Canadian Pacific Kansas City Ltd (CP) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Canadian Pacific Railway third quarter results conference call. At this time all participants are in a listen-only mode. Following the presentation we will conduct on a question and answer session, instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star zero for operator assistance at any time. I would like to remind everyone this conference is being recorded on Tuesday, October 25th at 11 a.m. Eastern. And we'll now turn the call over to Mr. Paul Bell Vice President Investor Relations of Canadian Pacific Railway. Please go ahead, sir.

Thank you, operator, and thank you ladies and gentlemen for joining us on our 2005 third 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. I must remind you that this presentation contains forward looking information. Actual results may differ materially. The risks, uncertainties and other factors that could influence actual results are described on slide two and in the press release. All dollars quoted in this presentation are Canadian unless otherwise stated. This presentation also contains non-GAAP measures. Please read slide three. The slides are available on our website so I encourage you to follow along. Here, then, is Mr. Rob Ritchie.

Thanks, Paul, and good morning ladies and gentlemen. I would like to open by saying that overall I think the Company managed the challenges it faced in the third quarter well. However, I can also say that we can and we will improve in the upcoming quarters. So I could I ask you to turn to slide five. Our Q3 EPS grew 29%, the seventh consecutive quarter of EPS growth. And please note that this excludes a gain from the other specified item of $34 million reduction to previous accrual for the environmental liability. Our year to date EPS is up 46%. Our top line growth continues in double digits, the result of a sustained focus on getting appropriate value for the service that we are providing and recovering our input costs.

We are a very busy railroad. Our people were able to move record volumes of business for our third quarter and managed to weave the trains through 25 capacity expansion projects on the busiest quarter of our network. A task that's hard to appreciate if you are not out in the field. And they accomplished this with the safety record that remains one of the best in the industry. We posted a decline in both personal accidents and train accident ratios. So clearly what we set out to do at the beginning of the year, reinvesting in our infrastructure with a strong emphasis on safety is paying off. The western expansion program is going well and we expect to have it completed within this construction season. We will be we well positioned to handle the demand in 2006 and beyond. So in spite of the foreign exchange hits, fuel cost -- cost increases, and the stock price appreciation which pushed up comp and benefits big time, we are on plan to hit our year end EPS target, the $3.15 to $3.25. Mike's going to take you through the third quarter financial details. Fred will then follow with the overview of markets and operations. So Michael, over to you.

Thank, Rob. Let me turn to slide seven with the EPS summary. Reading left to right off $0.65 last third quarter. You can see yield was worth $0.37, a strong price and yield story, which Fred will go into in a moment. RTM's were up slightly. Just under 1% and combined with mix drove an additional $0.05 of EPS. Wage, pension and benefit expenses reduced EPS by about $0.07, so that's more or less in line with expectations for this year. But the big item related to stock-based incentive comp expense which was another $0.07, and I'll come back to this in a moment. Moving right on the chart. Depreciation expense was $0.04 and the stronger Canadian dollar compressed EPS by $0.03 leaving $0.02 of all other net. Key takeaway, a strong quality revenue story.

Turning to slide eight in the income statement, operating income totaled $249 million, that's up 14% from last year. Reading below the operating income line, we continue to work down interest expense now at $50 million with a repayment of a $250 million medium term note midyear, we spoke about this before. And we're also benefiting from our US dollar debt strategy, both in terms of lower interest expense and improvements to the balance sheet. Adjusted income, then, was 135 million, that's up 30%. Tying out adjusted income to recorded, we reported a lower but nevertheless significant foreign exchange gain on the debt -- $48 million net net of tax that compares to $73 million -- $73 million gain last year. I should be quick to add this is essentially an unrealized gain, this is why we segregate this item. And again, we have spoken about this in the past. I also want to point out we partially reversed an environmental accrual relating to our property in the US this quarter. We had accrued this liability at the end of 2004. And we have been successful in reaching an agreement with one of the parties involved with that property, thereby reducing our overall liability that helped us to the tune of $21 million after tax. But again, for clarity, this is excluded from the adjusted numbers, this benefit. So tying out the P&L, reported net income was 204 million, that's up 15%. And our operating ratio improved 50 basis points.

Turning to slide nine on expenses, beginning with comp and benefits expense. This was an increase of $39 million quarter-on-quarter. About $16 million of the increase was due to higher stock-based incentive comp, which I mentioned earlier. And this is the specifically the mark-to-market impact of expensing SARs and DSU's. The 18% increase in CP stock price in the third quarter had an impact, a negative impact, I should say, of 150 basis points on our operating ratio. But I think as most of you know we mark these to market, unlike stock options, which we effectively amortize the expense. If we exclude this item, comp and benefits expense would have been about $328 million, that's again in line with run rates to date this year. I know this group likes to have the price and volume impact isolated, so here is the split. Wage and benefit inflation drove an $8 million increase while pensions were up roughly 6 million. On a unit basis, our inflation rate for wages, benefits and pensions combined continues to run around 4% or so. Looking at the volume effect, you'll see the total head count was up by about 430 on average. And about half of that increase due to capital programs, notably including our Western Corridor expansion. The balance were volume related, which increased expenses by about $5 million net. These counts were up slightly as we staffed up to deal with some of the expected inefficiencies as we work through the expansion and as we prepare for 2006.

Fuel is the other big story in expenses. The price of WTI averaged $60.15 a barrel, this is U.S.. This is up from $41.25 last year. And combined with the increase in refining margins,drove a $45 million increase in fuel expense. Fortunately our hedge program efficiency gains and currency limited the increase to 33 million. This increase was essentially recovered through revenue from our fuel surcharge program, and more from Fred on that later. So all in expense is up 11% to 855 million. Excluding the impact of higher fuel prices, expenses were up 40 million or 5%.

Turning to slide 10, as Rob indicated we are on target for our full-year guidance. The Western Corridor expansion project is on budget and CapEx will come in consistent with the target range of 900 to 920 million. No change in free cash flow, we still expect to be in the 50 to $100 million range full year. Balance sheet is strong with debt to debt plus equity standing at 41%, I see no issues there. And while to date we have had or share of puts and takes, I still feel good about full year, 39 to 43% increase in EPS. So with that, Fred, over to you.

Thanks, Mike. Let's go to slide 12. All in this was very good quarter on the top line given a soft July and a very challenging operating environment with all of the track work. Revenues excluding currency impact were up almost 16% versus last year. Breaking this apart, foreign exchange negatively impacted our revenues by $37 million or almost 4%. Volume and mix contributed 3%, fuel accounted for about 4% and price another 9%. Selling value and our focus on quality revenue growth remain the key marketing drivers. This is very evident in our yield results as our average revenue per car and average revenue per ton mile metrics for the quarter were up 12% and 11% respectively.

Turn to slide 13 and I'll walk you through the freight revenues for the quarter. I'll speak to the revenues as reported, but I note that on an apples-to-apples basis, that is, excluding currency impact, we grew all seven commodity sectors this quarter. Moving to revenues by line of business we had an excellent quarter in grain with revenues up 11%. We -- benefited from a better quality crop in both Canada and the US and we sold out our new Pacific Northwest Shuttle Program. Year to date grain is running about 13% ahead of last year. Full revenues were up 35%, reduced carloadings were due to demarketing some U.S. coal and a plant shutdown in Chicago that impacted eastbound domestic volumes. Also payload per railcar was up almost 2% as a result on our focus on mine loading practices. Fertilizer and sulfur revenues for the quarter were down 1%. We saw some temporary softening on the expert potash side as South American buyers waited out high prices and drew down existing inventories during negotiations. Sulphur revenues were very good and included some spot traffic due to the effects of Katrina. Revenues were down slightly for forest products due to spotty commodity prices in the lumber and panel sector. Industrial products were up almost 11% with good lift in various construction sectors. We also saw a rebound in plastics volume.

On the auto slide we flat to last year with increased longer-haul import moves offsetting weaker domestic demand. Intermodal revenues were up 13%, domestic volumes were impacted by the truckers strike at the Port of Vancouver. But strong pricing and good bump in export traffic more than offset the strike impacts. So all in, up 12% on a reported basis and 16% excluding foreign exchange impact.

Turning to slide 14, I'll remind you that the guidance we provided was for 12 to 14% growth at $0.81 exchange and WTI of $55. Our grain volumes will be strong as the quality of -- of the grain crop looks good and the Canadian exports are forecast to be up approximately 15%. We expect somewhat heavier Q4 volumes on the Canadian (indiscernible). Export potash would be another annual record despite the midyear softness. There have been a few spot shut downs in the fertilizer sector, so I'm keeping my eye on the energy cost situation as it affects these markets. Our merchandise and auto group will deliver to the targeted revenue growth and yield with the chemicals and energy sector leading the way. We have not felt significant impact of the high dollar on Canadian producer competitiveness, but it's worth watching. And intermodal revenues will continue to be strong from both a volume and a yield perspective. On the fuel front, surcharges and fuel indexation and term contracts have served us well. Our coverage is now over 90%. We will also introduce some program changes this fall to take effect in 2006.

Now let's move to slide 15. Implementation of our Major Capacity Expansion program continued through the third quarter. I'm pleased to be able to confirm my comments from past briefings that the work is being done safely and the program itself remains on schedule and on budget. To date 16 projects are in service and roughly 85% of the construction activity completed. The remaining projects, including double tracking at three key locations on the Moose Jaw to Vancouver corridor will be completed and commissioned during the second half of November. Getting all of this work done on a short schedule and in the face of strong market demand has been challenging, our people are meeting that challenge, and as a result this Company will be well prepared to efficiently handle volume growth in the years to come.

Turning to slide 16. When we announced our Western Network Expansion in April, I was asked if the construction activity would impair our ability to handle increased volumes. My answer was and remains no, as related to capacity. But as evidenced by our Q3 train speeds, the efficiency of over the road train operations did temporarily suffer as we took extraordinary steps to move the available business over our reduced capacity network. Frankly the train speed impact was larger than I anticipated and continues into Q4 during our busiest period of cutovers. However, even with the number of track work blocks at unprecedented levels we moved a record volume of freight for the third quarter. The same time we posted strong gains on important asset utilization metrics. Average terminal dwell dropped an impressive 10% and active cars on line were reduced by almost 3%.

Finally on slide 17 I would like to close with a few brief remarks about my outlook for the balance of the year. In Q4 demand is expected to remain strong. October month to date volume is up several points over 2004 month-to-date. We were stress tested during Q3 and moved record volumes during a period of unprecedented -- precedented engineering activity. I remain optimistic about our ability to drive continued improvement through our IOP. And finally our Western Corridor Project will be finished safely, on time, and on budget, setting the stage for benefits realization next year and beyond. Rob, that concludes my remarks so back to you.

Thanks, Fred. So that's the summary, and we're on track to deliver what we said we will do. We will end the year with solid double digit revenue growth and we expect to see improved productivity and fluidity when this expansion project is completed. We look forward to discussing all of this at our detail -- in detail at our Analysts Day which we're going to be holding in Vancouver on November the sixteenth. We'll now open the floor to questions on the third quarter, so if I could ask you to limit your questions to two and time permitting we will get back to you. [Misea], if you could please set it up.

[OPERATOR INSTRUCTIONS] Thomas Wadewitz, JP Morgan.

Yes, good morning. Two questions for you here. Let's see, in -- on the pricing side, you know, it seems like this remains a very, very good news story for the railroad industry in general. I'm wondering if you could give me a rough sense of how much of your business you haven't yet touched in '04 and '05 that you may be able to price up in 2006? I guess that would be contract business which you really haven't touched yet in the strong rail environment, pricing environment.

Tom, it's Fred. I would suggest that the -- a good portion of our book of business has now rotated through over the last two or three years since -- or two years really, since the pricing environment improved so much. There remains a -- I'm just going to call it a handful of substantial -- I'll call them legacy contracts that have one or two more years to run on them with preset terms. So that -- probably the term vast majority already covered it as well as I can do at this point in time.

I mean, just in terms of magnitude do you think it's closer to 10% or more in the 20, 25% of business that you haven't really touched yet?

Well, I want to be careful how I answer the question. There's -- every year at least about a third of our book of business turns over. So some of the things that looked good to us two years ago may not be so appealing. So to the extent that we can get 25% of our business for further review, if I understand your question correctly, Tom, you're trying to determine if there's another big step function price opportunity.

Right.

And I would argue that even though some of those early contracts took a pretty good bump two years ago or a year and a half ago, the market remains extraordinarily strong and therefore should lend itself that even if it was visited a year and a half or two years ago may -- may well lend itself to further substantial price increases.

Okay. That's helpful. And then on the one question on coal, I may have missed this, but can you give us any sense of what your expectation would be looking to 2006 for coal volumes? Do you think they are going to be up year-over-year, modestly or is -- just any kind of broad color on how we should view coal volumes for next year?

Yes. It's -- it's a little delicate, Tom, because I can't get ahead of the -- of the customer's perspective, as you can appreciate. But I think if you look at the coal industry right now and look at a kind of a global demand for met coal and take a look at DHP or any of the other major players and the analysts who cover that -- that -- those industries, they see a very robust outlook for two -- for the next two to three years on both price and volume for met coal. Everybody is a little bit sensitive, Fording’s call yesterday, or the income trusts call yesterday, a little bit of spottiness around China moving volumes or not picking up their volumes on a monthly basis or maybe even arguably in Q4 pushing into Q1. But the order of magnitude of what we're talking about in the short term nature of that is very modest. So we are looking forward to a very strong and robust outlook for met coal over the coming several years. I can assure everybody on the call that our 3.15, 3.25 does reflect any new information that was provided yesterday on the forwarding income trust call in that we have been monitoring carefully the volumes produced and the volumes sold. So we have calibrated our expectations to reflect that, and I would like to make a note that production continues because it's very important given the first quarter volatility that the marketplace has experienced in recent years, that the production will continue and therefore, the rail shipments will continue even if they want to build up a little bit of inventory out at the ports. So our numbers reflect the marketplace as it was shared with people yesterday, and we feel that we will deliver somewhat more coal Q4 this year versus Q4 last year.

Okay. Thank you.

You're welcome.

James Valentine, Morgan Stanley.

I was wondering if I could talk about labor costs for a minute or two. Just, we see that they were up 13% on a per carload basis and in the first quarter they were up 9% on a per carload basis. I know you have incentive comp. I know you have some additional –- some of this track work being done, but it -- it just seems like there's a lot of inflation here and I guess I thought that the IOP was going to have some benefits on the other side. I guess, are you guys pleased with the labor costs for the quarter?

Jim, I mean this -- this -- this work is never done. What we said before is look, let us get this West Corridor Expansion through. We're evolving with our IOP, we're absolutely committed to that. Now let me try to take your questions in two parts, and maybe I'll ask Fred to add some comments. But on the unit rates, I think we're still very much on track. I mean, generally we're seeing wage inflation coming in at around 3%, that's combined represented and all employees. If we take a look at the good work we are doing on benefits, and if you add in with that pensions, that number is still looking at about a 4% type number on a unit rate basis. We are getting a little headwind from pension. Again, I think this is manageable in a long term. So units rates, I think, are coming in right where -- right where we need them to be. When we take a look at the total count, I tried to give you the -- the split there. I think as we move forward in terms of getting the efficiency out of the system -- and Jim, this is not just on the operating side in terms of balancing our system with crews and locomotives and so on, but also, you know, to the extent that we run to plan there's less variability there's more fluidity. That takes costs out of the system. Less issues around order management, customer service, billings, disputes, analysis and so on. And this is what we've been talking about for a good part of the last year. And so I -- I would expect to see this to be a fairly pervasive increase as we go into 2006. And let me clarify that. Increase in terms of efficiency. What that means is we will continue to work headcounts down on both the -- the operation side, and that's a function of volume, but also on the support side. So we're not where we want to be, but a lot of good progress and this is unfolding more or less the way we expected it to be, but more work to be done. Fred, over to you if you have extra comments.

Jim, I would add just that the -- on kind of a quantum, the numbers of people. When you have the kind of construction program we have had underway, we have had a large number of what I'll call extra supervisors, train masters out running these programs, extra people in the network management center because of the condensed activity that has to happen when you are trying to dispatch through these kinds of programs. The planning for 2006 clearly extracts those numbers of people. Arguably you could look at the number of extra work trains that we have out there. And there's another 10 or 20 people. So -- and the last thing that probably most people haven't picked up on, FTEs, is remember that we are converting from halogen CsX to running rights on NS between Detroit, Chicago. And there's another 36 or 40 people we have hired on our Running Trade side to enable us to do that. So it's a long answer, Jim, but I -- I like Mike believe very strongly that when we complete the program and start to run the railway the way we think we -- we can run this railway, not only will we see the benefits in the field but we'll also see the benefits in the lack of re-work and therefore the ability to simplify the support team that's behind the scenes.

Well and I -- that's great. I hope all does play out next year. Is there a way we might be able to put some parameters around it in terms of, you are running about 30% of revenue spent on labor right now. It is realistic to think that next year that number drops 100, 200 basis points? Do you think we'll see a nice step down or is it going to be more of a gradual, multi-year move? Or will it not go down at all?

Jim, I -- I think we need to get into this more, as Rob indicated, we have our upcoming meeting in November. I mean as we go into next year on the unit rates side, as you might imagine, there's a great deal of work going on. And also the answer to your question is -- is a function of volumes. And as we have said before, if the volumes are substantial and we -- we look forward to a very strong next year, you know, you have to adjust for that, but I would say we expect to see ongoing significant work going into next year on this font. So it's not many, many years; it's more the front 12, 18 months or so as we see these deficiencies come through and we take action.

Okay. Great. Thanks.

Ed Wolfe, Bear Stearns.

Yes, I'm just a little confused on the conversation about the headcount. Can you talk a little bit in -- in more detail. The sense I get is, as you pull back on the Western Corridor Expansion you're going to reduce the headcount? Can you give -- can you quantify the number of extra people that are involved in that right now?

Well --

Ed --

Let me -- Ed, it's Rob. I think there's -- there's the short-term issues we can deal with and we can quantify. But the longer term ones, I think, we're going to have to wait until our conference with the analysts in November. But on the short-term impact, Fred, do you feel a feel for that one.

Why doesn't Mike provide Ed with kind of the bigger picture and I'll get more specific [inaudible].

Okay, Ed, just a couple of numbers maybe to -- to help you out, and then Fred will come in here. But if we take a look you can see off of the fly sheet, the summary of rail data, that our average head count was up 431 about half of that was due to capital, so that's the piece obviously that's not flowing through the P&L directly. So with respect to the balance, all in, we're seeing an increase -- this is essentially in -- in Running Trades employees and on a net basis, with that increase offset by some of the other staff reductions, we're in the process of completing -- this is of this original 820 number that we'd set back in 2003 and we will meet those targets generally. That gives you an increase of 150 to 200. Part of that, Fred spoke a little bit about the NS arrangement and so on, that's really the -- the breakdown on the numbers so hopefully that's helpful.

If I can add a little more color it would be of that 100ish, 110 that Mike refers to in the Running Trades side, think about 10 people, or 10 to 12 people probably running more work trains. Think about the 36 that we're putting in place -- 36 to 40 we'll put in place on the out cart new play, which is not West Corridor related but it is -- is Running Trades employees. And then we have to look at the fact that the -- we are dead heading more people because of this seven and eight hour blocks we have to put in place. So that means that we -- we have to reposition them to keep the -- the railway fluid. And we have to also have more people in the pool to ensure that we can work in a -- not an ideal balanced arrangement. I don't mean to talk in code, I'm simply say it's not an efficient use of labor when you have to stop your railway for seven hours every day for four or five days in a row. So it's a little -- a little hard for me to put a specific number on -- onto that, but obviously it's -- it's going to be somewhere between 20 and 25, 30, 40 people could be eaten out quickly with a -- with a very inefficient program. So all in, you pretty quickly see where the 100, 100 plus Running Trades people come from.

Okay. And just in terms of the compensation and the stock impact, I'm guessing there's nothing different that's changing going forward in your comp plan, so if you have another good quarter for the stock we're going to see this again? Or is there something that's going to change with your stock plan thinking about that going forward?

No, Ed, there's -- I mean there's two parts to that discussion, if I may. Certainly going forward we still have the existing outstanding SARs and DSUs. It's mostly SARs, and those -- those are options that have been granted. That is a very cost effective way of us to -- to deal with this component of our -- our comp expense. Going forward, I guess is there's a question as to would we continue on with those? I don't anticipate, at least at this point, a change. Although I can't rule that out. We are looking at maybe smoothing that variability with -- with some financial instruments. The issue I want to focus on there is, while we don't like the volatility, and we -- we typically haven't seen this as you know. It's a very inordinately large move in the price in one quarter, but we are looking at ways to smooth that. But I don't want us to incur an economic cost to -- to smooth variability, or certainly not anything significant. So we will look at that, but I wouldn't expect to see this, I guess -- after -- even absent that action. I wouldn't expect to see this kind of volatility on a go-forward basis. Although, Ed, I'd sure like to see the stock price continue up on a go-forward basis. Let me -- let me say that.

And then as an update on the Western Corridor, now that we're pretty close, can you give a sense of what those four new trains are going look like? How are they selling so far, and maybe talk a little bit about what phase two might involve? And if there is a phase two evolving does that mean there could be further congestion in the railroad in '06?

Ed, I think we're a little ahead of ourselves because that's clearly going to be the subject matter of our -- of our November analysts meeting. I will say to you, as I mentioned, that October month-to-date as of today, we are running a couple of points ahead of last year despite this big work program. So we're quite comfortable that the demand is out there. And when we get together in November, we'll do our best to show you the consumption of our new capacity over the various quarters next year and therefore, what the impact will be on EPS.

Okay. I look forward to that. Thanks guys for the time.

Thank you.

Scott Flower, Citigroup.

Good morning, all. Wonder if to -- to Fred's point -- and he obviously talked about some impacts of the Western Corridor. Do you catch a break where you can catch up or is just the incremental capacity, once it cuts over, give you the ability to become more fluid? And what I mean by that is, obviously, fourth quarter is a busy time. First quarter obviously is seasonally normal winter, which has the vagaries of winter obviously in your service territory. I'm just trying to get a sense of when you get a break to -- to turn the corner? Or is it as you turn [inaudible] some of the Western Corridor on you just get that much more incremental capacity that you can smooth things out and gradually catch up in terms of some of the metrics.

Scott, Fred, here. I think that -- I mean, it's unrealistic to kind of say flip a switch and the world changes overnight. But I can tell you that there are a team of operating folks that are absolutely focused on thinking through today how they can best utilize this new capacity once we un -- undo the handful of big bottlenecks that we still have to deal with over the coming three or four weeks. So I guess, the best way to describe it is -- I think it would be a pretty quick recovery in the sense of eliminating some of the -- inefficiencies that we have experienced over the last quarter and Q4 to date. And I would expect that -- that we ought to hit the efficiency run rate pretty quickly in 2006. I don't think -- I know I will not be satisfied and I know this team will not be satisfied, you know, taking many, many quarters to eliminate efficiencies that -- that were caused by something that -- that we have now undone. So anticipate a reasonably quick ramp-up in -- in Q1 of -- of the benefits of the fluidity of the system.

I guess, Scott, it's Rob. It's a little bit of both, and I know it's hard for you folks to quantify what that means, but it's improved fluidity, which is just built into the design of the railway. You have more capacity, but you have a better railway, and it's increased volume. I would point out that we do have a better grain crop. It's -- and that's something that's different that this Company has faced in both -- quality and quantity, so that's going impact us in the fourth quarter and first quarter positively.

And then the other question, I know Mike has addressed this, and I just want to make sure I understand this, obviously it's a good thing that the stock price goes up. I just want to understand, when you talk about the mark-to-market on the incentive comp, does that mean you capture the full impact in the current quarter of the stock moving to current levels, or do we actually still have a continued year-over-year impact as we go into fourth quarter because obviously the stock price is still up? So from a year-over-year perspective you still have the impact or is the full impact of that stock price move captured in third quarter ergo some of the volatility effects you talked about?

Full impact is in the third quarter, Scott.

Terrific. Thank you.

Robert Fay, Canaccord Capital,

Hi. A couple questions. First of all the potash sulphur outlook for the fourth quarter, do you think that that's going to have significant pick up in Q4, or is it going to be in the Q1 early [peer] part of next year.

I think they -- it's Fred, Bob. I think the -- the potash marketplace is going to be strong in Q1. I do not anticipate a rapid escalation during Q4. It's a good solid quarter, we're satisfied with what's there. But the Brazilian sale did not come through and will not repeat itself until the spring run. So I think we'll have a good solid fourth quarter but not -- not rapid growth during Q4.

Okay. The other question is on the hedge gains, what were the hedge gains in the quarter, Mike?

On the fuel in total -- well the swing up, Bob, was $6 million on -- and the total gain was approximately $15 million.

One five. Thank you.

David Newman, National Bank Financial.

Good morning, gentlemen.

Good morning David.

Just on the -- on the split of your fuel hedges, Are you hedging off WTI or do you also have a mix of heating oil and diesel in there to immunize yourself in the crack spreads?

No it's essentially -- essentially a feedstock based WTI base, David. We -- we were looking at putting some crack spreads on. Obviously the crack spreads have moved up very significantly, but -- for a number of reasons we did not. Let me say a few words, if I may, about -- about fuel going forward. I think that we have all learned and certainly with this kind of increase in prices, both crack spreads and feed stock that we have to pass those along to the customer, and -- and we're no different obviously from trucks, airlines. And that's what you'll see us do. So I'm not ruling out further hedging activity, but I would expect to see that as being a smaller component of our fuel risk mitigation. Having said that, we still have a -- a very solid hedge position this year, obviously with about a third of our requirements hedged at about $35.50 or so a barrel. So we'll still have some hedging activity, but at the end of the day the theory and the practice really requires us to flow that through.

Okay. Very good. And on your surcharge program, if I hear right, does it sound -- sounds like you may consider lowering the surcharges at some point?

David, it would be premature to declare exactly what we're going to do. But maybe I could characterize it this way. Obviously based on our ability to grow the business by 16%, the combination of our pricing and our fuel surcharge has left us very competitive. So what we are trying to assess is as our coverage expands, and it's a -- it's expanded as I said to 90% plus, that positions us to be in a position -- because this is not meant to be a profit center -- positions us to consider whether there's an alternate way to go to the marketplace. So we are considering that including issues as -- as was raised earlier with regard to the crack spread and do we -- do we price on WTI, or diesel prices, et cetera. And we believe that there -- there's -- at this point, emerging an opportunity for us to alter the plan. So if, as a result of our dialogue with our clients, we can find a solution that accommodates those issues, it's conceivable one of the options is that we would alter the -- the plan, and it could conceivably be a -- a change in the scale.

Okay. Very good. The last question if I might. Just on the -- obviously -- the Canadian government looks like they invested a little bit in our western ports, [if anything] it's 590 million. I think 190 million immediate. Any comment on that -- and do you -- do you -- do you view that as a bit of a -- a domino for your future CapEx programs?

Well I think it -- it certainly is coordinated with what we see in the way of expansion of our western network. They announced specific programs, some that will impact our -- our ability positively to access Robert's Bank. So that's going to be great separations between Mission and Robert's Bank. The other one that was specifically mentioned was a great separation down at Porto, which is where we cross the border in the United States in North Dakota. So those are very well coordinated and we complement the government for working with private industry to work on this. There is still a pot of money out there to improve the overall port fluidity from rail, truck and ship points of view, and that has to -- we need to do some research with them, with their announced secretariat. So we look at it as it bodes well for the future, David. They're putting money up to increase the -- the gateway aspects of British Columbia, so we believe that regulation will be in line with that as well. So they want to lever private investment and public investment to improve the -- the overall transportation network, which is, I think, a great sign for the future.

Excellent. Thanks, gentlemen.

Ken Hoexter, Merrill Lynch.

Hey, great. Good morning. If I could just clarify on that last question a bit. Just on the surcharge, are you basing that on WTI or are you basing it on -- on your diesel costs?

What we're doing at this point in time, Ken -- it's Fred -- is the program exists -- and it's triggered, its index is triggered off of WTI -- WTI movement every 30 days. What we are considering, amongst other things, is whether there's a better vehicle out there which would be -- let's use an example -- heating oil or diesel prices, something that includes the crack margin. And if we could find a way to do that and do that effectively we will consider that as an alternative. We would obviously like to go down that path, but finding a solution that's applicable to thousands of customers is -- was complex the first two times we did it, and we're trying to find one that we can migrate people from, or towards from where we are today that is fair to them and also protects interest of our shareholders.

Great. Thanks, Fred. Just because, I guess, even a little step further because somebody's noted in the last answer that you don't want to be making up front -- the goal wasn't to be making a profit. But if I understand, looks like from results, the -- the thing that really missed was on the fuel side because of that crack spread. So I'm -- I guess is there -- I don't understand why there's discussion of lowering it if you're -- if you're still missing the gap between where WTI and the crack is right now on those results.

Well, I think on a go-forward basis, Ken, as we anticipate our coverage expanding, in other words, getting more and more people under the umbrella of a fuel surcharge or a vehicle like that such as indexation, we will reach a point where conceivably we would be accumulating an equal amount of revenue relative to our expenses. The minute we go past that, sticking with the principal of not making this is a profit center, we -- we think we have an obligation, and we will find a way to calibrate the -- the rate at which we charge it to ensure that we're not overcollecting.

Okay, so you are talking in the future? You're not talking about, that's the concept at this point.

Well, I think at -- we're reaching a point, looking out into 2006 -- remember we have to be basically far enough in advance that we can have dialogue and forewarn our clients about a change. So there's nothing going to happen in Q4. The run rates will be as you see them, but as we start to work our way into '06 and beyond we have to consider what that world will look like to us. How are we doing relative to the expense variation, and do we have to alter the program. So we will talk about that probably in -- in more detail at the November 16th session.

Great. Two other quick ones. Fred, is the anniversary of the [Amerans] Coal Contract coming up?

January first, or December 31st, Ken.

[inaudible] Okay. And then congestion on the network because of the construction, is there -- we have seen velocity slow a little bit lately, is that -- any of that because of the expansion build or is that irrespective of --

No, that's largely attributed to the -- to the expansion. And again, if I could just help you visualize that we are running a lot of trains, and then we get them to a certain point we literally have to stop them for seven hours while the engineering forces go on to do some of these major connections. And then once that's done you fleet them through afterwards. So you can appreciate that a train that would normally run across the property, in whatever, 24 hours, now has -- has to run 12 hours, stop for seven and run for 24. So the mathematics of train speed is simply, how long did the train take to get across divided by the miles it went. So that's why you see the train speed moving about 5, 6, 7% lower some days and I think arguably month-to-date's probably in that range, 5% slower or so. But once we get the work programs off, like my full expectation, subject to mix of course, because some trains are slower than others, is that you will see a substantial recovery. Just like you have seen a recovery in the -- in the yard fluidity that we anticipated as we said we -- when we put ties in place it would come and it's coming big time now.

Great, thanks. And just a quick yes or no answer, I guess. On the -- on your target, is the West Coast Expansion now in the target or still out of the target?

I just don't think there's going to be an in -- it's going to be the end of November before we get the physical plant open and we start to wind down based on demand. If you look at our demand it kind of winds down starting mid -- mid-December. So, call it in, call it out, there's almost no -- no material impact, in my view on -- on the Q4 results as a result of getting this up and done. We want to see the benefits that materialize in '06 and beyond.

Thank, Fred.

My pleasure.

James David. Scotia Capital.

Thank you. Good morning. In -- in the face of some labor cost headwinds, and I guess, [inaudible] that you're just modestly -- modestly down, as per Fording’s comments yesterday, it's not a big change, but you haven't changed your guidance. It is fair to say that that the reason that you're comfortable is the grain picture is better? I think, Rob, you alluded to this earlier. Is it better? How much better is it than what you may have anticipated, you know, a year ago? And the other question related to that is -- are you expecting more of a Q4 bias versus last year versus the -- how much you might move in Q1?

No, James, I guess we have been reluctant to give any quarterly guidance, although we have been encouraged to do so every call. And we have stuck with your annual guidance, and you'll appreciate that there has been pluses and minuses, and that's why we did not want to back off of our principal of annual guidance. With respect to the grain we -- we've had some ups and downs as the years unfolded there. And Fred, why don't you say where your opinion is right now.

I think, James, the best way to describe it is, it is impossible to accurately predict a grain crop other than using some kind of historic averages, because if the circumstances are different each year. So for planning purposes, we would have used about 48 million tons because that has been the average of the 10-year exclusive of the two droughts, and in fact we're going to come in at about 47.9. So I -- I don't think we would attribute any more benefit in the -- in the quarter to -- to grain beyond what we would have otherwise planned. What I can tell you is, is there's a group of people very very focused on bringing home both the revenue stream, the yield stream, and the expense stream. And as we talked about earlier, once we -- once we pull off our -- our work activity, and that's what -- what gives us the confidence we can -- we can deliver in that range.

Okay. Great. And just quickly on the Western Capacity Expansion Program. And I appreciate, Fred, that you will address this next month. But at one time, sometime ago you -- you attributed potentially earnings upside of 25 to $0.40, tied to this. Rather than going into that detail, I'm just curious, of -- of the guidance that was attributed to it, how much of that is -- is efficiency related? And how much of that is tied to the possibility of – well, tied to greater revenues? If you could just sort of split it up percentagewise, in terms of the EPS increment.

Well, I'll be very broad and just say the vast majority of that guidance would be attributed to the -- to the upside volume opportunity that exists. And we will -- we will deal with our assessment of that in November as to what we think is going to materialize and give you our best assessment.

Okay. That's all for me. Thank you.

You are welcome.

John Barnes, BB&T Capital Markets.

Hi, good morning guys. Real quick on the 90% coverage with the fuel surcharge, is that 90% of your comp -- your customer base is now under some sort of fuel surcharge, or are you recouping 90% of the higher fuel cost?

John, it's the -- it's the coverage ratio. It's greater than 90%, and it can apply to the percentage of contracts or the percentage of revenue that is -- that has some form of fuel coverage on it. So it's actually in the low 90s and it varies whether it's contracts or revenue base that we're using.

Okay. Where do you think you can get that to? I mean, is your -- is your goal obviously 100? But do you think you can get to that point?

I do think we can get to that point. We do, as always, have to manage a series of legacy contracts, which we have done, I think, quite effectively over the last two years. As the come due we deal with them. I believe that 100% is not at all unreasonable, and -- like to think that we're going to get awfully close to that within about a year or so.

Okay. You talked earlier about the percentage of your contracts. You know, how -- you know, and you indicated that a good portion of your contracts have been re-priced in the last couple of years, that you still have a couple of legacy deals, but I just wanted to make sure I understood. You feel like the business that's been re-priced already gave you kind that stair step improvement in pricing. But what you are saying is you think further price increases are possible, maybe smaller than what you have seen in -- in the last couple of years. But probably more consistent and more sustainable going forward?

John, let me -- I'll try to state this as succinctly as I can so there's no -- I don't leave any missed messages. One is, I believe that there's a sustainable market environment for us today, and -- and I don't see anything on the horizon to believe that we can't get that -- that price increase in the 3% to 4% range minimum going forward. There will be exceptions because of unique circumstances, but as a general rule that's what we're looking for. I also believe that some of the -- some of the book of business that was maybe re-priced, let’s say two years ago, when we were maybe less certain about the sustainability, less certain about the consumption of the -- of the North American capacity, probably took a good step function, but it may have a second step function that it can take. And obviously that's a case by case evaluation that we'll undertake to our yield teams and our marketing pricing teams.

All right. That was clearer. Thank you, I appreciate that. And then lastly --

John -- John, could I -- we're running out of time and I do have some other people we have to get in. So can I – [Misea] if you could go to the next please.

Ted Larkin, Orion Securities.

Thank you Operator, and good morning, gentlemen. Just very quickly, on the automotive side, I think Fred, you mentioned the fact that there's been a domestic slowdown and that's been offset by the level of imports. Can you give us an idea of to what degree that's happening and more importantly looking forward, whether you're expecting a continued slowdown on the domestic front?

Yes, I think probably the best answer is that I believe that, while in general, the -- the domestic marketplace is obviously a little bit soft, if you look actual sales, while they're maybe a little less modest than they were in prior periods, they're not -- there's not a huge step function change down. I would suggest to you that the Q3 results reflect a timing situation whereby there was an awful lot of quality holds or holds for sales reasons as the case may have been. And therefore our volumes -- our volumes, and I think probably or maybe the industry volumes, did not materialize as we had might have hoped for in Q3. That said, I can tell you that month-to-date Q4 has been a very interesting month, a very positive month on the auto side for us. So I think that, you know, in principle we all know what's going on between the big three and others. The overall consumption date is avail -- available to everybody so you can reach your own conclusions about that. And our view is that it's -- you know, it's going to be a reasonably good fourth quarter and next year shouldn’t be that much different at this point, although we’ll talk more about that in -- in November.

Okay. That's encouraging. And the -- the last question then, just simply, I know your root structure might not appear to enable you to benefit from work being down South after Katrina, but can you give us an idea if you're looking for any lift from that?

I don't any it's material, so it hasn't significantly impacted any of our outlooks, but I think, as examples, I mentioned we had some spot sulphur moves, where some of the refineries went down and they weren't able to produce products so we back filled in from here. I think obviously on the lumber and panel side, we are well positioned to participate in whatever comes of that. I don't think we're going to get direct moves into the effected zone maybe beyond those two -- two items. But it's not inconceivable, for instance in the area of construction materials or steel, that product that's going to be sucked out of, let's say the U.S. Midwest down into the New Orleans area, would then be subsequently back filled from the players that we participate with. So, I think there'll be collateral damage but it might be hard to track it because it won't be destined to New Orleans.

Yes. No. Correct. Okay. Thank you very much, Fred.

Thank you.

Bill MacKenzie, TD Newcrest,

Thanks. Mike, I just wanted to get a little bit more commentary on your CapEx [allocate]. You stuck to your -- your guidance of 900, to 920 for the year, but looking through the first nine months of this year, you're tracking a little bit below what I had you at, and you’re 85% complete on the Western Expansion, which I still have a hard time understanding how you're going to spend that much capital in Q4. Is that just you being very conservative on that CapEx outlook or should we see a big pickup in -- in Q4?

I think you should expect to see some of the additions coming in Q4. So to answer your question, no change on that outlook. In terms of what we have done on the Western Corridor Expansion, obviously we -- we accrue that work, and that is in -- in the -- in the accrual for work that has been completed, but not necessarily billed. That -- that is obviously the proper way to deal with that, but you're -- you're probably seeing a little bit less on the cash side year-to-date as those bills are coming in. And then the other part of it is, Bill, you know, the timing of expenditures including locomotives and so on and so you do see a swing quarter-to-quarter. So to answer your question, no, it should still be 900 to 920, and we see the path there at this point in time and, if it doesn't have to be that, we try to bring it in less, obviously. But this is a project we want to get done and behind us and look forward to a good '06.

Okay great. And then second question just on -- for you Mike, on the pensions, you know, we're starting to hear some companies talking a little bit more about the sort of the '06 potential impact of rates still staying low. And I'm just wondering -- I imagine you'll address this in more detail in November, but can you give us some initial thoughts on -- on pensions in '06, both from a -- an accounting perspective and from a cash perspective?

I'll give you some -- some general response, Bill, and I'll ask that obviously the group bear in mind that clearly going into '06 some of these discussions will be impacted by what we see in terms of asset turns for this year and obviously interest rates as we go forward. If I can take the expense piece for a moment, we are probably tracking for a full year annualized pension expense of something like $40 million. That's up about $20 million in round numbers from last year. Again, this is very rough, and very subject to qualification when we see the year end numbers. But going into next year on expense, I would expect to see a comparable dollar increase rough cut. Now again, I reserve the right to change that, but it gives you some idea, Bill, as to what we're seeing on the expense side or likely to see, and it may vary a little bit from that.

On the cash side, as you heard me say before, this is the one that probably troubles me a little bit more. I do think it's manageable. What we said and what we disclosed in our MD&A is that if the rates, the long rates come up 1%, our -- our liability is -- is reduced by $600 million. That basically takes away the unfunded liability for us. Clearly, we're not sitting around here hoping that interest rates increase in this respect, although a little bit of help there wouldn't be bad. But the other things that we're doing obviously, portfolio management, net liability management, there's also some pretty strong advocacy going on in Canada from a number of companies on the cash side to say look, for these strong companies the way you support [DD] plans is to make sure the -- the financial sponsors are strong. And so there's some -- some pretty good discussions, some changes on a provincial basis around funding your shortfalls from a cash standpoint. As you know for federal employers it's five years and there's some variations [I have seen] that maybe give us more funding flexibility there. And I don't want to oversell that, but we're going to push hard on that as well. So all and all, a little bit of a headwind for us. I do think it's manageable, but we'll continue to work hard on it.

Okay. Thank you.

Operator we have time for one last question from the analyst community to keep -- to our preannounced schedule, and then we'll just have time for a media question as well.

Joseph Leinwand, RBC Capital Markets.

Hi, thanks, guys. Just a very quick one. On the coal -- I noticed on the coal yields, either revenue per carload or revenue per [inaudible] all those that a -- 6%, 7% decline from the previous quarter. I know it was up substantially from last year, and I know the previous quarter had some catchup with the -- from the previous year, but did we use this quarter three yield on coal carloading as sort of a run rate for -- going forward? And, I guess, on the same thing, on the same question, when does the -- I believe the surcharge kicks in on some of the coal, a fuel surcharge, and when is the timing on that?

Joe, Fred. I'll break it into two pieces. With regard to the surcharge, it is based on a volume trigger, past a certain volume. And so, sitting here today I just can't calibrate whether it's going kick in or not kick in. But we would be happy to -- to confirm that to the group on November -- at the November meeting. So I'll take it as -- as a to-do. With regard to the pricing and whether the Q3 pricing is representative of the go forward pricing for Q4, I am not aware of any dramatic changes or any one timers. And I guess, again, what I would say is that you should use those numbers, and if for any reason, that's -- I'm making an incorrect statement we will clarify that at the analysts meeting.

Okay. And, I guess, one quick one. You had a 30% tax rate in that quarter. I was -- I was modeling a 34%. What should I model for the rest of the year?

Joe, we -- if you take a look at the year to date effective tax rate, this is on the adjusted earnings number, we brought that into line at around 32.5%, and I think that's a good full year number.

Okay. Thank you, guys.

Okay. Operator if we could -- if there are any media questions, we will handle them.

Thank you at this time we will take questions from the media. [OPERATOR INSTRUCTIONS] Chris Sorensen, National Post.

Thank you. Just one or two quick clarifications. Fred, you mentioned earlier, just you were surprised by the -- the impact on the train speed from some of the construction work going on, or expansion work. And I just wanted to clarify if that was because there was more traffic than you expected or just delays directly related to the construction projects?

Chris, the [call speed of speed] I made a mistake. I thought we could do a little better than we did, and we didn't get it done. So I'm going wear that one.

Okay. So that's -- that's just related to the -- the construction or the details of the completing those projects?

That's correct.

I would get Fred off the hook a little. He made a mistake on the assumptions, but the work has been done by the team very, very well. And there's a heck of a lot of work going on up there with a lot of trades.

Right. Okay. Understood. And just one last thing, Rob, you mentioned that in November you were going to address, you know, sort of the possibility or considerations regarding a phase two of expansion, is that -- did I hear you right?

Yes, we need to take a look at what the market looks like. The conditions, the requisite conditions that we set for the '06 expansion, are they in place for '07? The market looks good, it's not as hyperactive as it was this time last year. So that -- we need to collect our thoughts, get the team together and see what that holds for '06 and -- or '07 and we'll make that decision then.

Sorry, can you repeat the last part? You'll make a decision in '07?

No, we'll make that decision for '06, '07 expansion and we'll make that decision in the November time frame.

Okay. Okay. Thank you.

Okay.

Thank you.

Thank you. [Misea]. I think that we are out of time. So that concludes our Q3 session, and so I want to thank everyone for participating. We do look forward to presenting our vision, as we were just saying, plans for '06 and beyond at the Analysts Day, that's Wednesday, November the 16th in Vancouver. It is going to be fully webcast for those people who can't make it there it. So it begins at 11 o'clock eastern time and 8 o’clock pacific time. So we will talk to you at that time. Thank you very much.

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