Canadian National Railway Co (CNI) 2003 Q4 法說會逐字稿

Welcome to the CN fourth quarter earnings conference call. I would now like to turn the meeting over to Mr. Robert Noorigan, Vice President investor relations.

Good morning, and thank you for joining us. I hope everyone got the notification that we were not having a live meeting. We have wimped out a little bit with the snow, but actually it's a pretty reasonable day in Montreal. I Understand a few of you were having some trouble getting around in New York City today, though.

Before we start, the presentation is on our Website, www.CN.ca, along with two press releases, the earnings press release -- including all the attachments -- as well as our press release announcing our three-for-two stock split and our 17 percent dividend increase.

Before we begin today, the presentations that you will hear may refer to non-GAAP financial measures for purposes of comparability. You'll find at the end of the presentation a reconciliation of the certain non-GAAP measures that we use today, and we are using some that will be for Q4 and 2003 financials that are attached to this presentation, as well as on our Website. Also today, we will be making some forward-looking statements within the meaning of the U.S. Private Securities Reform Act of 1995, and other applicable legislation. And obviously, there could be some risk and uncertainties that could cause actual results to differ materially from what we present today. Some of the risks and all the other information is detailed on the first slide and in different reports that we file with the Securities and Exchange Commission, as well as Canadian regulators.

Thank you for joining us this morning. It is my pleasure to introduce E. Hunter Harrison, our President and Chief Executive Officer.

Thank you, Bob, and good morning to all of you. Let me add my apologies also that we are not live in New York with some of you that we had planned to, although it looks like we made a pretty good executive decision yesterday afternoon when we decided to do this via conference call.

Before I call on Claude and Jim to talk about some of the results for 2003 and the fourth quarter, let me make a few overall observations and highlight a few issues.

As we went into 2003, it appeared that it was going to be a very challenging year. We experienced the worst winter in the first portions of the year that we had in 30 years, although we are facing some challenges this January that are very difficult. We had a continuing weakening of Canadian grain at that time, a strengthening of the Canadian dollar, power outages in the East, forest fires in the West. So the first three quarters we had some very difficult challenges that I was extremely proud that this team was able to overcome.

So we faced all that and we bounced back in this fourth quarter. I trust you have seen the press releases, and it is, clearly, in my view, the best quarter we have had all in since I have been associated with his organization, now for almost 6 years.

If you look at our adjusted earnings, EPS, for the fourth quarter we came in at $1.58; that excludes the 41 cents deferred tax adjustment from Ontario. Our reported earnings were down 35 million, or 2 percent, but if you look at it adjusted for exchange they were up 7 percent. We experienced a record, which is outstanding in our book, a record operating ratio of 66.1, which is best (indiscernible) in history. Record free cash flow of 578 million. We also announced yesterday our eighth annual dividend increase of 17 percent and a three-for-two stock split, which is the second split since the IPO in '95.

Two other things of significance that I should highlight that took place that I was very extremely pleased with in the fourth quarter. We announced the acquisition of Great Lakes Transportation Company and BC Rail, both in the fourth quarter. We are expecting, subject to regulatory approval, to close both of those transactions some time early in the second quarter.

And of recent note, and I will have comments about this later, we settled with the CAW late last week, which averted potential work stoppages that had been reported in the press. I was very pleased with that. So we expect to hear mid-February whether that agreement is ratified. I am not in a position to talk about the details. We have agreed with the CAW that we would not disclose the contents of that agreement, subject to the ratification. And I was also very pleased that last week we learned that the hourly agreement with the engineers on Grand Trunk, represented by the BLET teamsters was ratified, which only leaves now one collective bargaining unit which is the United Transportation Union on the Grand Trunk, which has not signed those agreements that we've been working on very diligently for some years now.

So I am extremely pleased with the results, and with that, let me call on Claude to go through some of the financials.

Thank you very much, Hunter. We're very pleased with our Q4 results. We had a strong finish to the year. On a reported basis, are results show $1.17 of EPS versus 11 cents in 2002, but there are a few items that impacted the comparability which I would like to draw your attention to.

In 2002, if you recall, we had a total of $400 million of charges for personal injury reserves and also for a workforce reduction charge. And in this fourth quarter of 2003, we have a deferred income tax expense of $79 million, or 41 cents per share, to reflect the Ontario decision to increase their corporate tax rate. If you exclude these items, our adjusted EPS was $1.58, up 16 percent versus 2002. I think this is a strong earnings rebound, especially if you factor in the fact that the 19 percent appreciation in the Canadian dollar really cost us on the order of 13 cents per share. So really, if you look at it from a Canadian standpoint, our reported results had a drag from the conversion impact of the higher dollar of roughly 10 percent on a year-over-year basis.

This very good performance was driven both by solid growth and productivity improvements. Adjusted for exchange, our revenues were up 7 percent, led by a long-awaited grain comeback, but also very solid growth in a number of our merchandise sectors. Jim will give you a lot more detail in a minute.

On the cost side, despite high fuel prices, we were able to keep very low incremental costs and deliver an operating ratio of 66.1 percent. As Hunter said, this is a record for us and it is a 2.2 operating ratio improvement versus 2002. Overall, the strong performance allowed us to finish the year with adjusted EPS of $5.24, if you exclude the 16 cents gain we have for a tax settlement in Q3. That is essentially flat versus 2002, but I think there are many reasons to be proud. We faced a tough grain situation in 2003. We had fuel price above $30; in fact, they ended the year on average at $31 per barrel. And in the face of these issues, to be able to come in with an operating ratio below 70 percent is quite remarkable. And we are very proud of that.

On the EPS standpoint, again, the exchange not quite to the degree of Q4, but overall a very significant increase for the full year of about 12, 13 percent. And that cost us essentially 32 cents, or a drag on EPS of 6 percent. So overall, very good performance both for the year, but particularly a strong finish in Q4.

Let me turn briefly to the expense performance. On a reported basis, our expenses are down 57 million, or 5 percent. Obviously, we are getting the help here from the benefit of exchange to the tune of $100 million. So if I exclude exchange, expenses are up, but they are up only 4 percent against volume growth of about 7 percent. We did well pretty much across the board, but labor productivity was up significantly. With strong volume, we were able to turn in a labor productivity improvement of 10 percent. That helped us basically offset the cost of higher pension and also the cost of higher stock-based compensation. If you recall, we made the decision in early 2003 to record as an expense the cost of stock options, which is something we did on a prospective and voluntary basis.

We also had strong discipline in discretionary spending, showing through in purchased services. It helped us in Q4, but I would like to spend a minute and give you a recap of the benefit of this so-called war on bureaucracy for the full year. This is small stuff, but when you add it up, it counts for a lot of savings.

A few examples. Our courier and telecom expense are down on a year-over-year basis by $8 million. Our office rents are down 7 million. Our consulting expenses are down 30 million. And our OCS and small supply expenses are down by essentially 5 million. Totaling up, that's $50 million of savings, which is almost a point on the operating ratio. And that, obviously, helped us offset the cost of fuel and the other inflationary pressure we faced during the year.

In the fourth quarter our equipment rent also improved. A lot of this is due to exchange, but we also have the benefit of focusing on our fleet and reducing high-cost leases, and also the benefit of lower rates for intermodal flatcars. We also had very good performance in fuel when you look at it -- we benefited from a good hedge position. We have 46 percent of our consumption (indiscernible) at $23, and obviously that helped us offset the impact of the fuel price, which as I said earlier, during the quarter was above $31, and in some months above $33 during the quarter.

Overall, very solid performance, and I think it carries benefits into 2004 in terms of productivity and expense containment.

If I turn to cash flow, also a strong finish. Cash generation for the full year, 578 million. That's an increase of 13 percent versus 2002 and a yield of almost 10 percent if you relate it to our revenue base. We are basically focused on every driver. We made particularly good progress in working capital, improving both receivables and payables. We also had lower claims payments during the year. Our severance payments were down 22 million to a total of $155 million. The only area that has a significant increase was cash CapEx, up roughly $100 million, but this is driven mostly by the change in accounting treatments for dismantling of ties, and you have an offset in proceeds from disposals.

Overall, this performance helped us finish with a book debt ratio of just below 36 percent at 35.6, and just above 40 percent on an adjusted basis, including all of our leases. This positions us very well for the upcoming financing of BC Rail and GLT. As Hunter mentioned, if we obtain the regulatory approval, we should be in a position to do the financing towards the end of Q1 or early Q2. And we will go to the bond market for the full amount of roughly $1.5 billion Canadian. This cash strength is also why our Board of Directors expressed its confidence yesterday in with a decision to move forward with a three-for-two stock split and also a 17 percent dividend increase, which will reward our shareholders going forward.

Just a few words in capping about the 2004 outlook. As we look at next year, we see 2004 shaping up with, obviously, a grain comeback -- which will help us -- and also on an economy that is going well, particularly in the US. Our goal in this environment is to deliver 10 percent EPS growth. We have a few challenges that we have to face. Obviously, exchange will continue to be a factor. It's very difficult to predict where exchange will be for the full year, but we're summing 76.5 cents as an assumption or expectation for the year 2004. And if we prove to be right, that would be an increase on a year-over-year basis, impacting our EPS to the tune of about 20 cents, or a 4 percent drag.

We also have to deal with fuel prices. As I said earlier, we finished the year and we entered into 2004 with fuel prices well above $30. Our budget assumption had been to use a $28 price per barrel on the (indiscernible) side, so we have a bit of a challenge there. But fortunately, we have a very good hedge position. We have increased our hedge position to (indiscernible) percent, and the price for the hedge position is just about $25 -- I think it is $25.10 per barrel.

So with these challenges, how do we get to a double-digit EPS growth? First and foremost, through revenue and volume growth, we are targeting a core growth of roughly 5 percent on a stand-alone basis next year. That is excluding exchange. If you exclude exchange, obviously, it's going to be more like flat to up 1 percent. BCR (ph) and GLT, if we can close in Q2, could add up to five or six percent of additional revenue growth and a bit of accretion, helping us in the second half of 2004.

On the cost side, we will have to face volume and inflation; that's normal business. But our goal is to shave at least a point in the operating ratio, driving our productivity forward and helping drive earnings to the tune of the guidance I have just given. On free cash flow, our goal is to stay within a range of 575 to $600 million of free cash flow next year, and that is despite an increase in our total dividend paid out of about 35 million, and also increased cash taxes which will start to increase in 2004.

All in all, we are gearing up for a year of growth. And I think our results bode well for the year, particularly in the first part -- the first six months -- when we will benefit from the rebound in grain. Jim?

Thank you, Claude. For those of you that don't have the presentation, this is Jim Foote, Executive Vice President of Sales and Marketing. I'm going to go over the revenue performance for the fourth quarter, and in discussing these revenues, I want to exclude exchange, so we get a better understanding on a year-over-year basis how the business is performing. As Claude said, excluding exchange in the fourth quarter, revenues were up seven percent. Very good performance. Volume up seven percent on an RTM (ph) basis. Price up another 1 percent in the quarter, offset slightly by some mix changes as our link-to-haul improved considerably. Merchandise business, the strength of the franchise grew five percent, bulk a full 20 percent as the grain came back. Intermodal down three percent.

I'll go through these in a little more -- I'm sorry, Intermodal down 2 percent -- in a little more detail. We can take these segments apart as is outlined in the presentation. Petroleum -- and again, on an exchange-adjusted basis -- petroleum and chemicals up three percent in the quarter, driven mostly by strong sulfur moves as we saw throughout the year. And the chemical traffic staying relatively flat in the quarter. Metals and minerals up 26 percent in the quarter. Again, strong underlying fundamentals in the steel business and the aluminum markets as we have seen in the second half of the year. But also contributing to this growth, about 1/3 of the growth in the quarter coming from a new ore move that we picked up starting in the fourth quarter, moving iron ore from a GLT origination to Prince Rupert across Canada, where it is being transloaded into vessel for export to China. So a very strong movement pickup there in the iron ore traffic.

Forest products, a huge part of our franchise, again performing well, up nine percent in the quarter. Lumber up seven percent, due to the continued strong U.S. housing market. Panel traffic in the quarter up 20 percent. About 1/3 of that new traffic -- 1/3 of that growth coming from new opened OSB mills on our line, another 1/3 of that panel (indiscernible) growth coming from the reopening or increasing in volume from OSB mills that were shut down in the fourth quarter of last year. And then just generally higher volume in (technical difficulty) commodity with the increased pricing, and again, demand for the product.

Paper in the quarter up nine percent, with our producers in Eastern Canada doing very well, as well as our continuing growth in market share gains, and as our service continues to be extremely good. And pulp being flat.

Coal, 18 percent decline. Again, it's the same story we have talked about quarter after quarter, as the Canadian metallurgical coal mines continue to shut down. This quarter the impact off (indiscernible) mine closure brought Canadian coal down 44 percent in the quarter. But U.S. coal was up 10 percent from strong shipments from Illinois-originated mines. Again, the strong turnaround to talk about in the quarter, grain and fertilizer is up 24 percent. 53 percent increase in Canadian wheat movements this quarter versus last quarter; clearly, just the impact of the return of the average crop that we realized in the fall in Canada, now moving in the fourth quarter. Again, 53 percent improvement there. But also very strong movements of corn to export in the U.S. Our export business, the corn business in the U.S. up 11 percent in the fourth quarter. And potash and fertilizer is relatively flat.

Intermodal down, as I said, 2 percent. Our overseas business there was flat. Again, we had year-over-year difficult comparisons as the fourth quarter of 2002 was extremely strong, but it also shows that we are not chasing the peaks in that business that we used to do, and are very confident with the more stable, balanced flow of business in the overseas traffic. And our domestic intermodal being down somewhat, as we have closed three smaller intermodal facilities in the U.S. -- St. Louis, Mobile, and Green Bay -- where we had relatively, somewhat high volumes at those facilities. But really the profitability of that business, very suspect.

Auto up three percent in the fourth quarter, driven principally by the Nissan start-up, which is now at full production. And some increase in West Coast imports, as well as some market share gains in the auto traffic in Eastern Canada, due to the closing of a facility by one of our customers in Eastern Canada.

Next page, looking forward. Again, I will talk about the outlook for the year, not factoring in the impact that we would have as we integrate the acquisitions, and on a stand-alone basis, excluding exchange. The solid merchandise growth that we've seen in the past, this 4 to 5 percent range, we certainly expect that to continue. For modeling purposes, and for looking at our expectations for '04, we are using the five-year average concept that we used in the past. At this point in time it's just too difficult to try and guess what the crop might be, so we're expecting an average crop in the '04/'05 crop year.

The full year contribution gains from our Intermodal Excellence project, the re-engineering of the way we deliver our intermodal product, which is focused on improving service, balance, fluidity and profitability of intermodal -- a very significant program at CN. You remember that we consolidated or IMXed our trains in Eastern Canada in February of last year. We re-configured, re-engineered our trains in Western Canada starting in September. And we have now down the same in our U.S. operations in January. We will get the full year impact from that train consolidation in '04. In addition to that, the improved throughput in fluidity of our terminals and the lowering of the costs there will also begin to show greater improvement throughout the year. So very excited about that project. It is really a significant program here at CN and we are all very excited about it.

Price. '04 should be similar in (indiscernible) what we've seen in '02 and '03. We have clearly turned the corner with long-term, sustainable price increases in the 1 to 2 percent range. And we would expect that to continue in that range, and we'll be pushing even stronger there as we go forward. And the synergy potentials for BC Rail and Great Lakes Transportation, really that is taking the best practices of CN, applying that in a very methodical way to those railroad properties, as we have done with our other acquisitions. And expect that that would be a smooth integration there, with the market share gains to come from our improved service.

So with that, I will turn it back to Hunter.

Thanks, Jim and Claude. Let me not overlook highlighting a few of the productivity gains, continued improvement by the operating group. And I would just highlight three.

If you look at our network density from the revenue ton mile per route mile, it was up almost 10 cent. Our gross ton mile per ploy was up 10 percent, and our train link was up 7.2 percent. Those were all fourth quarter this year compared to last year, which is pretty strong improvements there. So we are positioned for the rebound that we have talked so much about. We're looking for -- with a strong grain crop in this year, we're looking for our base business to grow. Excluding exchange in the five percent range, we are clearly focusing on topline growth and converting that to bottom-line earnings.

Our IMX model continues to produce record results. It will be extremely important to us in our results the next two or three years. Claude mentioned some of the efforts on this war on bureaucracy that will continue. We are starting to see some early benefits from our labor strategy, which I'm very pleased about. And we're looking for a smooth integration in the second quarter of both the GLT and the BCR transactions.

So in summary, we -- solid year, despite some of the challenges that I outlined earlier; record fourth quarter. The business model is clearly working, and you can be sure that this group is focused on long-term, sustainable, profitable growth, and looking for double-digit EPS growth in 2004.

With that, we would be glad to address questions the group might have.

(OPERATOR INSTRUCTIONS). Morgan Stanley, James Ballantine (ph).

Great quarter. On behalf of those of us who are not in New York, thanks for having this interactive conference call. No disappointment here. Claude, if I can ask a question about your shaving one point from the operating ratio. It just seems a little bit conservative, and I know that tends to be kind of the Canadian National way. But could you maybe expand a little bit, because it seems like from the strong grain volumes that you're going to have -- presumably through at least the first three quarters and probably even in the fourth quarter, based on your assumptions -- and IMX and the war on bureaucracy being a full year benefit, it just seems like one point is quite conservative. I'm just trying to make sure I'm not missing something here.

Well, Jim, I think you have to look at all aspects, both the momentum we have from the productivity and the other initiatives you mentioned, but also the headwinds we are facing. Fuel is clearly an area where we are concerned, as I said. The spot price at the moment is on the $33 range, and the (indiscernible) calls for $31. What we've been experiencing for the last several quarters is the spot remains the spot and we keep paying very high prices for fuel. So obviously, that is a concern and that is a drag. We also have an issue we have to deal with starting in 2004, which we discussed previously, Which is the cost of furlough board (ph) employees in Western Canada. That is a cost that is going to hit our operating expense going forward; it's a manageable element, but it is something we have to deal with through productivity and other initiatives. So overall, we do think that shaving at least a point of operating ratio is our goal. It is a realistic goal which we think we can deliver at the end of the day.

As I recall it was about what? 350, 400 furloughed employees out West?

That is about right, yes.

Right now, Jim, we have -- if you will recall, some of those employees went down into the U.S. to work, to help out with some shortages down there.

I think I did hear something about that.

And I think as we speak, there are probably about 250 active on the furlough board, but that could increases if some of those people come back. On the positive side there, there is a potential possibility maybe through collective bargaining issues that we might be able to solve some of those issues. But it is something right now that we need to be very conservative about.

Okay, good. Thanks, Hunter. The second question is labor related as well, that you did a great job with labor productivity. I think you mentioned 10 percent. And that was -- the fourth quarter was a much better run rate on your labor costs per person relative to the first three quarters of the year. And I'm trying to figure out (indiscernible) -- you tend to see in the fourth quarter for all companies a greater likelihood of kind of onetime adjustments or accrual changes and so forth. Is there anything in the labor costs that we shouldn't be modeling going forward, in terms of (indiscernible) a fourth quarter benefit? Or is that all due to just blocking and tackling and getting rid of excess people?

Actually, it is a very clean number. If anything, we had a few accruals which would tend to increase a little bit expense. But overall, I think our labor number is a clean number for Q4.

Thanks guys. Great quarter.

Bear Stearns, Tom Wadewitz.

I have got two different questions for your. One, I think this is for Jim, probably -- when we look at the volume performance, I think they are clearly, especially in intermodal, some efforts to prune the less profitable volumes. Is that going on in other business segments as well, or is that really primarily focused on the intermodal segment? And how long does that really persist until you've really gotten the less profitable volumes out of the system, and you start to see that uptick in the volume growth again?

It goes on to a degree in all of our business units as we manage our portfolio and seek price increases. It is very, very small in the other business units relative to closing down two facilities where overnight, you see the volume shifts go away. It is in the range of roughly 50,000 units of intermodal traffic at those three facilities, which will reduce our volumes but have a positive impact on our bottom-line. And certainly we think that is the prudent way to manage the business.

Sure. I agree with that. It seems makes to a lot of sense. The question on comp and benefits is -- your performance was pretty impressive in terms of relative to what some of the other rails have done with a lot of pressure on the comp and benefits line. Is this sustainable in 2004, or do you get more pressure coming back relative to what we saw in fourth quarter?

As I said, Tom, I think our fourth quarter numbers are as good an indication of the future as you can get. These are lean numbers. Obviously, next year we will be facing what we face every year, inflation from wage settlement and the cost of fringe benefits in the U.S. and in Canada, which unfortunately don't go down, they go up. But we will be trying to continue to gradually trim our workforce, and hopefully offset some of that and make gains in terms of labor productivity.

Maybe one quick one for Hunter. You talked about union negotiations and so forth. Any sense, again, on the running trades in Canada, whether there is some openness to the flexible agreements, and whether incrementally that is positive or whether there is a lot of resistance to that?

Tom, that is a very sensitive area. I got some questions raised in a couple of meetings in New York, as I commented about that, and it was interpreted that I was making those demands in Canada. You know, I think there is -- I think in my view, I think there is some opportunities and possibilities that the same type model in the U.S. might one day work in Canada. As I've tried to explain in my answers, that's kind of up to the employees, it is up to them. They are the ones that have to ratify the agreement if they choose to go down that line. I think it is fair to say that the UTU and the BLE have a lot of other issues on their plate right now. They have not been able to focus a lot of attention with us. But I think whether it is this negotiating session or whether it is in three years, there will be a point where I think that that model will be tried in Canada.

Okay. Thanks, and congratulations on some pretty strong results.

James Davis, (indiscernible) Capital.

Just a quick question, Claude, when you talked of the -- I think you said 10 percent earnings growth as a rough measure of initial guidance -- was that based on the 523 number or the 540 number in '03?

I think the way the market looks at our results is they exclude the 16 cents tax gains (multiple speakers) '03, so really the base is 524.

Okay, perfect. Second question, and I know this has been touched on a couple of times already, Jim. When I look at your intermodal volumes in the fourth quarter, it was one percent. I think CPU's (ph) was in the low teens. And yet you had very similar rate performance, as they did. And if I look at the year-to-date, you are trending even lower on intermodal volumes. Is this -- are we seeing -- I know this has been touched on -- but are we seeing aggressive demarketing of some of your international customers? And if so, we haven't seen any indication that that business is flowing elsewhere, so could you maybe just go into that a little bit more?

Our international customer base is very solid, and there are always shifts back and forth between customers as their customer shift from one another, and therefore one railroad might go up slightly in any given quarter and down. But we are not demarketing any of our overseas business; in fact, we see very strong growth rates in that business going forward.

But is there anything that would explain this sharp divergence between yourself and the rest of North American intermodal competitors, at least in the last couple of months?

As I said earlier, there's two things that are going on -- one, our volumes are down because we are demarketing domestic business in the US. 50,000 units is a significant number on our base. So you've seen that go away. And that has accelerated in the fourth quarter of last year when we finally decided to exit, principally, St. Louis -- the St. Louis and Green Bay domestic markets. The other point that I said, though, is we are not in the business any more of chasing the peaks. And the fourth quarter is clearly the peak season when a lot of traffic moves in. We are not going to have idle assets, idle cars, idle locomotives and idle employees, sitting around for nine months waiting for the peak surge to occur. So we are going to see more of a stable base in our traffic going forward. We think, again, that is the rational, logical thing to do to improve this profitability.

Scott Flower, Smith Barney.

Just a couple of questions. One was maybe more not administrative, but more tactical. Could you give us some sense, Claude, what the Ontario regional or the provincial tax increase might mean when we are thinking about your booked tax rates for 2004? When we think about your all-in booked tax rates, what should we be thinking about when we look at 04 for you?

Thank you for the question. This is an unfortunate development. Ontario had decided to lower their corporate tax rates in the previous government, but this government, faced with a tough fiscal situation, decided not only to reverse the decision but actually to increase the tax rate by roughly a point from what it was before. So for us, it is a meaningful impact because the swing is a big one. And if you recall, at the previous call I had indicated that we thought maybe next year we could get down to 31.5 booked tax rate? Well, unfortunately with Ontario going up, that increases are booked tax rate to around 32.5. So 2004 guidance, 32.5 effective tax rate is the best number to use.

And then a couple of quick questions to follow up with Jim. How much in terms of units does your U.S. intermodal business represent of your total, just from a ballpark standpoint?

In terms of volume?

Yes.

After this demarketing, you know, maybe 15, 20 percent. 15 percent.

Okay. And was the 50,000 that you noted in terms of units that are disappearing, is that because of the actions you took with those three terminals? Or is this a process that was ongoing during the second half of '03 that is carrying on into '04?

It is the closure of the facilities in third -- mostly in the fourth quarter which you will see, then, the impact of on a volume basis into the first half of next year. Again, on a volume basis. We have basically decided to hold our topline revenue growth relatively flat in the fourth quarter, and improve profitability in the 20 percent range.

Just one other question for you. When you assume a normal grain crop -- and I know the vagaries of weather, etc. -- what would that represent as a percentage increase over the crop as it came in this year? Roughly about 10 to 15 percent or so, is that right?

Yes, right.

Alright. And then just one quick one for Hunter. How much capacity when you look across your network do you think you have when we look at some of the train links and the opportunities as the economy is getting more robust? That number seems to have been -- and I know it varies by resource base -- but (indiscernible) in merchandise or in intermodal, 20, 30 percent type of capacity availability?

From a physical plant standpoint, yes. I would think probably 25 percent.

Okay.

We will probably, going forward -- from time to time we will probably reach more issue related to rolling stock and/or labor than we would physical plant.

Great. Thanks very much.

Ken Hexter, Merrill Lynch.

Just a quick question on the Intermodal Excellence program. Have you guys noticed any kind of shift in realization of benefits as you moved from the West to the East Coast? Any kind of difference in the structure as you move into the U.S., and kind of the potential benefits that you can gain?

The benefits to the gain were much greater in the last, because of the longer hauls and the more assets associated with that. When we talk about the Western (indiscernible) we're really talking Toronto to Vancouver. So the benefits to be realized were greater in the West, and the least amount of benefit to be gained was in the US. Because as an earlier question, it's just a much smaller piece of the pie. But the same practice is applied no matter where you do it, it's just a matter of balancing your traffic flows to improve the fluidity of the business. So you get rid of these peaks and valleys from one day to the other, and then focus on the terminal productivity and terminal throughput, to drive out the inefficiencies there. And the net result no matter where you apply it is a higher quality service and a much lower -- delivered at a much lower cost. Same principles that we did when we applied scheduled railroading to the merchandise segment is what we're doing to the intermodal business now.

Claude, is it possible for you to give us the hedging by quarter for 2004?

We buy -- sorry -- we (indiscernible) by buying on a forward-striped basis every two weeks, 24 months out. So by the time we start 2004 we have 56 percent hedged for the quarter in every quarter, and the average price is, as I said earlier, about $25.10 per barrel.

Gregory Burns, J.P. Morgan.

A couple of questions for Jim. On the coal front, when do you get to a point where the plant closings become a small enough percentage that that product line stabilizes? Are we looking at declines as far as the eye can see, or can we see the light at the end of the tunnel there?

At the end of '04, we're basically -- there are no longer any metallurgical coal mines on Canadian National.

So assuming the dollar is doing what it's doing and U.S. is up, then we should look for an increase in '05?

In the coal business, no. It's gone away. It's zero, the metallurgical business.

Okay. The metal -- but the overall coal?

Overall coal, yes. The remaining U.S. business and the remaining Canadian thermal business will continue to grow as it has.

Okay. And just on the intermodal, so I can understand some of the numbers better. Are you saying that the 50,000 units is in front of you from a comparative standpoint? Or if I just take 50,000 divided by per quarter about 12,000 units a quarter, did some of those -- have some of those already leaked off, so the comp going forward is not a 50,000 but maybe 30,000? Can you help me when that began to run off and how much more is in front of you on those three facilities?

On an annualized basis -- well, we started to see some of that go away in the third quarter. So it would be -- starting in the third quarter of last year, it would have been 50,000 going forward.

On an annual basis.

Annualized, yes.

Just one final question for Hunter. I'm curious what the feel is up there in January? Also, just business-wise, and also whether there is any concern given the strengthening in the Canadian dollar that may impact just the overall economy there? Whether that is a concern or not?

I think I have less concern today than I had a month ago. There appears to be efforts to stabilize the Canadian dollar to bring it down a little bit, and I think it is at a point now where we are -- I am much more comfortable than I was a month, six weeks ago.

BMO Nesbitt Burns, Randy Cousins.

I guess this one is to you, Hunter. The productivity performance that you guys are posting is just absolutely spectacular, particularly when it is benchmarked against some of the other Class 1 railroads, at double-digit productivity growth. A lot of guys are targeting sort of 5 to 6 percent productivity growth for 2004. What kind of numbers do you hope to get out of, in terms of unit productivity growth -- and I'm thinking really employee productivity growth -- in 2004 versus 2003?

Probably an increase of 4, 5 percent over -- year-over-year.

Next question, and I guess this is for Jim. (indiscernible) your view on the impact of a settlement of the forest products dispute between Canada and the United States. Clearly they're talking about quotas. You guys have been huge winners out of the buoyant shipment of lumber product in the United States, very strong housing numbers. What is your feel on what that is going to do to your forest products business? How do you see this playing out?

I think what it looks like right now, what we're going to do is go back to the quota concept that we had before, whether it is 31.5 or 32 percent does not make that much difference to me. But what it is doing is driving the business to the more productive mills in the West, which is good for me. I get the longer haul traffic out of Western Canada into the U.S., and it makes those mills more productive all the time. If you look at the mergers and the reconfiguration of tat industry in Western Canada, they want to do exactly what we want to do, which is run 24 hours a day seven days a week. And that is good for us, because that brings down balance and that brings fluidity to our business, and improves the quality of the service to our customers. So I see this really as somewhat of a positive for us. And obviously, the industry does as well, as you see the expansions and the new plants like the new OSB mill that has just been announced out there in Western Canada. You know, the cooperative venture between Louisiana Pacific and Slocan (ph). That is where they want to locate because that is where the productivity is. And it is all dependent upon them having the extremely high-quality service that they get from us moving into the U.S. market.

So you don't see any volume risk as a consequence of the implementation of a quota?

One could come to the conclusion that I might see a slight decline in volume, but I would see that slight decline -- take a look at my forest products business in the fourth quarter (indiscernible) excellent example, where my volumes are relatively flat and my revenues are up significantly, reflecting the shift in the lumber business to the West and the longer haul move that I get moving it all the way down to Chicago and beyond.

Last question. There have been changes in the rules of operations for the truckers in the United Obviously it has some potential to result in higher rates and a shift of business to rail and off-the-road. Do you guys see yourselves benefiting from that at all?

We're ready to handle it.

Lori Hahn (ph), Deutsche Bank.

Just a quick question on your CapEx. Can you breakdown where you think your priorities are for 2004, just between the different categories?

The biggest thing I'd say, probably -- typically 45 to 50 percent of ours is just replacement capital with the infrastructure. We will probably have a shift in 2004 more towards rolling stock and less towards software and some of the SAP things that are behind us. So we acquiring 30 new locomotives and significant numbers of boxcars and center (indiscernible).

Don Hand (ph), Prudential.

Jim, a quick question on pricing. Considering link to (indiscernible) changes, are their areas that you are getting more or less effective pricing, (indiscernible) by business segment? Can you give us a little bit more color on that?

We had some areas of the business that have not historically been priced properly, and that would have been mostly intermodal. We took that on in late 2002 and early in 2003, and cleaned up most of that. Generally, we price our business based upon our service, which is good across the board. And therefore, it is not that one area of the business sees a significantly higher increase than any other area. We're not cost-base pricing here. So it is based upon our service and it is based upon what the market will bear, which is pretty consistent across the various merchandise segments.

Maybe, Hunter, can you talk about what a theoretical best operating ratio might be for this franchise looking several years out, assuming your current productivity projections and a normalized fuel environment?

Yes, I could; I would prefer not. I guess that I've talked to some of you that -- if you take fuel prices and put fuel at $25 a barrel, and take the Canadian dollar at some reasonable number like we were experiencing -- I don't think 63 or 4, but at 70 cents -- and the -- the way we posture ourselves, and I think directly from labor agreement, from IMX programs (indiscernible) we put it internally -- could I see us going one day to 63 or 4? Absolutely.

David Newman, National Bank Financial.

Great quarter. A couple of quick ones; I know it's been a long call, I'm sure you're getting a little tired. On the bulk side, clearly you looked a little more prepared than some of your peers. is this true, and perhaps you can add some color as to why? And do you think they may catch up to a certain degree in the coming quarters?

From a grain standpoint, I would be the first to tell you that we have had -- we did have some challenges in the U.S., not near to the degree that some of our other roads have had. But we have had pretty significant increases of volume down there. But we are in pretty good shape. We have (indiscernible) cars in the future and those cars have not been taken. So overall there we are pretty good. Clearly in Canada we have had this situation with the furlough board; I wish we didn't, but we're not going to be in a position where we have shortages of labor in Canada in the West. In Canada (indiscernible) effectively, the government owns the cars. We've done a pretty good job with locomotives. I think overall we have been able to manage the process better. I guess the one thing we do, particularly in Canada, significantly different than others is we move a whole lot of grain on unit trains. We are not huge believers that unit trains are the low-cost operation. If you can take probably 30, 35 percent of the grain and move it on existing capacity of merchandise trains, it gives you a whole lot of leverage, which was one of the reasons you saw some of the productivity numbers that I talked about earlier with length of train and gross ton miles per employee showing those types of improvements.

That's great, Hunter. One last one. I have heard some rumblings of some of the metallurgical and thermal coal mines may possibly be reopened given the strong markets. Do you anticipate this at all or do you think you are going to stick with your view currently?

The impact of the demand worldwide for products, due to the increase and ramp up of production in China, is driving a lot of speculation. We do not have any of it, and so therefore there is discussion about the opening or development of coal mines -- metallurgical coal mines in Western Canada to feed the Chinese market. I certainly, personally -- or us, from a budgeting standpoint, don't have any of that baked into our expectations. But I could tell you if somebody would have asked me a year ago if we would be moving iron ore from the Mesabi Range in Minnesota to export through Prince Rupert to go to China, I would have given you the same answer.

Jeff Kaufman, Fulcrum.

I don't know what is left to ask at this point. Congratulations to all of you on solid results. I mean, the 66 1 is just amazing in the fourth quarter. Let me go a different direction, then. You are throwing off all this cash. Clearly, your core business does not require all the cash that you are generating on a free basis to be reinvested. What are you going? You're giving some to shareholders in dividend, stock buyback; you're giving some to help the Canadian budget deficit. But after all is said and done, there is not a lot of other BC Rail-type properties out there. What do we do with the cash you're going to generate? Because it is going to continue to grow the next few years in the 5, 6, $700 million range.

I think our first order of the day is to finance the two acquisitions we just announced in Q4. That is $1.5 billion Canadian of investments (indiscernible). That is where we will use our cash in the first instance.

So fund with that and pay it down over the next 2, 3 years?

Hopefully even faster. We have been increasing our dividend, we've announced the policy of gradually increasing our payout ratio. The last two years our earnings were flattish and we increased the dividend quite significantly in both years. So every year -- if you look at 2004 specifically, our dividend increases about $35 million of cash. From there, whether it is a share buyback or other strategic opportunities, we will use the cash to reward shareholders.

So the strategic opportunities are not necessarily done, but you're likely to go into a paydown mode for the next year or two?

The only other thing I would mention, Jeff, that would be kind of out-of-the-box normal is that with the new labor agreements, there are some real opportunities that we have not had in the past that we are exploring and will continue to explore for additional speed and velocity in the system. So there might be some compelling issues that said let's build even a better railroad than we did have, let's run it 80 mph instead of 60, let's give better service, let's turn assets faster, and let's have lower labor costs. That is something that is -- our models are not even set up to deal with now, that we are starting to explore. So (indiscernible) might give us additional opportunities to reinvest internally with better rates of return than we historically have had.

Hunter, thanks. Just a fantastic operating quarter despite all the challenges. Thanks.

RBC Capital Markets, Joseph Linwand (ph).

Just a couple of questions for Claude, particularly. The two acquisitions -- just remind me again. On the BC Rail and on the GLT, would their operating ratio be in line with your operating ratio? I'm just trying to figure out how that feeds in.

When you integrate them they will not be a drag to our operating ratio. Both properties are fairly profitable, and then with the synergies we bring in we see them coming in in line if not better than our overall operating ratio. So early on you might have a slight drag, but very quickly they're going to be a benefit to our earnings and a benefit to our operating ratio performance as well.

An accounting question. On the accounting for asset retirement obligations, is there going to be any change in the rate of depreciation?

No. Whatever you see in 2003 is the best indication of future run rates, because we have done that prospectively as of Jan. 1.

Lazard, Jordan Alliger.

Just to finish up some intermodal questions. Now that you've had IMX in place for some time, so the initial read from customers was positive on the changes -- I'm wondering if you can give an update on that? Secondly, I don't know if you mentioned it on the call, but do you still stick with the profit contribution target improvements that you talked about earlier in 2003?

The initial change is difficult for just about everyone. So were the intermodal customers ecstatic about what it was we were proposing with IMX initially? The answer would be no. Do they understand as businessmen what it is we are trying to accomplish and do they congratulate us for taking it on? Yes. So we have worked our way through this and I would say we are over the hump in that area, because they definitely see the improvement in service, they definitely see the improvement in throughput in the terminals, and that is good for them. In terms of profitability enhancement, this kind of 20 percent ballpark range is something we are still comfortable with.

Let me just add a little footnote to that. This is a learning process we're going through, to a great. Let me give you an example of one of the things we've learned. We knew that we didn't have this thing exactly right when we went into it; we were going to have to be kind of flexible. We have learned that, for example, to some degree we have made it difficult for the smaller domestic customer who has a more difficult time forecasting his business, to work with the reservation systems and so forth. So we are starting to adjust our systems to be able to deal with the markets better and respond. So this is a very successful venture and it's got a lot more to wring out before it's over.

Canaccord, Robert Fay.

A couple of questions. Jim, a question on the metal business. When we look at these new iron ore moves, they did pump your numbers up quite a bit on the RTMs. Can you give us an indication of what that is going to look like for the next year going forward? Is it a seasonal business or is it year-round?

At this point in time we think that the ore business that we picked up in the fourth quarter will move at least through the middle part of 2004, and there is a discussion with others about -- there is discussion with the current customers about continuing that through '04. And there's also discussion with others about potentially adding to that, but at this point in time that is preliminary.

Any other puts and takes that we can see in the next 12 months on that part of your business?

It looks -- the outlook for '04 looks positive that we will continue to see gains throughout '04 as we did in '03.

Two quick questions for Claude. On the labor and fringe, how much was FX impact was there in the labor and fringe number in this quarter?

I don't have that number exactly, but it was a meaningful impact. I would tell you that generally speaking, our labor expense, instead of being down would have been slightly up if you adjust for exchange. But I think the core number to follow is the fact that we were able, as we discussed earlier, to deliver productivity improvement to the tune of 10 percent. Take a look at it this way, Bob; our headcount was down 4 percent during the fourth quarter and 6 percent for the full year, on a year-over-year basis. That's at the tail end of our workforce reduction program. And for us to be able to come down in headcount and handle the surge in grain business and the benefits that we talked about on the merchandise side, is quite remarkable.

Especially with (indiscernible). The last question, cash taxes. You mentioned your cash tax rate would be going up next year?

Yes, we will. There is no free lunch in life and at some point you have to pay your dues. The good news is, while we will start to have to pay cash taxes in Canada in 2004, if we succeed in closing the transaction with BC Rail, then we will have acquired net operating losses which will bring us back to a position where for several years starting in 2005, we would have very little Canadian income tax to pay. So we have a blip in '04 to deal with, is the outlook for cash taxes.

(indiscernible) surprised with the BC Rail acquisition, that you were going to see any increase. But it's just next year?

No, you first have to close on the transaction and restructure, and you only get the benefit in the following year.

Last question, workforce reduction charges. What are they going to look like next year, cash flow?

You mean the severance payments? They're 155 for 2003, so down 22 million. So you should see them continue to grow down gradually, and (indiscernible) over the next three or four years.

Westwind Partners, (indiscernible).

Two questions. One, could you comment on how comfortable you are that the BC Rail and GLT transactions will close? Are you seeing any resistance?

I think we're going through the process in both countries. We were very pleased that the STB ruled the transaction a minor transaction, and I think that bodes well for that regulatory process. In Canada it is a different approach. The competition bureau reviews railroad mergers, like any other mergers in Canada. And so it is a process of basically going through the file with the competition bureau. There is no set deadline, contrary to what you find with the STB, but we are reasonably comfortable that some time towards the end of the first quarter or early in the second quarter, the bureau will rule. And we think we approached this transaction in a very pro-competitive fashion, and we are explaining that to our customers and railroad partners to make sure they understand the benefit of what we do offer.

My second question relates to foreign exchange. It has become a factor that is materially influencing CN's results. Hunter mentioned that the Canadian dollar has stabilized. But hypothetically the speaking, should the outlook deteriorate again -- that is, the expectation grow that the Canadian dollar will rise further -- how should I expect that you might react? In other words, what steps might you take to protect CN's earnings and cash flows? For example, might you put in place a currency hedge that you don't have in place today?

You know, we have essentially a structural edge, if you look at it from the position of net earnings. We have a lot of revenues in U.S. dollars, not enough to cover our expense -- operating expense in U.S. dollars, but all of our debt is U.S. dollar-denominated. And so, net net, for every cent of appreciation in the Canadian dollar, we only suffer 4 cents of EPS. Now that causes (indiscernible) to every line on the P&L, but net net, we are very close to a natural edge. And we're trying to continue to improve that edge position. And to give you a very specific example, our thinking for the BC Rail financing will be to go to the deep U.S. markets and raise that money in U.S. dollars, which would further improve this natural edge position we have.

Thank you, that's helpful.

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Harrison.

Thanks so much to all of you for joining us. Obviously we are very pleased with the performance of this quarter, and look forward to seeing you next quarter or visiting with you on the conference call. 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.