Canadian Pacific Kansas City Ltd (CP) 2003 Q3 法說會逐字稿

All participants please stand by. The conference is about to begin. Good morning, ladies and gentlemen. Welcome to the Canadian Pacific Railway third-quarter results conference call. These results may contain forward-looking information. Actual results may differ materially. The risks, uncertainties and other factors that could influence actual results are described in the Company's annual report and annual information form. I would now like to turn the meeting over to Mr. Rob Ritchie, President and Chief Executive Officer of Canadian Pacific Railway. Please go ahead, Mr. Ritchie.

Thank you, operator, and good morning, ladies and gentlemen and thank you for joining us this morning. With me here in Calgary I've got Mike Waites, our CFO; Ed Dodge, our Chief Operating Officer; Fred Green, our Senior VP of Marketing and Sales; and Paul Bell of Investor Relations. Before I start, I'd just reiterate the caution outlined by the operator and contained in those slides 3 and 4. I also draw your attention to the fact that we are using Canadian dollars and Canadian GAAP, and there are also some non-GAAP EPS references, and the reasons for those are described in our press release.

So let's turn to start -- slide 5 and we start. In summary, although we did not shoot the lights out, given the challenges we faced, I am satisfied with our third quarter performance --it came in pretty much as planned. Some highlights. First, we grew our business over 5 percent, driven by the strengthening Canadian and U.S. grain movements, continued strength in export potash sales to China and a strong demand for sulfur globally, and continued strength in our import intermodal business, driven by our new competitive service from Vancouver to Chicago in the U.S. Midwest.

Secondly, we established employee productivity gains of almost 5 percent, a remarkable achievement given the heavy preparation we were undertaking to get ready for the expected tonnages in the fourth quarter. For example, we had a heavier than usual engineering program, and we have hired and trained over 200 new train operating employees. We did all of this while we successfully managed our railway during the rail traffic controllers strike, a seven-week strike that lasted through July until the satisfactory agreement was reached in August. And yes, we had our other challenges. Thirteen percent appreciation in the Canadian dollar cost us 17 million in operating income, a 40 basis point on our operating ratio. Fuel prices remained high, averaging $31 WTI, over $4 higher than the same period in '02. And finally, to round all of this out, we had forest fires in the West and electrical blackouts in the east, which obviously impacted some of our customers.

As you can see on slide 6, our reported EPS were up 18 cents. After foreign exchange losses on the long-term debt, we came in at 62 (ph) cents per share, down 6 cents. If you turn to slide 7, you will see that almost all of the decline was due to foreign exchange. So taking it step-by-step, our business grew 5 percent, which would have been a 20 cent gain net of FX. As one would expect, we incurred additional cost to handle the new volume, offsetting the gain by 6 cents per share. Inflation and higher operating expenses because of that aggressive work program and additional training of the new crews cost us 4 cents. All in all a good story, bringing increased revenues down to the operating income line.

However, you'll note that other revenues were off by $7 million, or 2 cents per share. Depreciation, as predicted, has been running at 4 cents higher. Interest and other off 2 cents, as CP took advantage of the low interest rates and increased our U.S. debt to provide more of a hedge on the rise in Canadian dollar. So to this point, EPS was roughly equivalent to the prior year, leaving fuel prices and FX as the major remaining causes of the decline. Increases in fuel prices cost us 3 cents;, foreign exchange cost us the remaining 5 cents. Now I'll turn it over to Fred from Marketing and Sales to give us a review in that area.

Thanks, Rob. I will start on slide 9. On the revenue side, we delivered an impressive third quarter. Trade volumes and revenue adjusted for foreign exchange were both up 5 percent compared to Q3 of last year. Total foreign exchange impact on freight revenues for the quarter was -$51 million. I would like to run through the major developments on the quarter. The bars on the graph show our growth, while the arrows show the reported revenue after the impact of foreign conversion. I'll speak only to the bars.

The bold recovery we predicted in our Q2 outlook has begun. Grain up 15 percent, reflecting a stronger Canadian crop and good demand for grain from our U.S. origin. Sulfur and fertilizers are up 10 percent due to strong offshore markets. Coal was flat in Q3, but it ramped up at quarter end. Merchandise as a group, which includes forest, industrial products and automotive, was down compared to 2002, mainly due to automotive. The summer shutdowns due to power outage, exiting the former IMRL haulage business to Kansas City, and the last quarter-over-quarter impact of the closure of (indiscernible) St. Therese contributed to the decrease.

Forest products, despite the fires in D.C. and the strong Canadian dollar, held their own. Industrial products group was up almost 2 percent, with strength coming in energy, chemicals and plastics sectors. Intermodal gain contributed solid growth. The domestic side grew on good retail food and consumer demand. International was a West Coast story. We have successfully established our Vancouver to Chicago service, and we continue to grow this lane. Overall, our intermodal sector posted a 7 percent increase, our 11th consecutive period of quarter-over-quarter growth.

Let's move on to slide 10 and look at yields. Foreign exchange of $51 million was the primary drag on our revenue, per revenue ton mile results. At the left of the chart, same-store price was on plan at 1.2 percent for the quarter. Our fuel surcharges generated an additional $7 million for the quarter. In terms of mix, over 12 percent volume increase in the lower revenue per revenue ton mile bolt markets and the dip in higher rated automotive had a dampening effect on our overall unit rates, but this is a good news story, given the efficiencies inherent in the bolts. Overall, our yield program is on track to exceed our goal of 1 percent for the year.

Slide 11 addresses revenue results on a year-to-date basis. Overall, freight revenues have been impacted by foreign exchange to the tune of $108 million. Again, looking at real growth, grain, fertilizers, industrial products and intermodal our up over last year. The others are flat or down only slightly. The overall growth in freight business year-to-date is 4 percent, which is in line with our annualized expectations.

Turning to slide 12, I will begin our assessment of Q4 with an update on our grain model. In Canada, estimates from the industry have the crop coming in around 88 percent of the normal crop, just shy of the 90 percent we anticipated at the Q2 call. The export outlook of about 22 million metric tons is supported by a consistent quality crop. Production for our U.S. wheat and corn area will likely surpass last year's levels, and soybeans appear to be at similar levels. Our model suggests that Canadian and U.S. originated volumes combined will be up sharply in Q4, exceeding 30 percent. Q1 and Q2 2004 also look robust.

Slide 13 shows our Q4 outlook model. I've shown volume in the left column and revenues, including the impact of foreign exchange assuming a 76 cent Canadian dollar, on the right. I will speak to the volumes as I go over the balance of the portfolio. Full fundamentals are solid and demand supports an improved Q4. On the quarter, we are anticipating something in the range of a 15 to 20 percent quarter-over-quarter improvement. We expect continued strong markets for potash and sulfur and anticipate growing greater than 5 percent. On the merchandise side, we are seeing mixed signals, although industrial products activity has been improving through the second half. Our forest products model also looks positive in Q4. Our key players are still producing, marketing and planning to stay in the North American market through this period of foreign exchange adjustment.

In automotive, consistent with our previous guidance, we expect to be under our extraordinary Q4 2002. Sales continue to soften and production shutdowns are occurring. For intermodal, we expect to see imports slow down somewhat, reflecting both typical late-year seasonality and 2002's tough comps. That said, continued strength on the domestic side should assist total intermodal to deliver high single digit growth for Q4. To summarize, Q4 looks very robust. For the year overall, we still anticipate hitting our 4 percent growth targets before foreign exchange impacts. Over to you, Ed.

Thanks, Fred. Third quarter was a challenging one for our operations. We had record-setting workloads for Q3, while carrying out an increased track maintenance work program. With the work programs complete, you should see an even stronger Q4. Slide 15 demonstrates that safety continues to improve on our property. I am very satisfied with the overall 30 percent improvement in personal injuries and especially in our U.S. operations. Our train accident frequency is still the lowest in the industry.

You can see from slide 16 that we are making excellent progress in our train productivity. As shown on the left, train weights, with merchandise and intermodal contributing an overall improvement, up 3 percent. Similarly, our train lengths continue to improve, up 5 percent. These are both key productivity metrics forming. It means that we are maximizing the value from our new equipment and locomotives. The mantra I use with my team is "make every train count." Turning to slide 17 now, I told you at the end of the last quarter that you would see a positive improvement in the relationship between revenue growth and the increase in train runs. Our revised integrated operating plan is delivering just that. The graph on slide 17 shows our year-over-year revenue ton mile growth in green, going up 5 percent.

Compare that to our train mile growth in blue, which has dropped down to below 2 percent. One would have expected that these two lines track each other, all things being equal. Yet we have changed that relationship through our proactive, disciplined approach to train start management. As the bulk traffic has returned, CP has gotten back into our more normal and efficient traffic patterns, and hence the dramatic improvement in this ratio.

Going to slide 18, we told you in July that a decision had been made to accelerate the track maintenance work programs so that they would be completed before the start of Q4. And when I talk about a work program, it means that on a single track system like ours, we take the track out of service for 7 hours in order to let the engineers replace rail, ties and ballast. From a transportation perspective, we are compressing a 24-hour day into a 17-hour day. We actually had 40 percent more hours of track (indiscernible) allocated to the work programs in the Western Corridor this year versus last. This is a significant reduction in effective operating capacity over this busy corridor, which saw train miles increase by 7 percent.

The combination of increased work programs and the increased train miles had some impact on our reported metrics. However, we worked with our customers through this program to ensure that they would -- that they were aware of the impact and could manage their supply chain accordingly. In short, we were able to move record workloads with an increased engineering work program while delivering record employee productivities for the quarter, up nearly 5 percent. We have also increased our train crew base by over 200 compared to Q4 last year, or a 4 percent increase. This means that we are well positioned to handle the increased work expected in Q4, especially in our Western Corridor.

Looking ahead on slide 19, Q4 will be strong, as both grain and coal will generate consistently higher weekly holdings, which will improve our overall train wins. With the delivery of 35 additional locomotives in September, we have now increased our AC fleet by 76 units in 2003. At over 500 units, we now have more AC locomotives as a percentage of our total fleet than any other railroad in North America. They now move more than 70 percent of our gross ton miles. These locomotives are incredible workhorses, perfectly suited for our traffic mix, typography and winter conditions. As our locomotives become more homogeneous and interoperable, we were able to extend their use to our intermodal and merchandise trains. We can also use them in the mid train position, helping us to increased train length and weight throughout the winter. This will allow us to take some of the bite out of winter. Their improved reliability and excellent fuel consumption have allowed us to maximize train efficiencies on all accounts. Our locomotive productivity has improved nearly 35 percent, while our fuel consumption has been reduced by more than 20 percent since 1996, when we first introduced them into our fleet.

Turning to our new intermodal train efficiency program, it, too, is progressing well. We now have over 1100 new 53-foot standalone double-stacked cars online, increasing to 2000 by year end. We can see our slot utilization and train weights on intermodal trains already improving. The combination of the new cars and the longer trains will dramatically improve the number of containers per train. When this program is completed in 2004, we expect to see a 20 to 25 percent improvement in train productivity, giving us the capability of reducing our yearly train starts and intermodal by as many as 600, or accommodating growth with the existing train starts.

As you've heard from Fred, we expect our overall business to continue to grow in Q4, up in the range of 6 to 7 percent. But you should see our train starts only increase by less than 3 percent. Overall, you can expect a strong quarter operationally from us. Mike, over to you.

Turning to slide 21, the third quarter income statement, overall, we didn't see any big surprises with the quarter playing out as much as we expected (indiscernible) key points -- good fundamental volume growth and expense control. Total revenue was down $13 million to $904 million, and Fred's explanations of freight revenue covered about half of this variance. The remainder occurred in other revenue, which is made up of items like switching and leasing revenue, and items subject to timing differences, such as real estate income. I should say we're targeting to come in at about $180 million full year run rate in this line item for 2003.

Third-quarter operating expenses were basically flat. Volume, inflationary and fuel price increases were almost fully offset by foreign exchange. Interest expense was down due to exchange and some really good work done on the debt side to help grow earnings per share. We've been taking advantage of the low interest rate environment to replace higher cost debt and increased our U.S. rated exposure to act as a partial hedge against the impact of foreign exchange on our net income. We have been able to access capital markets at very attractive rates. Since the start of the year, we've issued $250 million U.S. of notes -- that's a 30-year term 5.75 percent coupon, as well as a $350 million Canadian 7-year note with a 4.9 percent coupon. Importantly, our spreads were very tight versus treasuries in Canada. So overall, our interest expense is down $2 million this quarter despite the additional debt financing.

Income taxes are down slightly because of the slightly lower earnings, with our effective tax rate at about 32 percent and that's a good indicator for the fourth-quarter run rate. In total, our adjusted net income was $99 million for the quarter, or 62 cents per share. Both are down 9 percent year-over-year. On a GAAP basis, net income and earnings per share were up approximately 45 percent to $95,000,000 and 59 cents respectively. This basis includes the non-cash and the unrealized losses, and we spoke about these in prior discussions with you. These are attributed to the U.S. dollar-denominated debt. While we've had an unrealized gain of $165 million year-to-date, we did experience a loss of $4 million this quarter compared to a $47 million loss last third quarter.

Moving to slide 22 and operating expenses, you can see again that foreign exchange almost fully offset inflationary increases, our fuel prices, and additional expenses related to the outstanding volume growth. Stripping out foreign exchange expense, performance was still solid and not unreasonable, given the volume growth and impact of our work programs. In terms of compensation of benefits expense, we had a number of puts and takes. Strong volume meant we had some additional costs, and Rob mentioned this. As well, we've seen inflation -- and this has been the case all year, as we see inflationary increases -- rising wages, in other words -- as well as rising pension costs, and these have been a drag on results, offset partially this quarter by a reduction in variable compensation expense. Another contributing factor was additional crew training costs for new and replacement crews, and you heard Ed talk about this earlier. But overall, while on track, job reductions related to productivity measures announced in June 2003 were partially offset by selective hiring because of the increase in the volume. So basically, a good news story.

Turning to fuel, despite forecasts to the contrary, the price of crude oil remained in the $31 per barrel range. That's about $4 higher than the same quarter last year, as oil refining margins worked against us this quarter. We hit a record low consumption rate or improved efficiency, while moving more freight, and certainly that's a good indicator for the future. As well, we had bigger gains on our hedging activity.

Equipment rent was a very good story for us, given our volume growth. Extensive changes to the fleet that Ed spoke about have not hurt this line item, and much credit goes to the car management group for keeping this in line. Depreciation was up in line with previous quarters of purchase services, and other was up slightly pre-foreign exchange. These were mostly volume increases caused with higher debt heading expense, crew accommodations and joint facility costs.

Summing up on slide 23, we expect to see continued strength in the Canadian dollar through the fourth quarter. We're modeling an exchange rate of 76 cents, or $1.32 if you like to do it the other way. We are not expecting a break from high crude prices and we're modeling West Texas Intermediate at $29.50 per barrel. We had about 24 percent of our fourth-quarter fuel requirements hedged at $22.70 per barrel -- that includes our collar position. Though we'll likely continue to see volume-related cost escalations, we will also experience greater efficiency with the return to the bulks and the shutdown of our major trackwork program.

In closing, I am pleased we've come through some very challenging circumstances reasonably well. What we've lost in foreign exchange through the quarter on revenues, we've made up for in real growth, and we expect to see the same in the fourth quarter. You've heard us speak to our restructuring and operating initiatives, and these will begin to bear fruit as we work our way through the fourth quarter. As a result, Canadian Pacific will end the year with a strong run rate. That concludes my comments. Rob, back to you.

Thanks, Mike. Let me wrap up before I go to the questions. So for the foreseeable future, we continue to grow the top line and contain our cost base. With the grain crop in at close to the 90 percent prediction and a strong export program expected, we should see excellent grain revenue comparable in Q4 and through the first half of next year. As Fred indicated, coal should remain strong over the same period. Our Vancouver intermodal product has passed the marketplace test. They like it, and with China's strengthening trade position, imports will also continue to increase into next year.

We have a host of productivity enhancement initiatives underway, which Ed spoke to. Our 820 FTE reduction program is progressing. The rail weight is settling into a pattern that plays to our business model strength, accommodating the surges we had in the import/export business and the return to grain and coal. On the strategic front, we are actively promoting CP's acquisition of BC Rail with a strong bid, which emphasizes the advantages of competition and job retention for the province of British Columbia. In summary, we have the people, we have the assets and the right business strategy to handle the opportunities coming our way. Operator, I will now open the phone lines to questions, so if you could handle the queue and we will start the Q&A. Thank you.

(OPERATOR INSTRUCTIONS) James Valentine, Morgan Stanley.

Good morning, guys. Good job. I wanted to ask about intermodal for a minute here, because there is -- it looks like some pretty good trends here in that you talked about you're very proud of your Vancouver-Chicago product. I know -- was it a year, two years ago, Canadian National came out with what they thought was a superior Chicago to Vancouver -- Vancouver to Chicago product. Can you kind of talk a bit about the differentiating factors? I mean, ultimately, it may turn out that because both of you are working so hard in this lane that you take market share away from the U.S. carriers. But trying to understand how you position yourself relative to your competition up there.

I'll start. It's Rob. I think both of us working on the Vancouver Lane has been very good. We been promoting it not only to the shipping lines, but also to the customers and the shippers, both in North America, as well as Pacific Rim countries. So I think working together, we've increased the visibility of the port. I'll turn it over to Fred to let him describe how he is trying to differentiate our product against all competing products on the West Coast North America.

I think probably one of the most distinguishing features is our inland facilities at Chicago are perfectly positioned right in the heartland of where a lot of this product wants to go. And so, we have identified that as a feature that's very appealing to the clientele and it seems to have really turned them on. We've again had great growth in the quarter. And if I could, I'd go beyond the fact that we've got more import now. We've had a great quarter in convincing people that now that we've proven this port as a port of entry, we've also turned our energies to making sure we've got good round-trip movements going. So the export volumes and the paid empties are escalating at a faster pace now than the imports, which is really going to give great balance and great profitability to the corridor.

Is there any time difference on speed between those markets? When CN, I think, introduced the four-day -- I believe the four-day product to their market, you guys initially weren't going to do that. I'm not sure. Are you now offering the same speed of service or does that really matter -- do your customers say five or six days is just fine?

We're selling consistency in this corridor, and it seems to be a very, very successful offering in the market. So we are not selling speed; we are selling consistency, and the client is seeing that really suits their purposes because they can predict with certainty their supply chain.

Great. If I could ask one last question intermodal question, I will be done here. As you may know, your competitor in Canada is changing their philosophy towards intermodal customers, specifically certain drayage issues and storage time in the yards. Is that offering you any kind of opportunity in terms of picking up share, or do you think that is in effect creating discipline in the market -- it's going to help lower your costs as well?

It is certainly the latter. We've had a pretty aggressive program over the last several years to encourage throughput in facilities. And certainly we have observed and are supportive of the principle of trying to use our facilities effectively. That said, we have a great inland facility complex that we have built over the last number of years, and to the extent that the client sees it as an advantage to use that capacity, we work together to ensure we find the balance for ourselves.

Great, great. Thanks so much, guys.

Scott Flower, Smith Barney.

Good morning, gentlemen. Just a couple of questions. I know that obviously you all were spot on relative to the grain crop outlook, etc. I'm just wondering, obviously you will be up in the first half, but I'm just trying to get a sense, because the crop obviously isn't really an absolute normal and certainly storage levels weren't particularly high after a couple of bad crops, and I know you will be up in the first half. How quickly, though, will the rate of improvement slow? In other words, my sense would be you should be up much more obviously in fourth quarter when a lot of the crop wants to move than what you will be in first half, that the tail, if you will, of this crop may be shorter. And I'm just trying to get a sense of how quickly we should model the rate of improvement slowing as we look toward first half? Obviously, this may be a more important issue for second quarter.

Scott, I think it was the last quarter that I tried to describe what happens as the market recovers, and if I could, I'll just take a second and describe again for everybody. What happens as the market recovers with regard to volume is that we will see perhaps a larger U.S.-bound program. We are going to see -- I can tell you for sure, we are going to see a larger what we call winter wheat or winter grain program, which moves out of the ferries, past the Great Lakes, all rail into Québec and the port of Montreal. And we believe that that program, from what we can tell at this point, will run very heavily right through the winter months.

Our perspective at this point in time is that with the minor vessel issues off of the West Coast that various parties have incurred, we are going to see probably a little bit different shift than most people expected. We are probably going to see this crop move maybe 48 percent in this year and up to 52, 53 percent next year. So we've got a good, strong fourth quarter, but we like the way the first half of the year is shaping up, as well.

If you could just refresh us, when you say 48 percent, 52 percent next year, how does that trend versus historicals?

I think historically it would tend to be a little heavier in the fourth -- like in this year as opposed to next year. Often we see a 55/45. We anticipated it might be something like that for the reasons that you had mentioned. It just seems to be morphing a little bit towards 48 percent or 49 percent this year.

Got it. And then just a couple other quick questions. I know that Mike mentioned the hedge program for fourth quarter. could you just refresh us what your hedge position is for 2004, if any?

Scott, we have hedges in two forms. Number one with futures contracts. We have under that arrangement 17 percent of our 2004 requirements hedged. The average price is $21.17 a barrel. We also have the collars I talk about -- you've heard me speak about these before -- but current prices, the ceiling on the collars would be $23.60. That's for another six percent of our requirement. So a total of 23 percent of those two numbers.

Okay, and just the other -- last quick question I had was on operations. I know that Ed described the relationship and how you are disciplining train starts and obviously that has impact on train miles versus units. I'm just trying to get a sense that --how should we think about this going forward? Are we at the peak of some of the productivity gain, and that as you fill out train lengths, you will start to have some end plus one issues of having to have totally de novo trains? I'm just trying to get a sense of as we look toward the first half of next year, obviously emphasizing productivity, that you will probably have a favorable spread. But will that spread narrow from what we're seeing at current, and if so, how tight might that spread get?

You're going to see improvements in the first quarter. As I mentioned to you, we are going to change our operating model for the intermodal trains and the winter operations, and take some of that bite out of it. We're well positioned to do that. As far as have we -- are you going to see year-over-year improvement from where we are? My answer is yes, you are. I can't tell you what the percentage is, but I'm going to be relentless in making every train count, and I think with our integrated operating plan that has proven success that we can accomplish that goal.

Great. Thank you.

Greg Ryan, Bear Stearns.

It's Tom Wadewitz at Bear Stearns. Kind of a macro question for you. We've got on the grain side, I guess to some extent you compete with U.S. wheat and Australian wheat, and I recognize that perhaps Canadian durham is higher quality. But I'm wondering if, given the strong wheat crop in the U.S. and also what looks like it's going to be really strong crop in Australia, is there any concern that that would hold back the exports of Canadian grain out of the West Coast, or is that not really a factor? And then also in line with that, in terms of the higher bulk rates, is there any risk to your coal exports, as well, given that the bulk -- excuse me, ocean shipping rates have spiked up so much?

Tom, first on the bulk rates, we have, over the course of the last six or eight weeks worked with all of our major industries and the major shippers within those to evaluate where they were at with regard to the impact in Q4, Q1 of the emerging higher bulk shipping rates off the coast. Their assessment to a large degree is that they may miss some modest spot opportunities but for the most part they are either contracted or comfortable just accepting the -- what they consider to be a reasonably temporary blip. So we do not see, at this point in time, any substantial impact with regard to the volumes of export product being limited.

Now with regard to grain, I don't want to speak for the wheat board, so I won't. But I will observe that our belief is that they will probably shift markets around a little bit. And as I referred to earlier, the winter wheat program has begun. It has begun earlier -- in fact, last week or this week it began, and that usually wouldn't occur until after Christmas. And that tends to be productivity now headed to the east. So I think what they're doing is they're identifying in situations that are reasonably abnormal will they start to sell more to Europe or more to other places? And I guess our overall collective assessment is they have predicted as an industry that they will ship close to 22 million metric tons export, and that is a big number, and that is a number that we are comfortable saying we can move.

Is it actually a better thing for you in terms of length of haul and profitability if you get more business going over to Quebec and Montreal for export to Europe?

Tom, I'm not going to get into profitability, but I would suggest that we've got a really busy fourth quarter going, so it's certainly not a bad thing for us to be moving eastbound with some of this export product during the next six or eight or ten weeks. That's something that we can work with.

Okay, and then just one more question. You've had a couple questions on the intermodal side. Is there any kind of a changing ship pattern where you are still getting perhaps more new ships coming into Vancouver, or are the ships more full, or on the margin are you taking any business? Because your growth has been a bit stronger in intermodal than with your competitor. I am wondering if that is temporary or if you see that actual persisting for the next couple quarters and what may be driving it.

To my knowledge, there has certainly been no shift of lines between us at all. We have aligned ourselves with some very successful and substantial players. They have done some rotation, I think, of maybe bigger vessels into certain cycles and ports of call that has given us bigger numbers than even we anticipated, quite candidly, on the West Coast. The market -- we keep waiting for the peak to happen and it's not happening. So all I can suggest to you is that the lines that we have aligned ourselves with seem to be doing exceptionally well in the business. The only thing that I could say is different versus say a year or two ago would be light line came in to the port of Vancouver and that's part of the CP ship's group of companies, which we are, of course, the supplier for.

Thank you for the time.

Ken Hoexter, Merrill Lynch.

Fred, could you just clarify on the coal volumes, if I recall that I guess with the export -- a couple of the export being shut down last year -- is that why you are seeing strength going forward starting in the fourth-quarter? Is there something that is driving this? And then secondly, Mike, you mentioned that you had been successful in issuing some debt. You obviously have sizable cash sitting on the balance sheet from a recent offering. Is that going to be used to pay down debt currently, or is that going to be used for keeping powder dry in case BC Rail comes through or something else? Thanks.

I'll take the coal question first. First of all, the coal story is coming to life. When we talked about this three or four quarters ago -- or two or three quarters ago, rather -- we said we didn't want to predict and didn't want to put words in the mouth of our major client. But clearly the Elk Valley Coal Corporation efforts to grow the business is very exciting for us. It's exciting for this year, and it's exciting into the future.

Now that said, we didn't have a banner fourth quarter last year, but we had an okay fourth-quarter. And what we really are seeing right now is a great market for met coal. The Elk Valley Coal Corporation is wonderfully positioned and are trying to seize the moment, not just for the quarter, but I think obviously to position themselves and also the supply chain in the global market.

So they are successfully selling into markets they have not been very substantial in the past, and that's a good news sign for them and for us. And we, I can assure you, are doing all possible. We've put in three new train sets, and we are doing all possible to keep a train under the -- or at the dumper at Westshore Terminals on the port at every minute of the day so we can maximize this for all of us.

Ken, it's Mike. With respect to your question, you're correct. Obviously we do have quite a bit of cash on the balance sheet. Really two reasons. Number one, financial flexibility. Number two, we like the rates. And while there is some negative carry by running cash on the balance sheet, we think from a longer-term viewpoint it is a good thing to do. The purpose -- BCR could be one purpose. I would anticipate paying down debt at this point in time, and as things come to fruition here, we will see what we do what that money. But again, I think a great thing to do, given the rate structure at the time.

A couple of follow-ups, if I may. On the headcount reduction program, you mentioned it is kind of going on on target. Can you talk about what has occurred so far and your timeframe for wrapping that up? And then just another quick question for Fred. Obviously, you talked about the impact of the currency exchange. Can you talk about your success in getting that one percent pure rate increases on the same-store sale basis?

On the headcount, we announced that we would ramp it up and get moving in the fourth quarter and then follow through in the next year with a little tail in the following. We've got a very strong process put in place to follow all this so that we know exactly right down to employee number and we can track by department head. So Mike, why don't you speak to those numbers?

Ken, in terms of the reductions that we've seen during the quarter, we were down 279 staff. That was offset, as we alluded to in the discussion, by an increase in our field operations groups of about 200. So if you net those two, you've got about 79 reduction you otherwise would have expected. We had a bit of structural change -- we brought in about 40 or so people that were working under contract, and we put them on staff. It's increased the count slightly but by that amount. And that was basically a good economic decision. We were paying quite a bit for variable work when in fact it was baseload work. So that would get you to a number that we would've expected a reduction of around 36. We came in at quarter end up 18. So you're looking for basically 52. About half of that, 26 people, was related to the temporary training and readying the crews for the additional volumes. And Ed spoke about this. So we are off about 2 dozen round numbers. Probably more detail than you really want to know. The key point is we have very good granularity in tracking this, and we will be on track to deliver the 370 by the end of the year. And obviously, the 820 over the next year and a half.

Your last question was with regard to price, and as I said in my notes, we did secure a 1.2 percent same-store pricing. I think the real issue is, what are you doing to make sure that that's institutionalized as a mindset within the organization. Many of you met Bob Malloy, who has formed our yield group for about the last eighteen months. We've recently promoted Bob to Assistant Vice President. He has become an important player together with the Vice Presidents as we establish our pricing strategies, and the level of rigor and granularity that Mike just referred to with regard to headcount is applied against not just every contract, but every lane within every contract. And I can assure you that the protocol that we have in place leaves me very comfortable saying that we are going to attain the kind of numbers that we have committed to.

Thanks a lot, guys.

Randy Cousins, BMO Nesbitt Burns.

Just in reference to the whole issue of the staffing level, historically, the railroad industry has talked about taking headcount out. We seem to be heading into an environment now where we are getting volume growth, and it seems to me that is more important to talk about productivity per employee rather than the absolute level of headcounts. I wonder if you guys could give us some sense as to -- in particular, given the mix change now that you're back to a more traditional -- your more traditional bulk volume levels, what we should be looking for in terms of sort of productivity growth, either revenue per employee or GTMs per employee for the fourth quarter and looking into 2004. And obviously, recognizing the leverage potential that you've still got from your integrated operating plan.

Well, Randy, you're right. We have to continue to get productivity out of our employee base. We are adding, as Mike said employees who are right on the front-line -- soldiers -- and we are removing the overheads as we get more productive systems in place, and we frankly do a zero-based budget on all the backup staff work we are doing -- do we really need it. So I think we are going on the right way overall. The new assets, sweating those assets is making the employees more productive. Getting right down to productivity by employee, I would say that Ed's metric of volumes -- revenue ton miles going up by 5 percent and train miles only going up 2 percent gives you a pretty good idea of how we see the productivity going into the fourth quarter. We can try and get it more granular on looking out further when we have our analysts meeting on the 20th of November.

Okay. Secondary question. I wonder a few guys could talk about sort of again sort of to some extent maybe '04, and I recognize that we are going to get a little ahead of the analysts meeting. But what is the status with labor negotiations, and if, to the extent that '04 is going to be a big contract year, do you see some opportunity to get some changes in work rules that would again drive productivity?

Well, we've staggered our contracts, as you know. We've given you those presentations where our IR people -- Industrial Relations people -- have done a very good job of making sure that they don't all come to harvest at the same time. The labor unions like it because that means we can concentrate our people on each and every specific contract as it comes due. The big one, which is running trades in Canada, is a little confused right now because of union representation that is going on with what is called the Canadian Operating Unions and the CCROU. As you know, there is issues going on there with both the unions in the form of the BLE and UTU, and so that is making that a little confused. Ed, do you want to speak to when you think we can get back meaningful negotiations there?

I think, Randy, with respect to our running trades in Canada, we expect it won't happen until next year sometime, probably in the first half of the year, just because of the issues that Rob spoke of. Like -- in all of our contracts, we go in trying to find a win-win situation with our unions and trying to seek -- make use of technology and other changes in our network to get more productivity. And one area this year, for instance, we gained the opportunity through arbitration of doing maintenance work on our gangs on the weekend, which helped us sort of better plan our train operations in some busy corridors. So we are always going at them. There is no big, big one that's going to come at us. But every round of negotiations, we get more productivity flexibility from our unions.

As far as metrics, as you know, when we were in Vancouver we talked about metrics, and we've got a lot. So on labor and productivity, the 5 percent is a number that we mentioned, about three years ago, four years ago that we wanted to see improve. And we are still on target for that. But we gave you some other metrics there to look at in terms of train length and making every train count. So we are looking at this in pretty granular fashion, especially in all our corridors. So you're going to see some more productivity improvements and they will be in different forms, whether it's train length or GTMs per employee.

Last question. Delaware & Hudson, you alluded to it here. Can you actually speak to sort of timing, status, changes in view and impact on the P&L of what you are proposing for the D&H?

The Delaware & Hudson, as we spoke about earlier, we had given you a timeline of the end of the year to announce some action on that front, and we are still on that track. And as far as the alternatives, everything is still on the table. We've talked generally in the past about different types of structure of hauling that asset and the operation. Lease-type arrangement, amalgamation, sale, partial sale and so on, and we're still assessing those. We've been working very hard on this file, as you might imagine. All I can say is going into next year, whichever one of the options we end up with, and we are advancing the work on that front, we will expect to deliver a solid improvement in terms of expense reduction and operating ratios on our results in 2004. Again, we will get back to you towards the end of the year and give you an update on this.

Okay, thank you.

Joseph Leinwand, RBC Capital Markets.

Mike, can you bring me up-to-date on what sort of assumptions we can put into pension fund expenses as far as the income statement for 2004. It's a little early yet, but any views as the pension fund deficit and the expenses for next year?

Let me say a couple of words, Joe, about the way we see that again. The issue there is we do have an unfunded liability. You've heard me speak about this previously, that on the one hand not a script we would have a written; on the other hand, that unfunded liability is extremely sensitive to the interest rates. And of course those interest rates drive, among other things, the discount factor on the liability -- that is the lower the rate, the higher the liability. But by way of illustration, if we saw 100 basis point increase in rates, we would see the unfunded position move by approximately $580 million. That is obviously a favorable move if the rates increase. And so what we say is, we have to be careful. Let's look at this bearing in mind that we are using lenses, we are taking a photograph with 45 year lows in interest rates. To get back to your specific question then with respect to P&L funding in '04, absent any actions we would take prior to '04, we would expect that expense to increase to somewhere around $40 million range in '04 compared to something in the 15 to $20 million range in '03.

Thank you.

Horst Hueniken, Westwind Partners.

Foreign exchange has been a significant factor, and Mike, you mentioned you're modeling the Canadian dollar at 76 cents. Has your thinking changed as to how to manage foreign exchange? I did note that you've increased the amount of your natural hedge by issuing U.S. dollar-denominated debt, but I'm wondering whether you're thinking of taking that further with financial instruments or otherwise?

I wouldn't rule that out. When we look at the exchange factor, it impacts us really in three ways. Number one is we get the realized gains and losses. They tend to be quite small and show up in other income and charges. We have the gains and losses, the unrealized gains and losses on the long-term debt. And again, as you've seen us do over the last several quarters, we moved that aside, and we will realize that at some point in time and that's when we will take that into account. Where we're struggling a little is when we translate those basically U.S. dollar-denominated profits into Canadian dollars and we see the compression there.

We have picked up about half of that impact in terms of an offset on interest expense below the operating income line. So we are still okay on an EPS basis to the tune of half of the impact. And I guess I should say obviously for those people, those U.S. investors that bought the stock some time ago, they've also done reasonably well on that basis. Having said that, I wouldn't rule out us taking forward positions going forward, given the opportunity arises over the next couple of months.

Okay, on just almost a housekeeping item, your other charges of 7 million in the quarter, you kind of glossed over. Can you just remind us what that might be exactly and what the go-forward rate might be?

Horace, are you talking about the variance in other revenue, or you talking about other income and charges?

I'm talking about other income and charges. It was a $7 million item.

I would expect to see a number in the 5 to $10 million range there, charge going forward. And it is a number of things -- foreign exchange losses -- there is a number of other smaller items in there. But I think a run rate of 5 to 10 as a charge would be reasonable.

Final question for Ed, perhaps. You had initiated a lot of track maintenance in an attempt to make sure that things run smoothly and perhaps at higher volumes in the fourth quarter. Where -- what's the status of that track maintenance program right now?

Most of it is complete, as I said. And especially in our Western Corridor. We have no work programs in that particular corridor. We have some odd work being done in some terminals (indiscernible). So by and large, the work programs are completed , our slow orders are off the track, and we are setting record volumes right now.

Thank you. That's all for me.

(OPERATOR INSTRUCTIONS) we are accepting questions from the media as well. Lorraine Gloster, Octagon Capital.

I wonder if you can comment on the coal side. You saw the volumes start to ramp up here, and I'm wondering with Fording Trust and perhaps some of the synergies that will go along with that if you've seen any benefits yet on the cost side as far as you're concerned? Or is that something that is going to take a couple years or another year to realize?

At this point in time, we are working in a very integrated fashion with everybody from the mines to the Westshore Terminals which does the export unloading and ship loading, to ensure that we have absolutely the most efficient terminal -- or sorry, supply chain that we can possibly create. That said, we have to recognize that we run through the mountains and we run through some pretty unpredictable weather. So when we end up with large windstorms and that type of thing, it does of course affect the supply chain a little bit. So, directionally, we are going down the path that you are inquiring about, which is to try and find the greatest possible efficiencies in the whole supply chain, and we are deeply engaged in our dialogue with the Fording Trust team at Elk Valley to -- and as well as Westshore to ensure that we've pursued as many opportunities, but it does take time to put a big operation like that to get to perfection.

Is it fair to say that you're still kind of more at the planning stage or are you kind of halfway through it now?

I don't know if we're halfway, a third or two-thirds, Lori, but we are very, very engaged together, trying to ensure that we are not doing things to optimize our respective pieces of that supply chain to the detriment of the bigger picture. So we are deeply into it.

Fair enough. Just last question, on the ties program, I understand that that was delayed with the traffic controllers’ strike that happened earlier on. So when do you expect the full rollout of that program now?

The full -- it will be completed by the end of '04. And we are just -- we've got our pilot up and running and are making some adjustments, because it was a pilot in Edmonton, and we expect to start rolling it over across our system in Q1 of this year -- next year.

Thank you.

We're going to go to the media now. Operator, we will turn the questions over to them.

Redge Current (ph), Bloomberg News.

Just, Mike, I'm wondering on the foreign exchange that you just touched on, you said that you were struggling a little bit when you're converting -- sorry, was that U.S. dollar profits?

Yes, we have obviously large and significant operations in the U.S. So what happens, Reg, is when we translate, when we take those profits in U.S. dollars, as the Canadian dollar strengthens it buys fewer Canadian dollars. That's what you're seeing.

You said you may consider some forward positions. Other companies have told me they don't like to take that kind of position because there is obviously an inherent risk if the currency goes the other way.

Yes, we've taken forward positions in the past, Reg, so this would be something that is not new to us. And if we saw good long-term trends, we'd take some actions to mitigate that. I think at the same time, our shareholders know that we have this foreign exchange composition in our earnings, and so it is understandable. But we will look for those opportunities and try and mitigate the risk to some degree.

Rob, I wonder just on the bigger sort of economic front, I heard some comments that you're experiencing a busy fourth quarter. Generally, what are you hearing from your customers as they go through the quarter and into early next year, especially on the noncommodity side?

Right. Really, Reg, I hear it described as the best of times and the worst of times. I think particularly in Canada, they see this as a challenge that we have to continue to improve our productivity. I was just at a meeting with the CEOs, and the benefits of a high Canadian dollar lets us buy the capital goods at a lower-price, something that we couldn't do before, to replace high-cost labor with lower-cost capital. So they see it as a challenge, but as Fred pointed out, our polling of our customers don't see them backing out of the huge U.S. market for Canadian production. So they still see a reasonably strong economic performance, in line with the 2 to 3 percent you're seeing the Bank of Canada calling for.

Even with the dampening effect of--?

Even with the dampening.

-- of the stronger dollar.

Now, in certain sectors I think more paper being one. It competes directly with a lot of U.S. direct customers. But that is -- again, I think we have to get on the productivity bandwagon, and I see them signing up for that.

Last question, what is driving the -- aside from the product offerings that you are making in the Port of Vancouver, both you and your rival, are there any other factors driving business to the Port? You would think with the rising dollar it would be maybe less attractive than it was, say, even six months ago from a shipper's perspective?

Well, I think Fred did a good job of answering that, but there is congestion issues on the U.S. West Coast ports. The ships tried our supply chain, both ourselves and our Canadian competitor, and I think we are pleasantly surprised at the ability of that supply chain to meet their needs. So I think what they have been doing is exploring that over the last 12 to 18 months and continuing to work with us to see where we can complement each other and get what they really need. As Fred said, it's good, consistent laydown goods in Chicago with a backhaul. If you can't backhaul right to the Pacific Rim countries, at least to get the containers with domestic freight to Western Canada so that their empty return miles are reduced and their costs are reduced.

And obviously --.

Canada is good for that. We have more export product going off in the West.

So I take it a lot of that business that might have, as you say, started exploring during last fall's lockout hasn't run away; it's stuck around?

Not only has it stuck around, as Fred says, the big shipping companies that we have, China Ocean Shipping, have been growing that lane.

Thank you very much.

Operator --oh, we have one more question, I believe.

Robert Seville, CIBC World Markets.

I was just wondering if you could update us on your hedging policy for fuel going forward? I know you updated us on the hedging positions for '04, but is there a policy looking ahead beyond that?

Yes, our policy provides for us to hedge up to five years out. It provides for us to hedge up to 75 percent of our requirements for the front 18 months, and then basically sets down in graduated steps to 10 percent at the end of the five years. And that is really the policy that we have. It is not -- the actual execution is not a mechanistic execution. We take a long view, and when we see those opportunities, we take those positions within those constraints under the policy.

And last question, with intermodal business you spoke to Vancouver how well it was doing. Is there anything you can update on the Brampton facility? Was there any incremental volumes there? I know someone alluded to that earlier with competition in the Ontario region.

The Brampton facility is a CN facility, you understand?

Right, sorry. Were you seeing any business coming off of that?

I would interpret it at this point in time that there has been no shift in lines between the railways, to my knowledge, over the course of last several months of the problems at Brampton. Our facility is well positioned to take care of the clients that we have, so we are not out there selling more volume at this point in time. Our customers are being successful in selling volume. So we've got a fluid system and a great terminal complex, and people seem to be successful working with us. So we are not shifting lines. We're growing the lines that we work with.

Okay, thank you.

Okay, ladies and gentlemen, that's it. Thank you very much for joining us. We are having a conference in Montreal at the end of November. For those who can't make it, that conference will be webcast. So we look forward to having a lot more time together and explaining what we think to be good prospects for our railway. Thank you very much, and we will talk to you in several weeks. Bye-bye.

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