Canadian National Railway Co (CNI) 2004 Q2 法說會逐字稿

Welcome to the CN second-quarter resolve conference call. I would now like to turn the meeting over to Mr. Robert Noorigian, Vice President, Investor Relations. Ladies and gentlemen, Mr. Noorigian.

Thank you and thank you for joining us today. With me is Hunter Harrison, President and Chief Executive Officer of CN; Claude Mongeau, Executive Vice President and Chief Financial Officer and Jim Foote, Executive Vice President of Sales and Marketing. The remarks that we make today may contain forward-looking statements within the meaning of the U.S. Private Securities Reform Act of 1995 and other applicable legislation. There are a number of risks and uncertainties that could cause these actual results to differ materially from what we talk about today. Also, today's presentations may contain non-GAAP financial measures for purposes of comparability. The Q2 2005 -- 4 financial statements and the notes attached in the press release are available on CN's website. With that, I would like to introduce Hunter Harrison, the President and Chief Executive Officer of CN.

Thank you, Robert. Good morning to everyone. We appreciate you taking time out to join us to discuss with you our second quarter results. All I can say is my view it that it was a knockout quarter. We set records in almost any of the metrics that you would want to measure or look at. It exceeded even my expectations. I trust that you have seen the press release and/or the presentation on the Web.

Let me just highlight a few things before I ask Jim and Claude to go through some of the details with you. EPS was up $1.13 versus 84 cents last year, or a 35 percent increase. This rebound was driven predominantly from what I would describe as operating leverage. We saw our revenue up 14 percent year-over-year, while at the same time, we were able to contain expenses to a six percent increase. That leverage is the result of a lot of initiatives that we have talked about with you before that are really starting to gain traction. Clearly, it was led by the comeback to some degree of grain and merchandise. At the same time, it was impacted very positively by yield, which Jim will talk about. But that produced, then, an operating ratio of 65.5, which is once again, another record, and I'm very pleased with that.

Free cash flow of 587 million for the second quarter, another record Claude will go through some level of detail on that with you on that. For this very strong growth at low incremental additional cost -- for an example, we saw our trainload increase about 9 percent. So to some degree, we were running the same amount of trains, hauling more business and the capacity up, so that creates leverage.

Also in the quarter, we were at the same time able to close on two major acquisitions for us -- the GLT and BC Rail, which we've talked a lot about in the past. And probably one of the things that I was most proud of was the improvement in our FRA accident ratio where we improve 35 percent and it created an even more solid foundation in the leading position of the safest railroad in North America from a train accident standpoint. So overall, outstanding performance by a great team of railroaders here. And let me call on Claude to go through some of the detailed numbers with you. Claude?

Thank you, Hunter. Frankly, I think this is just an all-around great quarter for us. We had promised you a year ago that we would have a rebound with the grain comeback and a stronger economy, and that is just what we delivered. I think the numbers speak for themselves. Our EPS of $1.13 represents a jump of 35 percent year-over-year. That is clearly very strong performance and it's driven by three key factors, which I would like to highlight for your benefit.

First, solid topline growth. Revenues are up 14 percent. But second, we were able to grow with continued focus on productivity and that allowed us to yield a very low incremental cost to accommodate that growth. The third factor is very importantly -- we are seeing the early benefits from our acquisition strategy with the GLT contributing to 3 cents of EPS in the quarter. Jim will take you through the revenues in more detail, but let me highlight a few key points.

Of course, we had a great comeback in grain, but all of our merchandise units are up double-digits. The most positive element is the significant gains in yield and pricing, and that is a key part, along with productivity that explains why the revenue is falling to the bottom line. Our ability to grow at low incremental cost is showing through with an operating ratio reduction of 4.6 percentage points. At 65.5, this is a record performance for us, which shows what this railroad can do with normal grain and a good economy. Overall, very good quarter and it bodes well in terms of momentum for the second half.

If I take apart the expenses a little bit, overall, our increase is about $64 million, or 6 percent. However, 43 million of that increase is due to the GLT consolidation, leaving a same-store, if you wish, increase of only 2 percent against a same-store revenue growth of 10 percent. That's operating leverage. Our labor expenses were up 12 percent. This is partly due to the GLT integration, which shows through in every expense category, but also higher stock-based compensation and bonus accruals. And, this is the first time for us as we have a new accounting, a 12 million charge for employee termination severances. In the past, we would've accounted for employee termination costs in a special charge, which, because of our downsizing over the last several years, would recur every other year or so. So now, when we have been employee termination, we have to book the expense as we go. And during the quarter, our expense on that account was a $12 million increase because we had none of those expenses in the prior year.

Casualty and other expenses are also up 17 percent due to environmental accruals, but also the fact that last year in 2003, we had a onetime operating tax reduction which helped our second quarter of last year. On the positive side, equipment ramps are down a full 17 percent on the strength of solid cost control, but also the benefit of higher carrier (ph) income, which is an offset to our equipment ramps because our cars are staying longer off-line due to some of the congestion that is currently impacting the railroad industry in North America.

Our fuel expenses are essentially flat as we benefited from our good hedge position, but also a onetime tax settlement of about $9 million on account of cross-border duty taxes. Overall, very pleased with this performance. Clearly, we were able to show that we are keeping expenses squarely in check, despite solid volume growth.

Free cash flow, clearly a positive story here also. After six months, we stand at 587 million. Other and working capital and dividend, every caption is improving versus the first half of last year when we generated $350 million of free cash flow. If I exclude the net proceeds from the EWS recapitalization, which we talked about during our last quarter call and the sale of our Canack (ph) subsidiary, which happened in the second quarter, that $175 million or so, if I exclude it, it shows up in other investing -- if I exclude that $175 million or so, our free cash flow in the first half is still around $410 million. If I take into account CapEx seasonality, which is back ended, this clearly positions us very well to achieve a full-year free cash flow generation on the order of $700 million.

The strength of our cash flow performance is what allowed us to finance our two acquisitions with only $800 million U.S. of financing. As you may know, we did a successful bond deal on July 9th and secured a blended interest rate of only 5.6 percent. If I stand back and take a look at those two acquisitions, which are now officially closed, we paid $1.5 to $1.6 billion Canadian for the two deals. Of this amount, $250 to $300 million is the value of the tax attribute related to the BC Rail. That leaves about 1.3 billion for the two rail franchises, which next year in 2005, will deliver for us on the order of $250 million of EBITDA. So we are paying about five time multiples and this explains why, despite their relatively small size, these two acquisitions are fairly strongly accretive to our results. For 2004, the second half, basically, we expect in the order of 13 to 15 cents of EPS accretions from both deals. In 2005, we see that number roughly doubling.

The last piece of good news is our debt ratio on a pro forma basis. It stands at 39.5 percent. If I adjust for all leases, it gets it up to about 44, 45 percent all-in. This is basically where we need to be. So that leaves us in the enviable position to enter these two acquisitions, focused on flawless integration and reassess use of cash in the next six months or so.

Finally, a few words on the outlook for the second half. Clearly, the first half was a good one. We had some challenges -- a labor dispute, headwind with exchange and very high fuel prices -- but we were able in the end to deliver a six-month performance, showing 21 percent EPS growth. I think this shows the strength of our business model. For the second half, with a good economy, with exchange in the 75-76 cents range and with fuel prices staying at around $40, hopefully less, we think we can deliver on the order of 15 percent EPS growth for the balance of the year. Of course, we will the lapping grain. The comparison will get tougher on a year-over-year basis, but we are reasonably confident all-in, the momentum of our initiatives should allow us to deliver up to 15 percent, which would mean up to 16, 17 percent on a full-year basis. With $700 million of free cash flow, that would cap a very good year. Jim?

Thank you, Claude. We had very good performance by the railroad in the second quarter, which allowed us to have solid revenue growth. I would like to take the revenues apart in a couple of different ways to help everybody understand the numbers. CN, without GLT in, grew its topline 10 percent. When we add in the revenue from the GLT, which added 4 points of growth, we were at 14 percent topline growth as we reported it. If one was to exclude the exchange impact in the second quarter, that would have increased -- allowed the revenues to have increased to 16 percent -- not basis significant impact in the second quarter from exchanges we had in the first quarter. Another way to take a look at the revenue performance is our merchandise business was up 12 percent, bulk was up 27, Intermodal down 1 percent and our revenue reported in other items now up quite significantly, again reflecting the revenue gains from Great Lakes vessels, moving ore on the Great Lakes, chain which adds revenue growth to that item.

And one last way to look at the numbers is that, from a volume standpoint, we were up 9 percent. And you at the yield of 3 percent, you get into the -- you get back to the same numbers that we're talking about here, a 3 percent yield to change, being about two-thirds from rate increases in the 1-2 percent range that we've talked about and another 1 percent gain from fuel surcharge.

As usual, I will take a brief time here to break the numbers apart. We will not adjust these numbers for exchange as I've done in the past. Again, there is only a $30 million increase that would've been associated with exchange. And you can take the numbers on this sheet and basically increase them each by about 2 percent and you understand where the impact from exchange is.

But in the merchandise business, petroleum products up 14 percent and chemicals up 5 percent. Solid growth in all of the merchandise businesses. Metals was up 16 percent without GLT, which is the reflection of the solid steel markets and the ore moves that we are having on the railroad especially out of the Minnesota, Masabe (ph) Range, and we continued to move, although not as many as we had in the first quarter, we continued to move four trains out of the mines in Minnesota over to Prince Rupert on the Canadian West Coast for export to China. When we add in the GLT revenues, that pushes that number up to 40 percent.

Forest products, once again, had a very, very strong, steady quarter. Lumber -- forest products up 9 percent with lumber up over 10 percent and panels up almost 25 percent. So a solid performance there in the lumber and panel market, continuing as we continue to move this product into the U.S. to feed that strong demand from the housing market there, and pulp and paper up 5 percent.

Our automotive was reported flat, although our finished vehicles actually in the quarter were up 3 percent and parts were up 16 percent. But offsetting that growth was some very difficult comparisons on a year-over-year basis because in the second quarter of last year, we had very significant movements of military vehicles; that is offsetting that growth in that group.

On the bulk side of the business, U.S. coal was up 3 percent, Canadian coal down 40 percent, although it is a very small component of our business now. That reflects the closure of Tex Bull Moose Mine, Luskar's (ph) O-bed (ph) mine. But again, we add back in some gain that we've picked up with moving coal on the GLT over the Bessemer and Lake Erie and onto the Kaniat (ph) Dock. That allowed us to show a 6 percent increase in our coal business. As Claude mentioned earlier, we had been anticipating the rebound in the grain business when the crop came in on the Canadian side. Well, Canadian grain up 85 percent in Q2 and the U.S. grain is down slightly -- U.S. corn being down slightly 8 percent. Fertilizers up 16 percent for a net growth in the grain and fertilizer business of 35 percent.

In Intermodal, Intermodal down slightly. Our overseas business up 3 percent, strong growth through both ports -- strong demand and growth I believe in both ports of Vancouver and Halifax, especially strong demand on the West Coast. We're managing that growth very carefully. That being offset by the continuing impacts of the closures of the facilities in the U.S. we've talked about before, especially Green Bay and St. Louis, which show some volume declines as well as our decision which we made in the first quarter to exit the roadrailer market in Canada. Those numbers there show offsetting the gains that we're having on both of overseas and domestic, excluding that impact.

So couldn't really ask for a more solid quarter across the board -- each one of the business units performing just about as we had expected, maybe slightly stronger. And if you look at the revenue outlook for the second half of the year, we certainly expect the strength in merchandise to continue. We will focus on that strength and continue to build upon the scheduled railroad philosophy and the service we're providing to our customers. That is obviously what is driving the pricing and yield strategy that we have. We charge a fair price for what I was considered to be exceptional service. That price increase from year-to-year, as I have said over and over again, in the 1-2 percent range, which we brought in again this quarter. And as we continue going forward to try and move that up into the 2-3 percent range in the future. But I think it is imperative that everybody understand the strategy here as to charge what I considered a fair price.

Grain forecast -- the outlook for the Canadian crop is now called for by the Wheat Board to be above the 10-year average, which is right in line with our expectations. And the U.S. corn crop is coming in above average, which bodes well for us in the second half. Rolling in the BCR with new service offerings there, I think we'll do just what we did with the GLT. When we came in there, we offered competitive, very good service options to the GLT and you can see the ore that we're moving out of that region into new markets for those customers. Same thing is expected to happen with BC Rail as we will greatly improve the service to the customers located on BC Rail, which will allow us to grow our volumes there.

Global demand in steel is driving GLT, which we've talked about with ore, but also, new opportunities on BC Rail, as there are a number of coal mines that are currently under development there to ship metallurgical coal to the Asian markets to meet the demand there, and we'll be extremely well positioned to take advantage of that with new service into packages there.

And finally, IMX -- we continue to grind out and improve the profitability of our Intermodal business, continue to grind out and improve the quality of the service that we can provide our customers. It is proving and showing results, which I think you can see in the numbers. And with a 20 percent improvement or thereabouts in profitability, we are very satisfied with this strategy. I'll turn it back to Hunter.

Thank you, Jim and Claude. Let me comment on a couple of items that you might have some interest in before we take questions. There's been a lot of talk recently about concerns over capacity with some of the other carriers. And I'm happy to say that we do not share those problems, whether it be from a human resource standpoint for rolling stock from a locomotive. In fact, I think we have 40 locomotives now leased out. So we're in good shape to handle a strong second half.

On the labor relations front, most things are settled in the U.S.. We still on the Canadian side have four collective bargaining units we need to deal with. We have had and continue to have a dialogue with all of them. IBEW -- I think it is fair to say that we're getting relatively close, I hope, to a settlement. The BMWE, we're not able to engage in a dialogue now because they are in a representation dispute. And until that representation dispute is resolved, we don't know who to negotiate with, which leaves the BLE and the UTU, which we have had dialog with both. And I am optimistic that we can gain fair settlements for both of us. I do think that probably the timing of those settlements will be because of some of these representation disputes and some of the rating activities will be a little later than the year than I had first predicted or hoped. But I think that we're in good shape there on the labor side.

The integration of the GLT and BCR are certainly ahead of schedule. Dave Edison on the BCR front has already taken a lot of affirmative action that his way ahead of the schedule. Net integration, I think that it's going to bring even more opportunities than we had originally thought. The same thing on the GLT front. Lord (indiscernible) and his team with Rusty Radloff (ph) and Jeff Leipeld (ph) are moving forward there.

We have made some significant changes with our service design in the U.S. that involves predominately three places. You've probably read about it, seen it in the press releases. We've effectively closed Battle Creek, Michigan totally and Centray (ph), Illinois and are performing switching services and classifications that were formerly being done there at other locales on the system, whether it be Memphis, Tennessee or Toronto or Chicago. We've significantly changed service plan in Chicago for predominantly two reasons -- to either further try to run through or run around Chicago and the congestion and problems that are being created there this summer. And I'm not very optimistic about what Chicago can bring this fall in the peak shipping season, and God forbid if we get into any weather issues. So our advice to people is to stay away from Chicago.

So wrapping up, let me say this. We had an extremely strong first half, in spite of the unfortunate work stoppage that we had. Clearly, you can see from these results that we are capitalizing on this strong operating leverage. This model is working, it's gaining more traction all of the time. I think the benefits from these two acquisitions are going to be even more than we had first envisioned. I'm extremely bullish on the second half and each day, it's proven to me more and more of this precision railroading works. So with that, we would be glad to entertain questions of the group.

(Operator Instructions). Thomas Wadewitz, Bear Stearns.

First of all, congratulations. Very impressive quarter. I have a couple of different questions. One, for Hunter, when you look at the leverage that very clearly showed through in this quarter, how much more is there to go, in terms of adding cars with the existing schedule? Or is there a lot of room to modify the schedule so you can continue to show this type of leverage? Or is it the case at of a certain point now or a couple of quarters down the road, the trains are maximized and optimized and then you end up selling a little less leverage? Can you give me some comments on that?

Well, Tom, let me address it two or three different ways. From a train capacity standpoint, and I am talking now predominately merchandise, because the IMX model deals with it one way Intermodal and the bulk is on a stand-alone basis. We still have, on average -- and sometimes averages can get you in trouble -- but we have 16 to 18 percent capacity on existing trains. There are certain lanes or quarters where, if we experience 10, 12, 15 percent growth, we would have to look at additional train starts and some -- predominately only train starts. From the equipment standpoint, I would still like to add a few more central beams. There is so much demand for lumber right now. Pretty well positioned with what we have planned and the capital plans that we've shared with you for the next five years. No changes there. And we're in good shape from a locomotive standpoint. So we are positioned now to really take advantage of this model and gain additional traction.

Okay, great. So it sounds like this can go on for quite awhile. As you look through the quarter, did you see any improvement in the interchange with the U.S. railroads, or has it pretty much just been difficult? And as you look to peak season, any expectation for improvement or are you seeing things fall off further?

I hate to kind of broad brush it, but the roads that we were experiencing difficulty with is becoming more difficult. I haven't seen improvements yet. I hope that I do see improvements. And I would have to share with you that I think there was not the greatest of planning in Chicago in that both of the switching carriers there are trying to do maintenance work and volumes that are higher levels and people are having the other problems based on the capacity and human resources. So, Chicago is kind of a migraine right now.

Right. Great, thank you for the time.

Fadi Chamoun, UBS Warburg.

Thank you, good morning everyone. Great quarter. I actually have one question and it is on the operating leverage. If we're trying to further, looking into the next couple of quarters or one year, can we use the margin on the incremental sales as a guidance for -- as of the operating leverage going forward? Or is there any pluses or minuses we should be taking into consideration to -- as of the operation leverage basically?

I think you have to be careful as you look forward. One of the key elements of our second quarter performance is the fact that grain, as Jim explained, is on a huge comeback. And grain, just because of the nature of the business and the fact that the cars are owned by the government, is at the margin, is a highly profitable business. But other than that, going forward as Hunter mentioned, we have the capacity in our trains to accommodate the business. We have the manpower resources to accommodate the business, so we're expecting to make the most out of growth and to continue to improve margins on the strain of a good economy going forward.

One other question maybe for Hunter. As we look into the peak shipping season on the Intermodal side specifically, there has been a lot of concern in the industry that we could fall back into very serious (indiscernible) issues. Not that it would impact CN Rail a lot, but if you have any views on that and how the industry is prepared specifically to see if we get into problems over the next few months, what kind of impact this could have on your guidance?

Well, I mean, I'm not near as close to the Intermodal scene in the U.S. as I used to be, but I read that people are looking for a huge season, I read of potential problems on the West Coast. Could that be some opportunity for a little business to bleed over to us? Yes, but this IMX model is not set up for that type of operation. We're not going to change our service for some short-term incremental gains. Certainly, we can make accommodations to try to help, if that opportunity presents itself. But I don't think -- it's not certainly going to be any windfall on the short-term.

On the longer-term, I would take this opportunity to say that I am hopeful and optimistic that within the next two or three weeks, there might be an announcement about investment in Prince Rupert, insofar as Intermodal opportunities present theirself. We talked about, those of you that were at the analyst meeting, about our five-year vision, significant opportunities for Prince Rupert. So I would think over the longer-term that if people go through problems and seasonal in this shipping season, that longer-term, that presents some more opportunities. But our IMX model does not set us up to just stay incrementally take business away for a day or two or a week -- that is not our model.

Great, thank you.

James Valentine, Morgan Stanley.

Great, thank you. Very impressive quarter. Hunter, given the strength that you have seen here in your volumes, operating leverage, I guess some of the pricing, does this change your five-year goals? I know you just laid them out in May, but you're below 65 percent operating ratio for 2009 looks like it is going to be much easier to accomplish, given that you're probably going to use something just below 67 this year. Is it too early to be starting to rethink that?

No, I don't think it's too early, Jim. We always rethink it. I would say this, a couple of things. In the presentation and in the five-year vision, we said below 65; we did not hone in on how much below. We give some guidance there. But as you know better than I, there's a lot of puts and takes here. When you we talk about fuel prices, you talk about the Canadian dollar, you talk about grain drop and so forth. I would say that we are -- certainly, if things continue to go like they are, we're certainly ahead of schedule. Could we exceed those five-year predictions? Yes, there is a possibility. Are we conservative in nature? Probably; you have seen that. I think this model is a strong model. I think we -- and I emphasize we -- are convinced it works. I think we've gone through the cleansing that we need to from the business that did not give us the appropriate returns like IMX. And I think once we get to those bases and start to rebuild them and then grow with the type of business, the sustainable profitable business, the controlled growth, would I argue that we won't to exceed those? No, I wouldn't argue that.

Great, excellent, very impressive. If I could ask Jim a question. Jim, if we adjust for foreign exchange, we estimate that your yields for forest products, as well as grains, fertilizers, were up about 10 percent. And yet, you said pricing was up 1 to 2 percent overall. Is this to assume that the rest of the change there was mix, or did you have certain commodities where you saw very strong pricing? In other words, where you saw very little by the nature of the contracts?

No. I think that the yields are pretty -- in terms of pricing. If I just looked at the pricing, you would see that the rate of increase is pretty consistent from business unit to business unit. And by that, I mean how much do I charge to renew a contract from one year to the next. If you add in mix as an example, when you look at our forest products business and you take into consideration that the quite significant shift that has occurred in the forest products business and movement from Eastern Canadian producers to Western Canadian producers and the length of haul that we get on that move out of British Columbia to Chicago, you start to add in there a lot of increase in yield that results from that. Similarly, on the paper side of the business as we go from the plate C boxcars to the plate F boxcars, again, you see yield resulting in a profitability improvement as a result of that.

So it helps profit,. but it's being driven by more mix than necessarily a big --?

A big component in mix and a huge focus on what it is we're doing in sales and marketing to concentrate our efforts in those areas where we are going to sell into markets where we're going to have a higher return based a lot upon the way we operate and getting it done.

If I can ask Jim one last question. I think there's two mines out west that you make go from seeing a decline in your Canadian coal shipments to some growth here. Then I guess Elk Valley has been talking about reopening a mine for awhile, and then Pine Valley is going to be a new export metallurgical mine on BC Rail. Can you talk about, first of all, if I got that right; and second, what the timing and kind of tonnage would be?

The Pine Valley mine is the one that is coming on track on BC Rail. It should be starting up relatively quick, quickly. That is about 300,000 tons that we think we can move out of that mine.

Per year?

Yes. And the Cheviat (ph) Mine, which has been talked about for a long time, that is already in the works as well. We are expecting that to start up this fall, less than what Pine Valley will be producing. And another startup in the fall, Grand Cash Coal again this fall, and that should be less than Pine Valley as well. But there is a lot of speculation going on out there and a lot of demand for this meth coal right now.

Very good pricing. Great, I appreciate it.

Jim, let me comment on your first question relative to Jim's comments about the price in yields and our vision. I have known for long time in trying to convince people that if you're into the lowering operating ratio, it is a lot easier to do it at the topline than it is controlling expenses. We know a lot about controlling expenses. We know a lot about operating productivity. One of the things we did not have as much experience in was trying to judge what type of price increases we can take to the market and the market would accept relative to our service offerings. And that's what we have had a great deal of dialogue internally about. And I think if I'm right, Jim or Claude will correct me if I'm wrong, but in our plan, we had somewhere in the neighborhood of 1.5 to 2 percent price increase.

Current, moving to 2 to 3.

Moving to 2 to 3. And I think what you have seen here is if you see around to 2 to 3 here, this quarter, about 3 percent, that we're kind of ahead of schedule there. That's what really gives you the leverage.

Absolutely saw the numbers. Thanks.

David Newman, National Bank Financial.

Good morning, gentlemen, terrific results. Has the incremental cash that you have, has it changed your plans or priorities with respect to CapEx, debt reduction, dividend payouts, share buybacks or acquisitions at all?

No, I would say it doesn't. I think we're ahead of plan and that is a good position to be. Quite frankly as I said, we are coming into those two acquisitions with a 45 percent adjusted debt ratio. That is what our goal is. So we will see how the integration goes. And the free cash flow that will be available will be available to reward shareholders. Our first priority would be to do other deals like the one we have just closed on because they clearly bring value not just to our customers, but also to our shareholders at the same time. And if those opportunities do not materialize, then what we go for is an opportunistic share buyback as we've done in the past and a follow-up on our policy to increase our dividend payout ratio so that dividend grows faster than earnings. That is our general stance. We will reassess all of those use of cash opportunities in the next 3-6 months.

Okay. And in terms of the congestion on the other railroads' networks,, do you think that may expedite the consolidation in the industry at all in the near future?

I'm not sure I'm smart enough to answer that question. I guess the short answer is, I doubt that. I think that -- my view would be that those people would think that they need to get things squared away and things under control before they look at going into an expansion mode, but that would just be my limited views.

And I've heard some discussion of the hours of service rules for the truckers may be reversed. Do you have any color on that at all?

I've heard the same speculation, but from our standpoint and our Intermodal operation, which is predominantly Canadian, it is a non-event.

One last question, if I may. In terms of the headcount reduction, Hunter, do you -- I think you left about 200 and change people go. What[s your plans there and how are you on track with that?

Well, I think you saw some of the in what Claude talked about with the charge or the additional expenses we had second quarter that we would have been a charge in the past. I think that represented somewhere around 350 so far of what we speculated. The reason why I don't want to hone in on a number closer than that or get locked in is this. We are having some, even with the organizations in Canada that we've settled with, we're having some, in my view, very encouraging dialogue about opportunities to do things a little bit differently than we've done in the past. For an example, some more aggressive insourcing. And if we can work with those organizations in a very progressive way and do that, then there will be fewer reductions. If we're not able to do that, then there will be the kind of reductions on the high side that we talked about. But effectively, the bottom line is going to be the same from a basis decisions standpoint. So that's why I don't want to get locked in.

Very good, thanks gentlemen.

Ken Hexter, Merrill Lynch.

Hey, Hunter. It's great to see the threat of another drought quickly moving to a better-than-expected crop up north. Just a couple of things. Can you -- you talked a little bit at the analyst conference about looking for some networks sharing opportunities, possibly even with CP. We saw a recent agreement out with Norfolk Southern and CP. Is there any update on the progress of those talks?

There is continuing dialogue. I think there have been some recent developments. We are -- the developments with the D&H, with NF and CP, we're in some dialogue there about possibly moving some traffic over that network. And I say possibly. I'm not sure if that will happen or not. And then individually with CP, we're looking at some opportunities from strictly an opportunity efficiency standpoint to do some more co-production. And I think there is upside and all of those areas.

On the Intermodal side, are there any more closings that you have planned, as far as the IMX program, or are the negative contributions pretty much done at this point?

I think the -- Jim could comment also -- I think negative spots are predominantly gone. I mean, certainly, most of them, if not all. And I think we've gotten to a point right now that we're very comfortable with the markets we're in, very comfortable with the service offerings that we're being provided. As Jim said, the yields are up. We are significantly ahead of the curve that we said we would be on from a coming standpoint of reaching X-level of profitability. And I think that hurdle is going to move up. I know one thing, I can just give you this anecdotally. Intermodal used to be at the bottom of the packet; it's not there anymore and it's threatening others. So IMX is a real winner.

Jim kind of highlighted the I guess even or more even spread between the days of the week that we saw kind of as a point of IMX. Has that continued to smooth out the flows, or are you at a point where you're comfortable now?

No. As Jim has showed you at the other meetings, there has been a lot of progress made there, but there's a lot more to be made. And as we start to learn the markets better and the markets start to learn us better, I think you'll see the opportunity for some further smoothing, which will improve yields even further.

On last question on fuel surcharges and hedging. I guess is there any update on the hedging percentage? And it sounds like you did a great job with the surcharges, I think Jim mentioned quickly. Can you provide an update on percent of revenues that are addressed now?

Jim, you want to talk about the surcharge, and Claude, you can talk about the hedge.

Sure. We have about 35 percent, between 35 and 40 percent of business which has a direct fuel surcharge on it today. Many of the other contracts have escalation provisions in them that are tied to other cost indexes which will raise their rates as we move forward as well. All of the contracts have either some CPI or some market basket of indicators to increase price. But about 38 percent of the business has a direct fuel surcharge.

From a hedging standpoint, we are at 56, 57 percent, depending on whether you include the volume of the GLT and BC Rail for this year in 2004, at just above $25 per barrel. And next year's, 2005, volume is hedged at just under 50 percent of our anticipated consumption at the 28.75 or so per barrel. So we are building that position, and in the next few weeks here, we will reach our goal for 2005 of having to hedge about 57 percent of our volume.

From our standpoint, with the 35, 40 percent of revenues that carry the fuel surcharge and 57 percent or so of our expenses with a hedge, we feel that we are dealing with the fuel price volatility adequately.

And, Jim, if I could just follow up on that for acquit second. It seemed like Canadian Pacific came out with an announcement talking about rolling out fuel surcharges on all their tariffed rates. Is that a chance to continue your rate increases, or do you believe that the surcharges you have out there are pretty much equal to what they are making with their announcement?

I think if CP put out an announcement, which I did not see on their tariff rates, my guess would be that would be a very, very small percentage of their business, just like it would be with us, maybe four or five percent of their business. And our tariff rates would already have that fuel surcharge already attached to them.

Great, thanks guys.

Jordon Alliger, Deutsche Bank.

Hi, good morning. Just a couple of things. One, is it safe to say, given your comments on Intermodal and where you are, that we will actually start to see some positive year-over-year carload comparisons, perhaps in the fourth quarter or even earlier?

Once the year-over-year impact of the U.S. closures gets out of the numbers, we're going to be haunted with the road railer numbers through the first quarter of next year. But once (technical difficulty) carload, those adjustments get out, you will start to see increase in the carload numbers after that. Revenue numbers are not necessarily tied to that volume number, as you see in the results with numbers -- volumes being down significantly, but profits in Intermodal, actually, if you adjusted for exchange being flat.

Just a second question. And forgive me, I don't know if you mentioned -- the carloads attributable to Great Lakes, in terms of the total carload increase I think was 12 percent. I kind of could rough out what Great Lakes is, but I'm just curious if you could give a specific number?

It would be about 4 percent without GLT. It's about, I want to say, at 90,000 carloads -- pardon -- 87,000 carloads of business, predominantly in the metals and minerals area, with a slight number in coal.

Great, thank you very much.

Randy Cousins, BMO Nesbitt Burns.

Hunter, I wonder if you could talk about labor productivity? You've consistently sort of said 4 to 5 percent, and yet you consistently seem to blow through those kinds of numbers, in terms of GTMs (ph) per employee. Can you sustain a 5 percent plus productivity growth? The system just looks like it's firing on all cylinders?

I don't off we can sustain 5 percent, it depends. I am not -- from a total corporate standpoint, that's not a great number that I look at a lot, as far as GTMs per employee. Now I think if you peel it down and look below the level, you can get the better metrics. We are at a point today where, with just strictly raw productivity, I would call it, non-revenue, non-topline and non-price yield, so I'm not talking about an operating ratio number. That minus some labor agreement changes, we certainly over time cannot sustain 5 percent productivity gains. Now with the breakthrough, once again, of like we made in the U.S. over time, we could have a little -- we could have a three or four year where we could sustain that type of gains, but then it would start to have a leveling effect to it.

Just in the context also of productivity against operating ratio, could you give -- the GLT is a bulk carrier, BC Rail is largely a bulk carrier. Could you give us some sense as to what the operating ratio differential is between those two units and where your bulk business actually is right now?

I would say, Randy, that the BC Rail is more of merchandise franchise when you look at it down, in terms of forest products. But we are confident that the BC Rail will have an operating ratio at or better than CN when we integrated into our fold, just by virtue of having a regional railroad which has all of the stand-alone G&A that comes with it. You take that out and you get very quickly to operating ratios that are at or better than what CN is doing.

You are right, the GLT is more of a bulk railroad and the iron ore (indiscernible) it's the supply chain, and that has very good performance. For us, the rail portion has operating metrics similar to what CN is able to deliver. The only factor here that increases the operating ratio a little bit is that the vessel component has, just by virtue of the business, it has thinner margins because it has less assets to deal with.

Okay. And just strictly as an accounting question, Claude, you said the other items in revenue line is now where the vessel revenues are. Is that net of all the vessel costs, or are there costs in the vessel now -- vessels crawling through the operating expense line?

No, you have the vessel revenues in other revenues and you have expenses for the boat and against their normal expense caption.

Okay, thank you.

Scott Flower, Smith Barney CitiGroup.

Good morning, all. Just a couple of questions, actually picking up on the productivity theme, and I guess this would be for Hunter. I just wanted to see if you could circle back. I know a lot of time in the last couple of years, we spent, and you all have discussed with us, how you have improved asset productivity, obviously, first locomotives and then tiering and focusing on the car side. I'm wondering if you could give us a sense of -- are you where you want to be on the car side? Is there still room there, or is it these other initiatives, in terms of basically filling out train links? Obviously, the incremental acquisitions and your ability to pull those in and get leverage out of those. Where are you, in terms of some of the base productivity measurements on the core system? And are you where you want to be, or is there still more there?

There's still more there, Scott, particularly out of the car fleet. A lot of our productivity, if you look at total cycles today, are masked to some degree because of the deterioration in our connecting carriers. So we have made significant impact improvements with the center beams, velocity, just raw speed and the velocity of the cars. But what we've gained has been given up by the U.S. connection. So as there is improvements in the North American network, we will see continued improvement in their center beam fleet and across the board. Our strategy going forward, particularly driven, as you can see, by our labor strategy, of going to an hourly compensation, is speed and velocity. And that is why, to some degree, we've talked about adding a little bit more of capital than normal. Take a look at moving this up into 60, 70 mile-an-hour railroad, to higher speed.

But without that, there is order of magnitude of what I can see and we understand today probably 15 to 18 percent that we can look at in the car fleet. Not that much probably in the locomotive without getting a little smarter than we are. But some of the additional opportunities in the car fleet is relative to the market behavior. Market behavior in that they react to assessorial charges to merge and other things like that, so there's big opportunities to pick up asset utilization there. It is amazing if you looked at the stuff and the number at what weekends cost, the people that now we are encouraging to load on the weekends, and if you have seven-day workweek, rather than a five-day workweek, particularly in a 365-day industry, that leverage is tremendous. So there's lot of opportunity in the car fleet.

This is just a clarification for Claude. I know that when you give us some sense on how you look at the second half relative to GLT and BCR, I think if I recall in my notes, it was 13-15 cents. And then you talk about double that next year. I guess I'm just trying to get a sense of, if that is just the second half, wouldn't it be something in the order of magnitude of maybe a little bit less than four times? Is there some distinct seasonality? I'm just trying to make sure I understood your statement on what you were looking for in the accretion of those two acquisitions?

Basically for 2004, and that includes a month and a half of second quarter performance for GLT, we see the accretion for GLT and BC Rail combined in the range of 13 to 15 cents. It's difficult to get a lot more precise than that. For next year, we see as a scope to double that and maybe a little bit more if coal on the BC Rail comes out early. And part of the reason, and I guess that's what you were alluding to -- part of the reason --.

(indiscernible) proportion, it seems like it should be more.

I think that's already quite accretive. It's close to the 7 percent or so accretion for two very small deals. The GLP has a very strong seasonality in the second quarter. Their first quarter performance is a loss when the lakes are frozen, the second quarter, which we are picking up in spades in this year, is a strong quarter. And so overall to the best of our ability at this point in time, we see next year in the range of 25 to 30 cents of overall accretion, with upside depending on coal and the speed at which we do the synergies.

Terrific, thank you very much.

Jacqueline Boland, CIBC World Markets.

Hi, guys, good quarter. Can you talk about -- you mentioned that you think that there might be an announcement in the next two or three weeks on Prince Rupert. Can you talk about the timing of your investments into that facility and where you see that ramping up?

Well, we made commitments relative to the BC Rail acquisition in the neighborhood of $15 million. And a lot of that, if I remember correctly, about half of it was to provide double-stack clearance on the route and about half of it was for infrastructure in the Prince Rupert area, basically track structure, to support an expansion of the terminal operation. We would, given that the announcement contained what I would hope it contained and anticipate, we would almost immediately start spending those $15 million to provide the clearances and the infrastructure to support Intermodal growth in Prince Rupert.

What kind of timing would it be before -- how long do you think those projects would take?

Probably 12 to 18 months before we'd see the first big revenues jumps or hits with the Intermodal shifts calling on Prince Rupert.

On the other revenues side, Claude, you mentioned that GLT, some of it was GLT. How much of GLT, of the 58 million in revenue, was in the other revenue line?

It's about $20 million for the (indiscernible) operations and for (indiscernible).

Okay. And should we expect that going forward? How's the seasonality in that, then? Is it second-quarter heavy, and how heavy?

Very heavy. As I said to Scott earlier, basically, in the first few months of the year, the lakes are frozen. There is no vessel operation. Then the minute the ice breaks, they go gangbuster and move as much as they can before -- in the following two quarters to three quarters. So there's a very heavy seasonality weighted towards Q2 performance.

Okay, that helps. Thank you very much. And on the road railer, can you just remind me of the size of the road railers so that we know what is coming out of Intermodal going forward?

That was about $20 million in revenues, not a big operation for us.

Over the year, and that will kind of wind down slowly?

The revenue is gone.

It was at second quarter.

With never started it back up after the strike.

Okay, thank you.

Jennifer Ritter, Lehman Brothers.

Good morning. I just wondered if you could comment a little bit on capacity. You had said that roughly you have about 16 to 18 percent capacity on average kind of left in your system. Can you give us some color on that? I feel like you're operating at a very high capacity today, given that the economy is so strong and grain is going so well. What sort of an average year capacity number that you guys like to operate on? And also, is 100 percent your best case capacity, or is there a point below 100 percent that your network really runs the best it can possibly run?

I don't understand the question, (indiscernible). We're talking about two things from a capacity standpoint. Number one, this railroad will never run at 100 percent. I hear others running at 118 percent, but I've never figured out the math. But we'll never be at 100 percent. From a physical plant standpoint, actual physical plant, we are at on an average probably at no more than 80 percent. But the point I want to make is just incrementally, just by adding strategic signings, you can start to add to that capacity very easily. So we are not going to get ourselves caught to the point where if we see a big run-up in gain market share and all that we're going to get caught from a physical plant standpoint and not be able to handle the business.

The second issue then becomes train capacity. Of our existing trains, merchandise trains, what percent of their capacity is used? And you can look at that two different ways. If you look at it with a normal locomotive complement today, normal being 1 point or so, 1.1 horsepower per trailing ton, which would be our normal capacity, we're running at -- we have moved up probably to about 76 or 77 percent of the available capacity we are using. But, incrementally, with additional locomotive, you can raise that capacity up, and then you're only constrained by length of train or tonnage. Bottom line, there's a whole lot of capacity left out there and we can add to it with very low incremental cost.

Great, thanks very much.

John Barnes, Credit Suisse First Boston.

Hey, good morning guys. Very quickly, Hunter, has there been anything surprising at BC Rail as you've bought it? I think you've only owned it for I guess nine days now. But as you have dug into that piece of business, has there been anything surprising, either on the positive or negative side?

No. I think, John, only that the further we peel back, that there's more opportunity there maybe than we originally thought. Is it some huge gain or did we strike gold? No, but we're very confident that everything we have said that would come out of the BC Rail transaction has come, and there is more to come. So we are very pleased. And every day, we are guilty of maybe patting ourselves on the back too much.

Do you envision a scenario? And if so, what is that scenario that you would need, the 40 locomotives you currently of leased out to another rail? And if you needed them, how quickly can you get them back into the system?

We have a deal on the callback, and I think typically what we do, and I'm sure this is what the operator guys (indiscernible) -- on a 30-day notice, they have to come back. And if they don't come back in 30 days, there is a huge penalty. Plus, we have locomotives, our new locomotives, come in the fourth quarter. So we're not going to get caught without locomotive.

How many new are you taking delivery in the fourth quarter?

Over the two quarters, 40.

In just looking at this, and Hunter, you have been through these service issues before. Is there anything you see out there on the horizon that worries you about this congestion spilling over and negatively impacting your network more than what you alluded to earlier with some of the car issues? Is there anything you see that worries you a little bit?

Not any worst-case than it is today, John, (indiscernible) oversimplify this thing. There's two carriers that are having some problems. I don't think, and once again, I'm certainly not an expert on this, but I don't think it's going to get any worse. And I read what you read, it's a lot of things they're doing to improve the situation. I think it's fair to say the other two carriers have made, I think it would be fair to describe, as pretty significant improvements. So those two have improved, the economy is picking up. The other two have initiatives in place. And so I'm hopeful that this thing will get better, but I am fairly confident that it's not going to get any worse.

Last question. Have you responded to the STB chairman's letter concerning plans for peak shipping season? And if so, did you have to outline any material changes to how you currently run the railroad on how you plan to handle peak shipping season volumes?

We don't have peak season. We plan not to peak seasons and we do respect and we gave a lot of details to the chairman, but it was basically more of the same. We don't have to pass the issues today. We're anticipating strong volumes for the second half of the year and that we have every gear on a relative basis and we've planned for that and it is not going to surprise us. And so as far as our network goes, relax.

Very good, thank you for your time.

Horace Unekin (ph), Westwind Partners.

Good morning. My aim is to explore whether CN's latest quarterly result is indicative of financial results that the railway could report in the future, or whether some unusual circumstances that are not likely to be repeated contributed to the strong financial performance in the second quarter. Specifically, can you tell me if there were any accounting adjustments that explained the latest financial results, other than the employee termination expense that Claude referred to?

I would say that it's a very clean quarter. If anything, other than that specific items I've mentioned, if anything, we have more accounting accruals of a onetime nature than lift. So this quarter just shows the strength of our model with strong grain performance, you have the ability to accommodate that growth at low incremental costs. You get to a number that is in the range of 35 percent, just on the strength of our ability to handle that growth. For the first half, as I said, we have delivered 21 percent. If it was not for the strike, we would have delivered about 25 percent EPS growth for the first six months. And a lot of that is because of the grain comeback and this operating leverage that slows the bottom line results.

For the second half of the year, you will see obviously a slowdown in the grain business because we are lapping. But nevertheless, we're expecting, as I said earlier, the second half to be about 15 percent, up to 15 percent EPS growth. And that would give us a full year in the range of 16 to 18 percent EPS growth. All of our quarters, except for the exchange headwinds and the strike impact that we're talking about, have no accounting element of any major significance. Those are clean results.

Thank you. Secondly, can you provide me your assessment as to the extent that the recent market share gains made by CN might be reversed in future periods? I'm wondering whether CN has temporarily benefited from the congestion problems suffered by the other class one railroads?

The only area where we would have the potential to pick up short-term and quick gains from the congestion issues would probably be in the Intermodal business that would divert from Long Beach to Vancouver. And you can take a look at our Intermodal numbers and we're not seeing that kind of a short-term peak. That would be inconsistent with our operating model in IMX.

Thanks, that's all for me.

I would like to turn the meeting back covered to Mr. Harrison.

Thank you very much, Nancy, and thanks again for joining us and we look forward to seeing you next quarter.

Thank you, Mr. Harrison. The conference has now ended.