Canadian Pacific Kansas City Ltd (CP) 2005 Q1 法說會逐字稿

Welcome to the Canadian Pacific Railway first-quarter results conference call. At this time all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference call is being recorded on Thursday, April 28, at 1 PM Eastern Time.

I will now turn the conference over to Mr. Paul Bell, Vice President Investor Relations of Canadian Pacific Railway. Please go head sir.

Thank you, operator, and thank you, ladies, and gentlemen for joining us on our 2005 first-quarter teleconference. The presenters today will be Rob Ritchie, our President and Chief Executive Officer, Mike Waites, our Chief Financial Officer, and Fred Green, our Chief Operating Officer.

Before I turn the presentation over to Rob, I would like to make you aware of the following. This presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties and other factors that could influence actual results are described in our annual report, annual information form in this presentation on slide 2, and in the press release issued this morning. This presentation also contains non-GAAP measures as outlined on slide 3 and as further explained in the press release. All dollars quoted in the presentation are Canadian unless otherwise stated. Our slides are available on our Website, so please follow along.

It is now my pleasure to introduce Mr. Rob Ritchie, Canadian Pacific Railway's President and CEO.

Thanks, Paul. Good day, ladies and gentlemen, and let me say thank you for joining us.

To begin please turn to slide number 5. Let me say right up front that I'm very pleased with these results. Q1 marks the culmination of a number of years of extremely hard work by a great team of professional railroaders. So, I'm going to take a minute to review the status of the key elements of our strategy that got us to where we are today.

First, two years ago we told you we would drive hard on yields. And we have increased revenue per car by an encouraging 16%. Secondly, we told you we would upgrade our book of business. We have now moved a record volume of revenue ton miles up 4%, yet overall carloads were off slightly, so we're getting the mix right. Thirdly, we told you we would improve fluidity. Our current velocity is up 9%. Fourth, we told you we would resolve the Elk Valley Coal issue in a professional and positive way. We delivered a fair and innovative agreement that reestablished a strategic partnership with the world's second-largest supplier of scarce net (ph) coal. Fifth, we said we would expand the Western corridor when conditions were right. We have now begun and we will pay for it within our 2005 cash flow. And sixth, we told you we had a professional and engaged work force, both union and management, with nearly 60% of employees being shareholders. On the union front, almost 80% of our men and women have ratified new progressive agreements.

We are a strong railroad with a long tradition of working through tough Q1 conditions and this year was no exception. We had significant weather-related events to overcome, both east and west. However, we were better prepared with the right amount of locomotives, crews, and an intense contingency planning effort. All of these efforts dramatically improved our operating leverage, increasing our EPS by $0.22, or up 92% from Q1 '04. Add on the $0.07 representing 17 million of coal revenues from '04 gives you -- gets you to $0.53, or 121% higher than '04.

Our operating ratio dropped an impressive 4.5 percentage points. Our unique franchise provides a growth catalyst for CP, as we continue to benefit from a strong Balkan export program to the Asian economy and the import of containers as global trade patterns shift.

I will now turn it over to Mike and then Fred to provide you with additional insights. First, over to you, Mike.

Thanks, Rob. Before I get into the slide discussion, let me make a couple of comments.

Obviously, this was a good quarter for us and certainly our yield program is delivering results. This benefit gets directly to the bottom line, as we all know. This is why it's so important. Further, we are beginning to see some of the dividends from fluidity and from our integrated operating plan, notably in car velocity. Importantly, there is more improvement to come. So, with that by way of introduction, let me turn to slide 7 and I will take you through our earnings per share on a more granular basis. I should add here, these are adjusted EPS numbers

Starting on the left of the waterfall, you can see just excellent top-line growth. Yield is the key story, highlighting the outstanding job being done by our sales and marketing team. These initiatives came in delivering $0.22 of EPS. And then you can see revenue growth and volume of mix changes contributing another $0.24.

Moving to the right, that $0.24, partially offset by the related volume expenses of $0.10, or approximately 55% operating margin. Inflation on labor and benefits accounted for $0.04 of expense, and the increasing variable incentive and stock-based compensation cost $0.08. Fuel price was up 37%, or $0.14, but our risk management program, comprised of fuel surcharges and an aggressive hedge program, helped offset $0.12 for a net of $0.02. Key point, these fuel management programs result in over 75% of our fuel exposure being covered.

Continuing on, depreciation and amortization was up slightly and rounding out the $0.53, or $0.12 of other, which includes the $17 million of the prior period EVC adjustment and the negative impact of the change in foreign exchange. All in, even when you take out the onetime EVC 2004 (ph) out to $17 million, you still get an EPS of $0.46; that's up 92%. Clearly, we're proud of this accomplishment, including the impressive 450 basis point improvement in operating ratio. So, an excellent start to 2005.

Moving to slide 8. As highlighted in the far-left numerical column, strong revenue growth, and Fred will give you the revenue story in a moment. Operating expenses were up 8% to 835 million, but excluding the impact of higher fuel prices, expenses were up just 4%, which I will touch on in a moment. Operating income then was 179 million, that's up 63 million, or 54%. Interest expense was down slightly at $52 million. So, adjusted income was $85 million, up 47 million, or 124%; that's with an effective tax rate of 34%, within the guidance range we've discussed. We then tie out to GAAP (inaudible) the unrealized currency losses on the debt for reported income of $81 million. Key take-away, strong top-line growth driving significant upside in EPS.

Turning to slide 9, operating expenses rose $65 million, with about half of that due to the fuel price impact. The three major expense stories for the first quarter were comp and benefits, fuel expenses and equipment rents. So, let me take each one of these in turn.

Overall comp and benefits expense rose 7%, or $22 million. Higher incentive comp expense accounted for an $18 million increase, mostly relating to higher expenses for stock-based compensation, deferred stock units and so on, and this reflects the higher CP stock price. If we move this aside, the increase was limited to just $4 million, which was due to higher volumes, wage, pension, and benefits inflation.

In terms of total headcount, we expect to complete the FTE reduction targeted at 820 positions by the end of the year, and we continue to protect unit rate increases of roughly 4%. And I should point out that's the combined total of wages, health and welfare and pensions.

Moving to fuel, still a significant expense headwind. Higher crude prices led to a $28 million increase versus 2004. We saw our WTI prices up $46 a barrel or more this quarter versus 33.60 last first quarter. I should add here that one of our key Western Canadian suppliers experienced a fire earlier in the year which has driven diesel prices up more than expected. This in conjunction with higher refining margins generally cost us almost $6 million during the first quarter and could cost us $20 million or so on the full year, and that's including the first-quarter impact. Obviously, we're working hard to mitigate this.

I am pleased to say that our hedge position is solid with a full-year 2005 hedge of 33% of our requirements. That's $35.59 per barrel U.S. And certainly, that price looks good given the current spot price levels. Equipment rents down 17%, or $10 million. While aided by favorable adjustments of $8 million, a 9% improvement in car velocity led directly to keeping our equipment rents flat in the face of both higher lease rates and volumes. So all in, overall expenses up 4% excluding the fuel price impact.

Turning to slide 10, with the outlook for 2005, a lot has happened since the 14 to 16% EPS guidance we gave to you last November. Let me emphasize that other than for the announcements we've made during the first quarter, and those are specifically Elk Valley Coal settlement and the western corridor expansion, it is premature for us to update our 2005 full-year guidance.

With the new EVC contract, we are now guiding to a 12 to 14% revenue outlook. With the announcement of western corridor expansion, our capital program will grow to the 900 to $920 million range in 2005. We should point out that the new revenue forecast will help us fund Phase I of the expansion and still leaves us with positive free cash flow between 50 and $100 million in 2005.

The two key assumptions that have been revised, I should say -- but again, no impact on guidance -- WTI, up from $48 a barrel U.S. to $55 per barrel, and the currency we have taken from $1.25 to $1.23. With all the puts and takes, our 2005 EPS guidance remains in the 3.15 to 3.25 range, or up 39 to 43%. And again, from an income standpoint, this reflects the EVC settlement which we spoke to you about earlier in the quarter, and it takes us up from our earlier guidance of about 2.60 a share. In effect, what we are saying at this point is the higher diesel prices and the stronger Canadian dollar assumption is an offset to the strong first quarter. But, obviously, our intention is to mitigate those items both specifically as well as with continued cost -- focus on cost management.

I would like to close on slide 11 by giving my view of the shareholder frame. 2005 free cash flow will be positive, as I mentioned. Importantly, CP is now in a position to grow and at the same time generate significant free cash flow. Phase I of the western corridor expansion will add EPS of $0.25 to $0.40 full-year run rate. And note, this will ramp up in 2006. I want to emphasize that this is incremental to the EVC bump in EPS.

Net debt to debt plus equity is up 43%. The balance sheet is in good shape, and I don't see a need to divert cash to pay down debt beyond the June debt repayment this year when we have a $250 million debenture maturing. We will fund this maturity by drawing down our cash balances and with cash from operations. As we have told you before, we will keep our dividend payout and yield competitive. All in all, I am pleased with the progress being made.

I will now turn the discussion over to Fred.

Thanks, Mike. On the revenue side, we delivered a very impressive quarter with freight revenues up almost 15% -- a record first quarter. Let me break this down.

Starting on the left, you can see we continue to battle the impact of the strong Canadian dollar which impacted us by $28 million. Excluding the foreign exchange impact, revenues increased 18% and were up in six of seven business lines. We also delivered excellent yield results in Q1. Revenues per revenue ton mile were up 10% and our average revenue per carload grew by over 16%.

(indiscernible) and fuel surcharges contributed just over 9%, or $80 million, to total yield. Our fuel surcharge recovery was in line with our target. Volume growth measured by revenue ton miles was up 4%. Bulk was the driver, featuring double-digit growth in grain and potash. Total carloadings were down slightly.

Elk Valley Coal rate negotiations contributed significantly on the quarter. For clarity, we have isolated the $17 million related to 2004 (indiscernible) volume. Overall, we saw no major surprises in the marketplace and we delivered some very impressive results in all of the key revenue management components.

Turning to slide 14, I will hit the highlights for the seven lines of business. Grain revenues were up significantly due to improved car cycles and shipping patterns affected by the late crop. We also increased winter rail shipments and had good success with our new U.S. efficiency train programs to the river and the PNW. Total revenues were up significantly. Of note, volumes for the Canadian coal were up over last year, while carloads of U.S. coal were down as we had forecasted.

(indiscernible) fertilizers were also strong, driven by record potash exports. Good performance on car cycles and improved (indiscernible) line connections enabled this performance. Strong steel, aggregates and chemical volumes drove merchandise growth. Forest products was (indiscernible) story, supported by some recovery in the pulp and paper side. (indiscernible) were soft, but in line with our modeling.

(indiscernible) had another good quarter based on planned, modest volume growth, good yield, and new business to replace the low-margin trailer segments we chose to exit. Overall, a great quarter on the revenue side, up 18% exclusive of foreign exchange.

Now, on slide 15, I'll walk you through yields. Let's start with the carloading chart on the left. As we told you, we have a clear plan to update our book of business. Through our strategic reductions we exited approximately 20,000 loads in specific low-quality segments such as short-haul U.S. coal, trailer on flat car, segments of expressway and bottom-quartile merchandise. And we replaced and upgraded a good portion. Good progress on a critical initiative. The key point, as you can see on the right-hand chart, is that the low-quality business was replaced with traffic of much bigger value. Average revenue per car was up over 16%. Breaking that apart, price was (indiscernible) 6%, fueled generated 3%, and the balance was related to a better book of business. Overall, good results in managing the business for optimum yield.

Moving to slide 16, I will update our revenue model for 2005. A few notes before I get started. First, no revenue is factored into the 2005 outlook for our western capacity expansion. And as Mike pointed out, we are now modeling based on revised FX and WTI assumptions. We are very comfortable with our previous modeling. We had an exceptional start to the year on grain; however, we expect to see revenues normalize over the next three quarters and will hold to our previous 6 to 8% target growth.

For coal, some new business in the Elk Valley negotiations will deliver a 40 to 45% increase. Offshore sulfur and fertilizer markets still look strong. On the merchandise side, the plan remains targeted at growth and yield. Railcar demand across the board has been robust in April month-to-date. We've recently converted some steel and paper business from truck, and we also see positive signs in aggregates, chemicals and plastics. No change in the automotive outlook.

We also expect 2005 to be a strong -- a year of strong prices and continued targeted growth for intermodal. Max (ph) stack direct, off the dock, direct to market solid (ph) trains from the Port of Vancouver were initiated in late Q1 as part of our continued focus on intermodal margins. This service will improve fluidity and reduce the cycles and supports the Vancouver Gateway CPR competitive advantage into the U.S. Midwest. Overall, we expect 2005 revenue growth to be in the healthy 12 to 14% range.

Moving to slide 17, I will provide some operations highlights. Network fluidity is our primary focus and we came through Q1 in very good shape. Our modified approach to train operations is having the desired earnings impact. We no longer focus exclusively on long heavy trains. A more sophisticated plan is progressing.

In the bulk area, long and heavy trains remain our focus. We improved our train rates by over 2%. In merchandise and intermodal, we focused on running the plan to improve service, increase asset velocity and improve crew utilization. In the short-term, we sacrificed some train lines to increase improved east-west train balance. This improved our crew utilization, reduced taxi and lodging costs as well as lowered fuel consumption. Longer and heavier trains will follow in the future with the obvious benefits.

And as you can see, three of our four fluidity metrics improved over Q1 2004. Car miles per day were up and improved almost 9%. Locomotive miles per day were up 4%. Train speed was up 2%. With our recent announcement on expansion in Western Canada, there will be significant activity through our western corridor during the next few quarters, so I've tempered by improvement expectations for the western corridor during this period.

Terminal dwell is not meeting my expectations but I am encouraged. Implementation of our new yard management system, TYES, is now complete across our network, having done Minneapolis and Chicago in Q1 with only the D&H to complete in May. There is significant opportunity to improve. This is based on our implementation findings which I find very exciting. Going forward, this area will be our primary focus and Neal Foot's operations team is in place and focused.

I would say we made good progress on improving network fluidity in Q1. That's good news, as improved fluidity effectively creates more capacity from existing assets and lowers expenses.

Turning to slide 18, let me show you how fluidity translates into productivity. We again increased our year-over-year employee productivity with gross ton miles per employee by 3%. Our investment in locomotives, crews and (indiscernible) capital projects have positioned us for faster recovery from unplanned outages, supported increased workloads, and it's helping to drive down expenses.

I would also like to draw your attention to the fact that our fuel consumption rate continues to improve. The 2.3% improvement is obviously something we're very pleased about given today's high fuel prices. Strong safety performance is also paying off. The personal injury ratio improved substantially and we continue to focus on reducing the cost of train accidents. This is important from a human, environmental and cost perspective.

To summarize on slide 19, our yield program is delivering and we believe that we can sustain 2005 same-store price yield above 6%. Full production initiatives will be implemented consistent with the timelines we originally shared. Our new (indiscernible) operation on the NS between Detroit and Chicago will start up in Q3 and will be fully implemented by year-end.

Obviously, fluidity improvement is the cornerstone of our service objectives and drives cost control and yield success. My team sells a value proposition to the client. We want to be the long-term partner with capacity to grow, but prices have to be investment grade.

In summary, it's shaping up to be a very exciting 2005. We're focused on beating the numbers Mike mentioned and we are still very hungry to squeeze more out of this operation. We're leading our team to fight the headwinds, put an intense focus on cost, and to try to hold the gains we made in Q1, or do even better.

Over to you, Rob.

Thanks, Fred. Turning to slide 21, let me conclude by summarizing where I see ourselves today.

First, the new Elk Valley contract has created significant improvement in shareholder value in 2005 and it will continue to do so for its duration. Secondly, our recently announced expansion of the western corridor represents significant opportunity to provide incremental value beginning next year. Thirdly, our effort on the yield program is sustainable. And you heard Fred say that same-store yield will hit 6% and that growth in revenues will come in in the mid-teens. Fourth, we have a dedicated team working on improving the fluidity, especially in our yards, thereby both enhancing service and reducing operating costs.

So, we continue to move a lot of freight. But, as both Mike and Fred have said, we still have headwinds to manage. So, for the remainder of the year, you're going to see us sticking to the integrated operating game plan and getting the expansion completed, safely, on time and on budget. So, I'm looking for an excellent year and we are off to a very good start. We are confident on an EPS for the full year in the 3.15 to 3.25 range, and, of course, will continue to strive to improve upon that.

I will now open the floor to questions. Operator, I will ask you to please set them up.

(OPERATOR INSTRUCTIONS). David Newman, National Bank Financial.

Good quarter. In terms of the yield split for revenue per revenue ton mile, can you break that out in terms of the actual (indiscernible) increase versus surcharge and Elk Valley? In other words, if it is 6, 8%. What was the breakout there?

David, it's Fred. I think the chart, if I recall correctly -- I don't have it right in front of me -- but I believe it was 3% attributed to the fuel surcharge. And the balance, Elk Valley -- sorry guys; I just don't have this at my fingertips. Elk Valley was established in our last discussion, so I didn't prepare that.

The real (indiscernible) increase would be ground 3%?

Closer to 6.

(indiscernible) that's a good number. And in terms -- if you back out last year's avalanche and this year's retroactive coal payment, what was the operating ratio, apples-to-apples? I expect it was pretty close.

It's Mike Waites. We can try and take that approach. What I would say is this quarter, while we didn't have the avalanche, we had a fairly healthy winter. And I think what you're seeing here is more of a run rate performance by this railway in the first quarter, reflecting a number of things, I think -- winter preparedness, strong contingency planning, a strong crew position and strong locomotive. I would say rather than to bring this quarter down other than for the $17 million, I think this is a quarter that all of us here would expect to see more so on a go-forward basis.

I guess what I am driving at is in terms of the operating ratio improving, I think you're calling for about a 2 point improvement this year. And you can look at the actual carload volumes. When do you think you are going to see improvement on those two metrics? Will it be when you get the CapEx program completed, or is the Elk Valley going to start contributing right away? How does that shape out in terms of, like, carload volumes and in terms of the operating ratio?

Again, what I say, David, is when you look at the numbers year-on-year and operating ratio -- clearly, you guys can do the arithmetic -- there will be a significant improvement there in operating ratio. And that is essentially being driven on the full-year numbers off of the EVC settlement and the volume growth. So, you can back into those numbers, but certainly gets you down to a 77-type number.

Fadi Chamoun, UBS.

One question on the guidance today and compared to what we had before. It seems that all the upside is coming from the EVC. And I was wondering if you can give us an idea about the upside or the benefit we can get from TYES and the different co-production agreement that you have made this year? How much of that is built in? If you can give us an idea of what type of upside from these productivity gains we can expect going forward?

Fadi, when we gave the EPS guidance, this was pre-EVC and pre-western corridor expansion. So, you may remember the numbers -- I'm sure you do -- off the EPS numbers last year, a 227 number. And we gave guidance pre those announcements first quarter getting us to 260. So clearly, some of the benefits of what you're talking about were in that 260 number. Would we like to do more? Again, I'm sure we're all very focused on doing more. And stay tuned on the co-production front and other areas. Basically, a big part of that is in the 260. We then go up to the additional numbers with the EVC announcement. So we have stepped it up.

What we're looking at on the first quarter is, obviously, a strong first quarter, as I alluded to. It's just early in the year, to be very honest, to start changing that full-year number. I can say we feel good about the quarter. We feel good about the year. We feel good about the economy. But, at this point in time we're going to push hard, as Rob said, and see what else we can deliver. And at the right time if we have some additional guidance to provide, we will.

Let me follow-up one question on this. Before you've talked about an operating ratio of (indiscernible) 5% given different assumptions. And, obviously, the pricing environment and the volume environments have been significantly better. Can you give us an idea, like, three years, four years down the road what can this railroad do in operating ratio given the new dynamics in the marketplace?

It's rob. We are setting that goal at the mid 70s and we have not changed that. We've said within the four-year plan. (indiscernible) within that four-year plan, we are going to be there. We are making progress and, I think, significantly so. So, I would -- I don't back off that goal for this company. This is a good weigh point for us to get there. I'm confident that we're going to get there in the timeframe that I set for it. And I told you before my view on it.

Yes, I would just like to add, Fadi, again I talked about the arithmetic, the 77 number. The team here would certainly like to see that begin with 76 something. I can tell you that next year with the things we have happening, the full year's impact, another year on EVC, what Fred is doing with yield, and what we're looking at in IOP, we have the crosshairs set on that 75 number.

One last question. On the EVC settlement, there were some costs associated with that. And you have mentioned earlier, I think, that amortized over the course of the year. Can you elaborate a little bit how much are those?

There was very moderate costs associated with it. I think the -- basically there were some legal costs categorically. And then on the other side, Fadi, we had factored in a little bit of incentive comp-related costs, assuming that for example we would see a bit of reflection in the stock price and that would flow through there as well. So, a combination of a number of items, but it's very modest.

James Valentine, Morgan Stanley.

Very impressive results, guys. I just want to clarify the 6% pricing you talked about going forward, that includes 130 million you're going to get from Elk Valley this year. So -- if I'm right. And that would imply that if you take that out, you're looking for 3% organic pricing for the rest of the business. Is that the way we ought to look at it?

Jim, I think you've characterized it correctly. Obviously, we set a target for self ourselves, as you recall, in November -- said that we're going to do 2, 2.5 maybe; then we're going to strive for 3. Well, we're growing increasingly comfortable we'll surpass that 3%. And then the Elk Valley bumps it up, obviously, by a further 3.

Okay. I wasn't sure if it wasn't 3 to 6. I just want to make sure that wasn't the case. Or, if it was, I understood it. The second question is -- and, Rob, I don't want to try to rain on your parade in terms of western expansion, but this sounds like a pretty big project here. What's the worst (indiscernible) we're sitting here in October reviewing third-quarter results, and there's a chance you guys say you know what? We didn't do as well from an operations, and therefore, a cost control standpoint, because we had all this expansion going on. Should we be thinking about that when we're looking at full-year numbers?

There's always a risk, Jim. I'm not going to say that there isn't one. However, a couple of things. We have been planning this for a long time. We have a team out there. I high-railed it from Baska (ph) to Rebelstoke (ph) last week. And I went through with all the engineers and with the operations team with me in the high rail. We know what has to be done. We have got the engineering blocks set aside. We're there with environmental approvals. We're almost 100% completed on land acquisitions. So, the feeling that I took away from that was that we've got the contingency planning in place, we have the materials, we have the contractors in place. So, we will get it, as I said, done safely, on time and on budget. But, you know, we have huge commitments not only to our owners but to our customers to get this job done. So, they have, obviously, gone through our plans with a fine tooth comb. But, Fred, this is your baby. So I will turn it over to you.

I will echo Rob's confidence. We, obviously, have our own measurement system for ensuring we are in great shape on this major project and that we are green across the board.

No pun intended there. One other question here for Mike. Mike, are you going to give your blessing (ph) 3.15 to 3.25, and that's before western expansion, which is another -- what -- $0.25 to $0.40. And then if we take another $0.15 from this year, Elk Valley, that spills into the first quarter of next year (indiscernible) the timing of export coal contracts, we come up with a number that would be kind of like a base rate run rate of where this year should end of about 3.55 to 3.80 for next year. And the Street's at 3.75. And I'm trying to figure out is there no organic operating income growth for next year, volume growth, productivity benefits? Or am I missing something here in terms of an offsetting cost that the (indiscernible) maybe the sell side are missing?

No, I don't think you're missing anything, Jim. I mean, we haven't gone out and given '06 guidance. And I think that's kind of the discussion we're having here. We would certainly plan to see some future growth there beyond just simply the western corridor expansion. I did allude to that earlier in terms of the additional yield work that Fred and his people are doing, and also in terms of I think there's a bigger prize, Jim. We all think there's a bigger prize here in terms of IOP compliance. And you'll see us pushing hard there.

The other area that we have to continue to push on is expense. We are having good success, as I mentioned, on comp and benefits, on units rates. We're taking those announced staff reductions out. But we have to continue to drive there, and we are looking in other areas to continue the improvements there as well. So, Jim, I'm going to stop short of giving you 2006 guidance separate from those numbers. But, clearly, there will be additional growth over and above the numbers we have talked about here. We'll give you a better story on that later in the year when we have really got a good fix on it. But, expect some good solid growth on the base organic model as well.

I'm sorry; if I can take one more question. It's somewhat technical. The stock-based compensation numbers you threw out for the first quarter, that headwind. I think you said 18 million. Can you walk us through what the mechanics are there in terms of trying to model that out for the rest of the year?

Again, most of that increase, that 18 million that is correct is relating to expenses associated with stock performance. That's really deferred stock units accounting where -- and also SARs stock appreciation rights accounting. And, Jim, as you know, when you account for stock option expense, that is really an amortization calculation, whereas when you account for DSUs and SARs, you in effect flow that higher stock price through to that expense in the current period. So, it's a difficult question to answer in the sense that that's really dependent on what the stock price will do. I'm sure given the good news we have, the stock price well hopefully reflect that good news. And so you'll see a little bit more in there, I would assume, on the balance of the year. But, a tough question to answer. But that's what's driving it.

Is there going to be another 18, 18, 18? Or you kind of shore it up now given where the stock price is, and we shouldn't see that go up unless the stock price goes up?

I think, first of all, the other thing I should point out is the swing -- the 18 on the quarter -- we saw a decline on the comparable quarter last year. So, the 18 is bigger than what you should see going forward. I would still like to see the stock price move forward, obviously. But, it will be less than the 18. I can't give you an exact number but that will be a fairly heavy number on the quarter. I would expect it to be quite a bit less than that on the balance, but probably still some impact.

(OPERATOR INSTRUCTIONS). Ted Larkin, Orion Securities.

Great numbers, gentlemen, at the risk of overplaying that. Just on the western corridor expansion, I guess this would be for Rob. Phase I, you're talking about $160 million being completed by the end of this year. And that's about a 12% increase in capacity, I guess, 400 cars a day. Can you give us a rough idea of what kind of revenue hit on an annualized basis for that part of (indiscernible) about $180 million. Would that make sense, Mike?

That's not too far off. I am assuming you're using the $0.40 number, Ted? That's pretty close, I would think, just off the top of my head.

And then, if we get into Phase II -- this may be for Fred Green -- Phase II, should you proceed with that in the year 2006, how much would that cost? And what additional capacity could that bring to that corridor?

The answer to that is a little different than maybe prior discussions. And the reason for that is we have gone back and evaluated whether what we call the gated approach, which was the first investment that we talked about today, had to necessarily have as big a second step. Was there another model in there that could get us two-thirds of the capacity for half the money type of thing? So, that work has not been completed. But, my point in saying that is that we are evaluating that should the markets remain as robust and strong as they are, we may consider an incremental investment at a future time. I'm not saying 2006. If this was necessary and opportunistic (ph), we might do that. But, it might not be as large as we had previously thought it would be. It's going to be a range. I can't imagine spending less than 50 million if you wanted to expand, but I don't necessarily think it has to be at the far-end of the spectrum.

Too early to tell then. The second question then for Mike. Just the fuel hedge for 2006 -- anything in place at this point?

Yes. And I think we have attached that in the appendix. It's a lower hedge position, and you will see us continue to work the ford (ph) covers as we move forward in 2005. Basically, our strategy as we have articulated to you before is that we look down the curve a couple of years. And if we see value, and as long as we see value, we'll take some of those positions. But again, at this point in time in 2006, we have a 13% coverage. I will point out that the price, $30.50 basically, is a very good price, depending upon where you see the crew prices going. It certainly looks good versus the strip at this point. And you'll see us likely step that up as we go forward. But again, it depends on what the curves look like.

I'm off-line right now. I will get that later. Thank you very much.

James David, Scotia capital.

Two questions. First question. Mike, on free cash flow guidance, can you give me a rough idea of what you're looking at in terms of non-cash taxes and working capital, in terms of assumptions?

In terms of non-cash tax, obviously, James, with the good news, when we look out over the horizon over the next two years, we are expecting to become cash taxable some time in 2006. At this point it looks like a little later in 2006. The other complexity there is, as you probably know, when you do under Canadian tax, it depends on when you actually set up your installment base. So, technically I think we will become cash taxable in later 2006. You may not see cash taxes until 2007. You may see a balloon payment there. So, that's really where we're going from the tax front in 2005, 2006.

In terms of working capital changes, you're seeing a little bit of consumption of working capital currently with the volume growth and so receivables. You're seeing a little bit of inventory build in anticipation of west corridor, which we have obviously announced. So that's the story in '05. I would hope to see that reverse slightly, but I don't think significantly from a working capital standpoint, other than tax, and I have just given you that story.

Second question for Fred, you talked about productivity metrics did well on the labor side, and it was a bit of a mixed bag on the asset side. And if I understood you correctly, you said there was a de-emphasis right now on weight and length. Is that a function of congestion? And if it is, how do you think those metrics will do as you progress through your infrastructure expansion plan?

Let me clarify for you that on the book franchise, it is about long and heavy trains right off the bat, and we did improve by 2 points, James. So, I'm satisfied the team is very focused on where they need to be. On the intermodal and the merchandise side, what we found is that as we held that train trying to get that extra ton on it, or that extra 5 cars on it, we were out of sync. And we were missing the opportunity to optimize the utilization of our locomotives and our crews. And as a result of that, we have gone back and become much, much more disciplined in what arguably is the schedule railway mindset. And our team is doing a much better job at it. And as we have rolled out the TYES software throughout the yards, we are discovering more and more opportunities. So, I look at this as a huge opportunity. I'm very excited about it. Nobody likes to find a bit of an issue or a bit of a problem. But, when you find it, it can turn into an opportunity.

What you will see I am convinced in the coming quarters is our team is going to lock in on this execution to the disciplined plan. And now what we will do is get those trains back up and make them longer and heavier as well. I don't want a scheduled railway running short trains; we want a scheduled railway running long trains. But you've got to get the schedule running, you've got to get the consistency moving. And now what we'll do is process more.

Last comment, James, with regard to congestion, at this point in time, other than in Chicago and Milwaukee, which is only about three weeks after the TYES implementation and is now, frankly, back in pretty good shape. Not as good as we'd like it but will be within a week. The biggest problem we have is simply making sure that the vessels off the coast which have been hit by some storms on the Pacific are causing just to slowdown. So you see, our train speeds aren't what they -- I would like them to be by maybe a mile an hour or so. But, it has nothing to do with our ability to move; it has to do with the -- the interface, obviously, into terminals and with the ships coming and going a little sporadically. We've had to hold some trains and that effects train speed. So, the operating metrics I'm satisfied with. I want them to be better. The team is committed to making them better, but the Railway is running, frankly, very, very well right now.

Scott Flower, Smith Barney Citigroup.

My questions have been answered. Thank you.

Jackie Boland, CIBC World Markets.

Can you talk about any spend you have had so far in these capacity projects? You've talked about kind of preparing for the build, etcetera. So, can you talk about where or what you have had so far, and maybe a quarterly distribution of some of the expenditures?

We should probably stay out of the quarterly distribution. What you saw on the inventory build on the first quarter is somewhat representative of what we were anticipating. When we started to see the year unfold, we were cautiously building some inventory. So, it was a combination of those materials as well as the capital program came in at around $140 million on the first quarter. That was very consistent with what we expected. And all I would suggest is -- I harken back to Rob's comments and Fred's comments -- we think this is very manageable for us. We have managed risk. Everything is in place. The materials are there, and part as you have seen on the inventory build. We announced this, obviously, in the first quarter. So, not a big part of the capital spend on west corridor. In the first quarter you're going to see that ramp significantly 2Q, 3Q. But, everything is on track. I just don't see this as a big risk for us. Obviously, we're going to stay very mindful of it, but it's very manageable.

Jackie, this is Fred. The last comment would be that, obviously, we are driving to have the capacity in place as close to the end of the third quarter as we can. And we know some projects will move into Q4. So, most of the spend is going to be split simply -- we're going to go like (indiscernible) between now and the end of the Q3, so you can probably split it pretty close to 50-50. And that is where most of the dollars will be spent.

That's helpful. Thank you. A lot of the other companies or a lot of the other trains have talked about going forward with some economic concerns, worried about with these fuel prices at these levels how the economy can keep rolling. You'll have to excuse the pun on that one. Where are you seeing (indiscernible) feel that the economy will be robust? Is that true?

Jackie, we're just not seeing any of that. April is just a busy, busy month for us. And across the board -- even in the past, I have been apprehensive about the pulp and paper business while we're moving an awful lot of pulp and paper. I'm sure people have their own observations, but at this point in time our railway has got a franchise that is heavily oriented to intermodal. And the import business off the west coast is booming and our clients want more. And the export business on all of our bulk commodities is strong, strong, strong. And merchandise for us is a less major component of what we do. But, even in that we are not seeing any softening of demand.

Ken Hoexter, Merrill Lynch.

A quick question. The alliance agreements that you had signed earlier, (indiscernible) Canadian National. Is there any progress on those as far as continuing cost savings and improving velocity that Fred noted earlier?

We did the D&H deals about -- the first one about a year ago. And we signed the agreements about a year ago. We have successfully implemented now two legs, two of three legs with the NS. We're out of Buffalo and they now run our stuff into Binghamton. And we also allow them to run up over us into Saratoga, that area. We also did a deal, as you recall, jointly with them and the CN. And that deal is also progressing and in place, operating very well. And the third leg of that is the one I referred to, which as of July the NS is committed to have the resources in place to allow us to operate between Detroit and Chicago on the shortest and fastest route.

So, we have a lot of success in that regard. All of the deals that we proposed and negotiated with our associates at CN in the west are operational and working just fine. And we are now putting the fine touches on some of the ones in Northern Ontario. But, I don't believe they are active at this point, but will be probably within a quarter or so. So, we're very satisfied with the choices we've made and very satisfied with the cooperation of our partners in this regard.

The only reason I ask (indiscernible) Canadian (indiscernible) your competitor kind of (indiscernible) in Canada views this as a way that is kind of secretly not as obvious as some other moves, but yet can really aid results. Do you view it that way, or just is this another step in the evolving partnerships of the railroads?

I think it's a good assessment. It's both. What we see as an opportunity, obviously, is that in areas of limited capacity, there's an opportunity to work with other people's franchise much more efficient use of capital (indiscernible) going to put our own on the ground, or same thing if we can sell some capacity, as we have done in some of those deals. Some of the arrangements -- we have also made our own sets of arrangements with regard to routing protocols through common gateways that have been in place for several years now, with UP for instance. They're all about fluidity. They're all about taking expense out of the system. We view them both ways. One is capacity and the other -- and capital effectiveness -- and the other is bringing fluidity and efficiency to our train operations. So, I think in orders of magnitude, Ken, it's such that I can't point to $100 million attached to them, but it's all encompassed in what we're trying to accomplish with our fluidity program.

Last one real quick. I just want to make sure I understood right. When you set the guidance at 3.15 to 3.25, that's including the potential -- are you assuming some extra cost from the western expansion, as far as kind of keeping that down? Do you view it as being a conservative number, or are you saying that's kind of aggressive, including what -- extra expenses that can flow through from the western expansion?

It's Mike. The range we gave you to include the western expansion, we think, is very achievable, the 25 to 40. So, again, for clarity, you would add that to the EVC guidance that we gave you. And again, that's very achievable.

But you add that for '06, not '05, right?

That's for '06. That's very correct.

Tom Wadewitz, Bear Stearns.

Nice results. It seems like things are really coming together well for you guys. I've got a question for you, I guess probably either Fred or Rob. When you look at the new capacity you have coming online in the fall and for next year on the corridor expansion, how much of that do you think in your mind is pretty much locked up already, given expansion at, for example, your potash customers, given what you know from intermodal customers and that you've been constrained on the intermodal side for a little while? How much of that do you think is already locked up in your mind and how much of it is growth beyond what, perhaps, customers are already planning for?

Obviously, we're pretty bullish on our western corridor. It's being driven by the bulk side. Fred can speak to the different commodities. But, it looks very strong, obviously, into '06 in bulk. Import containers -- I was just at a conference in Vancouver for the China trade. The whole West Coast of North America is seeing the demand growing by 1.5 million a year. So, there's a lot of containers looking for a home. That's another balancing lever that we will use as we look to optimize that traffic mix we have. But, it's looking very strong for us. Fred, do you want to --?

I think it's a bit of a delicate situation. Obviously, we're in dialogue with our clients as we sit here today. And our teams are doing their best to ensure that we are commanding the value for our shareholders and our dialogue, be it in price negotiation or allocation of resources. The bulk commodities continue to want to grow. As Rob says, the containers continue to want to grow. And there's a base merchandise fleet that runs back and forth there as well that is anxious for the territory, or for the capacity.

Obviously, we have put enough capacity in place, or will have when we complete this in the fall, to protect the interests of our clients and ourselves for 2006. What we are trying to do in our dialogue with our clients right now is calibrate how big their demand is for '07, '08 and beyond, to the best that they possibly can evaluate that. And that will cause us to determine how much of what we are building we can afford to sell to all these different clients.

I don't think I could declare today that we will be sold out for the 2006 season for sure. But, I can tell you the demand continues to be very, very strong. And it's conceivable that there is enough demand available to us, although not under contracted terms yet, to actually sell out the whole thing. And if that is the case, that would be the best thing I could imagine happening.

I've got one more if I can. When I look at the guidance and consider how strong the first quarter was and some of the initiatives you have in place, it appears that it's pretty conservative guidance. And I'm wondering if you can give me a sense of -- you say you don't have the western corridor expansion baked into any of this guidance. Is it likely that you would see some kind of intermodal trains for the peak season coming on as you have some of this new capacity in the fall, and that would truly be upside to what your guidance is? And also, in terms of your adherence to operating plan, do you have a lot of that in, or is that just -- is that also a source of some meaningful potential upside to your guidance?

Tom, it's really -- I'm really reluctant to get into a discussion in that amount of detail. You heard both myself and Fred and Mike say, look, we're pushing hard. We had a good first quarter. We gave guidance last year, and there have been pluses and minuses, as Mike said. And we are still holding the numbers.

We are building a lot of railroad out there. And I will go back to Jim's question. We don't want to get ahead of our headlights here and start saying I am going to go right down (inaudible) and push those engineers so they have no contingency. They pointed out to me that all the easy and least expensive work has been done over the year, so we've got some engineering work to do out there. We want to not be so bullish that we're going to say we're going to finish on October the 16 and we're going to fill that up. So, give us a little headroom here. And I think we're going to work hard to improve from what we said. And that is how I would kind of like to leave that.

(OPERATOR INSTRUCTIONS). Bill MacKenzie, TD Securities.

First question, getting back to the western expansion. I was just wondering if you could give me a little bit of color in terms of the timing of how the incremental capacity will come on. And specifically, the four additional trains. Do they come on sort of within a matter of days or weeks, or does that capacity get spread out over a longer period like two, three months? Just in terms of fast how fast do those (indiscernible) ramp up?

Bill, it's Fred. The program, obviously, would have a front-end to it where they do the grading and the laying of the track, etcetera. And the capacity arrives as we are able to connect in the signal systems and connect in the track that's been built to the main line. So, as a result of that, you won't see any incremental capacity largely for the next several months. And then we'll start to bring it on incrementally throughout, arguably, the third quarter and early into the fourth quarter.

So, the way the program works is that you don't really get a blast of a train each way until you've got critical mass in place. So, I wouldn't expect to see any incremental capacity available to us. And it's going to improve, but it's not enough to give you an extra full train today until probably mid third quarter is probably a reasonable time frame. And after that it will just be as Rob says, a function of how well we're able to get everything else in place in the timeframe.

The only other color I will give you guys is that, obviously, if we do have success doing that, you know we're going to be poised to sell and fill those things up. But, we need to be wise and, I think, prudent to ensure that our team gets it in place and gets it in place, and we don't disappoint a bunch of people, be it customers or you guys, with false promises.

So, it's just a matter of once you've got that first incremental train running, subsequent to that it's just a matter of going out and filling the capacity via your sales and marketing initiatives?

Bill, trust me. It's not going to take very many calls to fill the first trains. There's big demand right now. We are exploring with some other mechanisms the possibility of expanding our allocations on the intermodal side as we speak. So, we're not done here.

Just related to that, if we do -- getting back to the issue of the economy and assuming more concerns about the economy slowing down. If we do get a slowdown in the economy, maybe not the first train, but the third or the fourth train -- are there any concerns in terms of your ability to fill all of that capacity if we get a slowdown in the economy? Are you pretty confident that even with some slower growth, that there's sufficient pent-up demand there that you'd be able to get the majority of it filled up by '06?

Bill, again, I can't predict the length of the boom that we are experiencing. But again, I want to differentiate and note the franchise. We have a franchise that is heavily weighted to the west corridor with huge amounts of export product headed to Asia and import product coming from Asia. So, nobody can predict with certainty what exact consumption of that or how fast it will be consumed. I would say consuming it fast is good news. So, to the extent we possibly can, we're going to sell it as quickly as we can. And I have no reason to believe it's not going to sell out, as we said in an earlier question.

Randy Cousins, BMO Nesbitt Burns.

Fred, I wonder if you could come back and talk about sulfur and fertilizer for a minute. It had 11% growth in revenue ton miles, and yet actually a downdraft in terms of yield. In terms of the outlook, the volume -- is that just a seasonal thing due to last year sort of -- catch-up from last year's sort of poor winter weather conditions? What are the prospects in terms of -- can you go back over the prospects for the sulfur and fertilizer category, and over the balance of this year, and how we should be modeling prices?

Two things, Randy. Two forces at work there. First of all, on the base demand, with all of the oil sands production and gas fines (ph) and production occurring in Alberta, and the remelt programs that people are considering or actively involved in, I see no reason to believe that sulfur demand will not remain strong. And it's, as you know, it's split probably two-thirds to the coast and one-third to Florida. So, demand will remain strong, prices are strong, and ours will stay there as well.

On the fertilizer side, the forces at work there are twofold. Demand remains very strong. I think we moved 500,000 tons more product in the first quarter than we did last year for export, or something of that order of magnitude. It was very, very strong demand. We will have a good demand in the second quarter; I would imagine at least what we did last year. I don't have it right at my fingertips, but certainly the client, Campatex (ph), is busy selling and sees a robust market today and into the foreseeable future.

The one issue that you see a little bit on it from a price perspective is that you know that the export product is priced a little bit differently than the domestic product. And obviously, the weighting of more exports is what maybe affects the per unit revenues that you saw. And finally, based on their confidence in the market, Campatex has acquired 1300 covered hoppers. I think they've got 900 or 950 on already. And what that means is that we no longer supply the equipment for that. They supply the equipment. And, obviously, there's some kind of pricing compensation there for them putting up all of their equipment. So, those are the factors that are maybe sending a little bit of confusing signals. But, across the board, sulfur and fertilizers is alright from the export side in particular. It's just very, very robust.

How should we be modeling pricing for the go-forward?

I don't know, Randy. That's a tough question to answer on a call like this. The pricing is favorable, and from the perspective of us commanding price increases in the marketplace being offset by cost of leasing cars type transfer out of the price.

My next question or final question has to do with just avoiding double counting here. Because you've got the new capacity. If you were to sort of describe your ability to grow GTMs or RTMs over the next three years, what would you have said the organic growth rate was before you did this expansion, and what would you say the organic growth rate is post this expansion?

I don't think we have provided guidance with that kind of definition, Randy, on a go-forward basis. And as such, I think I probably am not equipped to give you that comment right now. Obviously, it is our busiest corridor and we're increasing that capacity by 12%. But, I can't do the math in my head and I don't want to misspeak. So, I think we can scope out just based on our GTMs and the fact that X% are in a certain corridor, which I think is public knowledge or available, what the number would be. But, I can't do it in my head right now.

Joseph Lewan (ph), RBC Capital Markets.

Most have been answered. One question to circle back on something a couple of other people have asked in regards to the western expansion. I'm sort of curious, you say (indiscernible) I'm just wondering how the logistics work when you expand the western corridor. Do you have to stop trains, block them off, or can you run them full speed while you're going ahead with the expansion? How does it work?

Joe, it's a combination of all those things. Some of the track is being built beside the existing main, so we will continue to run by that. But, obviously, you do reduce speed. That is common through our whole summer work program across the system. Nothing there. We are putting a lot of connections in. So, the magic and the art of railroading is when you put the connections in and break the main line, that you do that in a manner that has minimal impact on the trains. So, there will be some. There's no doubt about it. But, we have compensated for that with the operating plan that we put forward. So, there is issues that we are managing. And what I've tried to convey to two other questions on the same is that they are manageable. We manage them every year and we will do that through the summer.

It's Fred. Maybe just one thing that might not be apparent to people is that particularly in the summer months in a northern railway, you take that five or six months of the construction season and you always go in and take out either four-hour blocks or eight-hour blocks for a month in any given territory, whatever the case may be. Maybe for four days on and three days off (inaudible).

The work we are doing on the expansion we are trying to put in the shadow. And what that means is that when you have a normal work block that would have been there last year and the year before that and the year before that, we will -- 20 miles down the track we will also be building our expansion, so that there is no -- not no -- but minimal incremental impact on the available time to run over the main line. And there's a lot of thought gone into where to do those work programs at what days and at what time of day so that you don't have kind of additive impact, negative additive impact. So, playing in the shadows is the phrase that we just use to ensure that we minimize the impact on the main line operation.

One last question. (indiscernible). Just remind me what percentage of the revenue was fuel surcharge. And what is the delay again, with regards -- delay with regards to oil prices?

We have revised, Joe, our program over time. And we have about a 30-day lag on most of the new generation of fuel surcharge contracts. Some of the original contracts which might have been multi-year and have not yet turned over had a 90-day leg on them. And then, obviously, we have a portion of our business as well which would be more indexed as opposed to fuel surcharges. And they often occur at the end of a year, sometimes at the end of a quarter, but at the end of the year you catch up on the impact of fuel as a cost factor on the prior year.

Alan (indiscernible), Reuters.

Well, I guess they (indiscernible) quick question. You talked about the growth being (indiscernible) in terms of internal growth. The folks over at Canadian National have been talking about looking at perhaps possible outside purchases of smaller mid-tier railroads. Is that at all in your thinking at this point as you look ahead, in terms of your growth?

We never rule anything out, Alan. But, right now we've got great opportunities expanding our internal footprint. And we're concentrating in that area, but we never rule anything out.

Okay, ladies and gentlemen. Thank you very much. We have gone slightly beyond our time, and we will talk at the end of the second quarter. Thank you.

Ladies and gentlemen, this concludes the conference call for today.