Canadian National Railway Co (CNI) 2007 Q4 法說會逐字稿

This is the conference call operator. CN's fourth-quarter financial results conference call will begin momentarily. I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable security laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's fourth-quarter financial results press release and analyst presentation documents that can be found on CN's website. As such, actual results could differ materially. Reconciliations for any non-GAAP measures are also posted on CN's website at www.CN.ca.

Please stand by. Your call will begin shortly.

Good afternoon. My name is Syria, and I will be your conference operator today. At this time I would like to welcome everyone to the CN Rail fourth-quarter results conference call. (OPERATOR INSTRUCTIONS). Thank you. Mr. Robert Noorigian, Vice President Investor Relations, please go ahead.

Thank you for joining us today. I would like to remind you about the comments that have already been made about the forward-looking statements.

With me today is Hunter Harrison, our President and Chief Executive Officer; Claude Mongeau, Executive Vice President and Chief Financial Officer; Jim Foote, Executive Vice President Sales and Marketing.

After the presentation today, we will take questions from those people that are listening to this. Could you please identify yourself when asking a question, and in order to be fair, can you limit the number of questions to two.

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

Thanks, Bob, and thanks for joining us to review our predominantly our fourth-quarter results. Claude will speak a little bit to some full-year results, but most of the time will be spent on this quarter, a quarter that I think was very good considering some of the challenges.

If you look at our revenues adjusted for exchange were up 4%. Car loads were up 5%. Jim will talk about we had the ability to maintain some of our pricing momentum. Our earnings as reported were up $1.68. Adjusted we came in effectively flat at $0.90 despite those challenges I mentioned.

The precision railroad model continues to work. The [OR] compared to last year was effectively flat. I think we're down technically 1/10 of a point.

There's a few items I would like to highlight that took place that I am very pleased with. One is, as you are well aware of, we got Prince Rupert open and running, and the service has been excellent, and we were very, very pleased, and Jim will talk to you about some of those numbers and where we see that.

Two very, very important strategic acquisitions for us. The EJ&E in Chicago subject to STB approval, and we will probably have some questions about that, which we will be glad to address. And just recently, the ANY short line in Alberta, which runs Northeast of Edmonton towards the tar sands, and Claude lead that file for us and did an excellent job, and I think you probably have seen the press release. But I think you bought the railroad for $25 million, and we have committed to put about 130 to $35 million in a capital to get the railroad in the condition it should be.

We were successful into sales of our sale leaseback effectively of our Central Station complex here at headquarters and of our last remaining shares of EWS, which helped our cash flow performance. We saw further expansion of the non-rail services from CN WorldWide in North America.

And last but not least, on the labor front, I am proud to announce that the first one of these labor agreements to be signed was announced today. We initialed an agreement subject to ratification with the UTU in the US on the former IC property, which was the first, if you remember, first of the UTU agreements. So this is the first renewal which was completed.

In December we completed an agreement and was ratified with IBEW, and then I guess it was last week we announced that our new agreement with the steelworkers was ratified. It was ratified at 85%, which is effectively unheard of. So some pretty good performance across the board. Claude is going to talk to us a little more about the details of some of the numbers. Claude?

Thank you, Hunter. I think it is indeed a good quarter on balance, given some of the headwinds that we have to face. We had during the quarter the Canadian dollar really rallied and actually filled in above parity close to $1.02 during the quarter, and oil prices on the world markets were above $90; I think actually $91 on average during the quarter. So given those headwinds, we turned in a good performance, a particularly good revenue performance if you look at it. FX adjusted 4% revenue growth, good balance between the pricing and the volume performance. Jim will discuss it in more detail, but I'm particularly pleased that we have the FX adjusted growth in every business unit except forest products, which is impacted as we speak by the current uncertainty in the housing markets in the US.

During the quarter we also closed two very significant transactions, the EWS sale to the German Railroad and the sale and leaseback of our complex here in Montreal with Central Station. Together they delivered a gain of $165 million but also closed to $465 million of cash flow. So good for EPS and very good for cash flow.

The quarter also had another onetime item, the benefit from the lower corporate taxes that have been announced by the federal government here in Canada. That [DFIT] benefit was close to $300 million. If my memory is right, it is $284 million. So with this, we have EPS as reported of $1.68. Excluding the onetime item, that is the two transactions and the DFIT benefit, the quarter came in at $0.90, which is basically flat year-over-year. Good growth, good expense performance, but also a few areas where we had help on the expense side, and I would like to turn to the expenses and take that in more detail.

If you look at the expense performance, it is really a story of two tales or two big stories. The clear headwind is fuel expense, up a whopping 49% if you look at it on an FX adjusted basis. As I said, WTI at a $91 level. That is basically last year WTI was at $60 per barrel. In the fourth quarter, it had come down a little bit. So a huge increase on a year-over-year basis. That is not mentioning the increase in the refining margin of $3.00 to $4.00, which also add up to the equation.

So basically all-in with the benefit of exchange, you can see an increase for fuel of roughly $100 million, a little bit more than $100 million if I look at it FX adjusted.

Helping offset this fuel expense was lower labor expenses. A big help here unfortunately with the lower stock-based compensation. Last year our stock-based compensation was a meaningful expense to the quarter. This year it's a meaningful credit. On a year-over-year basis, it is a close to $80 million reduction. That has been helping us in terms of lower expense, and on the labor line, we also are seeing on our labor line the benefits from lower compensation for incentive bonus. All of this offsetting the slight increase to our headcount, which in the fourth quarter were up basically 2.5% on a year-over-year basis.

Purchase services and material and equipment ramps basically well-behaved, up 3% on a year-over-year basis FX adjusted. Our depreciation is up 8%. This reflects the normal increase that you would see due to our capital expenditure, but also the fact that we have not quite completed, but we have a best estimate for a new depreciation study of our Canadian assets. And that impacted our quarter by close to $8 million, 7 to $8 million. A run-rate of the increase to our depreciation expense for those categories that we have completed is in the range of $35 million. This is something in the fourth quarter that we will have to finalize, and I would expect perhaps a little bit more expense into next year. On a year-over-year basis, we should see an incremental run-rate in the range of 40 to $50 million for depreciation.

This is as a result of the intensity that we used our assets. The main areas of impact are in the areas of rolling stock where you would expect the fact that we are using our locomotive and our car fleet much more productively. This is having an impact in terms of life and depreciation rates.

Finally, casualty and other, this is a very lumpy category as you know. At around $66 million for the quarter, we are once again basically I would say around $30 million lower than the run-rate that I would expect whatever that means. Because, as I said, it's a very lumpy category. The reason it is lower is because we have had continuing benefit in terms of our personal injury reserves, both at [FILA] and [CASA], but also occupational disease claims are coming down based on our actuarial study. The benefit during the quarter was around $40 million, but we also had a $40 million last year when we did our Q4 actuarial study during the fourth quarter of 2006.

So all-in-all good solid performance. Clearly fuel expense, it is really little we can do other than covering ourselves with the fuel surcharge and the help on the labor and fringe benefits we hope to reverse next year with the better stock performance and an increase in those expenses. That is the way we're thinking about it.

On the free cash flow, we delivered $828 million on the strength of the cash generated from the sales of EWS and Central Station. If I exclude those gains, but also the significant cash tax installment which we did during the year on account of 2006 taxes, something I have explained in previous calls, our run-rate free cash flow would have been in the range of 650 to $675 million.

And, as you know, we paid during the year basically $860 million in cash taxes because we paid both the 2006 installment and our normal installment now that we're cash tax payable on account of 2007. This is a headwind we will not see next year.

The CapEx for the full year ended up at $1,680,000,000. $80 million of that is just the sale leaseback portion of our Central Station. So if I exclude that, our CapEx is coming in in line with guidance at around $1.6 billion. We see next year coming down. We have a number of our programs have been completed, and we're really focusing our and targeting our CapEx next year to the areas that deliver benefits to us in terms of productivity or growth. We see our CapEx envelope in 2008 in the range of $1.5 billion, and that will include roughly 70, $75 million at the first year of the ANY capital upgrade program that Hunter referred to. That is the line that links up [Linton] to our Edmonton -- to the Lakeland Waterway, which connects us to Edmonton.

Basically the only other item that went up in terms of cash consumption significantly is the dividend as per the increase that the board had decided last year, and I am very pleased to report that our Board of Directors again, and that is the 12 consecutive year that they do so, agreed to increase our dividend on a go forward basis. As you will see in the press release, that dividend will increase by 10%, which should put us at about our target of a 25 payout ratio give or take going forward.

Just a few words on the full year. To say that if I exclude the onetime items, we came in on the strength of the revenue performance around 3% FX adjusted growth. That is 340 of earnings per share for the full year, which is flat year-over-year. I think it is fair to say it is a solid performance. We had our share of challenges to deal with with a much slower economy, particularly impacting forest products. But also, if you will recall in the first quarter, labor disruption and a number of other challenges to deal with, not the least of which are exchange and fuel price volatility.

So on balance that 340 I think is a very good performance. And that is the basis upon which with some trepidation I would like to close my presentation with giving you a bit of guidance on 2008.

If you recall at our Q3 call, we had reserved the guidance because we thought there was a little bit too much uncertainty to make a call. I must tell you yesterday and this morning when I was seeing world markets and the volatility that we're seeing, I guess the volatility has not fully lifted. But it is our view basically that within this uncertain environment we are -- it is our view that the economy in actual fact may not be as feared by some in a full-blown recession. I think we still have a good chance of having a soft landing. It may be a little bit more bumpy, but what we're calling for is a soft landing basically on the order of just below 2% North American GDP growth, 1.7% to be exact. The dollar has settled back in in a range of C$0.95 to US$1.00. That is the Canadian dollar versus the US currency. And fuel prices last I checked were around $90 per barrel and with a forward for the year in that range. So, of course, these items have been all particularly volatile, and the economy remains a question mark. But if we're calling it right, we think we're very well positioned, and Jim will give you some more detail. But we see top-line growth next year being the engine of our EPS growth. Clearly we will need it because there are some headwinds that we're facing.

To be specific we are calling for growth of 6% to 8%, which really is around 10% adjusting for exchange. This will be needed to help offset some of the headwinds that we're facing. Let me give you just a few.

The foreign exchange, if it is in that range, say, midpoint should have an impact on out reported EPS Canadian dollar in the range of 2% to 3%. The fuel at $90 would be a headline increase on the order of $175 million. The important points for you to know is that about 40, perhaps even $50 million of that is the fact that our crack refining margin we had some very, very good contracts in the past where the refining margins were well below market. These have been renegotiated at market. We are also not always getting the full benefit of the exchange appreciation when we pay our fuel bill, particularly in Western Canada where there's a very tight supply. So net net we see independent of fuel price -- that is the movement in WTI -- we see a headwind in the range of 40 to $50 million that will be there on the fuel expense.

Labor we hope to turn around because we hope to have a good year and see the stock price go up. We also have lower bonuses than we would have liked in 2007 and are fully intent on changing that for next year. That is a headline. Both of them will be offset somewhat by lower pension expense, but labor expense next year should be a headwind again in the range of 1% to 2%.

So basically if I look at some of these items and focus also on depreciation and some of the benefit on the personal injury reserve that we had in 2006 and 2007 and should come down a bit in 2008, we're facing cost headwinds which basically bring us in terms of guidance to mid to high single digits given the parameters in the environment in terms of assumption. That will be backed up with very good cash flow generation next year. We are targeting $750 million free cash flow. And the key uncertainty at this point is whether we're calling the economy right. But you should know that under Hunter's leadership, we're managing and getting ready for both scenarios. We want to be there to accommodate the growth if it is there and it improves our top line, but we will be ready and also managing our expenses if the economy turns out to be tougher than what we're calling at this point.

With that, I will turn it over to Jim.

Thank you, Claude. As usual, I will be discussing the revenue numbers on an exchange adjusted basis. In the fourth quarter, we had revenue growth of about 4%. There was a good blend of volume and price across all the business segments. In total, our carloads were up 5% and revenue ton miles up 3%. These total numbers show the impact of a 45% increase of iron ore loads moved this year versus last year. All of our iron ore companies were back in full production this quarter versus last year when there was an explosion at a mine in two furnace outages. So there were a lot of ore loads here, but on average they only move about 60 miles so that they do not have nearly the revenue impact. This high-volume low-revenue per car move impacts the revenue ton miles, revenue per carload and length of haul as well.

On the price side of the business, the price environment continues to be solid. Rate increases on a per unit basis achieved this quarter were above 4%. Going through the various business segments, petroleum and chemicals up 11%, petroleum-related markets continue to be strong, up 16% in the quarter, led by diluent shipment into the oilsands region of Western Canada, strong shipments of fuel oil and diesel fuel and very strong shipments of sulfur due to the strong commodity prices and increased world demand.

The chemical side of the business also very good, up 8%, especially important methanol shipments over the Port of Kitimat on the West Coast.

The metals and minerals group up 11%. All subgroups in the metals and minerals business segment posted increases in addition to the iron ore business that I talked about in my opening remarks. Positive results in all of the metals subgroup. Strong demand for steel slabs, plate and aluminum. Construction materials were somewhat stronger in the fourth quarter than they had been earlier in the year and very good shipments of dimensional loads such as windmills and large pieces of machinery in the quarter.

Forest products, the only business unit where we saw a decline this quarter. Our lumber and panel producing customers continue to face difficult markets. They are rationalizing capacity and curtailing production as demand continues to decrease. Carloads in this area were down 12% and 25% respectively for lumber and panels. Paper results down 8%, largely due to the closure of a significant mill in Eastern Canada, which had just started operations earlier in the year. And woodpulp posted relatively flat volumes versus last year as -- but export prices stayed very strong throughout the quarter. Our automotive business segment up 7%, very solid quarter of performance. Finished vehicles and vehicle parts up 5% and 11% respectively. Gains there in the finished vehicle segment driven by new vehicle models, as well as very strong import traffic to the port of Vancouver.

On the bulk side of the business, bulk in total up 8% as the demand for our services from our bulk customers continues to be solid and growing. Canadian coal, coal in total of 12%, but Canadian call again a very strong quarter, up 44% driven by strong demand for the metallurgical coal to the export markets, coupled with new mine capacity that has again come on in Western Canada. The US coal business down 10%, some short-term production issues at a major Illinois Basin line, as well as an outage at one of the utilities served by CN and short-term related issues here affecting the US business.

Grain and fertilizers, the total there up 7%. In Canada lower volumes of wheat offset by a very strong demand for barley to export, as well as stronger volumes of peas in the West, and in the US we saw somewhat lower corn shipments -- although big volumes of ethanol and [DBG] commodities, as well as more soybeans moving to the Gulf Coast export markets.

The fertilizer segment very positive as we continue to move more Potash from Canada into the US markets where the crop size continues to increase.

On the intermodal segment, up 4% in total, overseas up 6%, reflecting the opening in the quarter of the new Prince Rupert traffic. The service there has just been phenomenal throughout to all the destinations, as well as we continue to show gains with other steamship companies over the ports and terminals in Vancouver.

Our domestic business also showing strong increases with our retail customers in the fourth quarter, domestic up 3%. And the other revenue up 7%, showing the increase there in our activities related to nonrail transportation services.

Claude touched on the outlook for 2008 from a top-line perspective. There is nothing out there that would shake my confidence in the pricing area. Our previous guidance in the 4% to 5% unit price increase continues. We will see very good growth in virtually all of our business segments, especially intermodal in bulk. On the bulk side, our coal outlook is very strong in the US as the Illinois Basin coal that we have talked about in the past, the new mines there come online, as well as the continuing demand for Canadian metallurgical coal to offshore markets. Corn demand and corn pricing in the US is very strong. Wheat exports out of Canada continue to be very strong. Potash movements should continue to be moving into our US markets, as well as strong demand for sulfur and intermodal.

In the merchandise segment, the area where we have saw softness or declines -- it's difficult to say that forest products was soft this year. It was down quite a bit. We think that the housing market is probably stabilized. And the run-rates that we saw in December will probably be where they were and will continue to be throughout the year. But the strong opportunities that we have talked about with more and more product moving into and out of the oilsands, very good outlook for '08 for metals and minerals, especially for the full-year demand for our iron ore. And if you add that up, top-line outlook at this point in time we would certainly expect to achieve 10% top-line growth in '08 on an exchange adjusted basis. Hunter?

Thanks, Jim and Claude, for those helpful remarks. Let me kind of wrap up '07 by making these comments that Claude alluded to earlier, but I think if you look at the performance of coming in effectively flat at adjusted $3.40 and if you take into account that that was comparing 2007 to 2006, which was a world record performance for us, with the obstacles that we have faced, this team faced in the first quarter with unprecedented weather in Western Canada, the worst in history, with the unfortunate work stoppage by the UTU which set us back, and then the strength, continuing strength of the Canadian dollar and the weakness of the forest products segment; if this had not been a strong operating team, we would not have been able to produce those type of results in the face of those obstacles. So I was overall very pleased with the performance that this organization was able to put together.

So looking ahead, it has been very difficult for us as Claude also mentioned earlier to try to figure where to stick the pin in with the volatility of some of the issues we faced that he withdrew. But all things in, I would just tell you this, that I am very optimistic about us being able to achieve those type things. I think we have got several initiatives in our pipeline that can produce some results for us, and so I'm looking forward to a real bounce back in 2008, despite some of the things that we read everyday.

We have targeted capital spend for productivity and to accommodate additional growth at $1.4 billion, and I guess that is -- that is wrong, it is $1.5 billion because we had the ANY added in. Originally it was going to be $1.4 billion, which is backing off about 200 to $300 million from where we had planned on being in 2007.

Keith Creel and Paul Miller, our Chief Safety Officer, are leading us in a real commitment to take full advantage of the opportunities that this whole safety loss control risk management effort gives us, and we will continue to be focused on rewarding shareholders as Claude mentioned. We just approved today with the Board of Directors our 12th safety dividend, and we will continue with our aggressive share buyback program in which we had -- it has been going on for about several months now. So all-in-all I'm very pleased.

Operator, with that we will be happy to address questions the group might have.

(OPERATOR INSTRUCTIONS). William Greene, Morgan Stanley.

If we look at kind of the carloads per employee or however you want to think about it, I guess I would have thought with the volume growth it would have gotten a little bit better. Clearly on the expense side, you benefited from some of the items that Claude mentioned, but can you talk a little bit about how we should think about this going forward and whether or not the new agreements that you're trying to put in place over time may be can it lead to even substantially better productivity, or have we kind of hit a ceiling?

I think we had a little technical problem, and we did not yet the first part of your question. Could you repeat that question?

Sorry about that. Can you hear me okay?

Yes, we can hear you now fine.

Alright. So the first question was just related to the productivity. Given the volume growth we saw, I would have thought it would have been a little bit better in the fourth quarter measured in carloads per employee, but maybe that's not the way to think about it. and so I'm curious what your thoughts are there.

And then how much better can it get? Have we hit a ceiling, or are some of these agreements you're trying to put in place, can those move the needle materially from here?

And you are speaking of labor agreements?

Yes.

Well, they can certainly move the needle. Keep in mind that I have always said that we are not -- we have not been obsessed with the operating ratio. We're trying to grow this business. And there are some initiatives that we have got going on. One being CN WorldWide, which is a startup business, which we account for differently which shows deterioration.

I guess the biggest issue from those metrics that you're looking at is that when you lose the amount of lumber business that we had in Western Canada, it was our largest segment, which now has dropped down enough that grain in Canada and intermodal are larger than forest products.

So it affects the train productivities. It affects a lot of things. But we have certainly not hit the ceiling as far as the ability to produce improved productivity in our operating metrics.

Basically I think we have had a slight increase in our headcount for the reasons that we discussed on our third-quarter call. Some of it you know replenishing our crews in the West in particular, some of it in-sourcing.

But the reality is in terms of getting leverage, the beauty is when we have a better volume outlook going forward. Take Rupert, for instance, and all the initiatives that Jim talked about. The ability to handle the business at lower incremental cost is when it is easier to show productivity from a headcount standpoint and from a labor productivity that you have been accustomed to in the past.

Okay. And then with regard to your outlook, you had mentioned in particular you do not have a recession in your numbers. Can you give us some sense for what you think the sensitivity would be if you had to move toward a more consensus view that maybe perhaps there would be a recession?

You know what? The consensus view is tough to call. If you had asked me yesterday, it seemed the market was calling for a near recession. Today I think people are not sure anymore. That is the difficulty in the volatility that we see going forward.

All I can tell you is we have initiatives that are totally independent of the economy. Rupert, some of the bulk business out West, some of the initiatives we have to take marketshare against, truck, etc. For sure, if there is a recession, that will have an impact on our topline.

But on balance that may also help with the exchange. It may also help with fuel price. And who knows our focus will be on doing the best in those circumstances and rebound strong when the economy comes back.

Tom Wadewitz, JPMorgan.

I wanted to see first if Claude could give us some insights on some of the moving parts on comp and benefits in your '08 outlook.

I guess you talked about pension and that that might be down year-over-year. On the incentive comp, can you give us a sense of the stock-based and incentive comp that was actually paid out in '07 and what that number might have looked like in '06 just so we have a little framework for understanding some of those moving parts?

2006 was a stellar year, so you know we blew the lights out and we had the highest possible moments as a team. 2007 was tougher, and in the end the Board recognized that, and we did not get any bonus.

So next year we're going to have to replenish. We're shooting for a stretch, and hopefully we will get a stretch. So that alone, having said this, might be an increase in terms of expenses in the range of, say, 60, perhaps $65 million, which is about the benefit that we will get on pension because of the higher discount rate. So the two of them offset hopefully, and the real impact will be the stock-based compensation that could be if things rebound and go as one would expect could be in the range of 40, $50 million increase.

Wait? What is the 40 to $50 million increase that's --?

Stock-based compensation. If the stock performs the way we would expect it (inaudible).

Okay. So you have got a 60 to $65 million potential increase in incentive comp and then on top of that 40 to 50 from stock-based?

Correct, offset by a reduction in pension expense in the range of 60 to $70 million.

Okay. And it was kind of a 100% payout in '06 and a 0% payout in '07 was kind of the way it worked out?

That is awful close.

Okay. Okay. Fair enough. Let's see on the productivity opportunities that you tend to run with a lot of different I usually think of you guys having a full productivity pipeline. And I'm wondering if, Hunter, maybe you could highlight some of the biggest productivity drivers and what the timing might be from when we would see an impact from some of those things in 2008/2009?

I think three areas I will mention on a short-term basis and one of a longer-term nature. One is by year-end we will have the new yard at Memphis fully implemented. We will I think within the next two months we will be "humping cars there," which will have a nice positive impact on terminal expense that we've talked about earlier at Battle Creek, [Vondelak] and Chicago, Stevens Point. So that's one initiative.

As a continuing initiative and taking advantage of the long sighting program which is near completion, it is probably 85% done, but it is just now fully kicking in. That is another one I would mention. There is a lot of them going on in mechanical and smaller, but the largest one is clearly where we are working and spending a lot of time in resources is with the EJ&E transaction in Chicago.

And if that -- I think the more we talk about and the more we learn and the more we looked at that transaction, it offers -- everyday I see more upside opportunity than we initially saw in the transaction. So that is just an example of two or three things.

On the Memphis and the long sighting, where would that tend to show up in the P&L? Is that a headcount where that would show up or equipment rents?

Well, it would not show up in equipment rents. You know, it shows up basically in labor productivity predominantly most of it. I am not kind of a headcount person. I am more of an expense person. I don't get expense as a headcount when I see the expenses down. So we've contracted in a lot of engineering work that we're doing ourselves, which was one of the reasons I think that we developed a relationship that we were able to get an agreement quickly with the steelworkers and get 85% ratification for it. And then we've talked about the replenishing of the predominantly older workforce and the overlap when we do the training. So that will wash itself out. So that is where those two things -- and that's just two of many.

I mean we have gotten new locomotives, and we're starting to see the opportunity with the fuel productivity, with the locomotives that will get better. And to some degree, it is difficult to take advantage of those opportunities when you are looking out here at 35 degree weather in Western Canada, 35 below in Western Canada and you are able to adjust to the weather.

But I can tell you this, as I said earlier, since we got the little setback with 2007 with those issues that I mentioned, we're back where we were prior to that, and I think you will see the productivity metrics making a pretty substantial move forward.

Edward Wolfe, Bear Stearns.

Can you talk a little bit about pricing? I know Jim talked about going forward 4% to 5% pricing. But if I look at the reported yields for the quarter on a mix adjusted basis down 6%, can you talk about what there is FX, what is fuel, what is pricing, what is mix?

Well, if you look at the quarter's results and you adjust the volumes for this significant pickup in iron ore, our volumes in the quarter were relatively flat, which I believe if you look at the other business groups with forest products being down as much as it was, the other businesses did very well. And then you add to that then the price impact in the quarter, you will see that the prices are pretty much in line with what we have been talking about in the past of around 4%.

Going forward into '08, we expect that trend to continue and would be higher as I said slightly higher than 4% between 4 and 5 in '08.

What makes you confident it is going to be higher? What areas?

Our pricing is pretty much consistent from business unit to business unit. What makes me confident that pricing in '08 is going to be good is because most of our contracts, number one, are two to three years in duration. So I have anywhere between 66 and a third of our business that is already price for next year, and that is in the range that we have talked about in the past at 3% to 4%. So those prices are already locked in for '08, and the price it takes that I'm getting on my current contracts is higher than that.

And are there any significant long-term legacy contracts coming up?

No, we don't have any long-term legacy contracts. All of our business, as I say, is contracts for about two to three years, and therefore, we have been pricing in these ranges for the last five to six years and steadily improving on our price tick, which has been reflected in our yield numbers in the past.

Okay. So we have got 4% let's call it pricing in the quarter. Let's reset the volumes to zero based on your discussion. What takes us to minus 3 in revenue from there? Can you take me through fuel as a positive, mix as a negative and FX as a negative? How do we get from positive 4 to negative 3?

Well, the reported fourth-quarter revenue number was zero. So the impact is the exchange. Yes, so that is the difference.

I'm guessing that there's some year-over-year fuel positive based on how much surcharges have been and so forth, right?

That is correct. So there would be a positive impact in the quarter from price. There would be a positive impact in the quarter from fuel. So --

Is fuel part of that 4%, or is that --

No, that would be separate from that. What you have to recognize is that the fuel is not as large as you would expect because there is a two-month lag in our fuel surcharge. So, in effect, I think the fuel surcharge WTI price during the quarter was nowhere near the $91 spot price that we paid for our expense.

So year-over-year fuel surcharge was up slightly. Price was in line with what Jim is discussing, and the volume was up slightly. So 4% price, 1% to 2% for fuel and 1% for volume.

That is helpful. I appreciate that. Can you talk a little bit about Prince Rupert in terms of numbers? In the past you have talked about a run-rate of $100 million for '08. Are you online for that, and what could take you above that in terms of having other boats besides Costco? Where are you in those negotiations?

Yes, I think Bob has given some guidance there in terms of that number, and that would certainly be the number that we're expecting in '08. The upside to that would be two factors. One would be having another customer make that a protocol, and we're continuing to dialogue with all the major steamship companies, as well as their customers, about calling there, and are optimistic that we will have another customer make that call, as well as the outlook for the existing customer consortium, which is Costco, [Hanjin] and Yang Ming who are all on the vessel rotation to increase their volumes, and we're in dialogue with them about them potentially doing that as well. So either one of those scenarios will bring our outlook for the year up.

And what are you seeing on exports back through Prince Rupert? Any business yet filling the backhaul?

Yes, in various different commodities. The backhaul opportunities that we have talk to ranging from machinery to paper products to pulp, working with a number of different customers today on nontraditional products, both products that have the potential to move via container. So we're working hard there, and we're working with Costco, and those opportunities are coming on.

Okay. Just last follow-up on that. Does that $100 million include backhaul, or is that gravy if that develops?

That would be gravy, but again we're not -- we're certainly not -- I'm not confident enough or bullish enough to say that I'm going to be 100% balanced here in terms of that backhaul. This backhaul business is going to take us a while for us to develop. We're in the process right now of just building a facility in Chicago where we can fill containers with the derivative product from the ethanol production. We have assigned some arrangements with customers to be bringing product in there. But again, that it is probably -- we're at maybe going to be 10% of the headhaul volumes filled on a going throughout 2008.

Randy Cousins, BMO Capital Markets.

(technical difficulty) -- context of your guidance. Do you see it sort of the earnings growth evenly spread over the year, or are you betting on a recovery in volume in the second half and a slow start to the year?

If your question is the EPS outlook and how it shapes up by quarter, the first quarter you have to recall last year was when we had the labor disruption. So we're going to have an easy comparison in the first quarter, and then after that we are seeing the business basically evenly -- back end should be better just because we're expecting the economy to come out of the slumps that we're seeing in some of the sectors in terms of weakness. But some of the initiatives, the growth of Rupert, the bulk business, all is that is such that we can deliver in the front end of the year because it is front of us. We just have to be fluid and run the railroad.

So there is no -- it does not require you -- your assumption, your guidance don't require a sort of recovery and economic activity in the second half to get your numbers. It is just a case of executing on the business plan?

Yes, I would say we do assume that the back end will be is when the economy will rebound. But, in terms of our EPS, the first quarter is an easy comparison, and we have initiatives to have growth throughout every quarter.

Okay. My second question has to do with equity linked compensation. Can you give us a sense is that tied to a US dollar calculation or is it the Canadian dollar? And do you -- how does it work? What is the sensitivity? So if CN's stock goes up C$1.00 a share, how should we budget the equity linked compensation adjustment?

I would have to give you the model on the basis of all of those factors. It is quite difficult to give you a rule of thumb because it does, indeed, depend on the Canadian dollar stock price or the US dollar stock price. But, by and large, you're not too wrong if you assume that a dollar increase in the stockprice would give you about 6 or $7 million of expense.

Okay. And then finally, just with reference to the fourth quarter so I can get it straight, can you repeat the numbers that you stated in terms of sort of the comp adjustment down versus bonuses versus the equity linked component?

Well, we answered that for the full year. Now you want it for the quarter?

Yes, because it was in the fourth quarter that you had the big change in sort of the labor expense line. I was wondering whether --?

Let me put it to you on this way. Our expenses on a year-over-year basis in labor were down $134 million. I would say that the stock-based compensation and the fact that we did not accrue for a bonus in the fourth quarter would explain about 110 of that. So that gives you an order of magnitude.

Cherilyn Radbourne, Scotia Capital.

I wonder if you could comment on the EJ&E, and just give us any idea how optimistic you are that you will be able to expedite that environment or a view relative to the timeline that was outlined by the STB?

Well, I'm not sure that they defined the timeline of the environmental review. I think they made in my view an error when they stated in the press release that it could take two to three years. I think that is a little ridiculous in my view.

I mean if you go back to the past deals, I think the Conrail deal, which involved many many states, 17 states and gillions of crossings and we're talking about Chicago, I don't think that the environmental review will be that long.

Now what is long? I would hope that within a year from when these activities were started, that we could get some kind of response in that regard. I think overall I think from an economic standpoint and from an competitive standpoint, I think there were virtually no problems with the transaction. I know a few people that are opponents of it.

So our issue is clearly going to be when you cut through the environmental, it is effectively a crossing issue in the Western suburbs of Chicago around the Western parameter.

If you look at the total traffic in the greater Chicago area, there will be fewer trains across crossings. And if you looked at the overall environmental impact fairly for the greater Chicago area, there will be a significant improvement.

Now it is going to be for others to deal with, and we will fight the good fight here and try to decide that trains should move out of the intercity away from McCormick Place, away from Soldier Field, away from Kaminski Park, away from the interstate that is not much better and more efficient and adds to capacity to go around the perimeter of Chicago.

So I guess overall I am optimistic. I don't want to put any number of percentage on it. I think the transaction will be approved. I do think that there could be an issue with length that could cause us a problem, or there could be an issue if somebody says we have got to spend a lot of money to mitigate some of the circumstances that we would have to review that very carefully.

Okay. Thank you. Claude, I wonder if you could speak about the dollar impact the inherent lag in your fuel surcharge program would have had on your bottom line in Q4. Is that something that you can quantify?

Yes, roughly speaking. I think the foreign exchanges we do disclose is about $0.05 or 5 pennies during the quarter, and the fuel lag is I would say was in the range of $25 million during the fourth quarter. That is basically paying a higher fuel price on a higher spot price than our fuel surcharge because of the two-month lag.

Scott Flower, Banc of America Securities.

Just I guess one clarification for Claude, and I know you've had several questions already, but in my own mind on the labor compensation side, in terms of the incentive comp, is the lack of bonuses or the accrual, is that just a fourth-quarter phenomenon, or did you actually reverse accruals for prior parts of the year in terms of how fourth quarter was versus what total year bogeys were? Or was it just a fourth-quarter phenomenon?

We adjust our accrual throughout the year, but in the fourth quarter, there was no reversal for prior quarters.

Okay. There was not a true-up for quarters one through three?

No, it was just the fact that we did not.

Okay. Alright. That is fair. I just wanted to clean that up.

And then I guess the other question I had maybe for Jim was just, and you've answered a lot of questions already on the topline side, but you mentioned obviously the one paper producer in Eastern Canada, and I don't know what caused that, but I'm just wondering are you seeing any lag impact from the much stronger Canadian dollar? Because a lot of times goods in trade we will see an impact on a lag basis to what was a sharp change in currency exchange rates. And I'm just wondering when you look at your book of business are you seeing some lag impact on your volumes that I am assuming paper would be one of those that are affecting your volume outlook?

I think the issue with paper is clearly our paper customers in Eastern Canada are clearly impacted by the dollar. But it is more to do with the overall decline in the market for papers, which has put them under pressure now for quite some time. And so in a very difficult business market to begin with, really not associated with the economy for the dollar to have come along and appreciated at this point in time has made it difficult for them. And there have been production cutbacks and curtailments in many locations by many producers in an attempt for them to adapt to the declining market. Some of those production cutbacks have been positive for us, and some of them have been negatives for us.

From a dollar perspective, that is about the only area at this point in time where I can point to and say where any of my customers are having difficulties from the dollar. The lumber and panel decline is associated with the housing issue, not the dollar.

On the other hand, I have an outlook for the movement of iron ore right now because US steel manufactures have looked at raising their production output because of the lower US dollar, which is making US manufactured products right now much more competitive globally.

So my outlook right now is very optimistic and is not dampered in any way, shape or form by the dollar.

Jacob Bout, CIBC World Markets.

Just a follow-up on that last question. Maybe you can just comment on the flow of traffic within North America as a result of the Canadian dollar strengthening, but more on the US weakening and be more active in the export market and some of the flows of volume out of New Orleans?

If you take a look at the business opportunities that we have talked about, not only just this quarter (inaudible) but in the past, we have worked very aggressively to make sure that our Company was positioned not reliant on one specific market.

And so the opportunities that we're talking about are clearly not dependent upon the strength of the US economy or the exchange rate between Canada and the US. Western Canadian bulk shipments to offshore, sulfur movement to offshore, potash movements from Canada to the US driven clearly by record (inaudible) and a 25% increase in corn production. As I just mentioned, iron ore volumes moving into the US because of the lower US dollar.

So our traffic flows are very diversified, are very dependent not only on one commodity, but not dependent on one commodity, but not dependent upon any one regional economy or commodity or economy. So I am very optimistic when I look at my portfolio of business and I see my intermodal business on the West Coast increasing, not only at the new port but in Vancouver where the predominance of that is coming into the Canadian market, then I'm realistically comfortable that we will not be impacted maybe as much as some other railroads might be.

Okay. And then second question, just as far as the STB ruling on the new rail cost formula for regulated freight, how big of a concern is that internally, and looking forward is there any concern about that spilling over into non-regulated freight?

I don't think (technical difficulty)-- we don't obviously (technical difficulty)-- the exact calculation and where they came out in terms of the cost of capital. We think in our cost of capital you should be a better judge of that actually higher than where they came out. But I think the impact is going to be lagged, and at the end of the day, I think people recognize whether it is in Canada or the US, we are in a world where there is a lack of infrastructure. And if railroads on a private sector basis are going to invest to build up that infrastructure, we will make a return.

Bill MacKenzie, TD Newcrest.

I was wondering if you can talk a little bit about your service levels and if you take a look back at 2007 how you feel you did from a service perspective with your customers, if you have any metrics you might be able to share in terms of on-time originations or just general customer service satisfaction levels? And what are -- if there are any particular end markets that you're really focusing on for 2008 in those particular areas?

I think overall our service was very good. We measure internally. You can talk about a lot, but we still measure -- each one of our nonbulk carloads has a trip plan that is measured in hours not days, and overall we did very well.

Now clearly during the weather problems of the first quarter and the work stoppage, you might say that service was not up to our normal levels. But after we came out of the work stoppage and through the second, third and fourth quarter until we've reached a point here with the weather here in the fourth quarter -- with the first of the year as a result of the freezing weather, our service has been very good.

The issue that you have with service is this, is you have a problem defining what is good service. You know we have -- in its -- I'm trying to learn a new phenomenon in Canada when they talk about service, they talk about you have bad service when you raise price. So you have got to define service.

Our transit times, the condition of our equipment, the timeliness of our switching, the investments we made in new equipment and capital, our switching is far better than any of the competition in our view.

Okay. Great. Thank you. And then, Jim, maybe to get into forest products a little bit more for 2008, we have been hearing about more facility closures. I'm just wondering if you have a volume expectation for forest products on a RTM or carload basis for '08.

Well, where we are right now I would think that we would see in the forest products business unit down 3% to 4% in terms of carloads for the full year. It is kind of where we expect to be. You know after a year where -- after this year where we were down 13% or so for the group. So obviously starting to, as I said earlier, bottom out in terms of some run-rates here and hopefully see some optimism as we move closer to the end of the year.

Just one last question, Claude, in terms of the balance sheet. You guys have been pretty aggressive at buying back stock. You have been spending more money than what you forecasting for free cash flow for next year. I was just wondering how sustainable is the current buyback activity, and if there are any particular debt thresholds that if you were to hit would result in you guys being a little bit less aggressive from a buyback perspective?

Well, actually we have been quite consistent in our approach. We adjust as we go based on our performance and strategic agenda, but effectively what we have said is that we're going to focus on a coverage ratio, and we have an ability to lever up, which we have during 2007 to some extent, but we're still in process of doing that levering up to a point where we target 2.2 times EBITDA coverage as a target going forward. I think we finished the year just under two.

David Newman, National Bank Financial.

Just further on the buyback, in terms of your guidance, what are you presuming in the second half? Are you going to keep it at the elevated level, or should we have it going back down to, say, 5%?

Actually we have a program, the current program is for 33 million shares. I think at year-end we were basically a little bit past midway with something like 17.8 or 17.7 million shares that had been purchased. And I think barring unforeseen circumstances, it is our expectation that we will complete the program between now and next July.

And in July, Claude, would you continue on at the $33 million rate, or would you step it back down to, let's say, a 5% buyback again? In other words, what have you presumed in your guidance in terms of the bottom-line guidance? Have you presumed as of July of next year in '08 that you moved back down to, say, the 5% level, or are you considering discontinuing at the current levels?

You know, we will reserve our judgment in terms of that decision when we make it with our Board in the spring to early summer timeframe. But I would say to you that effectively the first six months of buyback really tells the story in terms of the year-over-year impact. And it is our expectation at this point that our use of free cash flow will go towards share buyback, and without putting the pin in on exactly how many shares, we expect to be buying back in the second half of 2008 as well as the first-half.

Okay. And do you have discretion on the program that you can come in to these markets at these levels and buy back more shares than, let's say, a $1.00 cost average?

Well, we tend to be buying back on an ongoing basis if we are opportunistic, and clearly when we see the stock price coming down, we modulate accordingly. But we are buying throughout the year within the guidelines and what is available to us on a float basis, particularly when we are buying in the US market.

Okay. Very good. Switching gears over to Rupert, I have heard rumors there is some pilotage or tugboat costs that might be a little higher than, let's say, on the US ports or even Vancouver. How do you -- I mean obviously US ports have obviously raised a lot of costs as well. How do you benchmark against the US guys to Tacoma, Seattle, Long Beach? Is the Canadian -- is Rupert at a competitive advantage on the cost of that port?

Yes, the port there is very productive and competitive. From a complete logistics chain, significantly better service and lower costs than the other West Coast ports.

Very good. And last one, Jim, did you say that you have locked in about two-thirds of the price increase for next year?

That would be correct. The way our contracts are structured, if they have a three-year contract that I signed, it has already been priced.

Okay. And last one, Hunter, on the [J], do you think you might have to put more CapEx into the situation than you first envisioned to sort of appease the local residents?

You know, I think that is a possibility realistically. To some degree, some of that is -- we have a little leeway with a $100 million that we -- as I said when we purchased it. You know, we have talked to every community -- just about every community, if not every community -- that is going to the affected by this that had issues, and we have encouraged them to have a dialogue with us. We're prepared to do the right thing, but there is a limit. So could there be a case where we have to spend X amount more to help that situation and help in more ways than one? Because if there is, for example, great separations, there is formulas now that says how much is paid by the state and how much is paid by the Fed and how much is paid by the railroads. And if there are separations, that is a safer situation. But yes, we're prepared to step up, and if we need to spend a little more in capital to relieve some of those situations, we would be happy to take it under advisement.

Material or would it be within your $1.5 billion budget?

I think it is fair to say it would be a 2008 and 2009/ 2010 expense because, quite frankly, just the planning and the focus on getting the transaction approved will be what we have to do in '08, and then these expenses to the extent they are meaningful would be in the 2009/2010 timeframe.

Walter Spracklin, RBC Capital Markets.

Just on the union contracts, you have been pretty successful since first quarter last year in negotiating some union contracts. On the horizon 2008, can you give us color on the meaningful union contracts that you have coming up? And are you finding that given that you went the full all 10 rounds with the UTU and successfully came out of that, has that given you a little bit more call it leverage on those negotiations? Clearly they are never easy to do, but are you finding the pushback or the negotiating process on a relative basis any easier?

Well, I mean a couple of comments. I think it is fair to say, and I don't want to leave anybody out, we have got a couple of very small numbers as far as number of people represented in 2008. It is just handfuls.

So effectively with the steelworkers with the IBEW and with the UTU and the US, the big ones are out of our way until the end of '08, and that would be the engineers that would be coming up.

Now we have a philosophy that says we're not going to go to the negotiating table unless we have the ability to say no. And I don't think anybody should. We want to be reasonable. We want to try to make fair deals. And but if we are faced with the same situation we were last time with the UTU and I hope we don't get that situation, we're prepared to say no, and we're prepared to run the railroad.

Having said that, I'm confident that we can come up with a settlement, and if not, I did not -- I thought it was a little unfortunate in the whole process that we had the binding arbitration that was mandated to us by the government. But they basically set a pattern here. I mean if they get one organization 333 and status quo with everything else, that is about all there is, unless there's some negotiations on both sides, and that is not exciting to a lot of people.

So I think we have come a long way. Our labor relations group has done a stellar job the last several years, particularly on the non-op side of the shop, and we will get there with the operating crafts. It's a bigger change, and it is something that is more difficult to get done, and I have to remind myself with the first hourly agreement in the US, it took us nine years to get it ratified.

So we have to be, and I am talking to myself, when I say a little patient. But I think most of the labor turmoil hopefully is behind us, and everything will be go forward in a positive manner.

Okay, that is great to hear. And just continuing on the labor, Claude, you mentioned on the pension topic you're going to get some relief in the range of the 60 to 65. I'm just wondering what your assumptions are for interest rates given we have seen a big 75 basis point cut today. Equity markets are choppy. Is there anything on the horizon in terms of top-ups of defined benefit pension plans in the event that you have to change your assumptions?

Actually our expense for 2008 is set on the basis of the discount rate at December 31 of 2007. So that one we know. And so we know that the expense benefit is actually a little bit more closer to 65, $70 million in terms of year-over-year decline.

Now next year's discount rate, which will be set on December 31 of 2008, would have an impact on our 2009 expenses. But that one is just basically premature to try to judge where that is going to go. It is a function of that discount rate, investment return and a whole bunch of other items, which are too difficult to predict a year in advance.

You have given us some sensitivities in the past. I guess they still hold?

Yes.

Okay. Last question just on CapEx, you had budgeted $1.6 million for 2007. It came in at 1.387. Now you are moving us to 1.5 -- sorry, go ahead.

Walter, I think we always guide on a gross CapEx basis, and net CapEx is after leases and so capital leases, which are of basically non-cash CapEx. So we had guided at $1.6 billion for 2006. We came in at $1.6 billion if I -- 2007, I'm sorry, and yet we did come in at around $1.6 billion if I exclude the fourth-quarter impact of the capital lease for Central Station. And next year we are guiding to $1.5 billion on a gross basis, and that includes the upgrade for the ANY.

Okay. I just wondered. That clarifies, but the decline that you are budgeting compared to 2007 given I presume EJ&E is in there, you know you have your higher presumably higher revenue base and so on. Is there anything that you have decided not to go ahead with or any products that you're scaling back on, or is it just a function of being a little bit more targeted as you say?

I think it is a function of being targeted, but also a function of a number of the large-scale projects that have been a mainstay for CN over the last several years are coming to an end. I would give you as an example our significant investments in siding extension. We still have (inaudible) here or there, but we're basically for the most part completed there.

So we're targeting where it matters, and we're also sensitive to the general economic environment. So we think that is going to be sufficient to focus on what we have to do and drive productivity and growth and a safer plant.

That concludes the question and answer session. Do you have any closing remarks, Mr. Harrison?

Yes. Just thanks for joining us, and have a nice safe day.

This concludes today's conference call. You may now disconnect.