, would have been flat to only slightly up overall. Labor and fringe benefits were down more than 2%, and that reflects the traction of our downsizing effort, but we also had lower bonus accrual in the fourth quarter, which helped us. The equipment ramp and casualty in other categories were both down 7%. Casualty claims increased in line with our new (inaudible) funding rate which we started to apply in Q4, but this was offset by savings in other areas and by a reduction in operating taxes which we have combined in this category in other. Purchased services and material increased by $35 million. Part of this increase, which is higher than what we would like it to be, is again due to an unusually low base with credits benefiting 2001. But we also face higher costs for bad derailments during the fourth quarter. This is a negative trend we're focused on. These incidents were avoidable, and I know Hunter and the operating folks across the property are focused on reducing safety and accident-related expense in 2003.

Taking everything in, the quarter showed good expense control with underlying solid productivity improvement both on the labor front and on the asset front. If I turn to my favorite slide, cash flow, you can see here for the full year, we delivered a record $513 million of free cash flow after dividends. This is ahead of our target despite the adversity, and a full 16% increase driven by improvements pretty much across the board. Solid operating cash flow with a net cap-ex of only $938 million, which is flat year over year despite the integration of the WC. We also focused on improving working capital and on smart disposal of surplus assets. As promised, by the end of the year, our debt ratio was back to 40% on a book basis, 44.5% all end adjusted ratio. This is thedebt level that we had prior to the acquisition of the WC just 15 months ago. With a strong balance sheet, I know the question that comes to your mind is what will we do with this excess cash, and we can turn to that right now.

With Hunter as our new leader, this company will focus on cash generation more than of ever. At roughly 8.5% of revenues, our cash performance is leading the industry and we intend to stay there. Our goal is to provide shareholders with tangible rewards. Our first priority is to go after smart investment opportunities if they come available, like the WC acquisition. In the meantime, however, we have launched a share buyback program in the fourth quarter with a purchase of 3 million shares, and we will buy the remaining 10 million shares that are available to be bought in our program over the next few quarters. Yesterday, our board agreed with our recommendation to increase our dividend by a full 16% to 25 cents per quarter. This is the seventh consecutive year in a row with a significant increase, and it is consistent with our intent and policy of gradually increasing our payout ratio.

Together, when you take them together, these measures clearly show our confidence for the long term, and I believe provide a solid platform for value creation. Let me wrap up with a few words on our short-term outlook and give you a bit of guidance. It's fair to say that 2003 will be challenging, but we're ready for it. We will face a tough bulk environment again, particularly grain, which could be down in the first half by as much as $80-$100 million. On the cost side, we will also face a few structural issues that we have to deal with.

Pension, personal injury reserve, health and welfare are not going away. Pension alone is a $50 million increase. It's a non-cash expense increase, but it's a significant pressure on the labor expense category. But we are dealing with these issues. The announcement of the downsizing which we are accelerating is going to help us contain expense increase, end labor and other categories. We're getting new focus on driving out expenses that are associated with labor reductions like real estate expense and all ancillary expenses that come with the head count. We're driving out more generally discretionary expenses across the board. We are digging deeper, and this is how we will build a platform for a strong rebound in the latter part of the year-end in 2004.

If you look at it from a quarterly standpoint, you should expect Q1 to be with a similar pattern of results than what we've seen in the last or final quarter of 2002, with EPS down due to grain pressure and also much lower other income. But we are ready for a strong rebound in the latter part of the year, and we are committed to grow both earnings and free cash flow again in 2003.

Jim?

Thank you, Claude.

I'd like to spend just a few moments to go through the fourth quarter and the full-year results. Very, very strong fourth quarter and full-year revenue growth, hidden by the unprecedented declines in the Canadian grain situation caused by the drought conditions in western Canada. Our merchandise traffic was up in the fourth quarter 5%, and on a pro forma basis, up 6% for the full year. And it's - and the breakdown by the various commodity groupings on this slide are virtually the same. The growth patterns are virtually the same in the fourth quarter as what we saw throughout the full year. As an example, in the petroleum and chemicals group, the petroleum segment of that group had a very strong fourth quarter and full year, driven by strong plastics demand and sulfur shipments. That petroleum half of that group up 18% in the fourth quarter, and 17% pro forma for the full year.

In the metals and minerals group, we saw strong steel and aluminum shipments, but unfortunately offset during both the quarter and the year by declines in iron ore shipments and mineral shipments which pulled down the overall group somewhat. In the forest products group, lumber shipments strong in the fourth quarter and the full year -- 16% growth in lumber in Q4, and 14% growth in lumber for the full year, driven by the strong housing market and the low interest rates in the U.S.

Probably even more impressive than the lumber growth was the fact that our paper shipments were actually up slightly for the year in a market in which $4.2 million of production capacity was taken out of the North American paper production market. And we were able to actually grow our business in that kind of a down market by taking market share from truck based upon the strength of our service that we're delivering to the customer. Auto, given a very strong year as well based upon high production levels, up 3% in the quarter and 14% for the year. So the base business of the company doing extremely well. Also, our intermodal business did well. A very strong fourth quarter both for overseas and domestic, up 16% in the quarter. Overseas in the fourth quarter being up 4% with strong shipments coming in principally through the West Coast, but the domestic business also up 10% in the quarter, again driven by the strength of the service offering that we have in the marketplace.

The unfortunate side of this very good story, the bulk story. Western Canadian grain being down for the full year, $220 million. Grain down, of the grain and fertilizer segment that you see here, Canadian grain down 38% in the fourth quarter, 31% for the full year, and wheat shipments in western Canada, actually the strength of the Canadian wheat franchise, down 50% in the fourth quarter. Unprecedented declines based upon low available stocks to move. Again, strictly due to the weather conditions that we're experiencing out there. U.S. grain actually flat, and the fertilizer business actually flat. So the decline due almost exclusively to this unprecedented condition that we're experiencing in western Canada.

This slide here, I think Claude said he had a favorite slide, this is my favorite slide as well. It shows our strength of our merchandise business again, still outperforming the industry here. Carloads in the fourth quarter up 5%, while the industry up 1%. So the service plan drives the growth principally in this merchandise service-sensitive carload business.

I want to touch briefly on a new topic, a topic that we've begun to speak about really in the fourth quarter of last year, and that is our plan to redesign our intermodal service, taking the strength of the service plan that we've used to improve the quality of the product that we have in our carload business, which is focused principally on the merchandise section, and bring that disciplined operating mentality to our intermodal business unit, one of the biggest opportunities that we have right now. And just to start trying to discuss this generally with everyone, and what is it that we're trying to do, well, if you look at the left-hand side of this slide, you'll see kind of what our operating principles and practices are today and how we're transforming those operating practices in the future as we move forward with this redesign of our intermodal operations. Today, our operations, our operating plan is built around the service demands in the marketplace. Our operating plan varies from day to day greatly based upon the way the shipments have historically moved into and out of the import/export ports as well as the domestic movements have moved. Our plan in the future is to smooth that demand and bring that efficiency and operating discipline to the intermodal business as we have with the carload business.

Today, we're focused on the top line. Today, our plan is to dump as much revenue in the top and see what happens as it comes out the bottom. That's not -- the plan in the future is to focus on when is the best day of the week to ship, when is the optimal time to ship, what is the demand, what is the available capacity, and looking at the marketplace difference and focusing on maximizing contribution, and getting away from the third point, fixed price contracts and moving to day-of-the-week pricing, selling slots and being much more flexible while at the same time having a disciplined mentality and driving efficiency -- which does what?

Probably the most important thing on this side -- today the way we do this, the very ability that's built into the business and the way we think we are approaching the market makes it extremely difficult for us to provide consistent, high quality service. We should run at much, much higher levels of efficiency and on-time performance than we do, but because we are responding to a variable marketplace, it's difficult for us to do that. This plan will actually improve the quality of the service, which will allow us to improve the quality of the revenue just as we're doing in the other business. So we'll have a sales force focused on service, instead of focused on service issues, and we'll have a sales force focused on selling service.

The pilot program in eastern Canada here starts in 10 days. We spent a lot of time working on this project over the last few months. We have very, very good, sound customer support for this in the marketplace, and as I said, it's our biggest opportunity, something I'm very excited about, and you'll be hearing a lot about in 2003.

Just in summary then, just kind of taking where -- what we've accomplished in 2002 and where are we going in 2003? Well, 2003 is going to be a lot like 2002, both the good and the bad. The Canadian grain situation will continue through the first half of 2003. That is because our first half shipments are based upon the crop that was grown last year, so we are -- have available only to us the crop to move in the first half of the year that was there last year, and so our shipments in the first half will be down, and then we are expecting the grain to rebound in the second half as a more normal crop appears. We have for planning purposes only taken 80%-85% of an average crop for planning purposes. That allows the rebound to occur principally in the fourth quarter as the third quarter is the period when the crop is harvested. The current outlook, industry experts are discussing right now, the outlook is for an average crop. Moisture conditions, while they are bad, are better than they were last year. And our best expert on this topic, Mr. Jack McBain, our senior vice president of operations who actually lives right outside of Edmonton, calls me daily to how much snow he has on the ground, and as of a week ago, he just received a new foot of snow, so that's promising news for us on the grain.

On the merchandise side of the business, again, as I said, the good with the bad. The good, the merchandise segment will continue to grow at similar rates to what we had this year, driven principally by the strong operating plan and service package we have in the marketplace. We are projecting lower auto production, which will bring down the overall number somewhat, but again, a success story there. And finally, the most important project on my plate and the most important thing I do is ensuring that we get paid for what we do. We provide a very high quality product to our customers, and we expect to earn a very high quality dollar.

If you followed our numbers, you know that in 2000, we stopped the trend of declining revenues. 2001, we held that steady, and in 2002, we got actual price increases consistently, and in 2003, we will get more of that. To confirm that belief that I have, in '03, we had three significant contracts renew, all of which had significant pressure on us to reduce our rates. We did not reduce our rates. In fact, we got price increases, and the business stayed with us, again based upon the quality of service. Two of those major contracts occurring in the intermodal side of the business right near the end of the year, again, where the customers were very excited about what we plan to do with our new intermodal excellence project.

Thank you.

Thanks, Jim.

Let me for a moment now put back on my operating hat and look at a few of the accomplishments in this environment that we've described to you here that come from the operating side of the house. We will not deviate from this plan. We believe in it. A typical response -- if there is such a thing as a typical railroad to the kind of pressures that we've had is to reduce trains and reduce train miles. With that comes the duration in service. That's the wrong reaction. If you looked at our plan and started to understand schedule railroading and really peel it back, a high percentage of our grain in the past has moved on merchandise trains and filled out capacity. And the reason why we had the opportunity to do that is because grain would typically move to the western ports of Canada, primarily Vancouver, and would sit and wait for two, three, four days to be unloaded to go to the elevator. So we had latitude to ship that grain around which lowered the cost of moving the grain and, at the same time, lowered the cost of moving the merchandise. So when you have declines in grain, it's very difficult to have the intestinal fortitude to stick with the plan.

Our trip plan compliance continues to exceed 90%. People continually ask me why is it not improving more. It is improving more. We continue to raise the bar, so 90% this year would have been 93.5% last year. Example -- when we put this plan in, to give you some order of magnitude, in September of 1998, our scheduled service from Chicago to Edmonton was a very important corridor from us, was we quoted seven to nine days or 144 to 192 hours. Today -- and by the way, the consistency there was about 60%. Today we quote that in 111 hours, and we're doing it 90% of the time. So the improvement in the service, the people that really understand it, the only ones that understand it, is the customer. And that's why Jim and his people have been very successful in some of their market share gains.

We continue to see some productivity improvements in our cost control efforts despite this environment. The car velocity was up 15%. (inaudible) available horsepower up 3%. Grain typically in any productivity measurement you want to look from a cost control standpoint are productivity, efficiency measurements, grain, bulk movements help you dramatically so there was a lot of pressure in this area. Probably the one I'd like to highlight most is these groundbreaking, as we've described them, new labor agreements that we have now on the Wisconsin Central I've described them to the group in the past. We have also signed with the engineers on the Illinois Central, and within the next week, we're supposed to get the results, it's out for ratification with the United Transportation Union, and this is the first of what we think will be many large steps of opportunity to go with further efficiencies.

Last area was an area of safety. It's kind of a mixed message here, at least from my standpoint. I can look at the numbers and look at we improved our train accident ratio, we improved 9% under FRA criteria, but I would be the first to tell you that is a frequency measurement, it's not a severity measurement. We spent far too much money in the area of derailments and train accidents. So that's not good, but the issue is there's much opportunity to make significant improvements there and -- to my standards, if you will, in 2003, and very hard work went into this improvement of the FRA injury ratio coming down 32%. That is also only frequency, it does not measure severity, but I can report to you, proudly report to you that from the severity standpoint, we also made improvements there.

So as we go into 2003, we've got some key challenges. Claude and Jim have highlighted them. We have to maintain our pricing discipline that Jim described in our do-not-blink strategy. We're not bad poker players. We've got a good product, and if you've got a good whole card in a good hand, you can play the game. Jim just described this new intermodal model that we call IMX, intermodal excellence. I'm extremely excited about those opportunities. I think we're going to start up February 2nd in the first quarter, between Montreal and Halifax and then we will move across the system, fine-tune and react. We have opportunities to market some available capacity obviously. I talked about the opportunities with the train accidents and incidents. Focus on discretionary expenses, bottom line stamp-out bureaucracy, there's a lot of opportunities in our organization for that and you could come to our headquarters in Montreal and you'll already see that action taking place with desks being moved around and file rooms being closed. Those amount to a lot of opportunities.

And we will continue to maintain, in spite of these pressures, our high level of service as long as I'm heading up this organization. So overall, good year, good quarter. Are we satisfied? No. We've got some real challenges as Claude has described. We continue to focus on delivering this top-line profitable growth, superior cash flow. I am convinced, I am a believer that our model works. We've got the right strategy, we've got the right operating plan, a scheduled railroad, and we've got the right people to execute the plan. If we get a little rain in the west, watch this organization leap tall buildings.

And with that, we will be glad to address questions the group might have.

Good morning. It's Tom Waddell from Bear Stearns. Got two questions for you. One for Hunter, the cost side focus, certainly impressive with the head count reduction fourth quarter and it seems that the real big opportunity is usually in reducing headcount, or the big leverage for taking out costs. You know, at what point or how close are you to impacting the service or impacting the safety by pushing too hard to take out headcount, or do you think there's still room to do that?

There's still room. We're not close there. I would describe to you that in our restructuring, the plan calls to take out 1150 odd jobs, but I can also tell you that we have still, beyond that number, we have reserve boards in western Canada, a furloughed employee that we are responsible for paying of 500 people, so there's still opportunities that if we get significant growth in the west, we can handle it without any other labor implications. And the second part?

Yes. The second question for you and maybe for Jim as well, looking at this new intermodal program, pretty exciting potential. I wonder if you could give us a little further color on the customer response, in particular, one of the things you had mentioned before was pushing some of the volumes to weekends when there was less utilization of the system, and just help us to understand if customers are really willing to do that. And then maybe on the capacity side, if you balance capacity, how much excess capacity is there in the system as it stands right now?

Let me make my couple observations, Tom, and then Jim can kick in. The best way I could color this story for you is this. The first action we took, the first kind of signal to the marketplace that said we've got to do something different with this intermodal model, was we removed the free time in terminals. So where people had Saturdays and Sundays and holidays free, and four other days free time, we started reducing and took the Saturdays and Sundays out and the holidays. And then we also signaled to the marketplace that in three months more, we were going to go down to three days.

Now, the marketplace did not act well there. They said, that's going to cost us money and they did not like it, and you said, well, wait a minute, if we're moving this stuff at 70 miles an hour and trying to go across the country and have 99% on-time performance, to get it to sit at the terminal for seven days, maybe we've missed it here. So what we've done, one of the models that Jim and his folks have worked on very closely is we're bringing the import traffic, for an example, that does not have the sensitivity, that does not need to be in Chicago because it's just going to sit on the ground, and manage it by capacity. So rather than run the first train with 12,000 feet and the next day run 4,000 feet, we'll run 6,000 feet on Wednesday and take a little overflow and move it Thursday ,and some of the non-sensitive stuff and move it Friday (inaudible). Now, so we don't have the cost, we take these peaks and valleys out of it, and we have better satisfaction from the customer.

Second info evidence is a lot of the steamship companies have basically said to us, you should have done this a long time ago. We want to charge our customers but we couldn't stand the heat. We thank you for wearing the black hat because we're going to use your excuse and pass it on to our customers. So I think in the final analysis, bottom line is people know this is the right thing to do.

Jim.

I would answer your second question first about the capacity. We talk about the pilot project and what does it really mean. On February 2nd, 10 days from now when we implement this plan, what are we really doing? Today, we have eight trains operating in this corridor in eastern Canada, which is handling the intermodal, the international containers, really it involves international flows all the way east as far as Chicago, but those flows going to Halifax and reverse, Halifax to Chicago, and then the domestic service principally east of Canada, and to do that today, because the variances from day to day and the way we have to move our assets around to manage that, we have eight trains doing that, moving four each way each day. On the second, we're cutting that train number in half. We will provide a higher quality of service to our customers on that day with half of the assets dedicated to doing it. So that's the kind of capacity opportunity that we have with this program.

Secondly, as Hunter said, the customer perception of this, while in all cases where there is change, people are initially resistant to change -- at this point in time, the customers, especially the overseas customers, have said to us, if you are going to charge us for demurrage and charge us for ancillary services associated with us storing our containers on your railroad or us doing things to you that cause you to have inefficiencies, would you please put in your computer system a program that allows me to bill my customer? So they agree in the discipline, they agree in the process changes we are making, they agree that it is principally the customer, their customer, that is causing this variation and are completely willing at this point in time and endorse the option of passing through that charge to their customer.

Scott -- sorry, sorry. Scott, we'll get you next.

Good morning. Two quick questions. One, can you give us an idea of what (inaudible) forecasting operations are for 2003, and then secondly, I think January 1st when these (inaudible) organizational changes -- especially the Midwest, can you give us an idea of (inaudible) complexities that you're dealing with (inaudible)

Claude, do you want to talk about the separation payments first?

Yes. Our severance outflow in 2002 were $177 million, which is a slight increase over the previous year because we did increase the pace of our downsizing. In 2003, we should see that come back toward the gradual declines you had seen over the previous year on the order of $15, $20 million down, so $150, $155 million would not be a bad number to use.

John, the organizational questions -- we started off with shortly after the CNIC merger with the -- and after the WC acquisition, effectively gave us six operating divisions, three in the U.S. and three in Canada. There were some reasons for that, that we didn't want to just put everything together all at once, because there's some sensitivity to the old shop and to logos and headquarters and those type political implications and issues. So we walked very softly doing that. But I can tell you that I've learned the hard way, I've done the centralized and decentralized and gone through just about every model you can go through.

Every time you draw boundaries and create another division, there's cost associated with it. There's a place you go too far, so what we've done is gone from three divisions in the U.S. to two, the WC and the Grand Trunk (ph) now are -- have become one division, Midwest, which is headed up by Gordon Trafton, so he handles those former two properties, and the Gulf now is effectively what the -- I don't like to use this term, but the old IC was, headed up by Peter Marshall, so now we've gone to two divisions in the U.S. from three. We still have three in Canada. Is that -- are the changes over? I think not. I would probably say to you - and some of these are timing issues - you know, I don't want to force this all at once, but I would expect within the next 12 to 18 months that there will be -- we're making plans, that there will be some more changes and shrinking of divisions, that we don't have the model exactly like it needs to be at this point.

Scott?

Yes, just a couple questions. Understanding pricing discipline, I just was caught and usually I'm sensitive to the fact there are a lot of mix effects, but all the categories on a revenue per RTM basis were down this quarter, and four out of the seven were down per carload. Are there pressures in the marketplace? Is this simply just mix and length of haul? I mean, it's unusual that, that many are down and I'm cognizant of mix, I'm just curious what was going on in fourth quarter.

Well, there's always pressures in the marketplace. I think -- and Jim can probably speak to it better than I, but I think a lot of it is mix. I know that we are consistently taking price increases. We have said, and we've talked very candidly with the customer, we will not allow the service to become a commodity. That's the worst thing in the world that can happen. I have a theory about the price of low price, that once you get driven by price, and price is the only thing you're purchasing on, that puts pressures on organizations to lower cost, and then when you want to ask for service, it cannot be provided. And I will tell you the best example of that -- the airline industry in this country. You want to get some good service now on the airlines, tell me where you go back. We will not allow that to happen, and so we are consistently, consistently asked to be rewarded for the level of service that we provide. Now, where we do not have competitive service offerings, do we have to act accordingly? Absolutely.

But, Jim, you might want to make some additional comments there?

I think, yes, in terms of same-store sales with our pricing, there has not been a price reduction for at least two years, and we are consistently getting 1% to 2% price increases, oftentimes higher, with those businesses. Where we have leveraged our network as our network has changed, as we have more from the CN now to the ICN and to the WC, we have done things in pricing there to get our customers, principally the Canadian origins, down into those markets, and there have been pricing arrangements there that made sense for us to use our network.

And thirdly, on the specific numbers this quarter, they were totally consistent with what I just described. As an example, petroleum and chemicals up on a revenue per car basis, down on a cents per ton mile basis. Why? The plastics growth. Where does the plastics growth come from in our network for Saskatchewan? Long haul western traffic moving down into the U.S. Same thing, lumber traffic, where is our lumber traffic coming from? Western Canada. The tariff situation between Canada and the U.S. is driving production in western Canada. what does that mean for us? Long haul traffic, higher revenue per car, but lower cents per ton mile. Coal -- is the U.S. growth in western coal at the expense of the Canadian metallurgical coal, intermodal, container growth two times domestic, so all of these things are clearly driven by mix change, which are clearly driven by, to a large degree, our strategy of what it is we're trying to do.

It was also in the fourth quarter, Jim. We went to a haulage accrual, to an accrual basis for haulage payments, from a pay as you go, and there was a one-time $10 million hit there, which is only a timing issue which impacted the yield, mostly in the merchandise sector where they're dealing with short lines.

That was, yes, short line expenses.

Other questions? Yes, Scott.

One other follow-up. Could you tell us where you are in the process with the Grand Trunk and Western and working through the negotiations process? Have they -- are you in formal negotiations? Where is the process on that in terms of the U.S.-style labor agreements you've got?

They are -- the - see how I can say this - the environment there is not quite as conducive to the other properties as far as the change. Now, things have improved dramatically there. We have started negotiations. Because of the other issues dealing with the belt pack (ph) and so forth, there was pressures on -- both organizations have been spending a great deal of time on that in the U.S. at arbitration, the BLE and the UTU both, they had asked us to wait until that was behind them, which it is now, until we entered these negotiations. But I'll be the first to tell you, I think we'll get there on the Grand Trunk, it will just be more hurdles and take a little longer, because they understand, they would prefer not to see some of the work group changes but they would like to have the money. But you can't, you know -- you got -- can't have it both ways, so we'll get there, I'm convinced. It will just be a little tougher struggle.

Yes, sir.

Could you talk a little bit about the pension situation as well as the overall -- this is kind of playing on what you were just talking about with the work rules and how you can start to dig into labor and benefits cost beyond the days that there are individuals to take out of the system?

From a Canadian standpoint?

From both, if you can.

Well, from the U.S. standpoint, the leverage that these agreements provide, we have high fringe costs in the U.S. to begin with as opposed to Canada, given railroad retirement, system being different than Canadian, given medical inflation that we've seen, so we have cases now where our fringe benefits in certain areas are as high as 40% or 45%. Now clearly, that's put pressures on to get rid of people, very frankly. And our strategy has been to provide job security and to do this through attrition, so, you know, we've got kind of a win-win situation here. And as we go to an hourly compensation, and part of the strategy is what we're pursuing right now and kind of testing this on the Wisconsin Central, is we improve the infrastructure and improve the speed, we at the same time lower labor cost. And as engineers don't have a cap on the miles per month as they do in the traditional agreements like a 4,000, 4,200-mile cap, when there is no cap, and if we have the ability to provide the network that they can get 7,500 miles a month, you can do the math and you can do it with a lot less people.

So pitch and expense, all those fringe-related costs give you a tremendous opportunity for savings. Now, we do not have the similar - as much leverage in Canada, because fringe benefits, health care costs, the different systems don't afford us as much opportunity. There's still opportunity, it's just not what it is in the U.S. system, if that answers your question.

On the pension, just to go back to the discussion we had at the Q3 call, we have decided to take our rate of return assumption for the going-forward return of the pension plan from 9% to 8%, and that's what drives the increase in accounting expense of about $52 million on a year over year basis. You should know that this company has always contributed cash to the pension plan, so we did that, we never take -- we have never taken a holiday, so from a cash standpoint, it doesn't change our cash outflow. From an expense standpoint, we're being more conservative to reflect the fact that I think nobody here is expecting markets to have just a strong equity market, a strong performance over the long term that they may have had over the last 10 to 20 years. If they do better, we'll have an upside. If they do worse, we'll have to adjust that rate of return over time.

Just as a side note, we get a lot of recognition for a lot of things, for low operating ratio and efficiency and schedule railroad, and that's nice. Maybe the best operating unit we have is our investment division. If you look at what our investment division has done - has performed over the last 10, 12, 15 years compared to markets, it is phenomenal, and so they've helped us significantly in that area of pension expense.

Yes, their performance over the last 10 years is 9.6%, and in 2002, they finished essentially flat year over year, so -

Not many pension funds.

-- fool around with your money managers -- I'd like them to manage my money.

Other questions? Yes.

Hunter, Roy Blanchard. You recall over the years we've talked about the various drivers of the operating ratio and how revenue is the biggest one of the lot. I find it interesting that you're using the carload model to tweak the intermodal, whereas I hear other railroads saying they want to make the carload model look more like the intermodal. What sort of effects do you expect to see in terms of operating ratio improvement by sharpening your intermodal operations so it does reflect more of a carload approach to the business, handling the business?

Well, I think any railroad would tell you that they would much rather swap their margins and merchandise from intermodal, but there's always been this issue that you cannot have that kind of margin because you've got this tremendous pressure on service. But if you really peel that back, I don't buy into that model. And Jim's examples were explicit there. We're not going to be in a business that doesn't return us our cost of capital. We're in this for the long haul. I'm not going to manage this company quarter to quarter. I'm not going to go out and spend precious capital if I can't get an adequate return on it. I hesitate to get into the numbers because as you know, there's a lot of puts and takes here, but I can tell you that if we have normal grain crop, and fuel stays relatively stable in that type environment, and we make these gains in intermodal, and the other areas that we've mentioned, you know, can -- could this company go further with an operating ratio, could we go 3 or 4 points lower? Absolutely.

Now, we're not going to be driven by operating ratio, and we've talked about why that's not the smartest strategy. Am I going to go turn down business in a high fixed cost capital-intensive business that gives me a 70 operating ratio? No. Now, I say that and everyone says that sounds very smart, but how low can you go? So, you know, we're always going to have that interest end. You know, the IC got to 62.5 and we had coffee cups laying around that said 59, so, you know, where is the wall? I don't know. But I do know that this -- the exciting thing about this is that this can raise intermodal's yields clearly double-digit plus, high double-digits change potential there, and at the same time, improve the service offering. And at the same time as some of Jim's staff was having a little dialogue with him about, this might put a little pressure on top-line growth, and I think Jim made us all believe that we can do this and, at the same time, continue to grow the business that we've seen strong growth and improve the profitability of it.

And don't get me wrong, I'm not saying intermodal is not profitable today. It just is not the level of returns it should be with the cost pressures. And if you peel it back further from what the model is, the cost problems are in these huge terminals where you go out and spend huge amounts of capital for concrete and fencing and lighting to let stuff sit and stack up. And guess what, nobody picks it up on the weekends, and you got them seven high and all the trucks show up at 7:00 Monday morning, there's long lines, and the first truck comes in and wants the bottom box.

Now if you do the model, it says we're going to lift everyone one time. In reality, that doesn't happen like that. And we've lived up and understood those realities. So people understand that model. You know, if you wanted it to sit all weekend to get to the bottom of the stack, you got to pay for it. And so I think no one has had much of an argument that says this model doesn't work. I think the issue is what it comes down to, why do we do it and why haven't others done it, maybe I might suggest to you that we have some intestinal fortitude that we believe that we're going to do it.

So that's -- I hope that answers your questions, Roy. Any other questions?

Well, I would ask two things of you. Twice, please get on your hands and knees and pray for rain in western Canada, and we'll all be happy, okay. Thanks.

Thank you, Mr. Harrison. At this time, we would like to thank all participants for joining us today. The conference has now come to an end. Thank you for using Bell conferencing services and have a nice day.