Canadian Pacific Kansas City Ltd (CP) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen. And thank you for standing by. Welcome to the Canadian Pacific Railway second-quarter results conference call. This presentation contains forward-looking information. Actual results may differ materially. The risks and uncertainties and other factors that could influence actual results are described in the company's annual report, annual information form, and this presentation on slide 24 and in the press release issued this morning. This presentation also contains non-GAAP measures as outlined on slide 25. All dollars quoted in the presentation are Canadian unless otherwise stated.

At this time, all participants are in a listen-only mode. The media may quote comments by any member of management on this call; however, please do not quote other participants without their permission. On the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue for questions. If anyone has any difficulties hearing the conference, please press star, zero for operator assistance at the present time. I would like to remind everyone that this conference call is being recorded on Thursday, July 29th at 11:00 a.m. Eastern time.

I will now turn the conference with Mr. Rob Ritchie, President and Chief Executive Officer of Canadian Pacific Railway. Please go ahead, sir.

Thank you very much, operator, and ladies and gentlemen, thank you for joining us in our second quarter. Here in Calgary, I got with me Mike Waites, our CFO; Fred Green, our Executive Vice President of Operations and Marketing. And our slides are available on our web page. So please let's turn first to slide number 3. Canadian Pacific had a strong second quarter with earning per share up 23%. I am pleased with these results. Not so much the absolute level. We can and we will do better. But I am pleased with the momentum and the direction that these results show.

We had solid revenue of 10 percent. Driven by volume growth across five of our seven business segments. Our yield program is delivering real positive price gains and contributing significantly to our performance. Our operations are fluid; and, as predicted, our productivity initiatives are working out as planned.

The operating ratio dropped 1.7 points to 78%. This will continue to improve as we work through some of the one-time costs and training.

We are right on target. I will turn it over to Mike to take you through the details of our financial performance. Michael.

Thank you, Rob. Turning to slide number 6 in the income statement, you can see a very robust operating and financial performance with revenue up 10% and operating income up 19%. Expenses were up 8%, candidly still not where we want to be as we continue to carry additional training and other volume-related expenses. But I will come back to expenses in just a moment. That income on an adjusted bases was $104 million and EPS was 65 cents versus 53 cents, up 23%. [Tying] out adjusted income to report it, the Canadian dollar weakened slightly over the last quarter to $1.35 from $1.32, that drove a $20 million exchange loose on long-term debt, compared to a $92 million after-tax gain last year. As in the past, these are largely on realized gains and losses and we exclude them in discussing our operational results.

In the last second quarter, we had the charge for the asset impairment on the D&H and labor restructuring. That was $215 million pretax or $141 million after tax. So reported net income was $84 million versus $34 million last year.

Turning to slide number 7, operating expenses rose $56 million or 8% to $784 million, excluding comp and benefits, which I will discuss in a minute. We're fairly satisfied with the expense performance. Fuel expenses were up just 2%; [INAUDIBLE] gains, a 3% improvement of fuel efficiency and improved cracking margin and transportation costs, largely offset the higher WTI prices and the 7% increase in GTMs. I should note that the impact of a higher crude prices alone was $15 million. Our fuel hench position is attached to the presentation. You can see we have 23% of our requirements hedged at about $22 per barrel U.S., which works well for us given the current level of [spot] prices. And we posted a solid performance of both materials and rent expense declining slightly. Purchase services and other expenses up 7%, with over half of the increase due to the IBM out-sourcing arrangement. This was largely offset in other expense categories.

Turning to comp and benefits expense on slide 8, I will talk about the change quarter--on-quarter; then I will talk about the run rate. Reading from left to right on the water [INAUDIBLE], incentive comp was up $20 million. Performance bonus, which we accrue for throughout the year, is the largest component of the item, and in a normal quarter averages about $9 million of expense. I should note this is a paid-for-performance program, which applies to all of our non-scheduled employees.

In the second quarter of 2003, it was clear we wouldn't meet our performance targets and we reverse what we had accrued to date, which resulted in a $6 million benefit. This year we trued up to a more normal level of expense in the second quarter, including on a year-to-date basis for about $12 million. So to summarize, a $6 million credit last year and a $12 million charge this year for a total of $18 million which explains most of the $20-million swing. Overall inflation, that is wage increases and [INAUDIBLE] including pensions, drove a $12 million increase. Our guidance of unit rate for comp and benefits, increases including pensions, continues to be in the 5% range. Training expense continues to be higher year-on-year as demographics require us to train roughly 600 running trades employees this year.

This quarter is a peak of that expense. We want to see that come down to more normal levels by the end of the year. The net impact of the 7% increase in GTMs drove a $4 million increase in volume-related, basically crew costs and yard expenses. Our FTE reductions, which we announced last second quarter, were largely on track; and to date, we've reduced about 540 of the 820 positions. This was worth $6 million.

In terms of run rates, the comp and benefits expense, you'll have to take into account my comments on incentive costs and the training. Of course, it depends on activity and volumes. But you should probably expect numbers in the $310 to $320 million range over the next two quarters.

Slide 9 summarizes the change in adjusted EPS by component. Strong revenue growth, which Fred will speak about in a few moment, both volume and yield, drove a 47-cent increase. This is a full impact, adding back the foreign exchange effect. Volume-related costs were 11 cents, and that covered comp and benefits fuel and training expense. On a net-EPS basis, the exchange rate had a minimal impact.

Turning to slide number 10. I will conclude with a few words on the full-year outlook. A key take-away is that we are on track to deliver to the guidance we gave earlier of a 5% to 10% improvement in the EPS. Subject to some reasonable assumptions, I can say that we see the north end of that range as a likely outcome. Changes that we have seen since the beginning of the year include strong market fundamentals across a number of sectors, which is benefit [INAUDIBLE] our volumes and our revenues; strong operating performance, offset to some degree by higher fuel expenses; training; and to some degree efficiency-related costs.

Our focus continues to be on yield and to get the full benefits of the increased volumes to the bottom line. Key assumptions for th balance of the year include continued strong revenue performance, in the 5 to 7% range. Exchange rate of $1.34, about 75 cents if you like to look at it the other way. WTI prices averaging about $40 U.S. per barrel for the balance of the year.

Elsewhere, we should see the effective tax rate run in the 32 to 34% range. Interest expense will trend up slightly in the second half due to moderately higher [borrowings].

Fred, over to you.

Thanks, Mike. I will start on slide 12. Strong volumes in all three business groups drove freight revenues up 10% or $84 million over second quarter 2003. And before the impact of foreign exchange, revenues were up 12% on the quarter. I will now take you through the reported numbers on the graph. While commodities continued to lead the way with a 15% growth, record quarterly export and domestic potash volumes drove sulphur and fertilizer revenues up $19 million or 17%. Canadian grain revenues, as forecast, outpaced last year by 20%, and market share was about 51%, our historical level.

U.S. grain revenues were also up despite rail congestion on the Pacific Northwest route. Overall total grain revenues improved 13%, another $19 million. Our coal operations ran extremely well in Q2. Pushing revenues 14% ahead of last year. Our discussions with Elk Valley Coal recently reached an impasse, and we have taken the necessary steps to protect our interests by filing a statement of claim for revenues owed to us. As you know this matter is now before the courts, and it is inappropriate to comment much more.

Merchandise group was up 3% on the quarter. Industrial products were very strong, up 14%. Improvements occurred over across most commodities, reflecting general economic strength, pipeline steel volumes and success in the plastics and chemical segments. Forest products were weaker because of foreign exchange impact, longer offline car cycles, and planned actions to address low-margin segments.

Automotive volumes were soft, as predicted, and reflects the high inventory levels and lower-than-expected Canadian sales. Intermodal revenues increased 9% on the quarter with comparable improvements in both domestic and import/expert segments. Our intermodal renewal program, MaxStax, has been delivering as expected. Improving intermodal margins by over 20% in Q2 versus the previous year. This quarter also brought a healthy uptick in the exports to both key ports, Montreal and Vancouver. This load balancing supports our intermodal yield objectives.

Additional improvement in this area was provided by our West coast allocation program, which is designed to manage growth within our current intermodal train capacity.

Turning to slide 13. Our yield programs continue to deliver well. Contract and tariff renewals in the second quarter continue to be very strong. Year-to-date we have renewed about 13% of our book of business, at an average price increase of 6%. Another 33% of our book involving multi-year contracts with indexation clauses has been escalating in the 1.5 to 2% range.

On a same-store basis, our yield efforts have delivered a 2% improvement, year-to-date, matching our stretch goals, which I tabled last November. This result is exclusive of fuel surcharge revenues. Our new field surcharge program designed to respond more quickly and effectively to the changes in WTI prices was implemented on the June 1st. The new program applied to public tariffs immediately and also applies to any or new or renewed contract business. On the quarter, we collected $17 million in fuel surcharges, which is worth about another point to a point and a half on yield.

We can see the results of the yield and revenue management efforts in a variety of metrics. For example, revenue per train-mile was up 10% on the quarter and the average rate per car, exclusive of foreign exchange, was up over 3%. I am pleased with the progress the team is making in the yield area, and the market conditions give me confidence that we will deliver all that we targeted.

On slide 14, please note that we have adjusted our 2004 planning model slightly to reflect a foreign exchange rate of $1.34, up from our Q1 reference point of $1.33. For the second half, we are modeling the new Canadian grain crop at near normal. One can never be sure of the crop until it comes off the field, but current growing conditions support this forecast.

The outlook for our U.S. grain market remains consistent with the guidance provided in Q1; and that is down versus last year. All in, total grain for the second half will be up versus the last half of 2003.

On the coal side we expect to see year-over-year growth continue at close to the year-to-date pace. Sulphur and fertilizers are expected to remain strong in both the domestic and export sectors. Domestic fertilizer volumes should be decent, and exports will continue to be driven by Chinese and South American demand.

Turning to merchandise. Automotive projections for the second half remain soft based on sales projections and inventory levels. On the industrial products side, we expect steel and aggregates to continue at a pace similar to the first half. Our modeling suggestions chemicals and energies will also outpace 2003 in the second half.

Housing starts and low interest rates should continue to support lumber and panel growth. This segment will deliver stronger second-half forest products volumes; however, we will require fluidity on our U.S. connections and car-turn times must improve for any substantial growth to occur. Intermodal growth is expected to continue, but at a more moderate pace as we focus on serving our key accounts and targeting yield improvements.

To conclude, on revenues, I am bumping my forecast to the 5 to 7% range for the full year, which I may remind you would have been 7 to 9 had it not been for the stronger Canadian dollar.

Turning to slide 15. With the exception of a difficult two-week period in February, this railway has been operating very well in 2004. Through June, workload, as measured by gross ton-miles, has increased more than 7%. This was accomplished during Q2's busy maintenance work program season.

As shown on slide 16, we handled the 7% workload increase, illustrated in green, very efficiently, keeping train miles, illustrated in blue, virtually the same as last year. Keeping tight control on train miles is a daily priority. It's also the reason for initiatives like our acquisition of high-capacity double-stack cars, investment in sidings across our network to increase maximum train lengths, and the ongoing refinement of our integrating operating plan.

Slide 17 illustrates that in Q2 we set a number of significant performance records. Evidence of our ability to deliver the kind of operation we planned for last November. Our freight trains were the heaviest ever, up 7% ,in part due to the success of our MaxStax initiative. Traffic density on our network was the highest ever. Our employees were the most productive ever, with GTMs per active employee up 8%. And they worked more safely, with an FRA personal injury frequency well below 3 for the ever.

Turning to slide 18. With respect to the balance of the year, I want to highlight a number of actions we have taken to ensure we continue to capitalize on a strong market. In addition to the locomotives we purchased in Q2, we have leased an additional 34 AC locomotives for Q4 and beyond. We will continue to take delivery of more high-capacity, double-stack cars through the end of the year and continue to improve the margins on what is already an attractive intermodal franchise. Finally, we have been proactive in the management of our crews. As Mike noted, we've been hiring and training 600 employees through the first half of the year; and net of attrition, we will have 400 more employees qualified in time for the fall peak. With respect to productivity, I am comfortable with my previous guidance.

A quick update on the status of labor talks. On the Canadian front , we are in negotiations with two divisions of the Teamster Rail Canada Conference. One represents our running trades and the other represents our maintenance of weigh employees. Talks are progressing. On the U.S. labor front, we follow national bargaining. We have [INAUDIBLE] agreements in place for over 50% of our employees, and we are working through the balance in a disciplined fashion.

On the D&H, we settled with over 60% of our employees, and negotiations are ongoing with the others. In summary, labor -- CRP's labor dialogues have been constructive and we're optimistic that fair settlements can be reached without major disruptions.

To sum up, in the second quarter, we improved nicely; but we have more to do. From my perspective, we have the plans and resources to move the second half volumes in what will be a very busy period, and I look forward to continued improvement in our operating leverage.

Rob, back to you.

Thanks, Fred.

Wrapping up, as we pass the mid-point in the year, I am pleased with the progress that we are making. And the results show it. We have had a very strong revenue growth. This is driven by increased volumes in most of our business areas. Also driven by a very professional yield program that Fred outlined, and it is recognizing and capturing the opportunities that exist. Because of the strong demand for transportation services in virtually all of our product and geographic areas. Our productivity improvement and cost reduction efforts are on track.

Bottom line, we handled the volume increases with virtually no additional train starts. Last year, we said we would remove approximately 820 administrative FTEs by the end of '05, and we are on track to do this. We said we needed to find a solution for the underutilized D&H, and the imaginative [INAUDIBLE] action initiative of Norfolk Southern has taken us the majority of the way there. We have seen extraordinary volume increases in some sections of our network particularly to the Pacific. I have said that when we have indications that the volumes are sustainable and that the margins are attractive, we will expand our network there. This is normal work. Siding extensions and double track on the surface. There are no major bridges that are tunneling.

We will be in a better position at the end of the year to lay out future plans, if any, for the work. But right now we need to focus on the fact that this railway is fluid, and all traffic is current, except in those limited areas where there are current cycle issues. We are moving what is offered and positioned to handle reasonable growth.

Operator, I will turn it over to you to give the directions on the Q&A, and we will begin that session now. Thank you.

Thank you, sir. One moment please. Ladies and gentlemen, we will now conduct the question-and-answer session. We will take questions from analysts first, followed by the media. If you have a question, press star followed by the 1 on your touchtone phone. You will hear a three-tone prompt acknowledging your request. Your questions will be polled in the order they are received. Please ensure you lift the handset if using a speaker phone before pressing any keys. One moment please for your first question. The first question comes Fadi Shamone (ph), UBS. Please go ahead.

Good morning, gentlemen.

Good morning.

Quick question on the coal pricing contract. You said you were at an impasse. Can you provide us with a little bit of more details? What is the timing in your view that this could be resolved at. And also, if you can provide us with a guidance on the type of increase that we should be expecting for this year. And also, if the pricing for coal remains what it is, obviously [INAUDIBLE] could achieve [another] increase in '05, and would that also lead to and increase for CP in '05 as well.

Fadi, it is Fred. I think as I stated earlier in the call, it is a very difficult situation right now because this is a confidential contract. We now have a legal suit involved. And I think it would be inappropriate for me to comment on the specifics of this contract. Because it is an interpretation of the contract, any forward-looking statements about future periods, et cetera, really have to be resolved -- or this contract has to be resolved before we could comment on that. So I apologize, but I think the right answer for us at this point in time is simply to say that it is before the courts; and we are going to continue to work with our largest customer on a confidence contract in a constructive way and try and bring it to a head absolutely as quickly as we possibly can.

Okay. The other question on the coal side as well is Elk Valley seem to be -- or planning to move more volumes obviously into next year. How much more can you handle in terms of volume on the West coast before you have to look into capacity expansion. And if you can also give us the form of these expansion and the magnitude of dollar investment that we are looking at.

Well, I said, we are still in the process of determining what the demand is, not only for coal, but for all commodities. As you know, this company was faced with double digit, 15% growth year-over-year, in a lot of our westbound commodities. So we have a sense that that is a new level, and we are trying to determine from all our shippers of what kind of growth can we expect next year. That work has not completed. So until we have a long -- a sense of a longer-term sustainable demand, we are still in the planning process. I said we would be completed that process towards the end of the year. And rather than give you an answer that is half -cooked right now, we are going to finish off our planning and be in a position to tell the market what we plan to do, if anything, towards the end of this year.

Okay. Thank you.

The next comes from Tom Wadewitz, Bear Stearns. Please go ahead.

Yes, good morning.

Good morning, Tom.

Let's see, I have got two questions for you. I am going to take on one more shot at the coal. Fred, you said you can't really say anything forward-looking. Can you just give us a little further clarification on the quarter? There is the announcement you were suing them for about 14 million, which sounded like it was for the second quarter numbers. Your coal yields were clearly up year-over-year, up about 4.8% and up about 10% sequentially. Did you book the full 14 million that you are suing them for in the second quarter numbers?

Tom, I am not going to go there for reasons of not wanting to complicate our dialogue or the situation before the courts. It is a very strong and robust coal market. Their prices are going up, and we are trying to move as much coal as we can possibly move within the balance of all the other demands for our services. As you may have heard on the call the other day, they are very satisfied with the train performance and the volumes we're moving. I apologize I can't fill in any blanks for you at this time.

I mean, directionally, is it fair to say you booked some of that that is in dispute in the quarter.

Tom, it is Mike. The $14 million applies to the quarter. That is more of a cash item. That is the difference between what we have billed and what they've paid. From a financial accounting standpoint and revenue recognition, all I can see is we are appropriately provided for. And that has been factored into our EPS guidance.

Okay. Let's see. On the capacity issue, you seem to run the network very well in the quarter; and so congratulations on that, that's good to see. As you look to 2005 and you have some of these track-capacity constraint in the West, should we be modeling a significant deceleration in volume growth just as a function of some of those constraints? Or as you look at some of the gains you've had in terms of efficiency, do you think you still have the ability to, you know, realize, say, 5, 6% of growth in intermodal and other areas? Because it seems like it is getting late in the game to really have that track capacity come on next year.

Tom, I think you summarized it actually quite well. Traditional growth is, for our business and certainly for most of the industry, has been in the 3 to 5% range. If it is just traditional growth that we see on top of what has already been a very robust growth this year, then I am pretty comfortable that we can find a way to work our way through that system and move an awful lot of that business without any great complication. If, however, we've got ourselves a 25% growth on top of what is a huge growth this year, then obviously that is a different set of circumstances. So as Rob has stated, a big part of what we have been up to for the last month and a half or so and what we will be up to over the coming month is to work closely with -- especially with the big clients that we have and understand their perspective on what they see happening throughout next year. So we are in good shape to handle a normal year's growth. And from what we have seen at this point in time that leaves us pretty comfortable.

Tom, don't forget this is a transcontinental railway. We have got an awful lot of other movements that can give us top-line and bottom-line growth as well. You know, we are not just a railroad that goes to Vancouver.

Sure. Do you really need to see resolution on this coal contract before you can come up with what your full capital plan would be for expanding things? Is that really the necessary trigger point?

Well, I wouldn't say it's a go, no-go situation. But it certainly would be helpful. There is many ways to get capacity, as Fred and Mike have outlined. The crews are on strain. We have hurried up our locomotive acquisition. Cars are another issue. High-capacity cars are ways to get capacity into the planning that Fred's team did to bring on that 20% capacity increase in intermodal with the MaxTracks is other examples. So, you know, security going forward obviously is helpful; and you know, without going into the discussions with Elk Valley, that is obviously something we are pointing out.

Right. Okay. Great. Thank you. Thanks for the time.

Our next question comes from James Valentine, Morgan Stanley. Please go ahead.

Great. Thanks. Mike, just to clarify because I got confused by your response when you said -- I think you said a 14 million dispute is the difference between what you collected and what you believe you are owed. But then wouldn't that be the accrued rate? I am sorry. If you could just clarify maybe a little bit.

Well, Jim, again, I can't say too much. What we bill and what we receive, obviously that's a different set. The $14 million, as you know from a financial accounting basis, you have to accrue what the appropriate revenue number is. And all I am going to say, again, is that we have appropriately accrued for revenue. And Jim, I know you would like more, but I just can't go there.

No, I understand. I don't want you guys to show all your cards here on a public call. But what I am just trying to understand is, you are saying you are accruing in that rate, which I presume means in your financial statements, you're saying, I guess for tax reasons, you are doing it at one rate and then -- when you say accrual rate, I presume that is meaning for your financial statements?

Yeah, from the financial accounting standpoint, you accrue what you think the adequate number is. You know what the grounds for revenue recognition is. You provided the service. In our case we have contracts in place, confidential contracts that Fred spoke about. But, Jim I am just not willing to go beyond that.

Okay. Then, if we can just not talk about Elk Valley specifically and just talk about coal pricing in general, because you have business with other customers. Do you believe right now that you're extracting a reasonable price for export coal given -- metallurgical coal given where metallurgical coal prices are right now in the global markets. In other words, at some point in the future do you think if export coal prices stay where they are at, you are going to get a chance to extract more value, or do you think we've pretty much done that and we shouldn't look for another step up in the next, let's say, 12 or 18 months?

Jim, it is Fred. Just point of clarity. With the mergers that occurred over the last year or two, there really is only one substantial metallurgical coal client and it is Elk Valley. With regard to your question: If -- we have a contract. If the contract is applied as it has been and we think should be, and has been in the past and we think should be from today and going forward, we think we will benefit from the upside in future escalation in the price of coal sold in world markets. That, as you can imagine, is the essence of the discussions.

Right.

[We pride] ourselves in our business partner.

Fred, can you walk us through. When you said a 20% increase in intermodal margins, I'm always confused when someone references a percent change of a percent. Are you talking about that, you know, that went from 10 to 12%? Or are you saying it went from 10 to 30%?

It would be 10% of -- or 20% of the absolute number. It is not a step function increase. It is certainly not a 10% margin. But if it was then it would be 10 to 12. It's a much bigger margin, and it went up 20% of that margin.

That's great. That's impressive.

I guess this is for Mike. Mike, given that you are maintaining for your guidance even with the higher fuel price assumption, that implies something else is going better than you guys were expecting. Is it just simply the volumes, the strength in the export industrial markets, or is there something going on here in terms of beating your expectations for costs or efficiencies or pricing?

I think your [INAUDIBLE]. You may recall Fred's remarks that he's upping his guidance is to 5 to 7. So we are seeing a bit of a stronger performance on the volume side, and that's enabling us to deal with some of the cost pressure on fuel.

Okay. Great. Thanks guys.

Thanks Jim.

Next question comes from David Newman, National Bank Financial. Please go ahead.

Morning, gentlemen.

Morning, David.

Are you seeing any penalties for delays at all that you might be witnessing from some of your customers?

David, it is Fred. We did incur some in the first quarter, as you'll recall. And in the very, I think first month or five weeks of the second quarter, which were really a result of our first quarter slowdown. But since that time, we are largely out of any penalties attributed to train performance. Our railway is really very fluid. And as Rob -- I think as I said and Rob referred to, the interchange with a couple of the U.S. roads that are having their own sets of problems has effected us on a couple of car types, particularly -- a little bit on multi-levels and certainly on centerbeams. So there are the only places we're feeling a form of congestion, of substantial congestion.

Okay. They are working through their problems? I guess Union Pacific and, specifically, they are working through their issues? Are they trying to coordinate with you a little more effectively on that?

We have absolutely wonderful working relationship with, frankly, all of the U.S. railroads. And as we have been able to identify some issues in Detroit with one of the U.S. railroads, within weeks we had that cleaned up and it has helped us a lot. And on our Pacific Midwest and Pacific CanAm services, which are joint services with the Union Pacific, we have, from the top of the house down, we just have superb cooperation; and we've really worked through a, you know, the old cradle chart of what is causing the problem. So we are coming together very nicely. And we think we've got some good strong partnerships that are going to deliver the kinds of full service that we have done in the past and we're sure we can do in the future.

Very good. And your freight revenue per revenue ton-mile doesn't sort of reconcile with your yield improvement. I am just trying to understanding what the difference might be. Are we going to see a catch-up in the revenue per revenue ton-mile at some point?

I think, David, the key thing to look at there is, first of all, that you've got to take into account we've got, year-to-day, I think we are about $80 million in foreign exchange. That always takes a whack off it that's hard to identify. And then look at the mix of business. The mix of -- in our book of businesses, we've really pumped up on our bulk commodities. You're starting to get a -- you know, those move at a lower cents per RTM obviously.

Right.

And I think what you are starting to see is the impact of the combination of foreign exchange, and the mix is going to leave us, you know, with a cents per RTM that doesn't reflect the kind of prices we are getting. But if you listen to the other things I said, such as a cents per car, or the dollars per car, or the dollars per train-mile, you are seeing the benefits materialize. So, like every metric, you have to make sure you kind of triangulate off a couple of other ones. This one I wouldn't put too much credit as a single evidence of price success.

Very good. And last question if I may. And just on the capacities issue. Not to beat a dead horse here, but what sort of breathing room have you given yourself going into to the fall peak period? What sort of additional, I guess, capacity do you have as a percent? Are you down to, let's say, an additional 10% in terms of any of the handled increase in the volumes, as long as you're going to have an above-normal crop. You've got the automobiles, merchandise and intermodals, which should continue throughout the fall period. So any metrics that you can give us there?

It would be really hard, I think, David, if you'd just try and isolate it out as X percent over pipeline capacity. A railway, although people refer to it as that, is much more complex. We have to take into consideration all the forecasts for different types of commodities. They have different demands on the capacity of the line. Both Fred and I say we have adequate capacity to handle the growth in the fall, and that's what we can see coming from a grain crop, which is about normal. And the demand being put on us by very strong export movements of commodities and import movements of containers.

Fred, anything you want to add to that?

I would say, David, the last thing that's important to understand, we haven't dwelled on it over the course of the last couple of quarters. But we did within our capital envelope that we identified earlier in the year, we did identify about $25 million of rifle-shot capacity expansions, and we will be complete those. We are about a third complete now and we will be complete those by about September the 30th, which is perfect timing, as you can imagine, for our fall peak.

Right.

That largely addresses our Canada to U.S. routing. We've taken a couple -- put a couple of good long sidings, or will have them in place. And similarly on the Kings Gate corridor, which is the UP, Pacific CanAm corridor, both ourselves and the UP will have a total of about 4 extended sidings or new sidings put in there.

Okay. Very good. Thanks gentlemen.

The next question comes from Scott Flower, Smith Barney Citigroup. Please go ahead.

Good morning, all.

Good morning, Scott.

Just several questions. One is -- and, again, not recurring phrase, not to beat a dead horse. And I don't want to talk about the specifics of your litigation. But can you give us any framework on the process, i.e., timing of the court case? Obviously, if it is open-ended and the answer is you don't know, that's the answer. But I am just trying to get some framework. Is this something that is going to be years in the making, or is this something that if we look out six months is the timing? I am just looking for broad guardrails, not specifics. And I certainly don't want to know about the litigation itself.

Scott, it is Fred. We have filed, there is a process now where they must file their defense or their approach to defense. There is some possibility under the law that there can be a modest deferral for a month or so because of some unique circumstances that exist. But we can't, there is no way to say with definity that it will be settled by a particular date. Obviously, we triggered it; we want to deal with it, and I have reason to believe that, you know, our associates are going to want to get at it. So I don't think you're going to find anybody stalling. I think people are going to want to get at it and get whatever the outcome's going to be settled. But there is no way for me to say it will definitively be done in a time. We are optimistic, obviously, we will get it done either in the quarter or by the end of the year, and sooner is better than later in our perspective.

Perfect. Then a couple other of quick questions. I know that in terms of your commentary, Mike, on crew training that you talked about this being the peek. I guess what I wanted to get at is, just to get a sense -- and maybe this also ties into Fred -- some sense of the demographics of your workforce, particularly the train crews. Isn't this going to be an ongoing phenomenon? Is it just the peak because the economy has been so strong that there is a very rapid catchup in the short run, but this is going to be an ongoing fact of life in terms of training for replacement based on the demographics of the North American Railway age of train and engine crews, and/or the specifics of your particular crew base?

Scott, we have -- well, kind of deal with this in two ways. From my perspective, we had a catchup. We operated less than ideally last fall and in the Q1side because we had the -- a little bit of demographics and this huge surge come at us. We have, this year, in 2004 fiscal year, we have incurred expenses -- Mike can talk about some specifics here -- and that will enable us to get through, do the catchup, get through so we are running at a stable rate and prepare us for the first part of 2005. I think it is fair to say that, as demographics change, the training rate will probably -- or will be maybe a little higher than traditionally the last maybe 10 years, but not the kind of surge that we've experienced in 2004. I will flip it over to Mike.

Just to tag on, Scott. What we saw in the quarter, training was worth in rough-cut numbers about $5 million; and total -year numbers in the range of $15 million. As Fred has indicated, as we go into next year, clearly the uncertainty is what is the volume story, but we think that will converge back down to a more normal number and we'll see that benefit to the bottom line.

Okay. And then one last question, and you know, again, I know you won't have specifics; you all have elaborated on why. But I am just trying to get a sense, directionally, when we think about capital, is it fair to say that given the strength of the volume -- and I know that there are some variables you don't know and, therefore, you won't have specifics, about capacity and what makes sense and what doesn't -- but is it fair to say, given the environment we are in now, that this year in terms of spending levels probably as a base, and the question is, depending on opportunities or otherwise is that number may go higher, it may not, but this year is a good basis; there's certainly no reason to believe CapEx goes lower as we look towards '05.

I think that's a fair comment. Our guidance is remaining unchanged, Scott, in the sense of free cash flow. We expect to be moderately positive, and that enables us to preserve all the options we need to preserve going forward.

Thank you.

The next question comes from Joseph Leinwand, RBC Capital Markets. Please go ahead.

I am hesitant to ask any more coal questions, so I will just skip that. I think the answers were confusing enough, so we will just leave that one. Just to head back to a couple of areas. On the training costs, just remind me that you guys were initiating a new ties program that was supposed to come roll into the system in July and August. And I thought part of the training costs were associated with that. Where do we stand on that?

Ties has effectively been rolled out through Alberta, British Columbia, and Saskatchewan At this point, for the next two or three weeks, we have taken that team and they are rolling back through the organizations, applying the best practices that have now unfolded as people have now had a chance to play with it. And at this point, I would say, probably by either mid-August or September 1, we are going to head east again beyond Saskatchewan.

And we will see the effect of that system on fluidity or efficiencies fourth quarter or so?

We believe so. Certainly in the west where people have, you know, Joe, got it in and worked it and are as familiar as they need to be with it. And obviously the benefits will manifest themselves in 2005 on the places they get rolled out in the Q4.

And the training costs associated with that, Mike had mentioned the 5 million, but quoted a 50 million to year-to-date with respect to capacity restrictions or training a new crew. The ties, is the ties expenses included in part of that.

Yes, Joe. If you take the total of the ties expenses and the training expenses, the total number we are looking like in round numbers is $30 million; and of that number, about 7 or so million is relating to ties. We expect that number to go to, rough-cut, $15 million next year, and that's the $15 million that I've been speaking about, just not just on year-on-year comp it off by going into next year.

And then this will switch back onto the D&H. We haven't talked about this lately. Just a timeline. How are those things going? When can -- you know, at one point in time about a year ago, one had mentioned that if D&H didn't exist, it would help the operating ratio by about 1%. I am just wondering where we stand on the timeline with that.

Joe, why don't I deal a little bit with where we are at on the new NS arrangements, the co-production arrangements; and then maybe Mike can deal with the impact on the finances.

We are in active dialogue. Two very solid teams set up and everything is progressing as we expected to with regard to the -- on the D&H impacts, which is, you know, us doing work for them, them doing work for us; and flipping between haulage and trackage between Buffalo and Binghamton. On the collateral piece of the deal, which includes the new routing, you know, the fastest and shortest routing between Detroit and Chicago, that work also is very active; and we are working with our associates in NS, both in their operations house and in their strategic house, to ensure that we have got the exact routings, exact times in all of the components necessary to bring that to life.

Probably as we said on the call about a month and a half ago when Mike and I were introducing the deal, you won't see a dramatic change until -- we won't see a change until Q4 at the earliest where we might be able to move a couple of train sets or one train set that way. And you will see at throughout, probably the end of Q1 through the end of Q3 next year, you will see the majority of the rest of the business migrate over to the new routing.

Joe, to add on to Fred's comment, as Rob said, this transaction is a significant first step for us. We continue to pursue improvement and profitability on the D&H. And consistent with what Fred has said in terms of timing, we will certainly get a half point in 2005 on the operating ratio and we're going to chase that 1-point improvement.

And guys, I really can't resist. I guess what I got out of the coal discussion was that you are including -- you are accruing in your revenue as reported some of the rate that you feel is due owed to you; is that a correct interpretation?

Joe, we think we are accruing revenue on an appropriate basis, and that's consistent with our guidance.

Thanks very much. Good quarter, guys.

Thanks.

The next question comes from James David, Scotia Capital. Please go ahead.

Thank you. Good morning.

Good morning, James.

Morning. I do have a coal question. In terms of the car loads, I think historically some 90% of them were Elk Valley -- sorry, [40 met] coal. Is that still kind of the proportion? 80, 90%?

You talking about met coal versus the business that we have elsewhere?

Yeah. Versus thermal.

Yes, 85% is probably a pretty good assessment.

Okay. Thank you. On the thermal side, has there been any rate change? I presume they're kind of sort of long-term tied in inflation-type things. Has that moved much? Pricing on the thermal?

We are in the midst of negotiating one thermal contract. The thermal business is almost entirely our U.S. coal business. We are in the midst of negotiating one contract there. The others are on these multi-year deals with escalation built in. And that -- you know, we are in discussions, so we won't comment on that cost.

But can I say it is sort of CP I on the ones you're not negotiating?

Absolutely. We wouldn't be going below that.

Second question, Fred, you mentioned -- I think the question was asked earlier. You said the intermodal business, its profitability grew by 20%. That was the dollar profit grew by 20% year-over-year; is that correct?

The percentage, what we would call the operating margin on that business, has improved by 20%.

The margin, the percentage margin has improved by 20%.

Correct.

Okay. I guess the question is, how much of that would you attribute roughly to pricing and how much would you attribute to efficiency, including demarketing? Or have you demarketed any customers?

It is a very good question, James. It is a combination of a lot of things. The yield is comprised, in our world of such things as exiting the inefficient trailer market, which is consuming too much of our capacity, not giving us the kinds of return per lineal foot of train we were looking for, being replaced with double-stack EMP and Max-type containers in the domestic market. It also is comprised of such things as the storage charges and terminal service charges, which have escalated; and the basic pricing on the both international and domestic business has escalated, and quite aggressively I would maybe characterize it as. We have also looked at the terms and conditions of our contract, such as in some cases they might have had empty repositioning for free if we used them in domestic service. We have moved quite rapidly towards causing empty movements to always have a revenue move attached to it now. They must pay for those types of things.

So we just systematically worked our way through on the kind of -- I'll call it price yield and scenarios like that. In addition to that, as you can appreciate, the introduction of MaxStacks with the efficiency of per lineal foot of train and the density of trains, that I would -- I'm going to guess now because I don't have it at my fingertips, James -- I'd say two-thirds of our benefits could be attributed to, I'll call them, operational improvement and the other third may be attributable to the first stages of our price improvement programs.

Okay. That's great. And just a final question, Mike, if I might. I know it is still premature, but could you kind of maybe provide a range of what you would look to incrementally CapEx over the next 12 months versus what -- I mean I am assuming something around $700 million is a sort of run rate. If you deal with some capacity issues, and let's say you do nothing at zero, but if you were to do everything you could possibly want to do over the next 12 months, what would be the range? Zero to what would be the top end? And then presumably you'd come in somewhere between zero and that number.

James, in terms of this year's number, 675-type range up to 700 potentially. Next year, we still going to land on the number. There are things that we have to do in terms of furthering our planning work. Obviously, it would be more than that. And what we had like to do is give you some more color on that when we talk to you in the fall when we have completed our planning work.

Okay. If I understood you correctly, next year would be 675 to 700. And it is possibly the number could be higher, but you don't want to comment at this point?

It will be higher in 2004 than 700, but, again, we don't want to give you --

2005.

2005.

2005. I beg your pardon. Higher in 2005 than 2004; and the 2004, again, 675 to 700.

All right. Thanks a lot, guys.

Ladies and gentlemen, if there are any questions from the media at this time, please press star followed by the 1. As a reminder, if you are using a speaker phone, please lift the handset before pressing the keys.

Next question comes from Simon Lomax, Real Business. Please go ahead.

Good morning, gentlemen.

Good morning, Simon.

Two questions from May. The first was that yesterday's Norfolk Southern quarterly earnings call they said that they were suspending their fuel surcharge program. But I am just looking at the slides, and I wanted to make sure that I was safe in assuming that you plan to continue yours? And if that's the case, if I could get somewhat of an explanation as to where that fits into your business modeling and why you consider it important to keep in place?

Simon, I just want to make sure semantics are clear. From my perspective, we work quite closely with NS. And I am not aware that they have suspended their fuel cost adjustment or the fuel surcharge. I had heard rumblings on their call. They had talked about reconsidering their fuel hedging program.

I see.

I can assure you that from CPRs perspective, the fuel surcharge process is alive and active and will continue in a very determined way to recover the cost that we are incurring on behalf of our clients.

All right. Excellent. The other question that I had was, you've posted an average rate per car increase of greater than 3%. I wondered what guidance you could offer, if any, as to how that might unfold in the second half of the year?

I think Simon -- it is Fred again. The makeup of the business is such that there is a portion of the business that comes up for what I will call a pure contract renegotiation. The contract has now expired; and in those cases, we are doing nicely in the 5, 6, 7 and above range depending on the competitive circumstances. So much of our business is on multi-year contract rolling over, with indexation clauses that are now, as I said, settling in the 1.75, you know, plus or minus a quarter of a point, that I don't think you should expect to see a dramatic change in the second half versus what we have accomplished in the first half because of this large proportion of contracts coming due. I can say, and I suspect others are doing the same thing, that in circumstances like this, you reconsider policy; and as these contracts, these big contracts with mult-years come due, we consider whether we prefer to have a fixed rate, maybe no indexation, just fixed-rate increases, or whether we'd rather have shorter term contracts, depending on our collective outlook for how strong the market is going to be and for what period.

All right. Then. Thank you. Thank you all.

Thank you.

Gentlemen, there are no further questions from the media at this time.

Thank you, operator. And, ladies and gentlemen, thank you. I think it has been a good quarter. We managed through a lot of -- over the last year a lot FX and fuel [turn], a lot of volume increases; so I think things will steady down in the year ahead. We will talk to you at the end of the third quarter. Thank you very much and goodbye.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating and please disconnect your lines.