Canadian National Railway Co (CNI) 2005 Q4 法說會逐字稿

Welcome to the CN, fourth quarter 2005 results conference call. I would like to turn the meeting over to Mr. Robert Noorigian.

Thank you, Mary. And thank you for joining us for CN's fourth quarter financial results conference call. With me today are Hunter Harrison, the President and Chief Executive Officer, Claude Mongeau, Executive Vice President, Chief Financial Officer, and Jim Foote, Executive Vice President of Sales and Marketing. Today's remarks may contain forward-looking statements within the meaning of the U.S. Private Securities Reform Act of 1995 and other applicable legislations. Such statements are based on information available at the time and involve assumptions that may not materialize. There could be a number of risks and uncertainties that could cause results to differ materially from what we present here.

Please refer to CN's annual report; the quarterly MD&A, annual information form, and other forms. All 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 2005 Q4 financial statements and notes are attached to the press release, as well as available on CN's website. After the presentation, we'll take questions from those of you who are listening on the phone. Please identify yourself when asking questions; and in order to be fair, could you limit the number of questions to two? With that, it's my pleasure to introduce CN's President and Chief Executive Officer, Hunter Harrison.

Thanks, Bob, appreciate it. And thanks to all of you for joining us. I'm delighted today to be able to talk to you when we've had such a stellar performance by this wonderful team of railroaders. Before I ask Jim and Claude to break down these results in some level of detail, let me spend a couple of minutes to highlight -- to highlight a few points. I think, first of all, if you look at our earnings year-over-year, fourth quarter, you see diluted earning per share of $1.56 are up 21%, and I think on a full year basis it was up 28%. If you look at operating ratio, we had another record. In fact, this is the lowest quarter we've come in at 61, 61.8, so that's down 3 points -- 3.2 percentage points and was excellent performance. From a cash flow basis for the full year, we were in at a 1.3 billion.

Jim will talk about our revenue, but I think it reported was up 9% fourth quarter and about 11% for the year -- the full year. And with that type of performance, I think it gave the Board a great deal of confidence this morning to announce two additional activities. One, an increase of our dividend -- 30% of a dollar to $1.30. At the same time, we approved a 2 for 1 stock split, so all those I'm very pleased with. And overall, if I take just a minute to reflect on 2005, it's clearly one of the best years this organization has ever had. We saw some solid gains from some of the smart acquisitions that we've made in the past. Clearly, the integration of the BC Rail and Great Lakes Transportation added additional strength. I mentioned the growth that we had, the sustainable profitable growth. We have just announced, and announced last year, a couple of innovative industry partnerships. We've talked to you before about the routing protocols and the efficiencies that that brings to our system.

I was pleased last week that we signed a new co-production deal with Burlington Northern, which will do a lot for us in the Vancouver area, and I think will help them substantially in the Chicago area. And there are two or three others on the drawing board that I hope before the first quarter is over that we'll be able to announce. And finally, on the -- from a full year standpoint, the operating ratio for the first time broke through the 64% level at 66 -- at 63.8, excuse me -- which was -- 66.9 was last year, and it represents about a 3.1% improvement there. So all in all, an outstanding year, very pleased; and let me ask Claude to give us a little more details on the numbers.

Thank you, Hunter. As you just said, we had a solid fourth quarter and that really capped a great year. The fourth quarter performance was basically driven by solid topline growth. Our reported revenue was increased by 9%; but if you exclude exchange, the actual year-over-year increase is closer to 11% -- and Jim will give you more detail about the breakdown between yield and by business unit -- but we had pretty good growth basically across all business units. We were able, at the same time, to control our costs, and that's why we were able to deliver a 61.8 record operating ratio for the fourth quarter. And also, when you put it all together, deliver solid EPS growth with $1.56; that's an increase over 2004 of 20.9%.

If I turn to expense and review them briefly: Excluding fuel, which was up by 50 million on the basis of oil prices averaging just above $60 for the quarter, our overall expenses were essentially flat. Very, very good cost control across the board; particularly labor expense, which were down on a year-over-year basis in absolute terms. On the strength of our workforce reduction of 5%, we are continuing to have a number of initiatives and are making attrition work for us. Asset utilization was also very solid during the quarter, and that's helped us reduce our equipment rent down with cycle improvements, helping the cost, but also, you know, better revenues from offline moves.

We saw an increase in our purchase services and material, largely on account of preparing for the winter that we're going through now. We had higher repair costs, we had the preventative activities to do wheel change-outs, for instance, and do more inspection on our track; and all of these expenses are good investments to help us have a fluid network during the winter. These higher purchase and services material were offset by lower casualty in other. This was helped by lower personal injury claims; but also last year in 2005 -- in 2004, I'm sorry -- we had one-time costs which are making the -- basically the year-over-year comparison a little bit more of a decline.

This is a highly volatile category; but on a go-forward basis, a run rate of around $100 million or just a little bit above 100 million is not a bad number to use for casualty and other. If I take a look at the free cash flow, record performance -- $1.3 billion, driven by improved profitability, but also smart working capital management. Our growth capital expenditure for the year came in, as we guided, at 1.4 billion. When you exclude the capital leases, that makes for a net capital expenditure of 1,180,000,000. We used that free cash flow of 1.3 billion, which is after dividend, to buyback shares during the quarter. At the end of the year, on December 31, we were exactly halfway in our share buyback program, having purchased 8 million shares in the last six months. We were pleased that Moody's at the end of the year saw the strength of our balance sheet; and you can see there on the chart that our adjusted debt ratio stayed basically level at 41% , and Moody's followed suit after Standard & Poor's and gave us an upgrade to A3 level.

I guess overall, the strength of that balance sheet, the quality of the earnings and the strength in the cash flow is what gave our Board of Directors confidence to allow us to announce today a 30% increase in the dividend -- as Hunter said, a 2 for 1stock split from what was an all-time high at the end of the day on the trading floors. I don't need to dwell much on the full year result, except to say that it was a banner year. Basically three ingredients: Quality topline growth, solid cost control; you add to this additional support from our share buyback, and you have the recipe for a 28% EPS growth overall. I have to say, I'm very, very pleased with this performance and how the overall business performed, and you have to give credit to the team of railroaders who were able to deliver that performance in a year that's had some issues, particularly on the safety side. All of that gives us a lot of momentum, and we're entering 2006 with a lot of confidence. We will have some head winds to deal with.

I'd like the mention a few that I'm keeping an eye on. Fuel prices are higher than what we had assumed when we talked to you in November. They're trading above $65 at the moment; and as you know, we are only 17% hedged in 2006. So we will see an increase in our fuel costs on the order of $200 million year-over-year. The pension expenses is other area we're watching. We finished a year at the very low interest rate, and our discount rate for an accounting -- from an accounting standpoint for pension expense was finalized at 5%. That will give us an increase -- non-cash increase in our pension expense of roughly $60 million, which is on the order of $20 million more than what we had discussed with you at our previous meeting.

So you can call this a $0.05 or so headwind to deal with, and we're also monitoring foreign exchange, which is hovering at 86.5, which is basically $0.02 higher than what we had assumed. So the exchange is a volatile element, but if it stayed at the 86.5 level, that would be $0.06 to $0.07 impact to our earnings. So we have a bit of headwind; but overall, we are very confident we have the momentum to deliver in the range of what we've guided -- 10 to 15% EPS growth, and another year of strong free cash flow, with a target of $1 billion, despite the dividend increase and despite the cash tax increase which we have to face coming -- starting in 2006. Jim, over to you.

Thank you, Claude. I'd like to go through the fourth quarter revenues in a little more detail. On an exchange-adjusted basis, revenues in the quarter were up 11%. Excuse me. Breaking that down in some various components, our volume in the quarter was down 3%. Our price was up 4%. Fuel increased the revenues 5%, and a very positive mix ingredient added 5% as well. Breaking that down a little more, Volume down 3% or 37,000 carloads. Almost half of that is from lower U.S. coal shipments due to specific non-market related customer issues. The remainder is from a specific lower iron ore movement and lower forest products carloadings, primarily due to replacing low capacity, older equipment with newer, high capacity equipment, where we moved the same or more product -- or more product in the same amount of cars. Revenue ton miles during the quarter were down only 1%.

On the price side, 4% is in line with what we have talked about in the past, 3 to 4%; and that's spread fairly evenly across all of the businesses. Fuel, 5 percentage points of the growth coming from fuel, a surcharge. 80% of our customers are on our tariff fuel surcharge. 37% of those have migrated to the new, lower 7401 tariff. And the mix, the 5% positive for mix represents new traffic that's coming on to the railroad that we hadn't handled in the past, which is coming on at above average rates for those commodities, and we're having longer lengths of haul across all business units. As an example, the lumber panel growth is coming on in Western Canada versus the east. Western Canadian coal is up, while our U.S. short haul volumes are down.

The growth in our import international -- intermodal business; the transcontinental business is coming in on the West Coast. And as I said earlier, we're having some decline in some short haul iron ore movements up in the upper peninsula of Michigan. So that higher rated business coming on longer length of haul is having a -- had an impact, quite favorable, on our mix. In the various business segments, that breaks down to merchandise being up 12%, our bulk business being up 6% and intermodal up about 14% on revenues. Further detail, taking it apart here: Petroleum and chemicals on an exchange adjusted basis, up 8%. Chemical volumes are down slightly, as there was a very strong market in the fourth quarter of last year; as well as in the fourth quarter, we saw some lingering impact from the hurricanes on our Gulf Coast chemical producers. The markets from plastics are also weaker than they were in the fourth quarter of last year; however, those declines were offset by very strong shipments in petroleum products, especially lube oil, diesel oil, and heavy fuel oil.

In the metals and minerals business unit, exchanged adjusted up 15%. Overall, very good market conditions in this business segment. Customer prices are high and the demand is strong. We are selling new movements of pipes, bars and slabs for construction and drilling. And scrap iron shipments are also up strong, due to the market conditions. Minerals was up 35%, and it related to the continued strength for construction materials; a lot of shipments involving Alberta, sand cement and aggregates associated with the demand for drilling and housing construction there; roofing shingles and brick shipments associated with the hurricane rebuilding.

And the only down segment in that group this quarter was the iron ore business which was down slightly, due to the decision of one of our customers to use an alternative ore dock as opposed to our our dock in Escanaba, a dock that the customer owns and recently upgraded. Forest products, up 12%. Again, lumber and panels leading the way -- lumber up 13%, panels up 21. Strong shipments from our British Columbian origin base customers out there, like [INAUDIBLE], West Fraser are shipping very strong. And pulp and paper both up 8%. Automotive is up 14% - again, all these are exchange adjusted; again, due to the automotive as the import strength through both coast Vancouver and Halifax, offsetting some declines in some domestic manufacturers. The bulk segment up 6%, with coal being up 7, Canadian coal up 39% during the quarter.

New mines that came on last year, we had the full quarter impact of the mines that opened up in the fourth quarter of last year -- Burnt River, Grande Cache and Cheviot. And the -- those gains were offset by some declines in U.S. shipments -- one of our Illinois-based coal customers having some production difficulties, as well as we had lower shipments over our Conneaut Dock, which is connected to the Bessemer and Lake Erie Railroad. Granite fertilizers up 6%. Grain Canada, up 4% relatively across the board; good moves in all commodities, especially barley, canola and malt moving to export through Vancouver or Ridley, offset a little bit by some reduce wheat shipments. And again, a good balance of grain shipments in the U.S. to the feed -- for feed grains, expert corn and the poultry markets.

Intermodal, we're starting, as we talked about, to see the profitable growth, the volume growth coming on here in intermodal. Our overseas business up 18 -- total intermodal up 14 driven by overseas up 18%, with a lot of volume coming through both the Vancouver and Halifax, and good solid performance in our domestic intermodal as well. In the next slide, we talk about where we're going for the rest of the year. Clearly right now, January is looking very good for us. The outlook across the business segments is strong. Business opportunities in merchandise; we have more lumber and panel capacity coming online in Western Canada to handle the additional log cuts associated with the beetle kill. New [INAUDIBLE] Louisiana Pacific OSB plant opening up. [INAUDIBLE] West Treasure in Toko opening up additional -- bringing on additional lumber-cutting capacity. The steel market outlook looks very strong, and we see a lot of opportunity across the board in the merchandise segment associated to construction activity.

Solid prospects for both Canadian coal outlook still very promising. 2006, up another 100% for Canadian coal. Canadian grain outlook was again just raised in December. We have the largest available stocks in Canada in the last ten years -- 9% above the 10-year average. And despite some bad growing conditions in the U.S last year, the yield came in very good, and in our U.S. territory, we are about at the five-year average for both corn and beans. Intermodal, we're going to turn up the volume, so to speak. We've brought on train capacity from Vancouver in August of last year, and increasing that 15%.

We've increased the car capacity in Halifax twice in the fall, in August and in September. And we're working very aggressively at bringing new business opportunities, new growth from Vancouver into Chicago, and that traffic should begin relatively -- quickly in the new year. So with the volume activity and the solid business performance, we expect to manage our prices very reasonably, staying in the range of 3 to 4%; and added again to that was, again, some reasonably -- reasonable volume growth, looking at full year topline growth in 2006 in the 7 to 8% fuel -- or currency adjusted range. Thank you. Hunter?

Thanks, Jim and Claude for those presentations. In wrapping up, let me highlight a couple of points. Number one, I was very, very pleased today that we received an announcement that the -- finally the environmental review has been approved by the Canadian Government for the project at Prince Rupert, which removes the last obstacle in the way there. So I hope and would expect that the project will be -- maybe delayed it -- maybe a quarter. So I would hope that we see Prince Rupert up and running by the third quarter of 2007.

Number two, I mentioned earlier that these new asset sharing agreements to further improve our fluidity, and mentioned that the BN project, the routing protocols. Our car velocity has improved significantly. We kind of hit the wall here, but it's made significant improvements over the last 8 or 10 weeks. We have had an intense focus on rolling stock inventory control, particularly at our major terminals, probably the top 25 terminals. We've been able to reduce the active inventory in the 20, 25% level, which -- and all the associated expenses that go with that inventory. Clearly, I think that the opportunity that Jim has just mentioned in 2006 will be taking advantage of the opportunity to continue to leverage the service that we've put in place.

So I think, you know, what this says is we've got a strong team of railroaders that are basically focused on running a safe and profitable railroad. And I'm kind of knocking on wood when I say this, but we're off to an awful nice start. The metrics and the revenue performance the first three and a half weeks have been the best that I've seen since I've been associated with the organization. A lot of things are coming together, which makes me to be pretty excited about the opportunities for 2006. So with that, Mary, we'd be happy to answer questions the group might have.

Thank you. We will now take questions from the telephone line. If you have a question, please press star 1 on your telephone keypad. If you are using a speaker phone, please lift the handset and then press star 1. Should you wish to cancel your question at any time, please press the pound key. Please press star one at this time if you have a question. There will be a brief pause while participants register for their questions. We thank you for your patience. The first question is from James David from Scotia Capital. Please go ahead.

Couple of volume questions. First on the grain and fruits, down 3% the quarter; and as pointed out, agriculture kind of just didn't have a very good sort of optimistic view on expert growth -- I think they're talking about 16%. Does this suggest that a lot of the volume is going to show up -- I think, I guess, is going to sort of be disproportionately biased towards the first quarter, and can you give maybe some kind of indication of what kind of RTM growth you'd expect on the grain front?

Well, no, the rational -- the reason for the lower grain in the fourth quarter was more associated with weather issues that we had in Western Canada in December, not any kind of a skewing. It will require that we move a little bit more in 2006; but our grain volumes, we're still looking at only being up in the U.S., you know, 1 to 2%. It's not a significant -- we can't move a significant amount more of it. A lot of it's got to do with the carry. So at this point in time, grain and fruits kind of in the 1 to 2% volume growth year over year is what we're looking at.

And that's for the first sort of -- in the first quarter?

First quarter, we'd be slightly higher than that. You know, I'd say three to four in the first quarter; but on an annualized basis, one to two.

Okay. And sort of, I guess, more broadly on the volume front, the third quarter I think was softish -- RTMs was 1.4%; and I think at the time, it was kind of characterized as maybe a bit of an aberration on the negative side, but we're seeing obviously soft volumes in Q4. Was there something that happened between the time of the third quarter and this quarter that you hadn't foreseen? Is it the grain weather issue, is there something else -- something broader?

Across the board on a carload basis, our plan had been, our budget, whatever number you want to use, would have been for us to be flat to down 1% on volume during the quarter. So we were slightly below that from we had expected. Almost all of that was directly related to the specific one-time event, as I've said. We've had a coal, a big portion of it, associated with mine production issue in Illinois. We had a boat that kind of banged into the unloader at our Conneaut Dock in Ohio, which put us out of business for a little while there and that knocked some volumes down. Iron ore, moving up in the upper peninsula of Michigan from the Tilden mine that usually went down to Escanaba; that decided to go up to the Lake Superior Dock in Marquet because that Cleveland Cliffs owns both the mine and dock. So it was always these kind of these one-off kind of deals . We have not seen any kind of across the board general softening whatsoever, anything. And again, in the forest products, lumber, panels, metal area, that business continues to be stronger than we had expected.

Okay. Thanks a lot.

Thank you; the next question is from James Valentine from Morgan Stanley. Please go ahead.

Great quarter, guys. Claude, maybe just talk a little bit about labor cost per employee. I'm always intrigued when it comes in flattish. And if I'm doing the math right, I think it did. You would think that would have some inflation involved.

Well, basically you have a number of factors other than salaries, Jim, as you know, that come into play. On a year-over-year basis, our health and welfare costs, particularly in the U.S., has been very well behaved and that's helped us in the fourth quarter. If you look at the -- if you look at our initiatives to reduce the actual workforce, we have made significant progress during the fourth quarter. Our head count is down basically 5% on a year-over-year basis. And so, good quality control, management of overtime, management of the fringe benefit aspects, all of that together is how we were able to come in with these numbers in terms of labor expenses.

When I think about 2006, ex the higher pensions costs you talk about, is it reasonable to assume that they could stay flat, mainly your cost per employee?

We will have inflation next year, just on the basis of our collective agreements that we've signed with our employees on the order of 3% or thereabout as wage inflation. So if you're looking at it on a cost per employee basis, I would expect a slight increase. If you're looking at it from the perspective of our actual labor expense, if I forget exchange, we are going to see our sales continuing to make productivity gains and having attrition work for us into 2006.

Okay. Great. If I can switch gears here with Jim just for a second on autos, first year auto yields were really high. It sounds like it's because of some, I guess, higher revenue per unit imports versus domestic production. And so maybe you can just clarify that, and if possible maybe quantity any how that impacted you. And then secondly, if you can maybe just address how the GM and Ford announcements may impact your business. I'm sure you don't know every plant and every load that you may potentially lose, but maybe just give us a big picture of what you think that could do to your auto volume growth to 2006, later in the year, or maybe 2007.

The GM announcement some time ago we looked at would have a very limited impact on us due to some plant rationalizations. The Ford announcement that just came out, it would have -- from what we've been able to discern just by reading about it in the press clippings, et cetera, would have little to no impact on us from what we can determine. You're right, the average revenue per car moves associated with the definitely long -- definitely longer lengths of haul from Vancouver to Toronto versus you know, Flat Rock to Chicago skews the mix variability favorably in autos for us.

And would you say of the 19% increase there, aside from the standard fuel surcharge, that most of that was just mix?

Yes, as I said, you know, if you look at the 4% rate increase, which I said applies pretty uniformly across all business units, and now with 80% of the people paying fuel surcharge, you get a pretty good idea by looking at that the where the volumes are up and down, because everybody is kind of in the same range in terms of price and fuel.

Okay, great. Thanks, guys, appreciate it.

Thanks, Jim.

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

Thanks. First question for Claude. Just on the guidance, sort of a highlight question, you highlighted a number of things you'e seen since you gave your original guidance back in November with, you know, the three headwinds that you talked about. I was just wondering if there was anything that's -- if you've picked up any tail winds in any other parts of the business that would be included in the guidance; and if not, you know, how should we look at that? If there aren't any other tail winds, does that sort of bring us down to the lower end, or are other things working to just sort of keep you comfortable with the broader range?

I think the big tail wind is the momentum of the way we finished the year. So I think at the end of the day, that's what matters the most. I was just updating you on a few key areas where we don't control what the interest rate is and how that impacts our pension, and we don't control foreign education change. And I think it's important for you to know that when you look at those two elements, they represent basically a dime of headwind. But as I said, we're very confident coming into 2006 and the way we see it starting out of the gate. We're in good shape to come in on target with our guidance.

Okay, great, thanks. And then just one other question for Hunter on the routing protocols. You know, can you give us just a high level perspective on where you think we're at in terms of, A, sort of you know, what inning we're at, I guess to use a baseball analogy, in terms of the number of agreements that ultimately could get done here, and where we're at in terms of the what the long-term potential is from an efficiency -- realizing efficiencies from the protocols.

Well, it's already done a lot for us as we speak, number one. We effectively have agreements with everyone -- but technically I guess at this point we don't have one with TCF. But we effectively have a routing protocol through Jackson in the agreement we've had with them for several years. Right now the compliance, which I am extremely pleased with with the protocol, is in the mid- to high 90s. We are in the 98-99% level for traffic that we originate, and our partner are at various numbers, but all of them are in the low to mid-90s.

And I think what's starting to happen is that some of customer base is starting to understand and see that those gateways offer better service. And so they use the gateway that has better service, that provides lower cost by the shorter miles just by an example, and you get quicker asset turns, and there's a lot of momentum associated with it. So there are other phases that we're working on that we'll be implementing later on as additional opportunity for that protocol.

Great. Thank you.

Thank you. The following question is from Tom Wadewitz from J.P. Morgan. Please go ahead.

Yes, good afternoon, I've got two questions for you, which is I guess what Bob allows me to have -- so there. In any case --

You can call back after this call, we'll take another one.

In terms of pace of head count reduction, I mean, you're always so good at managing the cost side and squeezing efficiencies out of the system. You've had, I think, about 5% year over year reduction in head count the last maybe two quarters, and I'm wondering, can we project that into '06 as well, or is there a sense that that starts to slow a bit in '06?

As we provided you guidance on before, Tom, the last two quarters were getting the benefit of our two integrations with the GLC and the BC Rail, so I would say those numbers are a little bit higher than what we see going forward. We have said that on the order of 2 to 3% attrition working for us is the kind of longer term target that we're aiming at, and I think that would be a better range to use for 2006.

Does that work in like the first half of the year, you still get the acquisition opportunity boost; and then second half, you may be go towards that longer term area, just given the time of the acquisitions?

Actually, I would say that we are done, basically, the bulk of our acquisitions. So from here, it's more of the franchise and our same store efforts to gain productivity across the board.

Okay. And then one more on the expense side. On the casualty and other line, you commented on it a bit. I didn't -- I don't think I caught everything you said. I think run rate on a quarterly basis of 100 million, but at the quarter this time it was around, I believe, 87 million. Was there something one time in the fourth quarter number, or was there -- I mean, how should we view that I guess versus 100 million guidance going forward?

Well, I think that's why I provided you a bit of a run rate, Tom. Last year in 2004, we had 122 million, which was higher than normal, giving it's a volatile category. This year at 87 million, it was a little bit lower than the normal. We had some benefit on the legal claims that helped us; and going forward, you know, up or down, 100 to 105 million would be the best run rate to be using. So I think that gives you the best possible answer on the overall situation there.

Okay. So it's fair then, that just tends to be a little bit volatile?

That's correct. The same way, you know -- you have -- when you look at it overall, as I said, our purchase services and material for instance, was a little bit higher; so all in, we were very pleased with our expense performance in Q4.

Okay, great, thank you.

Thank you. The following question is from Scott Flower from Citigroup.

Yes, good afternoon, all.

Hi, Scott.

Hey. I wonder -- and you may have talked about this in November, but obviously there were some different moving parts and pieces, but Jim talked about obviously as we look toward '07, targeting roughly 7 to 8% revenue growth and roughly 3 to 4% price. How does the remainder break between volumes versus some incremental level of fuel surcharge? And related to that, are you assuming that some of these one offs that have hit you in fourth quarter start to turn, and obviously we move toward a more positive unit volume story?

Well, as of right now -- Hi Scott -- right now, we're having very good unit volume in January. That unit volume I would expect to continue at pretty much the guidance that we've given in the past, which would be about 3%, or 3 to 4% or so for the year in terms of volume growth. The rest is price with a little bit of fuel surcharge added in there -- you know, maybe 1% or so from fuel depending upon what kind of an assumption you want to put in there.

And then, Claude, I think it's sort of implicit you've got a range for guidance, and obviously -- I'm not trying to be too precise here -- but obviously you mentioned some things that were a little bit more of a set of headwinds than what you thought previously. Are there things that you've got from a contingency standpoint, or is it more just that you've got a 5% bandwidth on guidance so it continues to allow you comfort where numbers are and where you've led us to believe is a reasonable bogey for you all?

We run the business on quarter by quarter basis and we do our best every quarter. So at this point in time, it's early in the year; and with the broad assumptions that we've been providing you, we are still very confident we can achieve the range of 10 to 15% EPS growth and $1 billion free cash flow. So, as always, we try to do as best we can with the conditions we face.

Any if new initiatives, though, that help buffer that, or no? Obviously, it is early in the year, so it gives you plenty of times to come up with things and implement [INAUDIBLE] and reasonable run rate that has some impact.

Well, Scott, I think that you go back to what we talked about in November, clearly a lot of those things have not kicked in fully. I can tell you that I am very pleased at the momentum from fourth quarter and what's continuing in the first quarter this year of just the basic raw productivity in metric gains. Some of it's to -- due to Smart Yard; we're going to have some of the benefits to start to kick in from the siding extensions that will be completed this year but will start to kick in. We've got some new locomotives coming -- we've just gotten about 25 of the newer locomotives that will replace about 35 or 40. We've got the Smart Yard project. We've got the project at Memphis. So I think you're going to continue to see, later expressed on a relative basis, okay, flat; but we're going to be able to compete and overcome inflation through productivity. We've -- and we're doing this mostly to almost 100% through attrition. We've not been doing any separations. And if you look at the impact on cash flow, that has been very, very positive. So you know, it's a lot of these things that we talked about in November that continue to kick in, and the inventory control; so, you know, Claude would prefer I stop because I get a little too bullish sometimes.

All right, great. Thank you.

Thank you; the next question is from Ken Hoexter from Merrill Lynch. Please go ahead.

Hi, great. Good afternoon. If you could kind of go back to the capital discussion. I think, Claude, you mentioned you were up a billion 180 for CapEx, but 100 million of that was for leases. So if you excluded that, about a $1 billion. Can you talk a bit about what your targets are for going forward? And just jumping into that on the locomotive discussion that you must mentioned, what kind of expenditures are you planning for locomotives?

Just through a [INAUDIBLE], our growth CapEx before capital leases for 2005 was 1.4 billion, to which you deduct the capital leases, which gives you the net CapEx of 1.18. The gross CapEx for 2006 that we are using as a target at this point in time is just above 1.5 billion, and it will include on the order of 40 to maybe 45 locomotives, depending on delivery dates that we plan to order towards the back end of the year. And as we discussed in November, the key elements that make up this envelope are the strategic initiatives that we're driving -- increasing in our siding investments in Western Canada, the upgrading of our yard in the Memphis, Tennessee, and the other initiates that we discussed at that time.

Great. Thank you.

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

Good afternoon, guys. Hunter, you know, everybody is extremely bullish in listening to all these calls. I'd be interested to know if there's anything that concerns you at night, what that might be over the next 12 months?

You don't ask a question like that -- you know, look, I guess, you know, I've said this before: I get a little concerned about the behavior of some of us and the reregulation issue and the sensitivity of some of the shippers to some of the issues out there, and I hope that we will use good judgment. And we've tried to make some adjustment, for an example. I think Jim and Claude have done a wonderful job with the fuel surcharge. You know, I think we've got -- we have a service that we can be proud of. But I do get a little concerned about some of the things I read about the surcharges and about the service not being where it should, but prices being high. I don't think that bodes well for the industry.

Thank you. I'll go from the theoretical to the more concrete now. Claude, you mentioned in talking about the casualty and other line, I thought I heard you say that there was a legal claim in there. How much was the benefit in the quarter?

At the end of every year, we true up in term of our actuarial study, so this was a reduction in our personal injury and occupational disease claim that's for the quarter. And this looks good for into next year, because our severity is down in terms of the actual cost per incident. Our frequency is also very well behaved and down in a number of areas. So we see this as just a good indication of future costs for personal injury.

Okay. How would we look at this line item if it's 417 million for '05, how much growth in that expense line would you use to project it?

You know, in terms of our overall casualty and other, that our run rate of 100 to 105 per quarter was a good number to be using. So if you multiply that by four, that would give you a good indication.

Okay. So fairly flat, it sounds like.

That would be the right number to use, yes.

Okay. In just in terms of volumes, I know you've gotten the question a lot of ways, but if you look at the volumes reported, it almost begs the question, are you intentionally not taking on some volume, was it the result of the merger maybe too -- you know, you reducing some heads through the merger, but maybe reducing some of -- the volume wasn't as profitable and other pieces of that. Is that fair to say, or not?

No, we are not -- we are not intentionally driving off business. I've gone through it pretty specifically about the really one-off, unmarket related reasons for this; and as those reasons have gone away, you'll see the volumes here in the first quarter coming back pretty good.

Okay. I mean, the reported ARR through two weeks were only up 0.8, so I only assume that we agree to use [INAUDIBLE] I guess.

Yes, overall -- overall, the numbers are looking pretty good.

Okay, thanks, guys for the comments.

Thank you. The next question is from John Barnes from BB&T Capital Markets. Please go ahead.

Hey, good afternoon, guys.

Hi, John.

Hunter, a couple of things. Number one, where do you stand on -- and I think I asked you this quarter and I can't find my notes -- but where do you stand on all your labor contracts.

Are you done? Have you fully negotiated with all your unions, you know, both in Canada and the U.S.?

Well, let me -- let me oversimplify it and if we need to get into more detail, we will. We are effectively in good shape in the U.S. We have completed all the negotiations -- most all, with one exception, of the radifications have been successful. We had one that was a little bit out of the box, where it was an eight-year agreement. I think some people blinked twice a couple of times on it. But we're told by the leadership that they're going to come back with that agreement. I think it's fair to say that in Canada, with two exceptions that I'll talk about, we're in good shape. We've signed last year, for example with the BLE, Teamsters, five-year agreement.

So that's, you know, a while in coming. The only two that we have hanging out that are coming up within the next 8 to 10 months, end of the year, will be the CEW -- their three-year deal expires at the end of the December -- and the UTU. And I have all indications that those will not be major issues for you so, John, the bottom line is, that we're in much better shape from a labor standpoint than we were two or three years ago, I can tell you. The relationship has improved, the dialogue has improved and I'm pretty pleased where we stand there.

Okay. All right. All right. That's fine. As part of your concerns, to Ed's question, are you concerned at all about the labor negotiations going on among your peer group in the U.S.?

Well -- no, I'm not. You know, there's been a long time, and I'm kind of thinking back since there's been a, quote, real work stoppage in the U.S., that goes back about -- that's about, if I remember correctly, in the early 90s. That was only two or three days. You know, I don't think with the process in the U.S., with the mediation board, which some people would argue is a warehouse, not a mediation board. They go in and never come out. And with the potential for a Presidential Emergency Board, I think the thing could drag out and could be issues, but I don't think we're going to see -- I don't think, from what I can see from the outside looking in, we're going to see any work stoppage or anything that would hurt the industry from that standpoint.

Okay. All right. Very good. You know, as you look -- as you look at your infrastructure and your peer group, you know, a lot of these sharing agreements are starting to kind of show up. I mean, you know, the KSU and the Norfolk Southern agreement, the one you just announced with Burlington Northern, how many more of those do you think are out there? I mean, you know, have the large ones kind of -- they've been announced, or do you think we're just hitting the tip of the iceberg in terms of some of these sharing agreements between all the rails?

I think it's somewhere probably in between there. John, as I mentioned earlier in the call, you know, we have two or three other ones that we're working very diligently on right now that would -- that I think the probability of them kicking in in the first quarter, I think that will happen. Now, you know, it's what you call a large -- there's not -- you know, there's -- none of them are anything like the NSP [INAUDIBLE] deal, I can assure you that. But there's still a lot of opportunities out there. And you know, the deal with BN, I'm very pleased with, it's a very complex issue with the Vancouver complex, and it's something that when we were through, it was something we knew was good for us and we knew it was good for the BN, and it really opened the dialogue for other opportunities, just doing things the smart way.

Okay. All right. And then lastly, in November, your guidance was kind of, you see $400 to 500 million of additional cost cutting opportunities over the next five years. You indicated 150 million of that is kind on the head count. You talked a little bit about head count earlier, you're going to get it through attrition. Is all of that $150 coming through attrition, or is there some other opportunities on that $150 million bucket? And then in terms of the 400 to $500 million, you know, given how well you've done here just in the -- you know, in the period, since your November meeting, and how you seem to be very upbeat about what you've seen thus far in January -- and I'm -- you know, I'm not asking you to revise your guidance already -- I mean, it's only been a couple of months -- but do you think five years is conservative and you can realize this faster, or are you still comfortable with the five year period?

Well, let me make a couple of comments, and [INAUDIBLE] can get more of the details if need be. We are developing daily the ability to do more with less. So if we -- this is not necessarily directly tied to head count, but if we can start handling 7 to 8% more business with the same number of people and improve the size of trains, and take the opportunity of the terminals, there are still, in spite of the fact that I think we're kind of out in front from a productivity and efficiency standpoint, there's a lot out there to do.

I'm with you Hunter, I think we are quite comfortable with the guidance we're give and are going to be geared up to deliver in 2006.

Okay. And Claude, one housekeeping, can you give me the -- if I missed it -- the exchange rate in the quarter, I'm sorry.

You mean for the fourth quarter?

For the fourth quarter, yes, sorry about that.

I think it was around 85.2.

All right, 85.2. All right, guys, thanks. Nice quarter, by the way.

Thank you. The next question is from Jordan Alliger from Deutsche Bank. Please go ahead.

Hi. Just a quick question. Can you give an update -- I know you said you're half way through the buyback. Can you sort of refresh my memory as to sort of what's left, what shares ended and sort of the timing? And then I think there's specified times when it has to be done, right?

Yes, in Canada, basically it's an annual program; so we announced in July an open vendor offer and the program was for 16 million shares. And since July, we have bought back eight million shares and we intend to use our cash flow over the next six months to complete the program.

Right. So the plan is to go ahead and complete it?

Very much so, yes.

Okay, and then you've turned the corner on the intermodal volumes; any sense for, you know, how that trajectory might look? I assume maybe it ramps up more as we get, again, closer to the 2006 peak. You know, I don't know if it's sort of a sequential ramp that you're looking at in terms of growth.

Well, you'll see higher volume, more percentage year-over-year in the first half of the year, because we were relatively flat in the first half of 2005. Put on additional train service in the second half of 2005. So just the comparable will get more difficult as we move through the year. So you know, if we're going to be 7 to 8% for the year in intermodal volume growth, we should be kind of twice that rate in the first quarter.

Okay. Thank you.

Thank you. The next question is from Cameron Jeffreys from Credit Suisse First Boston. Please go ahead.

Thanks very much. Great quarter, guys. Just a quick question for you, Jim, on the pricing side of things. A lot of your U.S. counterparts have been indicating pricing increasing neighborhood of, I believe, about 6% coming for '06. Can you just, you know, kind of help us out in terms of understanding where your three to four comes from, and is there a structural reason for the difference, is it just you guys being a little more conservative? Is there less business for you guys rolling over in '06, maybe relative to some of your peers or mix or what have you?

I think our business rolls over -- you know, our business is rolling over on a more regular basis. We've been at this, probably a little longer than the rest of the group. And we're getting rate increases before the rest of the group talked about. We don't have long-term contracts. You know, a long-term contract for me is two years, and I've been at this for a number of years. So a 3 to 4% compounded, say over the last three to four years with a nice reasonable fuel surcharge on that, is the right behavior in the marketplace for the long-term.

And you're starting to -- have you sensed anything since your November meeting of any kind of increase and push back from customers or any noticeable difference in the past two or three months on that -- on the price increases?

No. Again, you know, it's an ongoing dialogue with our customers. We went to the marketplace with a much reduced fuel surcharge, which our customers were appreciative of. And our service, as I think Hunter alluded to, has never been better. The railroad has never been running better. And we're providing very good value to our customers, and we think to 4% is reasonable, and have not lost any business asking for that kind of price increase.

And keep in mind, we're not trying to manage capacity by price.

Right.

But we've got locomotives, we've got people, we've got line capacity, we've got great service. We've got business that is significantly exceeding its price per capital -- I don't want to go out in the marketplace and start pricing 6 or 7% and lose volume. I'm tickled to death to get 3 to 4% and move forward.

Great. The rest of mine have been asked. Thanks, guys.

Okay.

Thank you. The next question is from Robert Fay from Canaccord Adams. Please go ahead.

Thank you. A couple of questions. First of all Claude, what was the fuel hedging games in the quarter?

I don't know the answer, exactly, Bob. For the full year, it's 150; but I don't know exactly the number for Q4. We can get back to you offline on that.

Okay. Because I think you were indicating in November you had 180 for the year built-in? So it came in at 150?

Yes. You know what, you should probably get that question offline, Bob. I don't know the answer exactly.

Just call. Okay, on the fuel surcharges, we sort of see it having a fairly good impact on the revenue line -- I guess in the quarter it was about $185 million. Is there sort of a point we're going to see over the next year or whatever when this sort of revenue lift that you're getting, you sort of caught up on those -- on the fuel price increases and sort of neutral with the increase in the fuel expense? Is that going to happen during this year?

Well, in 2006, our edging expense is going down to 17% for the full year, and that's really 35% in Q1 and something like 10% in Q3, with nothing in the back end of the year. So the -- you know, basically, we are moving away from edging the expense; and going forward, we expect that the movement in the fuel price will be recovered up or down with the fuel surcharge mechanism.

Okay. But I guess what I'm saying is that in the quarter, the surcharge, you know, came in around 85, 86 million if I'm doing my math right; fuel expense was up 50. At what point does sort of the surcharge impact on revenue and the price impact on fuel expense sort of get neutralized?

We don't necessarily think about it this way, Bob. What we're looking at is, what is a market level for the fuel surcharge? And Jim, I think, has done an outstanding job in differentiating CN with what we believe is a very reasonable fuel surcharge. And going forward, customer base understands that, and it's going to move up or down with the volatility of fuel price.

Last question is cash taxes for the year. In '06 alone, what's going to be the change in your tax cash position? Are you going to hit your targets?

Yes, we are going to be -- in fact, we're going to be starting in 2006 to be cash tax payable from a standpoint of owing it to the Government. But as you know, in Canada, you don't start to actually pay your installments until the following year. So we expect our tax cashes to go up in 2006; but then again to go up even more significantly in 2007, when we have to pay the 2007 cash taxes, plus some of the installments on account of 2006.

It should be relatively light then in '06?

I would say it's about 40 to 50 million higher than what we paid in 2005.

Okay. Thank you.

Thank you. The next question is from [Walter Brackman] from RBC Capital Markets. Please go ahead.

Thanks very much. Just had a question back on the capital expenditure program. I know you -- your press release there back in December, the $1.5 billion target for 2006. Just wondering, two aspects that might affect that here, and just want to get your comments on that. First of all, the Prince Rupert expansion, a lot of what we've been hearing on the West Coast is significant demand for labor and labor going up for a lot of construction projects. Price of steel obviously also impacting. Is that built into your 1.5? And the second part of that question is also on your acquisition with the -- for the shortline in the RailAmerica acquisition. Do you have any upgrades planned there, and how will that impact your CapEx spend for '06?

Yes, the answer to your first question is a lot of the CapEx that we do is with our own resources. So we are as fast to be able to deliver the program that we delivered and we know what it is we're going to buy, whether it's rails or ties or ballots when we set our budget in the fall. So we know that there is some inflation in there, but we are very comfortable with our overall CapEx guidance, and it's not impacted by the factors you've talked about. As it relates to the acquisition of the MacKenzie Northern, we will have to do some work there in terms of upgrading the track, and we expect on the order of 15 to $20 million is the amount we'll have to do in 2006. At this point in time, it's a little bit early to decide whether that means a slight increase to our overall CapEx or whether we'll be able to accommodate that by offsetting with other projects. But that's the order of magnitude of the CapEx for that line.

Okay, thanks very much, Claude. And Hunter, maybe you could talk about regarding -- something you talked about in the past is trying to recapture or capture market share from the trucks, and talked a bit about service improvements that are in place and are continuing, you know, combined with some of the operator competitive advantages you have, particularly from the fuel standpoint. Can you step back for a minute and just from a railroad perspective, what market share is up for grabs here? Is it significant, and what are your prospects, maybe even anecdotally, of any evidence that you've had in capturing that market share? And maybe that just leave it with that.

I just think that the opportunities going forward are significant. I mean, anecdotally, one of the examples would be if you looked at maybe [INAUDIBLE], where five or six years ago our market share was 48, 50%. Today it's approaching 70 -- 65, 70. I think that's the direct reflection that [INAUDIBLE] we saw, we had the. ability to provide the service at a more competitive price and made the conversions. I think sometimes I get a little impatient that we're a little slow with converting those opportunities, but that is a huge market out there. And just to capture a small portion of a percent is significant.

I mean, there are some challenges; and as I've said to some of you before, the challenge is to get to the customer's door on both ends. If they're a customer, as a lot have been since the changes that really significantly made market share in the late 70s and 80s that don't have a rail spur, we can't get to the customer without our friends the truckers. So we've got a component of trucking built-in. So to some degree, that hinders our ability to do that conversion. But I just think -- I've read some comments of Matt Rose's the other day, which I think were right on. If you look at the U.S. particularly, if you look at highway policies, tax policies, the highway system, some of the problems that our friends the truckers are having with driver shortages and quality of life and fuel, if this industry doesn't take advantage of that the next three, five, seven years out, we're going to miss a golden opportunity.

And taking advantage of that, is that something that you see as a slow process over time? Is it something you're going to be targeting in '06, and are we seeing that built-in -- have we built that market share gain into your volume growth guidance already, or is that something we might see in terms of --?

Well, I think we -- you know, I think to some degree, some of it's built-in. Now I think the difficult thing that frustrates some of us, but I continue to learn, is change is tough. People don't like to make changes; they resist change. When our salesmen go out and knock on doors and somebody's been trucking and has had as frustrating experience with the rail 15 years ago, and we're trying to tell them, now we're a different -- we're a group now, we've got a different product -- sometimes that conversion is difficult.

Okay. Thank you very much.

Thank you. The next question is from [Reg Currin] from the Bloomberg News. Please go ahead.

Gentleman, are you taking media calls on this as well? I didn't know; I just dialed in.

You're on.

Okay. Hunter, you talked about there's more to do in terms of productivity. I mean, you talked about the headcount, but where else do you see this coming in your operations?

Well, number one, probably the most significant one, is the siding extension program that we talked about that can significantly reduce the number of train starts that we have. At the same time, that provides more capacity so we can accommodate growth without bringing on any additional employees. Of course, we're going to grow over time with these 5, 6, 7% type growth. If we can achieve those type numbers, when you do that, and you can do it by keeping head count down, there's a huge leverage there. You lower overtime, you become more productive and do things more yourself in house, rather than buying people off and then contracting to work out. We've got a huge opportunity to make significant impacts in our [INAUDIBLE] productivity, not to speak of, our mechanical department, engineering -- I mean, there's just a lot yet to do. And, you know, I guess the proof will be in the results you see the next two or three years.

Great, thanks very much.

Thank you. The next question is from James Valentine from Morgan Stanley. Please go ahead.

Yes, real quick, just on -- Jim on price escalators. When you think about the percent increase you're going to try to get on -- I guess longer term contracts for you would be two or three years -- are you looking for just standard inflation or something above that? It would be more -- traditionally be something below it? Where are you at on that?

We're tied into a very fixed number in terms of the percentage increase based upon what we see as what the number one, what the market will bear; and two, what we see as our costs that Claude and everyone else may project out in terms of where we should be setting price. We are not tied to any kind of market basket of prices. We set a fixed rate of increase this year and next year when we do our contracts.

But there is -- okay. Because what I'm trying to get my hands around is just making sure -- I guess make sure I think through this modeling, unlike in the past, where railroad would go to their customers and say, look, we're in an advantageous position here and so we're going to raise your rates 10% and then keep them there for three years. The point, if you have that ability to take up rates now, you're doing that and then you're also saying, well, by the way, you're going to be paying us some level of inflation because we're going to have cost of inflation over time as well.

Well, that would be factored in. More than likely, as I said, I would go to a customer and say -- whose contract is renewing the 2006 -- that his rates are going to go up 3 to 4% in 2006 and then again in 2007, 3 to 4%. He will pay fuel for the tariff during that three year period, and then in the third year, we'll sit down and rediscuss what the rate increase should be for the next year or two.

Okay. Great. That's helpful and that's great. The other question I just wanted to follow up on, is there been any update on what's going on in Western Canada with the Government regulations on train lengths and how that -- obviously didn't hurt your earnings in the fourth quarter here -- but any impact that could have in 2006?

No. No, Jim, it's basically -- our people have been able to work with the regulators. We have monitored that situation very closely and working with them; and effectively, what works for us, those restrictions have been lifted that we shouldn't exceed that. That railroad is extremely difficult from a physical plant. It's got extreme grades, it's got extreme curvature; but the bottom line of your question is that the regulators have worked with us very closely and it is a -- not a bench.

Great, thanks so much guys.

Thank you.

We have time for one more question.

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

Good afternoon, gentleman. Just a couple of quick ones. With the conservative Government coming in, would there be any implications in terms of the regulated cap or the efficiency with which you can move grains in the prairies, ultimately down the road if in fact it goes forward?

You know -- well, we don't know, number one. And number two, none of that is in the plan. You know, will it maybe potentially have forward opportunities? It's something that we'll be interactive with that group about, and I think that they've been pretty public that they share different views than the liberals, and we'll see potentially what their policies can do for us up or down.

Would that improve the fluidity of the network in Western Canada for you and increase your velocity in addition to the sidings? Would that help you, if it indeed did go through?

If what went through?

If it indeed went through that the Canadian Wheat Board was made voluntary, would it improve your velocity and your fluidity across Western Canada? That coupled with your sidings program?

I don't think it's so much necessarily the Wheat Board that impacted. I think there is significant potential to move grain in Canada much more efficiently and cheaper, and we could make more money and the farmer could pay less for transportation, and we would all be rewarded and happy. Now, that's -- the challenge here is to sell the right people on that.

Excellent. Thanks, Hunter. And just last one, Claude, in terms of your fuel hedges, you mentioned, I think, 35% hedged in Q1 and 10 in Q3. How does that scale down throughout the year, just for modeling purposes?

Well, you're just missing one point in between. So do the math; I don't remember exactly, but it was around 17% or something like that.

Excellent.

Yes.

Thanks, Claude.

Thanks, everybody. I appreciate you joining us, and we'll look forward to talking to you next quarter.

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