Canadian National Railway Co (CNI) 2005 Q3 法說會逐字稿

Welcome to the CN third quarter 2005 results conference call. I would now like to turn the meeting over to Mr. Robert Noorigan, Vice President Investor Relations. Ladies and gentlemen, Mr. Noorigan.

Good afternoon. Thank you for joining us today. We're going to do CN's third quarter financial results. With me today is Hunter Harrison, the President and Chief Executive Officer of CN, Claude Mongeau, Executive Vice President and CFO, and Jim Foote, Executive Vice President Sales and Marketing.

As usual I will say today's remarks 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 actual results to differ materially. Please refer to CN's annual and quarterly MD&A and information form and form 40-F for discussion of such risks, all of which are available on CN's website.

Also today, presentations may refer to non-GAAP financial measures for purposes of comparability. Please refer to our website for reconciliations to GAAP. The Q3 2005 financial statements and notes are attached to our press release and also available on CN's website.

The question format after we finish our presentations, we'll take questions from those of you who are listening by phone. Please identify yourself when you're asking your question. In order to be fair, could you please limit the number of questions that you're asking to two.

With that, it is my pleasure to introduce CN's President and Chief Executive Officer, Mr. Hunter Harrison.

Thanks, Robert. Appreciate that. Welcome and good afternoon. I trust by this time that you have seen the press release and our website presentation. Clearly it's another record quarter for this organization, but I need to share with you that these results were produced with some pretty challenging obstacles that we've faced in this third quarter.

We had the unfortunate incident at Lake Wabamun. We had a serious derailment in Mississippi where we lost some employees and we faced two hurricanes. And so in spite of the fact that I'm sitting here proud that we had the financial wherewithal to deal with these from a financial standpoint, I can tell you that those incidents put a chilling impact on this organization, and it's hard to be pleased with a quarter when you've faced those type issues.

But we've got to move on, and as I said, in spite of those obstacles, we, from an EPS standpoint, we produced $1.47 in earnings, up 24% from last year as reported. There's some one-time pluses and minuses in there that I'm going to let Claude go through with you and explain. From my perspective, this is as good a service quarter as we've had. Our service throughout the network with our customers was consistent. That's why I think that we've been able to consistently take the modest price increases that we've had and have seen improvement in the quality of our revenue.

We also clearly, as you see from the results, had some pretty outstanding productivity gains continuing. That supported the real improvement in the operating ratio, and one of those measurements, just to give you an example, was gross ton miles per employee was up 7%, and I guess the area -- one of the areas that I'm the most proudest of and continue to be impressed with is the free cash flow that was generated is $1 billion over the first three quarters.

So certainly from a financial standpoint, it was an outstanding quarter, and let me call on Claude here to give you some of the blow-by-blow details of the financials.

Thank you, Hunter. I'm also particularly pleased with the results, as you said, Hunter, it was a tough quarter, particularly with the unfortunate and very costly accident in Alberta. The cost of that accident, on the uninsured portion of that cost totaled $28 million for us, but nevertheless, we delivered solid earnings of $1.47 per share. That's up 24% over 2004. We had some help below the line which basically offset the cost of that accident.

Other income came in a little stronger. In fact, about 20 million stronger than last year, half of which is due to a realized foreign exchange gain which was close to $10 million during the quarter. We don't normally have foreign exchange realized gains or losses of that magnitude. Our effective tax rate was also lower by almost two points, lower than the 34% guidance that we are providing you normally. The effective tax rate was at 32% because of some favorable adjustment. So when you take into account those two elements, all in all you could say that $1.47 is not a bad proxy for a run rate in terms of our actual performance in the quarter.

Two key factors, once again explain this very strong performance. First we had solid top-line growth, revenues on a reported basis were up 6%, or 10% adjusted for foreign exchange. As Jim will explain to you in a minute, solid yield performance and also strength in most sectors. The second factor is solid cost control. The railroad was very fluid and we're continuing to make solid progress on a number of key productivity drivers. All of this led to a 63.3 operating ratio, which is a full 210 basis points better than last year.

Let's take a minute to review the expenses in more details. Total operating expense, adjusting for the 50 million benefit from exchange came in only 6% higher than last year. This is very good performance when you consider the cost of Wabamun, which shows up in casualty and other, and also the headline increase in fuel costs. WTI during the quarter on average was at $63 per barrel, which compares to $43 during the third quarter of last year. This drove a 44% increase in our cost of fuel net of our hedging gains.

We had, as you know, during the quarter, just above 50% of our fuel expenses hedged at the roughly $30 per barrel. I'm particularly pleased with our performance on the labor front. We are leveraging here the merger synergies and also making attrition work for us. Our workforce was down a full 5% on a year-over-year basis, and basically that's helped us fully offset wage increases and also inflation and other fringe benefits.

Equipment rents came down again quite significantly, I might add. Some of this is due to higher income from other railroads, but the key -- the car velocity initiatives we have in terms of yard dwell time and other key initiatives we have on this front, and also the benefit of integrating the BC Rail fleet, which allows us to have more of our goods moved on for our own fleet when BC Rail was an inter change partner. Purchase services and material behaved in line with expectations, with just a 4% increase, driven mostly by higher equipment costs in terms of repairs.

Let me say a few words on cash flow before I wrap up with the outlook. Cash flow at more than $1 billion reached a record for the first nine months of the year. This is a full $300 million higher performance than last year. The key is improved profitability but we also benefited from strong revenue collection and also much higher deferred taxes. What's driving our deferred tax is the use of the BC Rail attributes which are shielding taxable income and helping to lower our cash taxes quite significantly.

The excess cash that we are generating is being used to bay back shares in the open market. During the quarter we repurchased 4.8 million shares, or just under 30% of our 16 million shares program, which was just announced at the end of the second quarter. With the strong start for the first nine months we are well on our way to achieve the high end of the guidance we provided you of $1.3 billion in free cash flow for the full year.

So let me wrap up with the other key elements in terms of outlook. With the strong third quarter results we are closing in on another record year. I would say there's still a lot of railroading here before we can ring the bell, but I am comfortable with the high end of our guidance. That is a full year EPS growth of 25% and free cash flow of 1.3 billion for 2005 as I indicated. The strong momentum is very good news for 2006, but before anybody gets too carried away here I would like to say the less so good news is that we will indeed need a lot of momentum for next year to address some key head winds that we are facing.

The two key ones are fuel and pension expense. On the fuel side, you're not without knowing that WTI on a forward curve basis is at $62.50, as we speak, but also the crack refining margin is at an all-time high of around $18. So when you factor those two elements, we could see our expenses and fuel next year go up by on the order of 200 to $225 million.

On the pension front, the record low interest rates that are currently in place in Canada and in the U.S. are adding an impact on our discount rate which we use to book our pension expense on an ongoing basis. If they stayed at the level they were at the end of September, we would be outside of our corridor and could see an increase in our noncash pension expense on the order of $50 million.

So these are two head winds we will have to deal with. Having said this, we remain quite bullish about our business, and we will provide with you a lot more specific guidance when we meet in New York later in November. Jim.

Thank you, Claude.

I would like to take the opportunity to go through the revenue numbers in a similar fashion as I have done now quarter to quarter, that being on a pro forma exchange adjusted basis, so we can look at these numbers more apples to apples. Most of the difference in this quarter is associated with exchange as GLT's results were in the full quarter, Q3, last year, as was BC Rail with the exception of only two weeks at the beginning of July. So most of the adjustment is associated with exchange.

On that basis, as Claude said, pro forma exchange adjusted revenues up 10%. Volume during the quarter flat. Price in the range similar to that achieved over the last two quarters, 3%. The fuel surcharge, having an increase in revenues in the quarter of 4%, and mix having a positive impact during the quarter of 3%. Again, rounding out to 10%.

That positive mix being more and more traffic growth coming on line in western Canada, lumber in particular as it shifts its production base out of eastern Canada and more into BC and western Canada. That's a favorable result for us. As is the growth in this quarter coming on line in the intermodal segment through the port of Vancouver. So, again, a positive result for us there.

In the major business segments, merchandise up 7%, bulk very strong in the quarter, 20% growth in intermodal 11%. Broken down in more detail, petroleum and chemicals down 1%, we had quite strong shipments during the quarter of petroleum products, but that was more than offset by reduced shipments of petrochemicals and plastics, the gas-related businesses that we serve both in the gulf and in western Canada being somewhat down due to the high gas prices, as there was some impact during the quarter in those business segments as a result of the hurricanes as well.

Metals and minerals up 9%, very strong performance in all of the various segments in metals and minerals. Our ore business being up both in the iron and copper ores. Strong pipe movements due to the gas and oil construction activity, and construction materials, aggregates, sand, cement, et cetera, being driven by continued growth in the construction markets both in Canada and in the U.S.

Forest products, the strength of the franchise here, again, 11% growth, lumber a strong lumber being up 11%, panels up 9%, the housing market continues to have a strong run rate, record run rate, and that's -- that continues to drive that business, although there was some slight aberration at the end of the quarter that due principally to some declines in lumber prices, but that business is certainly bouncing back.

The paper business, we are continuing to see opportunities in our paper business. That was up 6% in the quarter. We are moving and gaining market share there, and one of our major customers in eastern Canada came back on line after a long strike. So the forest products business doing very well.

Automotive, the Nissan facility in Canton is at full capacity, and strong imports as well, through both Vancouver and Halifax, where we have some declines with some of the major producers, the sales rate for vehicles continues to be pretty strong and consistent, and we're picking up more import business through the ports.

Bulk traffic, as I said, very good, 20% in bulk. Canadian coal being, once again, very, very strong. Coal up 18% but Canadian coal up 82%, representing the new mines that have come on line in late last year, and they're now producing these strong results in '05. Coal in the U.S. being down slightly due to a mine issue with one of our major customers there.

Grain and fertilizers being up 20%, grain Canada almost 30% with good export moves of barley, canola, peas, through both the Vancouver and Thunder Bay, and grain in the U.S., with feed grains being up 24% with some good strong shipments into the poultry markets. Fertilizers was also up by 23% during the third quarter.

On to intermodal, I said we had some opportunities for growth coming through Vancouver. We've added capacity there. Our overseas business, the import-export segment of the intermodal business being up 15%, and domestic, the retail and wholesale part of that business being up 6%.

Again, this import export business with the new train and capacity added through Vancouver is helping us, as is the business coming through the East Coast, the port of Halifax, where as I said last quarter, call, China shipping had announced that they were intended to make a port of call there, starting up the Suez trade, the Asian shipments through the Suez into North America, that way, and that has actually started now with vessels being unloaded there as we speak. So the outlook continues to be favorable.

The merchandise outlook, there's strong demand for the petroleum -- in the petroleum segment of the business. We'll have to continue to watch whether or not the softness in the gas related, the petrochemicals plastics end of the business offsets that growth as gas prices stay high, but from a merchandise perspective, that should not be a damper on that segment, forest product, the outlook there is very favorable as new construction, new production capacity comes on line in the fourth quarter with lumber capacity and panel capacity being added by our customers in British Columbia which will increase volumes there, as well as we will continue to maintain and gain market share in this new segment of this white paper shipment for our customers into our distribution facilities in the U.S. That traffic is all coming on line at -- from a market share gains from trucks and is a great growth opportunity for us there.

Metals and minerals, construction related activity outlook positive. The bulk franchise, again more growth coming in Canadian coal, the demand for metallurgical Canadian coal up. Canadian grain stocks added with the pretty high carry-forward from last year's crop gives us the most amount of grain stocks to move since the 2000-2001 crop year. So very bullish on the bulk franchise outlook for Q4 and into next year.

In the intermodal growth we have the available capacity, we have the opportunities to continue to put on train service to meet the needs of our customers both in the east coast and the west, and that, as a result of our very significant focus on improving the profitability with our IMX program has now positioned us to take on more volume growth, and we are doing that.

Overall, the pricing environment remains good. The outlook is similar to that that I have said in the past. We want to be very responsible in this environment and continue to focus on price increases in the 3% range. That's what we have been achieving, and I sense that that will continue into the future.

So with that I'll turn it back to Hunter.

Thank you, Claude, and Jim.

Let me just briefly summarize this way. This was clearly another quarter of record results. Solid operating performance across the board under some very difficult circumstances. This model is clearly working. The railroad is running as well as I've ever seen it run. It continues to prove every day.

At the same time we have a pipeline of some pretty exciting initiatives and opportunities moving forward, and we are working diligently now to prepare a new long-term vision for you in November at our analyst meeting, and we'll give us some opportunities to share some of those thoughts and some of those initiatives that are in the pipeline. So with that, Lisa, we would be happy to answer questions the group might have.

Thank you. We will now take questions from the telephone lines. [OPERATOR INSTRUCTIONS]. The first question is from Jim Valentine of Morgan Stanley. Please go ahead.

Thanks. Guys, another impressive quarter, especially in the face of some challenges here. I had a question on fuel in the sense that you have put in a new fuel surcharge which actually lowers the surcharge and it seems a little counter-intuitive but I think I understand why you're doing it. I guess what I'm trying to get my hands around, is what percentage of your revenue is -- will be covered under the new surcharge program, namely what portions of the contracts will allow you to -- or basically take into account this lower rate, and what impact is it going to have on your -- the revenue for the fourth quarter, or even '06 if you want to go out that far.

Hi, Jim. As a result of being very steadfast with our customer base and moving more and more of our customers on to the fuel surcharge, it's a benefit for our customer base, as we're able to lower the fuel surcharge. The percentage of customers that are on, or have the availability -- well, all customers have the availability to go on to this new fuel surcharge.

The people that are on the lower fuel surcharge right now would be around 20% or so with the remaining percentage on the old fuel surcharge but we'll over time migrate to that. What we want to do is just have one fuel surcharge that applies to all the customers. That should in no way have any change whatsoever in our outlook and guidance that we have given here for our revenue growth going forward either the rest of this year or into next year.

Okay.

We have not -- again, this is is not -- this is viewed as clearly just a cost recovery mechanism and not a profit center for us.

Okay. Good. What portion of your customers now have some form -- would portion of fuel inflation do you think you're capturing now, let's say in the fourth quarter?

Short answer is all of our customers are covered in some way, shape, or form, to protect us from fuel. Those that are paying a direct fuel surcharge, excluding those would it make no sense for us to apply it to, i.e. like regulated grain, of those that we can apply fuel surcharge to, about 90% are now covered correctly by one of our two fuel surcharges.

Right. Makes sense. One other fuel question. If we assume $65 a barrel of oil, If I'm doing the math right, I think that your surcharge comes out to about 11.5% and Canadian Pacific comes out to 19%. What's the probability that you can benefit from this in terms of taking market share because CP has a higher fuel surcharge?

I think it relates more to do, obviously, with our service. We want to focus on our service. Principally what it's doing here is giving a significant spread between our cost structure and the trucks. So we want to focus on that market where the greatest opportunity lies for us.

great. I've got a few more questions but I'll queue in later.

Thank you.

Thank you. The following question is from James David of Scotia Capital. Please go ahead.

Thank you. Good afternoon.

Hi, James.

Hi. Just on the pricing, Jim, I appreciate on an FX-adjusted basis, 10% you gave us a breakout, but if I look at sort of the reported 5% on an per-RTM basis can I just say 1% mix, 2% surcharge, 2% organic price? Is that close? In terms of how that would break out?

Just splitting that in half? Sure.

What sort of reactions are you getting from customers vis-a-vis pricing? Obviously pricing has been very important for the last few quarters. Is this something where you have long-term visibility, that they can continue to handle, it's been a very significant reversal from a very devastating trend, if you will, over the last few decades.

Well, it's certainly a reversal, but it's a reversal that we started here, long before the rest of the railroads began to realize price increases. Our price increases have been always focused on the level of our service going back to this trend starting to turn around in the 2001 time frame, as we -- refined the scheduled railroad.

So I think if we continue to focus on the fact that what we want to provide is a good quality product for our customer, that we are -- that we are very careful in that we charge a fair price for that service, I think that this trend line is certainly sustainable into the foreseeable future.

Okay. Thanks, Jim. Second question, just on the forest products. You've got sort of two competing forces right now in terms of the outlook. There's a lot of discussion surrounding the structure rebuild and the Gulf Coast, and that will be a draw for construction material and lumber. Then we're hearing the BC government is very concerned about sort of insect devastation. Can you speak to those two issues?

Both of which are opportunities for us. Obviously the rebuilding process in the Gulf is going to have an impact on the price of lumber. Higher praise of lumber is good for our customers, so we're looking to work with the major BC producers to feed into that strong -- what was already a strong and now strengthened marketplace. Compounding that on a positive side is the fact that they have this lumber out there that's being infested with the beetles that they need to cut, and they need to harvest, and they want to get it out of there, they want to cut it and they want to move it. So great available demand driven by the need for them to harvest it into a market that's strengthening.

That's all for me. Thanks.

Thank you. The following question is from Scott Flower from Citigroup. Please go ahead.

Good afternoon, all.

hi, Scott.

Just a couple questions. One was in understanding you'll probably cover this more in November but I was wondering if Hunter or Jim could give us some color on some of the initiatives we've talked about in the past in terms of smart yards and CX, give us some color of where those are in the progress curve.

Yes, I'll give you a little bit. Smart yard, the prototype is being tested at Mac yard in Toronto. That -- the same version of that product that would apply to the flat yards will then be shortly thereafter tested in a different environment. We are encouraged by some of the initial results, although I'm a little frustrated with the timing, it's not gone as quick as I thought it might be. I think it's going very well.

I think I'lll ask Jim to comment on CX. I think all the things and initiatives that have generally speaking been led by Jim and J. J. Ruest's team with CX have gone very well for us. And I would only mention one other thing; the routing protocol has worked and is working even beyond where I thought it could and it's got some additional potential going forward. So Jim, do you want to make any comments on CX?

Yes, we've made great strides in trying to normalize our car fleet, get down to more generic types of equipment, eliminated many of our car pools, our weekend loadings in the merchandise segment continues to increase, so generally, and thanks for the opportunity for the little promo here, things are on track and we'll get into these and other initiatives at the analyst meeting next month.

Then just the second question, and I know, Jim, you gave us some color as you lacked at the foreign exchange adjusted revenues but when I just look at the RTM side obviously RTMs in total were down this quarter. I'm just trying to -- obviously bulk was up, but then some of the merchandise categories were down. I'm just trying to get a sense of -- are we getting to a point where aggregate demand is not as good, and the pricing environment versus truck and/or your ability to mix up is really what's going to drive more of your revenue growth going forward versus when I look at units, obviously RTMs having length of haul in there, they're slightly down now after lapping the M&A comparisons.

Obviously the environment for to us to concentrate on yield is something that's going to continue, but we are certainly not anticipating flat volume growth going forward. As I said, there are opportunities for us in market share gains from truck as our cost spread continues to increase despite the fact that we're going to be raising prices. There are new production plans coming online, so it's very much some of the same old story. Scott, we're going to grow the business both in terms of volume and yield going forward, and I don't see that this kind of aberration that we saw coming on line continuing.

Let me add something to that. I think something that we should be preparing for going forward, I think as we go forward, revenue ton mile numbers are not going to be nearly as important because it's not going to have the degree of accuracy that it ever had, and the reason is we don't sell in tons any more, we sell in carloads. Intermodal, our weights are estimated. From a carload standpoint, a lot of the carloads, most of them are sold on a carload base, not a per ton type basis. So a lot of the cars today are not weighed. They're only weighed from an audit safety purpose. So as we move forward, and one of the things I've been giving a lot of thought to, is what is the appropriate measurement to sometimes step in and take over for the RTM of the past.

Okay, thank you.

I know your model doesn't like to hear that, but it might have to be some adjustments.

Okay.

Thank you. The following question is from Bill MacKenzie of TD Newcrest. Please go ahead.

Thank you. Claude, first question for you on the cash flows next year, and I know you'll go into more detail in November, but just on the cash taxes next year, you touched a little bit on that in terms of the -- sort of the shield you've had up to the BC Rail acquisition. Can you give us a sense as to roughly how many of that comes off next year in terms of how much the cash taxes might up in '06?

Well, we'll be discussing it in November in more detail, but we are approaching now the time where our tax attribute will basically fade away. So, into 2006 and 2007 is you will see a gradual increase in our cash tax rate, and so that will put a bit of a headwind in terms of our cash flow, but generally speaking the -- it's more in 2007 that you'll have the impact than 2006.

Okay. Great. Then secondly, just a bit of a more sensitive question, but with the derailments this quarter being sort of unusually high, some people are -- have asked the question and wondered if CN from an efficiency perspective needs to invest a little bit more on the maintenance of the railroad.

I'm just wondering if you think that is the case or if these issues that happened this quarter were more sort of anomalies, anything that doesn't necessarily require any increased sort of maintenance on the railroad. Just your overall views on that I guess.

Well, if you -- if you look at that time three occurrence that got attention, I'm not saying they're the only ones, but the other ones are relatively minor, clearly one of them was caused by human failure, which doesn't need to spend additional capital in the infrastructure. Maybe we need to do a little better job of training and development but does it not have an issue from a capital structure standpoint.

The other -- one of the other accidents, we frankly will probably never know what took place because all the evidence went away, but it was not due to any infrastructure failure. For some reason one of the trains didn't stop at the signal, so it was not a case of once again infrastructure. Now, the Wabamun incident, in our view, and you'll get your perspective at some time from the various regulatory agencies that investigate, but we clearly thought and reported the second day it was caused by a broken rail. The rail was 20 years old, it was an internal flaw and defect, so I don't think this is the result this quarter are any reflection on deferred maintenance or not spending the right amount at the right places.

In fact -- I don't want to get into statistics because people can do anything they want to with statistics but we keep a close eye on these issues. It's obviously critical to our business and -- will we make some adjustments? Yeah, we're never perfect. Were there some things we learned? Yes, there were some things we learned, but I don't think it's going to have any major impact on what we're going to be going forward -- I think we're the most efficient carrier and I think we'll remain the most efficient carrier and I don't think it has anything to do with any deferred maintenance or system policies.

Okay great. Thank you very much.

Yes, sir.

Thank you. The following question is from Ed Wolfe from Bear Stearns. Please go ahead.

Just was wondering what's going on with the yield on the metals and minerals. It seems like the carloads are down, the revenue per carload $100 sequentially, and I'm guessing some of that is mix and some of that might be currency.

Short haul, the ore is moving more and more over the dock at Duluth, which is about a 62-mile haul for us. So we were moving some of that further the third quarter of last year, so it's all just based on length of haul.

And that continues, going forward? Should this be in the 800 range a car load and going forward? How do we look at that?

Again, unless we get some demand to move that ore more again, over to Vancouver, or to Prince Rupert, which we don't have any right now, this is probably more appropriate run rate.

okay. There was a release recently by Western Canadian Coal Corp about an arbitration case. Can you talk to where you stand with that and what the potential impact there is?

Yes. I mean, the question here is it's more -- not going to comment on necessarily the specific details, but we are challenging in essence the fairness or the constitutionality of the law. It's something that we have been focused on for sometime. This challenge really had nothing to do with the specifics per se of the case with Western Canadian Coal. It's just one of a timing issue that involved them. The -- the magnitude of that award financially really is not even noticeable in our results.

But let me --

is there a potential here that if things go your way this could apply other places and can you talk about that potential?

Let me talk about it on a broader base. We are not opposed to FOA. We believe that everybody should have the right of appeals. We just think it out to have some structure and ground rules.

Tell me what is out of bounds, rather than saying to an arbitrator, you decide based on arbitration whether the shipper's rate is right or whether our rate is right. Tell me what is appropriate, tell me what are the boundaries? Give me some structure so we can know and try to avoid these confrontations with the customers for FOA.

So all we're asking is for that to be reviewed, and we think it's appropriate and we'll be raising our voice in Ottawa that the law should be maybe amended and changed to add a little more structure and guidelines.

So if you were to win that appeal there's nothing that the next day gets restructured? It's just kind of an ongoing change in the regulatory environment.

No, I just think it could have been a better environment to work with the customer in a more positive way rather than the law kind of creating that adversarial relationship.

Okay. Just switching gathers for a second, when we look at fuel surcharge in the quarter you reported versus a year ago, trying to understand kind of the magnitude of what you collected. The cost side is pretty clear but on the revenue side can you give some sense of what you collected this quarter versus --?

I said 4% of the 10 was fuel.

versus a year ago?

Correct. Or on a reported basis somebody said split it in half. I'm pretty comfortable with that one, too.

Thank you.

Thank you.

Thank you, the following question is from Thomas Wadewitz from JP Morgan. Please go ahead.

Good afternoon. Two questions for you. On the yield side, you did mention about mix. I'm wondering, how should we view that going forward? I look particularly at grain yields were very strong year-over-year, and forests were very strong year-over-year. If the grain is a function of stronger Canadian grain and that mix benefit do we expect that to continue for a couple more quarters and likewise with forest product are those mix issues going to the for a couple more quarters?

I think from a forest products perspective, yes, we will see -- we will continue to see the trend of the lumber growth coming from western Canada which is favorable to us. Similarly, it appears right now that the intermodal import-export business, which has a lot of potential for us going forward, and when we open up the new port in Prince Rupert we'll have a great opportunity for us. It's a good trend from a mix standpoint, as it's a longer haul, profitable business moving all the way from the west coast either into Toronto or Montreal or Chicago and beyond. So those two trend lines in the forest product and intermodal will continue.

What about the grain side?

Grain is, you know, grain is -- always goes through one of three place. It's just a question of the crop size. So yes, you're going to see a more positive mix when we have a bigger crop because we're moving it. There's no significant change in its destination that would have any kind of long term positive mix trends.

Okay, but that should -- given the size of the Canadian crop and inventories,that should look good for a couple of quarters as you're transporting that.

We have a great -- we're sitting on a great amount of grain to move, and that's a good thing.

Okay, good. And then second question is on the headcount reduction side. You guys are always impressed with how efficient you can -- how you can make efficiency improvements and take out costs and I'm wondering if this 5% headcount reduction is partially a function of realizing further efficiency from BC Rail, and if that slows down a bit in 2006, or have you got more good things going on where we're continuing to see a 4-5% headcount reduction in '06.

Our strategy is quite simple. We're getting the short-term benefit from integrating the GLC and the BC Rail, so that's helping in those results as we speak, but if you take a longer timeframe we have been able to work attrition to our favor and to reduce our headcount anywhere from 2 to 4%, 3% would not be a bad number to be using, in terms of our ability to do more with lifts.

So do you still have some further BCR opportunity in '06?

In terms of labor reductions the two acquisitions are basically done with. That doesn't mean we don't have more opportunities on the revenue side, and more opportunities also from the integration of the last leg, but the bulk of the head count reductions are behind us as we speak.

On those two.

On those two acquisitions.

The rest of the headcount issue, Tom, will be basically across the board.

Okay. So a 3% type of number is a reasonable ballparkish thing to think about for '06?

Yes, and I think we're going to probably talk a little bit more about that in November with you, too.

Okay, great. Thanks for your time.

Thank you.

Thank you. The following question is from Ted Larkin, from Orion Securities. Please go ahead.

Question first of all for Claude. Claude, just in an attempt to normalize your operating ratio during the most recent quarter, can you quantify for us the revenues lost and the additional expenses realized as a result of those -- the two hurricanes and the two derailments?

I would say the hurricanes happened toward the end of the quarter. I don't know that it's really measurable in terms of impact. If you take just the Wabamun accident, 28 million that would have been another one point, 1.5 point reduction in the operating ratio, that order of magnitude.

1.5 points?

Yes.

Okay, and you're implying -- you're suggesting that there could be an impact in the fourth quarter as a result of some issues related to the hurricanes then?

No, if anything it's going to be a positive as we pick up more traffic to go down that direction.

Okay, and then the second question would be just on the repurchase program. Looks like you've got about 11.25 million shares left to go. Shares today are trading just about $1.50 above where your average price was during the last quarter, is it fair to say that you'll continue buying at these levels?

Yes, actually, if it stays the way it is today we're going to be buying aggressively tomorrow.

It's a stinky day today. Thank you.

The following question is from John Barnes from BB&T Capital Market. Please go ahead.

Claude, you rattled off a couple of the headwinds that you're facing going in to next year, and I recognize you're doing as good of a job on fuel as you possibly can, but understanding the headwinds what do you view as kind of the tail winds for the business? There's got to be a couple of things you're optimistic about. You've talked a little bit about the technologies and things like that, but is there, one or two things you look at in the next year that gives you confidence that you've got an easier cop in some aspect of your business?

Well, as I said, we've got a lot of momentum, all of this performance that you see in Q3, whether it's on the underlying productivity or whether it's the quality of the revenues coming our way in a high fixed cost business, all of that is tremendous momentum supporting our business going forward well into 2006 and beyond. I just want to point out to people just so they don't get carried away that we also have some head winds next year and two of them are particularly volatile. The fuel expense, which is more well-known, and the pension issue which relates to interest rates which I felt was important for to you start to factor into your thinking.

all right. I just -- I wanted to make sure it wasn't all doom and gloom. You hear headwind and you look at the stock's reaction and I just wanted to make sure we weren't missing something, you know, on that front. As we go into next year, and I know you're going to get more specific about it at your analyst meeting, but would you expect the cash flow that you generate in '06 to be used in a similar ways that you used it in '05 or, you just commented that you plan on buying more stock. Is there anything else you're contemplating as you go into '06 for use of cash?

Well, our use of cash totem pole is very simple. First, invest back in our business, if we can find strategic opportunities, like the BC Rail or GLT, that's what we go for. However, when you don't have those, our excess cash is to reward shareholders. Our balance sheet, as we've indicated in the past, is slightly underlevered, so the cash that we generate and then some is going to be used to buy back shares in the short term.

Okay. We should look out next year. I saw you announce the dividend again for the quarter. I mean, do you foresee a more material increase of the dividend? Are you comfortable with where it is and would rather use the cash to buy back stock? It gives you a little built more flexibility on a share repurchase than dividend?

We have a blend of -- like consistent increase in our dividend, and opportunistic repurchase of shares. Our policy is to gradually increase our dividend payout so you should assume in a year of 25% EPS growth that next year's dividend will increase and the increase, when it's set by the board, will most likely be a headline increase.

Very good. Thanks, and congratulations on a nice quarter.

Thanks, John.

Thank you. The following question is from Ken Hoexter from Merrill Lynch.

Good afternoon. Jim, you talked a lot about a positive outlook, but volumes at the end of the quarter really took a dip in I guess maybe the last two weeks and first two weeks of this quarter, they're looking like they're down again, particularly at coal and a bit on forest products. Talking about the positive outlook in a bunch of the mines that are opening up, can you delve into why we're seeing that?

The coal loadings that you're seeing down are in the U.S., which are short haul moves for us, due to some issues associated with mine production that not markets down there. Lumber, as I said, lumber, we had a short aberration, I would say, where lumber car loadings in the end of Q3 dropped off really associated with some pricing issues that were going on as some of the big box stores were using lumber for marketing purposes and drove the price of lumber down, and it kind of changed the market structure. That has come back. Our car loadings are coming back, and as I said, our outlook for the fourth quarter is very positive as new -- not only the general sense, the price in the market is good but we're seeing new capacity come on production facilities come on in the west.

Okay. So that U.S. coal is outweighing the growth of the additional new met coal mines?

That's where you see a lot of high carloads moving around, is in the U.S., very high number of carloads, short haul. The outlook, nothing is changed, the outlook in Canadian coal continues to be very, very strong, and we are exceeding, as I said, guidance before, we were going to double the small -- the amount to start with but we were going to double in the year and double it next year and almost do 200% growth this year. So the met coal outlook for Canadian met coal is very positive.

One last question if I may.

Ken, let me clarify something further. On the U.S. side, as Jim said, some of that coal is very, very short haul. And we've -- we have it on more or less the haulage arrangement. Indications are from the carrier that we're hauling for to some degree they're going to take some of that business and haul it themselves. So if you focus just on car load numbers, which I don't think is the way to focus, you're probably -- if they tell us, if they do what they say they're going do, as far as doing some of it themselves, you'll see the car load numbers in coal come down, U.S.

Okay. Then similarly on the petroleum and chemical side, Jim, if you could just run me down on the hurricane impact, Claude said there wasn't going to be much of an impact financially but similarly on the car load side we're seeing that down as well. Is that something that is due to the hurricanes, or is that more the pricing issues that you talked about earlier?

Two pieces to that business. The petroleum part of the business as one would expect with the high price of fuel is very good for us, moving gasoline, moving diesel fuel, jet fuel, et cetera, that part of the business is very good.

The gas related business, the plastics business out in Alberta and the petrochemical business in western Canada and the Gulf, production is down again due to high natural gas prices which is kind of offsetting that, and then combined with that at the end of the quarter was the hurricane impacts as they shut down much of the production capacity in the Gulf Coast region.

Order of magnitude just to kind of give you -- I mean, this is just ballpark, maybe would have changed the petroleum and chemical group, its performance 1.5 to 2 points difference. We were down one, maybe we would have been up one if it hadn't been for the hurricane. It wasn't anything hugely significant but would have moved that business unit around a couple points.

So are we looking for a down quarter in carloads if we're just looking at the car load number?

Going forward?

For the fourth quarter.

Again, going into the fourth quarter, we're probably going to be in the -- on a pro forma basis kind of flat. And then that's consistent with the outlook for the year that we have going in. Okay. Great. Thanks for your help, guys.

Thank you. The following question is from Robert Fay of Canaccord Capital. Please go ahead.

Thanks. Just want to firm up a little bit on this fuel, the ins and outs on the revenue line. Can you quantify in dollar terms your hedging gains in the quarter and also the fuel surcharge, what it meant on the revenue in actual dollar amounts?

As Jim said, in terms of the fuel surcharge, on a pro forma exchange adjusted it's about 4%.

is that $60 million?

I don't know, Bob. You can do the math. I don't have it in front of me. In the hedging gain was about $50 million during the quarter.

50 million. Okay. On the intermodal side, your revenue yield on that is up about about 9%. Is there anything in particular there that you're getting in that business? Is that a mix or is that a fuel surcharge, or is that rates? What's the driver?

All of the above. All of the above. The marketplace is very good for both growth and yield improvement, and you see the results -- you see the results.

Okay. Last question for Claude. The 28 million from Lake Wabamun, should we just basically take that 28 million out as we go forward in projecting the casualty insurance over the next couple of quarters? Would that be a good number?

Certainly our intention to run the railroad and not to have another accident like this, yes.

But basically the run rate is just take the 28 million out in the quarter?

That would not be a bad number to start with, yeah.

Thank you.

Thank you. The following question is from David Newman of National Bank Financial. Please go ahead.

Good afternoon, gentlemen.

Good afternoon.

Good quarter. Just on the crack spreads, if you had to look at how you're hedging your actual fuel consumption, the mix between WTI and, let's say, heating oil what would be the split? In other words, how are you exposed to that crack spread?

Well, we are -- let's take it all apart because it's important going forward. For 2005, we are hedged at about 51% of our consumption overall, of which 65% is on WTI and about 35% is on heating oil. As we enter into 2006, we are hedged only at 17%, front loaded in the first two to three quarters. And the same split in terms of crack margin and the -- or heating oil and WTI. So it's fair to say into 2006 our protection against the refining crack margin is diminishing.

And your overall mitigation obviously with the crack spreads where they are, if refining capacity does come back and obvious well your new mechanisms in place, how much of the overall book of business in '06 do you think you'll have covered? Will it have been similar to this year?

Today it's probably about -- if you just looked at the total book of business forgetting about what you can apply the fuel surcharge to, the total back of business about 78% of the total book of business has the specific fuel surcharge on it. That will be a higher number next year, about 85% of that back of business, which is getting pretty close to about 100% of what I can apply it to.

Excellent. Last question, Hunter, obviously you've been -- couple times you've been asked by the media what your plans are and what CN's involvement might be in the cleanup and the rebuild of New Orleans and Louisiana. Have you specifically been approached and what are your overall plans to help in the rebuilding of that area?

Well, I mean, number one, we have offered a lot of assistance down there. We were real fortunate that we did not lose any employees, number one. So -- and we worked with trying to take care of our own. We've made appropriate donations.

Now, Jim & Company have worked with -- are working with the various agencies there. Obviously there's a lot of stuff that's going to have to be hauled out of there. We're positioning ourselves so if they need to us do that we can do that.

Jim's people are scouring the areas for opportunities as far as transload and reload opportunities in the reconstruction of New Orleans to the degree it's reconstructed. So there's nothing we can put unless Jim has something later, there's nothing I can put my finger on right now and tell you. It's just we're positioning ourselves to be in position to help out with the reconstruction and take advantage of the business opportunities.

Have you been proved at all by I guess Canadian or the U.S. government about the potential trade war between -- on forest products and how that might potentially be lifted for a short period of time to actually bring more lumber down into the area?

We have not.

Very good. Thanks, guys.

Yes, sir.

Thank you. The following question is from Jason Seidl of Credit Suisse First Boston. Please go ahead.

Good afternoon, gentlemen. You mentioned some of the headwinds going into next year and that you're hoping the momentum overcomes it. When we lack at sort of the pricing gains by yourselves and some of your competitors this year can we assume that those need to increase in '06 to help offset some of those headwinds?

No, I think as I said we're very bullish about our business. We have Jim and his people have a very consistent approach to the marketplace, we're focusing on quality of service, quality yield and market share gains against truck. We are underlying productivity in terms of the range of initiatives that we have underway more of which we will talk about in November is quite compelling, and so we are overall very, very bullish about next year but there is some reality with a few big ticket items, and that's what we said earlier, the fuel price and potentially the pension expense if interest rates stay very low.

Thanks very much.

Yes, sir.

Thank you. Unfortunately due to time constraints we have time for one last question from Jordan Alliger of Deutsche Bank.

Yes, hi. Quick question for you. Given all the work you've been doing on intermodal and trying to improve throughput, et cetera, are the volumes responding as you would expect at this point in that process and how do you think about the trajectory?

Yes, I think that the volumes growth now that we are very -- we are comfortable growing at that business, are in line with our expectations. That is a business that one can increase volumes relatively easily. The challenge is always to make sure that we increase volumes and do so profitably and going forward, we're comfortable that we will be able to do that.

So does the growth start creeping up from sort of the low single digits to the mid single digits as the throughput improves? Is that the thought process?

Mid single digit to higher.

Okay. Thank you.

Thanks for joining us, and we look forward to seeing most of you in the analyst meeting in November.

November 17th and 18th in New York City. It's going to start at 5:00 on the 17th, and if you want details either e-mail me or call me at 514-399-0052. Thank you very much.

Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you all for your participation, and have a great afternoon.