Canadian National Railway Co (CNI) 2006 Q2 法說會逐字稿

Welcome to the CM Second Quarter 2006 Financial Results Conference Call. I would now like to turn the meeting over to Mr. Robert Noorigian VP Investor Relations. Ladies and gentlemen, Mr. Noorigian.

Well good afternoon. Welcome to CN’s 2006 Second Quarter Call. Thank you for joining us today. With me today is Hunter Harrison President and Chief Executive Office of CN, Claude Mongeau Executive Vice President and Chief Financial Officer, and Mr. James Foote Executive Vice President in Sales and Marketing.

Today’s remarks may contain forward looking statements within the meeting of the US Private Security Reform Act. Such statements are based on information available at the time and involve assumptions that my not materialize. The disclaimers in the front of the presentation, as many of you know.

After we do our presentation today, we’ll take questions from the people listening on the phone. Could you please identify yourself when asking the questions. And in order to be fair, could you limit the number of questions that you ask to two or three. With that, it’s no my pleasure to introduce CN’s President and Chief Executive Officer, Hunter Harrison.

Thank’s Bob. Thank you for joining us this afternoon. We appreciate it.

Before I call on Claude and Jim to go to the second quarter results, I think the first thing I need to do is to recognize, and it saddens me to have to report, that in spite of the fact that we had such a lovely quarter from a lot of line standpoint that we experienced a horrific accident in British Columbia at the end of June.

And in that accident we lost two loyal long time railroaders. And so it humbles us to go through that experience, and it kind of puts everything in proper context. Our thoughts and prayers go out to the families and the colleagues of those individuals.

But if you look at our financial results, I was extremely pleased the results, our earnings was at 22% year-over-year and that excludes the $250,000 gain from the deferred income tax, which Claude will talk to you more about.

From a revenue top line standpoint, we saw revenues up 6%, as reported, but 11% if you adjust for the exchange. We continue to focus on the core principles of service and safety. I’ll talk a little bit about it later, but I think one of the things that highlight the quarter is three things. And that was productivity, productivity, and productivity double gains.

And in – to some degree as a result to this outstanding performance and the free cash flow that Claude will also talk about the board today, authorized a new repurchase program of 28 million shares, which I’m proud to report. So overall, I think an outstanding performance. And I think as you’ll see as Claude and Jim go through the numbers, you’ll start to have a better appreciation for that.

So, with that Claude.

Thank you Hunter. These results were indeed outstanding; a record quarter on a number of fronts. Let’s start with the ETS. We delivered $1.35 of reported earnings per share. That includes a $0.46 deferred income tax adjustment. So this is 250 million reduction in our deferred taxes. This is very good news.

It reflects the fact that during the quarter, the federal government enacted a corporate income tax reduction. These income tax reductions will take the Canadian income tax rate for business from 22% down to 19% over three years starting in 2008.

So the benefits are only between 2008 and 2010, but overall this is very positive news, which was followed up by two provincial income tax reductions for corporation: one in Saskatchewan and then one in Alberta. And there are other provincial jurisdictions which are following suit. Manitoba being one where they have not yet enacted those corporate income taxes, so we are not reflecting them but they are in the background and they will be reflected in the next several quarters when enacted.

When you take all of that together between now and 2010, the accumulative impact of those deferred income tax reduction, is reflected now up front in this 250 adjustment. But over time, you will also see our effective tax rate come down from the slightly below 34% it is today at CN. It could come down by another 2 to 3 percentage point by 2010 so overall, good news.

And if we exclusify them, we deliver $0.89 of earnings per share during the quarter. That’s an increase of 22% driven by solid top line growth and also solid productivity. The top line growth on a reported basis is 6% but if it’s adjusted it’s 11% with good balance between yield and volume and also grows across all business units as Jim will report to you in a minute.

We have solid cost control, a lot of focus on productivity and maintaining a fluid network. And this is what helps us deliver a sub 60 operating ratio and I believe this is the first time in the railroad industry, perhaps, that the railroad was able to achieve that kind of performance.

So, let’s take a look at the expense performance to try and understand what’s driving the results. Overall, very solid cost control. Our expenses are up only 1% as reported, 6% if you adjust for the benefit that we get from the foreign exchange translation, but a lot of this is fuel.

Excluding the fuel increase, our FX adjusted expenses are up only 1% and fuel is really a story of the dramatic increase in the worldwide price for crew. WTI exceeded $21 during the quarter and we are losing a good chunk of our edge position. During the second quarter we were average only at 23% versus a full 51% last year.

Labor expenses, very well behaved. We’re continuing to streamline our workforce. The workforce is down 3.5%. That’s helped us to drive labor productivity up 7% on a year-over-year basis offsetting the wage increases. Stock based compensation was down was a year-over-year basis and that offset our significant increase in pension expense. So overall, very, very good labor performance.

Purchase services up slightly on account of doing more repairs for equipment. Also, the impact of inflation in some of the categories were commodity based; purchases, steel products, oil based products, et cetera.

Equipment rent; a very, very strong performance here. Our velocity continues to be of focus and I’m happy to report, equipment velocity car cycle was up 12% during the quarter in the low double digit range. That helped us drive the significant reduction in the equipment rent.

But some of it was also true up to our car higher liabilities. That’s $38 million, I think we’re slightly below the run rate we’d like to guide you to. Our equipment rent for the second quarter should have a run rate closer to the $45 million range as opposed to the $38 million. But that would still be a 15% reduction when tax adjusted.

Casualty and other, also a very strong performance. We did have here two true up in adjustments to our legal claims. Very, very good progress on our personal injury side so most of this variously and the frequency of our personal injuries have been coming down. And so we reflected that with a true up to our [Asada] claim and so at 83 million, very significant reduction.

Our run rate for the second quarter for this expense category, closer to $95 million range or thereabout. So, overall, very solid performance despite roughly say, 20 million in lumpy adjustments. Our cost management has been outstanding. And it reflects the strong focus and the discipline execution of our operating model by the field railroaders that we have out there.

Let’s take a look at the free cash flow. Solid performance. Free cash flow at 740 million, is only slightly down from last year. Driven by solid profitability, but also good working capsule management. We’re continuing to make progress on our collection cycle.

First six months, we had the help of a slow start in our cash spending on a gross basis. Including capital leases we spent roughly $570 million capital during the first half, which is only 37% of our full year billion 5, billion 5.5 guidance in terms of capital spending.

This is just the timing. A lot of what we do in terms of large capital projects in Canada is done in the summer. So we will be catching up with a higher capital spending in the second half of the year.

We also had help in terms of free cash flow during the first six months with the fact that we have, in Canada, very little, if any cash tax payment. We are cash tax payable in 2006 to the tune of around 22% of our income. Yet we paid out, in terms of cash taxes, only 11% of our income. So there’s a benefit here of $150 million of payment, which we will have to do in 2007.

So we discussed this in the past but, basically on a just big picture numbers, next year we will have on the order of $350 million of cash taxes to be paid in 2007 on account of 2006 cash taxes. So we should expect next year a very tax cash payment in 2007 affecting our free cash flow.

All of this does not basically impact our – the strength of the performance in terms of free cash flow. We are well on our way to achieve if not exceed our free cash flow of $1 billion for the full year 2006. And we are using this cash as we speak to the excess cash to complete our buy back program. We’ve bought seven million shares during the second quarter.

And, as Hunter said, all of this has give the confidence to our board to authorize a new share buy back program, 28 million shares, roughly 5% of our outstanding shares. And we will be continuing to buy shares at a rate of around seven million shares per quarter. We might be opportunistic on timing, but that’s the guidance for the next 12 months in terms of use of cash.

Just a few words to wrap up in terms of our financial outlook; fair to say our first half of the year was just basically stellar performance, driven by solid top line growth and also focus on productivity. We’re going to be having good quarters here in the next two quarter or the second half of the year. But we have good momentum and we’ll need that momentum to deal with some of the challenges that we face.

I’ll name just two very important challenges. Fuel prices are trading today on a spot basis at 72 73 and on a four basis in the fourth quarter at around $76. So, fuel on a year-over-year basis, will be a very significant increase, and we will also see a significant reduction in our edging gain.

We only have 10% edge for the third quarter and 0% edge for the fourth quarter. So if I look at it, we have $75-80 million left the edging gain for the second half of the year, versus last year.

Foreign exchange with the dollar trading closing nine cents to close to 90 cents is also a significant headwind in terms of reported EPS and Canadian dollar terms. And so if I just take those two factors, that’s about 15 cents of EPS or 10% on a year-over-year basis of EPS growth.

Despite these challenges, we are confident with our performance. We have the momentum, and we believe we will achieve the high end of our 10 to 15% guidance. And with a bit of luck, we might even do slightly better. With this, Jim.

Thank you Claude. The company sure performed great in the second quarter. We delivered a good product to our customers with high customer satisfaction, which allowed us to really have a quality revenue stream in the core. I’d like to go through it in detail as I usually do.

11% exchange adjusted growth, 4% from price, 3% fuel cost recovers, and the balance of 4% from volume and mix. Our carloads full of 2% and a quarter and our RTM’s up 5% and across the board a increase in the average length of hall, which both well for the improvement theory in the mix.

Again, growth in all business segments. The merchandise segment up 8%, bulk 17 and intermodal18. Within the merchandise segment, petroleum and chemicals was up 10%. Favorable market conditions and new opportunities drove the petroleum products up. Favorable market conditions helped increase plastics business and polyethylene shipments.

We also started a major condensate project moving [Dilloant] from the west coast to Alberta for the oil stance project. On an annualized basis, that would be – is 15,000 carloads of new opportunity for us. And that could increase significantly next year.

Those gains were somewhat offset by lower gasoline and diesel shipment due to a temporary shut down of refinery in Quebec.

The chemical side of the business is just the opposite. A very weak market for chemicals. Chemical volume is down just because of the market conditions as well as the paper business, which is struggling somewhat, which I’ll talk about in a few moments.

On the metals and minerals side, up 14%, excellent quarter and strength in all subgroups. Continued strong demand globally for steel and iron so our iron ore volumes increased as well as strong shipments of scrap metal, pipe fittings, bars, rods. Overall strength throughout that business segment.

Forest products up 5%. In the lumber and cannel segment, we started out the quarter very strong; first 2/3 of the quarter very strong. Some softness in the lumber and panel business in June but what’s brought us down to a run rate below what we’ve had significantly, but still very good performance in Q2 for lumber and panels.

The pulp and paper segment, as I said, is having some difficulties. Same story that we talked about in the first quarter. Some issues associated with the high dollar as that it’s making it difficult for some manufacturers especially in eastern Canada to continue to produce.

But a lot of people are taking an opportunity here to restructure and reconfigure. There are new production facilities coming online. We think that the industry will be stronger in the future as a lot of companies are taking on labor issues and other situations to make that part of our company that much stronger. Overall pulp and paper in the quarter, flat.

Automotive up 1%. Some down times and retooling taking place with the domestic North American manufacturers, but that is being offset as we see stronger imports on both the east coast and the west coast.

In the bulk area, bulk was up 17%. Coal up 8% with coal Canada driving that up 33%. Mine expansions in western Canada. New mine coming online early in the year; February. It’s again, driving the volumes there as the offshore demand for metallurgical call continues to be strong.

The downside of that is the – again, which we’ve talked about, the short haul, par of our basin coal moves that we are not handling. As well as some lower outputs in the Illinois basin cause US coal to be down 7%.

Grain on both sides of the border are very good. Grain and fertilizers up 22, again, grain Canada up 38%. Weak export, weak domestic use, Canola, canola oil, very strong environment right now in the Canadian grain segment as in the US. US grain up 27% with significant moves of corn to the Gulf for export, as well as domestic use in the poultry markets.

And good markets right now for soy beans as well. Fertilizer down a little bit because of the lower demand for pot ash right now in the US.

Big story on the revenue growth, intermodal 18% revenue improvement in intermodal driven by overseas business up 24%. A lot of volume, new volume growth coming through Vancouver from existing customers as well as a new customer joining us in eastern Canada. And our domestic business of both the wholesale and transporter markets also very strong.

So across the board, I’d say a very positive story. Very similar to what we saw in the first quarter, but a very positive story

The next slide Mr. Noorigian wanted me to discuss very briefly. Just it might be helpful for some people to understand the volume situation here. You can see in terms of the items that I’ve just discussed in terms of the volume growth, carload growth a strong or intermodal in grain, driving up volume to before we take on the US coal situation so we add four to 5% carload growth.

But one to 1-1/2% of our total carload is associated with these decline in the short haul, high volume coal business in the US. So our overall carload growth up 2%. Again, just to help to bring some clarity to the strength of the fundamental for the business.

Going forward the outlook. Certainly the pricing environment is strong as we have said all along, we want to make sure that we have good quality service. Make sure that we charge a fair price for that service in the price range which we’ve talked about for the last two years or so is three to 4%. And that’s exactly what we are delivering on.

As long as we continue to deliver service, and I should point out that we continue to be recognized in independent survey’s as having the best service in the industry, that kind of price take is certainly sustainable.

There is strong demand out there for our product. The outlook for both the core, the crop outlook in Canada and the U.S. is good. The forest products industry we think is going to have a good, especially on the lumber and panel side – good fall. And into the next year.

And as we have focused, as we’ve said, as we’ve focused on improving the profitability of our intermodal business we have now turned on the growth engine in that segment. And the outlook there is very positive for us in Vancouver, and in Halifax as well as the US Gulf coast. And we’re already focusing very aggressively on the opportunities that are going to come to us when we open up our new port in Prince Rupert in the fall of next year.

So right on target to deliver the seven to 8% annual growth on an exchange adjusted basis as we talked about. And with that, I’ll turn it back over to Hunter.

Thank you Jim and Claude for those informative presentations. These results could not have been produced without significant productivity gain. And I’ve got to tell you [inaudible] if you have the presentation that just takes about six areas and points out a few of the metrics that helped produce these type results, as well as we’ll continue in the future.

If you look on the train side of the ledger, it was up. The train side goes ten miles per train mile was up almost 2%. That will be improved with our siding extension program in the west. In our terminals and yard, which is the high cost of this business. The improvement was up 17.4%. I was amazed with that number.

Locomotive productivity laughing on record year last year was up 3.2%. Claude mentioned the velocity numbers and the car miles per car date was up 12.7%. The labor stance hold with the gross ton miles per employees was up 7.2%. And finally the fuel was up, fuel productivity’s gross ton miles per gallon of fuel was up 6%. So, some outstanding productivity for the quarter.

So, the bottom line of all this, and I know there’s been focus on the operating ration and our potential obsession with the operating ratio, I don’t think that’s the issue. I think the issue that our fundamental model is to provide for Jim and his marketing and sales team a quality product of just doing what we way we’re going to do.

If we do that, and we have successfully done that with the operating group, if they produce that and the give Jim and his group an opportunity to go out ad make market share gain, which we’ve done. And to make reasonable price increases. And if, while we’re doing that, we produce these kinds of productivity levels in control of the coast, the byproduct and the result become an operating ratio.

We don’t start the game off and go into the game with a goal or objective to get some target from an operating ratio standpoint. As we’ve talked before, the real objective here is to take this low cost and to turn it into growth. So we have to contain to do this basic model, a pretty simple, effective model. We’re going to contain to focus on running a safe railway.

And finally rewarding shareholders, our share repurchase program we just announced and Claude talked about of the 28 million shares. So, overall I was delighted with the quarter. And Mary, we’d be glad to take questions from the group at this time.

Thank you. [OPERATOR INSTRUCTIONS] The first question is from Tom Wadewitz from JP Morgan. Please go ahead.

Hi, yes good afternoon.

Hi, Tom.

Let’s see, I wanted to ask you for a little bit more color on the sense of volume growth going forward, you saw a pretty good pickup in the second quarter versus what the growth had been in first quarter. Do you think there’s room to show a further pickup and the pace of pickup in the second half or would your sense of that be – I know there are a lot of different moving parts Jim mentioned but overall how should we think about that in second half?

I think overall the second half will pickup. And again adjusted, which again with the flat first quarter and adjusting for the coal volume declines that I described will bring us in slightly ahead of 2% for the year.

Okay. And what is your read on the economy? Do you see, again a lot of different moving parts for you – does the economy feel like its pretty strong right now, or does it feel like its changing much from where it’s been in second quarter?

You know, with the real weak economy it’s tough to produce these kind of results, I mean, some of - much more about the economy going forward than we do. You know, we see a lot of string. Jim described a couple areas that we’re going to see weakness in the second half.

I don’t know if we’re qualified to sit here and try to tell you about what the economy’s going to be in the future. I can just tell you this, okay? We’re going to haul our share of what’s out there to haul and we’re going to do it more effectively and efficiently than anybody else and those will be good results.

Okay. And just one more on the productivity side. I know you’ve got a pretty good pipeline productivity initiative. I think some of the things you’ve mentioned in the past Smart Yard and then the western siding expansions. Are those going to give you further boost in second half or is it kind of a smooth type of thing that flows in throughout the year in terms of the bigger productivity initiatives that you’ve been working on?

I think it’s probably going to be a smoother flow. The sidings are coming on as we speak so it’s not going to be like all of the sudden they’re all kicked in and there’s a big surge. I think you will see the type trend that we just described productivity wise in the second half being pretty consistent. You might see a little more gain in the tons per train as these items kick it. But it’ll be a pretty smooth transition.

Okay. Great. Thank you.

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

Good afternoon gentlemen.

Thank you.

Excellent quarter.

Thank you.

Are you shifting any of your business or your assets to western Canada to take advantage of the strong Alberta economy or BC to the degree that you can? And on the back of that, would you see any recruiting problems in doing so?

Well, we haven’t seen any recruiting problems. I mean with making these type productivity gains and I know Claude can tell us but I know the headcount which continues to be down 3-1/2%. And having said that, there’s certain pockets that we have to reinforce. We’ve ordered new locomotives given that preparing for Prince Rupert coming on. We look for a strong grain crop in the west. You know, we’re handling the business out west now and so I just see more of the same there.

Excellent. And on top of the obviously great productivity, do you see any opportunity to perhaps take down the headcount any further. What’s your plan on the running trades and on the managerial side?

Well, our issue is controlling cost. And optiboard is controlled. I mean we’re not into headcount, we’re into producing effectively and efficiently and once again, the headcount becomes a byproduct.

When you produce the type productivity gains we have, that’s what you see happen. You can do more with less. And I see those trends continuing as we go forward.

All right fine. A lot of plans were made – just the western plains obviously going through a bit of a drought and it seems to be extending into Canada, I mean, I guess the offset would be, naturally you’re going to see obviously maybe perhaps some yield compression in terms of the actual volumes. But with the actual crop prices rising, do you think that’ll be enough such that he farmers et cetera will actually market their grains?

Well there’s always demand for Canadian grain when it is a good quality product. Last year they had a lot of supply of grain and the quality was suspect. This year it definitely appears that the quality of the product with come in. And it’s going to be certainly in the kind of five year range, we’re not seeing any kind of areas of concern in our draw territory. So, we’re very optimistic about our ability to move more grain in the fall and into next year.

And Jim, just your ethanol moves, are you seeing a pickup in the ethanol move side?

Right now the development of the ethanol industry and both sides of the border is still pretty much in it’s infancy. Obviously we’re moving some product as these plants come online. And depending upon which scenario you want to play out, it could in the future be significant. But for now if it were – it’s a fringe kind of move for use at this point in time.

Excellent. Thank you gentlemen.

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

Hey, guys, it’s actually Scott Graham for Ed.

Okay then.

A couple quick ones for you. Jim, you talked about lumber rebounding in the fall, feels pretty weak right now just looking at the AR volumes, just what are you thinking about in terms of lumber rebounding in the fall?

Well we’ve been running on lumber panel franchise really for the past three years at 10-15% growth per quarter.

And so each quarter it gets a little more difficult for use to achieve that kind of run rate. I think what the information that we’re getting from our customers and our largest customers are some of the biggest in the world in terms of lumber producers is that right now prices are such that it is conducive for them to take this opportunity to do any kind of maintenance. Work on their facilities because they are anticipating that after the summer that the demand for lumber will rebound.

During this period of down time in production, inventory available lumber supplies is diminishing. So, in the fall, when that supply gets down and the demand goes back up, we’re expecting kind of run rates, in which we’ve seen in the past to return.

The other reason that we’re probably more optimistic than most is, and we’ve talked about this in the past is the fact that this beetle infestation in British Columbia, which by the way, has now expanded so the area in which there will be this cutting on going is right on our line.

And this is what the plants were built for was to take advantage of this opportunity. These trees are going to get cut no matter what 1.85, 1.9 run rates for housing starts, it is very good. So we’re positioned we think to grow in the second half of the year and into 2007.

Okay. Thanks. On the tax rate, I guess Claude, you talk about it coming down two to 3%, by 2010, how should we be thinking about that over the next couple years?

Actually the big kicker is the federal income tax, the 250 million income tax adjustments for it to give you an ordered magnitude 180 of it is for the federal income tax in Canada for us. And so that’s the big one. And it starts reducing from the 22% level down to 19.1% per year at starting in 2008.

So really, we see our defective tax rate at CN hovering for 2006 and 2007 in the range of just below 34%; 33-1/2 to 34%. And then in 2008, you’ll start to see it coming down for roughly close to a point or 3/4 of a point per year. All the way to 2010.

Okay. Great. Thanks. And then just one last quick one. On the strike with the BMWED I saw that they agreed to return to work just wanted to get any further thoughts on that.

Well you’ve got it right. You’ve got the – this morning I think it was I was on the phone with them about 2:00 or 3:00 o’clock this morning, they agreed to withdraw the picket voluntarily. And we have meetings set up tomorrow with them.

And I am cautiously optimistic that we will come to an agreement without additional work stoppage or disruption and by the way this caused no disruption whatsoever we were ready to go and get the trains moving in spite of the fact that there were pickets and it was effectively from that stand point it might have been.

And we were very appreciative that we were able to sit down with them and have reasonable people and have the pickets taken down and maybe we could settle this at the table where it belongs.

Okay. Sounds good. Thanks for the time guys.

Yes.

Thank you. The next question is from Scott Flower from Bank of America. Please go ahead.

Yes good afternoon all.

Hi Scott.

Hey. Just a couple quick questions. Is the improvement in terminal productivity just good elbow grease and focus or is that [inaudible] yards or could you give a little color on that because it obviously was a fairly substantial jump.

I think Scott, is it’s all of the above. The initial – some of the initial learning process from Smart Yard is being implemented along with some hard, as you described, elbow grease. Big gains have been made at [Mack McMellon Yard] in Toronto which is our business complex.

We have reached a point there where we were concerned two or three years ago about the capacity of that terminal. I was running some numbers this morning and I think we can handle a pretty aggressive growth for the next 15 years. And not have to worry about [Mack McMellon Yard].

Unless Foote breaks world records for the next decade. But it’s across the board, it’s a reduction in inventory in the yards and with reducing inventory is reducing cost, reducing handling. It’s just the basic ABC’s and getting better at it and getting a little sophisticated from a learning standpoint from a Smart Yard.

Okay. And I guess maybe a question for Jim or a couple questions. I know that you just got the question on lumber, but I’m just curious, how good do you feel about your customer’s work ethic because obviously the rate of change in terms of housing turns from the US continue to show some flowing and I was just wondering, how good do you feel about their fork out think pop back up again after summer.

Obviously you do have the cup of the deal infestation which will help you in terms of how they’re looking at cost and trying to get production up. But I just how would you feel about they’re forecasting when obviously housing turns and interest rates are moving up in the US?

Well we talk to our customers, we do our own work. We, if necessary, go out and retain the services of experts in the area. And try to come up with our best view.

And right now, I think the consensus is, from everyone we talk to, is that there will be a rebound later this year and especially going to be driven by the fact that if you’re looking at the inventory available stocks of lumber they’re going down. And so they’re going to be replenished.

And the capacity, the lowest cost and highest productive capacity in order to produce this lumber, especially being driven by the available feed stock is in western Canada. And that’s what those factors, it’s what gives us a higher degree of confidence that we’ll be -- this will be there in the second half of the year.

Okay. And then the other last quick question from me is: help us get a little color on where the intermodal growth is coming from. Is that just higher run rates from existing, is that new end? Help us get a little more color on how the intermodal volume growth is getting accumulated and obviously beat the good numbers. I’m just trying to get a better sense of where that’s coming from, new, old, shifts from carload.

It is available capacity. You may remember last year when we announced it we had put on an additional train start out of Vancouver into eastern Canada and into Chicago that we had added a new train to increase capacity. And in fact did so in such a manner that the train was sold out before we put it on. That was with existing customers of ours that were current, were then calling on Vancouver.

In addition to that we’ve seen increases in the overseas business from Halifax. We talked about the fact that China shifting had begun to make a call on Halifax. And that, while that has been slow, there is certainly more interest in the Suez route and the growth of Halifax. As well as one new customer to us in Montreal.

So it’s pretty much spread around. I think again, driven by the quality of our service and the available capacity to move overseas products into North America. As well as a strong growth rate in our domestic intermodal because of our service quality and our competitiveness with trucks there that which allows us to grow that business as well.

Well, thanks all.

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

Hi. Just really one quick follow up on the lumber side. Who your principle customers the home builders directly?

Our principle customers are the manufacturers in western Canada. Their shipping obviously to the big box stores in North America.

Okay. And then just more of a philosophical question. Things do slow broadly speaking, in the economies your operating ratio is obviously the best out there. What would your philosophy be – would it be you give up some margin for volume, or do you sort of try to preserve the type of margins you’re getting.?

We do it smart. If you have to ask that sitting around and you’ve got track that you own, and you need to gain market share, you do what you need to gain the market share. And you’ve got the ability to do that when you’re a low cost carrier. You have a lot of advantages there. So, I mean, there’s certain markets that we wouldn’t need to do that.

I think to some degree one of the things that I’m confident of, is whatever happens to have these starts in the average week it potentially could get, we’re going to gain [inaudible] market share again.

If you look at our lumber business over the last two or three years, at the time we purchased BC Rail, a lot of the lumber coming off that territory was being trucked across the border and translated. None of it being trucked across the border now, to my knowledge, with our two connections at Vancouver we’re setting record levels.

There’s lumber being right now being trucked to the water and being loaded and going around the horn. That’s not going to continue. We’re going after that business. So we’re going to aggressively pursue the smart business strategy to take care of that.

Just one quick question, and I think Claude had mentioned, you know you feel comfortable with the top end of 10-15% earnings guidance, but he also mentioned with a little bit of luck perhaps he could do somewhat better. I’m wondering if that contingent on fuel or there something else that may get you to the – above that 10 to 15?

No. I don’t think it’s any one thing. I think that if everything to get the haul cylinders and volumes are a little bit better than we expected, and a couple of things come together, we could do a little bit better than that.

At the same time, Claude described what some of the headwinds were. And issues that we have and probably one of them is what happens to the Canadian dollar. So, yes, we’re comfortable with the high end of the 10-15. Could it be better? It could but I don’t think there’s any one thing you could post it on that says if they hit there it’s going to be better, if they don’t its going to be worse.

Fair enough. Thanks.

Thank you.

Thank you. The following question is from Randy Cousins from BMO Capital Markets. Please go ahead.

Afternoon.

Hi Randy.

Claude, I wonder if you could give us a little bit more color on the fuel side of the equation. How much was the hedge gain in Q2 and Union Pacific’s conference call, they talked about this notional lag between sort of the – what happens to fuel prices and then how the hedge mechanism kicks in.

And they kind of indicated that their going to deterioration and their going to recovery rate in Q2 versus Q1 and I wondered if you could speak to sort of what’s happening to you guys and how do you see this playing out prospectively in terms of your ability to recover the escalation of fuel cost.

Yes. There’s maybe [inaudible] this one Randy. On the revenue side, Jim and the team have done an outstanding job of driving through to our customer base. The concept that if everybody pays the fuel surcharge we’ll be able to charge less and. But we have the lowest fuel surcharge of any railroad out there. But I think it’s fair to say we have probably the highest coverage in terms of the revenue base.

And today, as Jim can comment further, but we’re slightly ahead of 80% coverage and well on our way to continue to improve on that count. So that piece allows us to basically cover the increase or decrease of fuel cost going forward. And that’s why we’ve stopped edging all together.

Now, the edging gain and I said so earlier, the edging gain for the second half of this year will be roughly $75-80 million less than what it was in the second half of 2005. So we have a fairly significant head wing as we ram down. Our edging position for Q3 is 10% at 38 bucks per barrel and is zero for Q4.

Okay. And the hedge gain in Q2 was what?

Oh, it was roughly $23.5 million, Randy.

And isn’t there any kind of a leg phenomena in terms of your surcharge, i.e. if fuel prices have gone up quite rapidly, you almost get instantaneous coverage or does it take a quarter before…

No

…to see those numbers come through.

No we get a bit of a lag, but Jim’s program is a one month lag basically. So we’re keyed off of WTI with a one month lag. So in a highly volatile environment like today with Middle East and what’s happening out there you’re going to get a one month problem if fuel prices spiking. But we don’t, I mean, that’s just unavoidable. You’ve got to key onto something and the rest is very straight forward.

Okay. For Jim, you guys I think in past presentations have given some indication of the revenue potential that you see out of Prince Rupert. I wondered if you could true up your current thinking and do you actually have a lead container ship line that’s going to be pulling into the Prince Rupert complex now? Or are you – do you see yourselves announcing a lead container shipping line pulling into that complex, in say the next six months?

What I have in Prince Rupert is available capacity for steamship companies to bring in product to the North American market that doesn’t exist anywhere else. And so I am in constant dialogue with the shippers of those manufactured products, the receivers of those manufactured products, and the shipping companies that want to have the ocean leg of that.

So we’re adding a constant bylaw with multiple parties about the use of Prince Rupert. A lot of people would love for me to sell them that capacity today. And I am in no hurry to do that because as each day goes by, this capacity becomes more valuable. So that’s the short answer.

Maybe the long answer to of do I have that plan and do I have anybody signed up or do I plan and sign them up for the next six months? No. The revenue potential there – think the numbers that we’ve talked about in the past is $100 to 300 million additional of intermodal there at the 500,000 TEU level. And we’ll start seeing the benefits of that in October 2007.

So if you’re seeing sort of a competitive, you’ve got a valuable capacity, is a bias in the race that you’re looking at in terms of that incremental business, is that moving up. Can I read that from what you’re saying?

I think. Yes. You know, that supply and demand would dictate right now anybody that’s got a door to get in can charge a premium to do that. And we certainly have a brand new doorway in that I don’t see anyone replicating in the near future.

okay. Last question. I guess with reference to acquisitions you guys have picked up that kind of short line into the tar stands, I think years back, you looked an Ontario northlands. Do you see any sort of other bolts on opportunities over the next six months?

Randy, we’re always looking. I don’t know if we’re going to see something tomorrow or no? We’re always in the market to look at railroads because we think we do a pretty good job of running them. And the key is which that is the right price and so this is just a ongoing process that we’re all always talking, looking, and exploring.

There’s nothing on the drawing board that I know about right now that’s going to pop up in the next six months. But stranger things have happened.

Okay. Great. Thank you.

Yes.

Thank you. The next question is from Kent Hoexter from Merrill Lynch. Please go ahead.

Good afternoon. Hunter, just kind of take a step back it seems like the market over the past few days has basically been saying that a huge slow down in the economy is coming through and I know Jim gave great insights into what you see in the back half of the year. But what can occur quicker than you anticipate or what have you experienced what commodities. I know we’re looking for forest products in general to slow down, but what other things can kind of creep up on you just a lot quicker on the slow down side that you’ve experienced in the past? Thanks.

I don’t know that anything creeps up on us. I think if there’s a slowdown in the economy overall and it depends on which sectors of the economy it slows down, if it affects industrial output it would hit all our metals, and minerals and forest products and all those products across the board.

I don’t [inaudible] that personally the market is reacting in funny ways. I’m seeing people having record performances and the market doesn’t like it. I don’t know what the market likes. I’m convinced that we are as in good a shape as we can be by being the low cost carrier. It gives us a lot more latitude and flexibility. And I’m not – I’m sleeping very well and not worried about the second half of the economy.

Great. Thanks Hunter. And Jim, I think somebody had mentioned earlier on the corn crop, did I hear right that we’re seeing a little bit of drought kick in there and it’s not as strong a crop as it was last year and does that then have an impact on you’re ad volumes in the back half of the year?

No. At this point in time, I am not seeing any kind of impact in our immediate draw territory. Especially the crop in Canada in the territory in which we serve in northern Canada, that’s very good. And in the US the corn crop looks at this point in time looks very good.

Last year the crop surprised everybody in terms of the yield per acre that came out of what everybody said was going to be a disaster. So I think we learned our lesson last year in trying to call this crop. There’s certainly nothing catastrophic out there ongoing that I’m aware of.

That’s alright. Thanks Jim. And last question on capacity expansion. Do all these sidings that the programs that you’re engaged, can you quantify with a percentage on kind of what kind of percentage capacity these projects have?

If you care [inaudible] it was done on the basis of it was justified through operating savings by being able to accommodate larger trains fewer train starts.

But at the same time to your point, I would imagine in the west between Winnipeg and Vancouver, I would say at least 25% capacity. To an existing line that we’re not starving for capacity right now. So it gives us a cushion going forward from the capacity standpoint.

And we’re doing this a little different. I mean we are effectively we’re taking siding that are existing out there that are 6000 feet of the leak and putting them together to make a long siding. So we’re taking up a lot of railroad.

We’re getting rid of turn outs. We’re getting rid of single bungalows. We’re getting rid of switch heaters. There’s a whole bunch of operating savings associated with it and at the same time, it’s really a redeployment of half of that stuff there. Very little new material. But it creates additional probably 25% capacity from Winnipeg to the west coast.

That’s right now I remember the diagram from the conferences. They’ve been a great visual. Thank you very much for the time guys.

Yes.

Thank you. The following question is from [Walter Bracklin] from RBC Capital Market. Please go ahead.

Thanks very much. Good afternoon.

Hello.

Just on the labor side, just wondering is there any currently any lapsed labor contracts or pending or under dispute that are out there now, and if not, when would be [inaudible] the next most significant contract that would be coming up for renewal?

Well, I described the BMWE and that’s just [inaudible] 250 people in the grand trial so, that probably wouldn’t be significant. But the two – the next two that are the most significant to us clearly are coming up in December with UTU and CUW. And we have already entered informal dialogue with those two groups and we’ll be into formal negotiations probably within the next six to eight weeks.

Okay. Switching gears a bit. You complained a little bit last quarter, Hunter, about the slower cars from some of your competitors when ;you had them out there. I was just wondering, are you looking at any new co production agreement and perhaps giving us an update on the ones you have already secured. How are the productivity improvements that you were, are they coming inline better or worse that what was expected?

No. No. They’re all I think of – number one the update is I would say the turn on all the equipment has improved. So that’s a positive development. The co production agreement with the bin that involved Vancouver and Chicago and [inaudible] in the US.

The Vancouver side is going very well ahead of schedule. There’s a couple other things that have to be done, but we took over the dispatching at Four Configure Well, the CP co production in Vancouver is working very well as we speak.

We are continually in – and where there’s other opportunity to with CP we’ll be in the continual dialogue. So, we’re very pleased with the progress and what we’ve been able to do with those agreements and there will be other opportunities going forward.