Canadian Pacific Kansas City Ltd (CP) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Canadian Pacific Railway Fourth 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. If anyone has difficulties hearing the conference, press star-zero for operator assistance at any time. I would like to remind everyone that this conference call is being recorded on Tuesday, January 31, 2006, at 11:00 a.m. eastern time. I will now turn over the conference to Paul Bell, Vice President - Investor Relations of Canadian Pacific Railway. Mr. Bell, please go ahead.

Thank you, John, and thank you, ladies and gentlemen, for joining us in our 2005 fourth-quarter teleconference. Presenters today will be Rob Ritchie, our Chief Executive Officer. Fred Green, our President and Chief Operating Officer. And Mike Waites, our Chief Financial Officer. This presentation contains forward-looking information. Actual results may differ materially. We make reference to assumptions used in our guidance, and we provide sensitivities to these assumptions in the appendixes, the last section of the presentation material. The risks, uncertainties and other factors that could influence actual results are described on slide two in the press release and in management's discussion and analysis and CPR's annual and quarterly reports filed with Canadian and United States securities regulators. Please read carefully as these assumptions could change throughout the year. I remind you all dollars quoted in the presentation are Canadian unless otherwise stated. This presentation also contains non-GAAP measures. Please read slide three. The slides are available on our web site, so please follow along. Here, then, is Mr. Rob Ritchie.

Thanks, Paul, and good morning, ladies and gentlemen. I would ask you to start by turning to slide five and let me start by saying that 2005 was an outstanding year for the Canadian Pacific Railway. We hit every target we set for ourselves for the year. We grew earnings per share by 45% and finished the year at C$3.30. Our full-year operating ratio improved 2.6 points to 77.2%. Our fourth-quarter operating ratio came in at a promising 74.1%, an improvement of 3.1. Our quality revenue growth plan delivered within our forecast range as revenues up 13% with increases in six of the seven commodity groups. Four of those were up double digit. Our strong, well-managed yield program worked exceptionally well. On the productivity front, we moved record volumes while completing the largest track expansion program in Canada in over a decade. Which, by the way, was completed safely, on time, and on budget. We focussed on running our scheduled railway and reduced our terminal dwell time by over 10% as we had forecast. Train speeds held their own given the size of the engineering expansion program. So combined car velocity rose by over 4%, which has positive step toward our goal of being the most fluid railway in North America.

Our people rose to the challenge. Our personal safety record improved dramatically, and our train accident ratio remained at an industry-leading low level. Our operating people set new standards in fuel conservation and lowered our consumption rate by almost 2%. We came to positive agreements with six of our unions in 2005, and we have a progressive union management relationship. We reworked our internal processes to eliminate redundancy and waste and completed our three-year, 820 employee reduction on schedule at the end of 2005. We were then able to announce further reductions as a result of continuing improvements in service levels. Perhaps the most satisfying accomplishment for the shareholders and personally is that we broke through the C$1 billion operating income threshold for the first time in the Company's history, giving us excellent momentum going into 2006. So I'm going to turn it over to Mike who's going to take us through the 2005 financial details. Fred will then give you the marketing and operations stories. And both will give you some insight into 2006. Mike, over to you.

Thanks, Rob. Turning to slide seven, I'll summarize the year's results, and then I'll focus on the quarter. Let me say at the outset the quarter results were robust with solid revenue performance, notably from our merchandise and intermodal businesses underscoring the diversity of our revenue base. Obviously that translated into a strong story for the year with revenues up 13% and expenses up 9% resulting in a 27% increase in operating income. As Rob mentioned the first time we surpassed the billion-dollar mark of OI. In terms of revenues I should note, that we have moved certainly intermodal revenues, container storage and so on, out of other revenues on the income statement and into freight revenues for better matching. No change in accounting policy, estimate, or total revenue numbers in the income statement, this is simply a superior presentation. But I think you probably want to adjust your models accordingly. We've also provided the details of these changes on our web site.

Moving on, interest expense was down 7% to C$204 million, and the effective tax rate was 32%, both in line with expectations. Adjusted income then was 528 million. That's up 46%. This equates to EPS of 330, north of the guidance range reflecting the strong exit to the year. Tying out adjusted income to reported, the three items are the currency gains on the long-term debt was C$22 million. We exclude unrealized gains and losses, for that matter, from adjusted income. We also had the combined impact of the liability for labor restructuring taken this quarter and the partial reversal of the environmental charge earlier in the year that netted to C$8 million. So reported net income was C$543 million or 3.39 per share. Key take away, 2005 adjusted EPS improved by 45%.

Turning to slide eight and specifically now the fourth quarter, clearly the big story was yields, which together with volume drove C$0.41 of EPS improvement. Comp and benefits inflation increased, reducing EPS by C$0.05. Higher depreciation reduced EPS by another C$0.05, these are essentially capital ads. Currency on the net basis and after the interest expense offset with our US dollar denominated debt not a big impact at C$0.02. Combined with C$0.04 of other change, the net result was C$1.06 for the quarter, up 45% driven by a strong yield program. Turning to slide nine, in the quarterly income statement, revenue growth was 14%. Expenses were up 10% driven by higher fuel costs. Operating income was 302 million, that's up 30%. This translated into a 310 basis points improvement in the operating ratio to 74.1%. Interest expense came in under C$50 million. This was the first time since the spinoff in '01. Reflecting reduced borrowings and ongoing expense management. The effective tax rate was again 32%, resulting in adjusted income of 169 million, up 45%. Reported net income totaled 135 million, with the lower number reflecting a small, unrealized currency loss and the labor restructuring liability.

Turning to slide 10, comp and benefits expense declined by C$3 million. Incentive comp expenses were in line with run rates this quarter as stock performance was relatively flat compared an C$8 rise in the share price in Q4 of 2004, and thus we saw favorable C$15 million variance. Offsetting this were higher wage rates which increased expense by C$6 million and higher head counts, about 280 volume-related additions, which drove another 6 million of expense. Fuel rose C$43 million or 35%, with the higher posted crude prices and refining margins. This was essentially offset by hedging gains and fuel surcharges which were included in revenue. Materials expense rose C$15 million. Last year's numbers included the benefit of a favorable C$6 million adjustment with a third-party supplier. Almost half of the remaining increase was due to increased costs [for wheel changes] as we've tightened tolerances. This is consistent with industry standards for the detection of bad wheels. This is equivalent to an investment from our standpoint. The payout being the reduced likelihood of derailments. Equipment rents were up C$6 million, but in line with quarterly run rates. Q4, 2004, had some one-time credits. Locomotive rents were up C$2 million, and there were a number of puts and takes on car hire. Car hire lease rates were, in fact, higher, but we were able to offset that with the velocity improvement in the fourth quarter 2005. Purchase services and other was up just C$3 million with a number of favorable operating items including lower casualty expenses, reduced trackage right fees thanks to the completion of the west corridor expansion and the benefits of additional co-production agreements. So excluding the higher fuel price, expenses were up roughly 4%, reflecting inflation in the volume increase.

Let me say expense reduction remains the focus for us at CPR. From a cost perspective, 2005 was a transition year operationally considering expansion work, but in 2006 and going forward, we will deliver more cost reduction benefits from our fluidity and asset velocity initiatives. We will also achieve savings in comp and benefits. And with that by way of introduction, please turn to slide 11. And I want to say a few words about the head counts. In reconciling the head counts, as you can see on the left side of this graph, we ended 2004 with 15,637 employees, which about 1,000 or so were people involved in capital work. In 2005, we added employees to volume and essentially complete our 820 three-year staff reduction program. So the lion's share of the increase were over 530 capital employees working on the west corridor project, who have since come out in January. The key message is that we are quickly implementing the 400 staff reduction we spoke about last November with 170 gone already, and another 230 positions scheduled to come out mostly by the end of the first quarter. Bottom line, a drop of over 270 employees compared to year end 2004. As well we've reacted quickly to the lower bulk volumes, favorable operating conditions, and improved fluidity, temporarily laying off an additional 240 running trades employees. So a great deal of focus on managing staff counsel and comp expense. Let me conclude with the shareholder frame on slide 12. Free cash flow came in at over C$90 million at the north end of our guidance range. Obviously that's after funding the west corridor investment. The balance sheet continues to strengthen with net debt to net debt plus equity below 40%, and return on capital employed continues to improve at 9.4%, certainly covering our cost of capital.

A few words on 2006, the EPS guidance. This reflects the Elk Valley downward revision to 2006 coal tonnage which we updated in December. For clarity, no change in guidance. But the revenue growth with the possible lower coal volumes now results in the range of 5% to 8%, and expenses of 3% to 6%. We've given you the fuel and currency assumptions, and although we have crude prices of $58 per barrel US, a mid US$60-per-barrel number will not cause significant change given our fuel surcharge, so rather than try and predict fuel prices or adjust guidance every time the fuel price changes we've left the assumption unchanged. But the key take-away is we don't expect a material impact from fluctuating fuel prices within some reasonable range. My view at this point is that a strong finish to the fourth quarter combined with a fast jump on staff levels in January auger well for a solid 2006. So, Fred, over to you.

Thanks, Mike. Let's turn to slides 14 and start with freight revenues. Our guidance for the year was that we would grow revenues by 12% to 14%. Full-year revenues were up 13% or almost half a billion dollars over 2004. Right in line with the guidance we provided you. Breaking this apart, volume and mix contributed 3%, fuel accounted for 4%, and price another 9%. Translation impact of the stronger Canadian dollar negatively impacted our revenues by C$117 million, or 3%.

Let's turn to slide 15. And the fourth-quarter commodity results by line of business. Freight revenues finished the year very strong. On the green side we grew our revenues by almost 13%. We created value with improved product offerings and very high order fulfillment rates. Exports were strong in both Canada and the US. Turning to coal, Canadian export volumes were hampered during to the Elk Valley production issues. Domestic volumes were impacted by a plant shutdown in Chicago. On the US front, new business overcame the loss of the Ameren US coal volumes. In total, our coal revenues were still up 25% on the quarter. Sulfur and fertilizer was our only soft business segment. We saw volume down on the domestic pot ash side driven by poor volume sales for the Fall. Fertilizer shipments were also off as a high -- as high prices for gas feedstock caused temporary shutdowns. On the upside we experienced double-digit growth from sulfur. The merchandise group finished the year strongly. In the forest product sector, revenue gains were accomplished against lower car loadings, demonstrating our strong quality revenue focus for the sector. On the industrial products side, revenues were up over 20% with excellent results in the construction, steel, chemicals and construction segments. Auto revenues were up 18%, built on strength in the import segment and specialty markets. [Inaudible] intermodal revenues also finished up strong, up 18%. Led by solid import demands for the Port of Vancouver. In total, despite the continued foreign exchange impact, the quarter was up 15%.

Now, turning to slide 16, 2005 was a good year for our operations. We were focussed on reducing dwell in our yards and improving the overall utilization of our car and locomotive assets. The evidence of our success is positive. Cars on line trended down in Q4 despite record volumes. As I told you on our Q3 call, the efficiency of our over-the-road train operation suffered temporarily as we took steps to move the increased business during our capacity expansion construction. Once the programs ended, the train sp -- train speeds began to improve. On the asset utilization front we continue to sustain the improvements in dwell time, terminal dwell time with an improvement of 11% over 2004 Q4. This in combination with the continuous improvement of our [scheduled] railway generated an improvement of car miles per day of 6% in the fourth quarter.

Before I move to coal production, I'd like to make -- take a moment to speak of some organizational changes we made January the first. We implemented a new organizational structure in operations. It's intent is to facil -- facilitate faster and better decision making in the field to improve execution excellence. We did this by combining all train operations, mechanical, and track maintenance activity under regional leaders. The AVP's job is to drive cross functional coordination with a clear mission to safely deliver the scheduled railroad and to drive dollars to the bottom line.

Onto slide 17, we've previously announced a series of successful coal production arrangements between ourselves and other class ones. As announced January 26th, we've now signed a new agreement with CN to expand coal production activities in the Vancouver area. This arrangement will allow us to reduce congestion, improve asset utilization, and achieve operating improvements without the need for adding new capital for infrastructure. CPR will serve the south shore of the inner harbor and CNR will serve the north shore. This is an important development not only for enabling operational fluidity but for improving the service and competitiveness of the port of Vancouver. It is a very positive step in our Pacific gateway strategy.

Turning to slide 18, I'll give you an update on the 2006 markets as we see them today. The commodity forecasts generally remain in line with what we provided in November and December. On the green side, the latest production forecast for the six major grains in western Canada is 50.5 billion metric tons, a significant adjustment to the 47.6 million metric tons we modeled in November. We expect these higher grain volumes to help offset some of the coal weakness. On the coal front, we have nothing new to report with respect to Elk Valley's production challenges. We are modeling 2006 volumes in line with Elk Valley's announcements which, as you know, cover all of their mines. Until production outlooks are clarified at a much more granular level, we have little choice but to guide in the broader range we are now using. In short our outlook remains subject to Elk Valley's ability to produce. As a consequence we are aggressively managing our variable expenses related to coal, and we are retaining some ability to handle coal volume upside should Elk Valley increase demand for our services.

Sulfur and fertilizer volumes remain consistent with our November modeling. However, we will see some seasonality changes. We expect to see strength through the second to fourth quarters offset some weaknesses we are experiencing Q1. Pot Ash Corporation's recent -- recent announcements was quite bullish which bodes well for our client [Campitex] and CPR's export volumes. On the merchandise side we see the fourth quarter strong demand continuing into early 2006. Forest products will continue to have some challenges as the dollar and high input costs squeeze the producer margins which will lead to some mill closures. However, the construction segment looks robust and the steel sector looks strong. As we noted in November, we expect to see another flat year on the auto side. The growth from our partnerships with Toyota and Honda will offset any modest downside related to the recent announcements by Ford and GM. The intermodal business is healthy. The only new development concerns the Hapag-Lloyd CP ships acquisition. This will result in some rationalization of vessels and sailings, but no negative impact to our international volumes. Pricing environment remains robust. We will be turning over almost half of our book business this year and expect solid pricing results to gain in 2006. In addition, our product is excellent. Never better. And I'm banking on leveraging our product quality on targeting truck conversions and price. So to wrap up, the revenue outlook at foreign exchange of C$1.18 and WTI of C$58 we expect revenues to grow in the 5% to 8% range.

Let me summarize on slide 19. We will deliver the scheduled railway benefits we promised, and [end] improve our service offering. This, in turn, will continue to drive quality revenue growth and yield while opening new growth opportunities. We will continue to leverage our new infrastructure and coal production arrangements, and you can expect increasing focus on expenses including greater [nimbleness] to eliminate expense management or expense activity, should we see market changes. In summary, I'm feeling very good about how the railway is running. We have excellent Q4 and January momentum, as you have likely seen from our AAR performance metrics. The markets are generally strong. And our team is very focussed on expense management. Rob, back to you.

Thanks Fred. So to close, I too, see the franchise as being in great shape. We have strong markets, there's a nice balance between bulk exports and retail import intermodal. Our automotive and industrial product businesses, they're aligned with successful partners and the medium to long-term demand remains very healthy. Fred has the team focussed on driving the operating ratio to 75%. All through our execution excellence models. So we're poised, I think, for another great year. Track infrastructure is in place. The locomotive fleet is one of the highest quality in the industry. Our running trades are right sized. Our coal productive initiatives are working well, and we have a strong and revitalized management team in place. And our scheduled railway has never operated better. Mike's got a clear line of sight to improving the EPS and cash flow with his strategic initiatives and free cash flow is growing and will exceed 200 million in 200 -- 2006. Proof that that business model is working well. So CPR is well positioned and 2006 is shaping up to be another solid year with double digit EPS growth. And with a little tail wind from our coal and potash customers, it could turn out to be even better.

So let's go to questions. We're going to start with analysts, and because we all have deadlines, I ask that you limit your questions to two a piece. And we'll go to media questions at five minutes before the hour, at 9:55. So operator, could you nw open the lines? Thanks.

[OPERATOR INSTRUCTIONS] James David, Scotia Capital

Good morning, everyone. Was the quarter -- you did a full C$0.10 better than, sort of, the mid point of the guidance range which was -- which was impressive. Was this at all a surprise to you? And the reason I ask is you did sort of mitigate at the bottom end of your guidance range for 2006 after the Elk Valley news. And I'm sort of curious why if this was stronger than expected, why you might not have been a little bit more bullish on '06, or you just want to keep your powder dry?

James, it's Mike Waites. There's a number of considerations. We came through the guidance range. I think it reflected a number of things. Certainly a strong performance. We saw, as I mentioned in my words from the intermodal business and the merchandise business, so not necci -- maybe a pleasant surprise modestly. Also given the uncertainty around coal going into the new year, we had factored in a coal forecast for 2006 which taken into account some fluctuation in the coal volumes. But clearly that was a big impact to us. And at the time, late fourth quarter, we saw revised forecasts for grain. We saw the strengths in the intermodal and merchandise businesses, and we kept pushing on expense management. That, in fact, helped us mitigate the downside just to C$0.10 on the EPS guidance. All of that to say, I think we -- we remain cautious, but we remain confident about how 2006 is unfolding given how we ended the year. And it reconfirms we can -- we can get a good mitigating effect on the coal with some upside, as Rob had indicated.

Okay. Thank you. And very quickly, perhaps Fred, you -- you noted successfully, at the end of the quarter, your utilization improved with the Western Canadian Expansion Program sort of completed on time, on budget. But I guess earlier in the quarter, was it at all -- was it at all a drag on earnings? Was there, you know, perhaps something left on the table that we might see next year, as a result of any disruptions that might have cost the network?

I think, James, clearly the -- and I think I acknowledged this on the, either the last quarter or at the analysts meeting, that the train speeds were impacted a little more than I had anticipated they would be. So in the '06 EPS estimates that we provided, we did account for a lot of good initiatives, but also the recovery of train speeds and fluidity of the railway to a -- to a pattern that I would consider to be more acceptable to us. And I can assure you that the early evidence in the first 30 days of January is -- is favorable, and -- and it just reinforces my confidence that we can make this railway run much better.

Okay. Well, I don't say it often, but great quarter. Thank you.

Thank you, James. Next question --

Ed Wolfe, Bear, Stearns & Co.

Good morning, guys. Fred, if I look at the compensation and benefits minus the restructuring, 324 million in the quarter be that's lower than -- than a year ago in fourth quarter '04 despite a higher average head count. Now I realize some head count came off at the end of the -- the quarter, but how should we look at this going forward? Do you expect that line to be lower in first quarter, for instance, than it was a year ago? Compensation and benefit all in, and how should we think about it throughout the year?

Ed, it's Mike. In terms of the 324, bear in mind when you look at the variance, we're down C$3 million and as I mentioned there was a favorable C$15 million swing, incentive comp. As you know, we expensed the SARs and DSUs currently. In the fourth quarter of 2005, we saw a fairly normal, if you will, performance in our stock price. The previous year in the fourth quarter, we saw a -- an 8 million -- or a C$8, I should say change in the share price. For every dollar change in the share price, it's about 1.5 to C$2 million impact on pretax expense. Fourth quarter 2004, if you will, you saw whacked pretty hard by incentive comp expense. We didn't see that in the fourth quarter of '05 in terms of favorable 15 million swing. But to put that another way, if we were down three million, but if you add back in the C$15 million, we would have been up C$12 million. That's about 3% to 4% increase in terms of year-over-year run rates. More or less in line with -- with what we would expect. I'm going forward to try and answer your question. The run rates obviously will depend on volume but I think if you look at the run rates, on an average basis through '05 we've been running sort of a 325, 330-plus number. I would expect that to be a little bit higher in -- in '06. We have given guidance on unit rate inflation for next year. But obviously we'll be trying to offset that with volume. So I'm not going to get specific on a quarterly run rate. But, you know, we'd hoped to do less than, say, a 5% overall increase in comp and benefits expense. But I do have to qualify that it depends on volume.

That's very helpful. And then just as a second question, on the volume side, you -- volumes came in for the quarter up 1.2% through three weeks, the AA -- AR data that I'm looking at, volumes are up 1.4%. What should we be thinking in terms of volume growth throughout the year, you know, assuming the economy stays kind of where you're looking at it now? What's assumed in your revenue assumptions for volume?

Ed, my recollection of what we said from a -- on a volume perspective was kind of in the three to four range is what our expectations were. And obviously price is over and above that. So I have no reason to believe based on what I consider to be a good start to the year that we have any reason to believe we won't deliver some -- some volume growth of that nature.

And Fred, is that rampant through the year or pretty consistent three to four do you think?

Well again, I think, Ed, that the difficulty that we have, and of course you in the analyst community have, is that we have a degree of uncertainty associated with our biggest customer about when they will move their tons. Similarly we have the situation around Pot Ash which, as I mentioned, has some seasonality movement. So I think at this point in time the best I can say to you is that over the course of the year, we believe that we will grow by the amounts I've -- I've referred to. Exactly which quarter it's going to happen in, I wish the customers could give me that clarity, and I'd be happy to share it with it.

Fair enough. Thanks a lot, guys, for the time.

James Valentine, Morgan Stanley

Yes, thank you, great quarter, guys. Pricing was up 9%, but we've got to take out Elk Valley. And candidly, I didn't do the math yet, and I'd probably do it wrong anyways. So can you walk us through what you think, kind of the core pricing was in the fourth quarter and do you think that level would be sustainable into the full year 2006 for everything x coal.

I think, Jim it's Fred. The best way to address that i simply to say that as -- as we have up until this point on the previous calls, that our experience has been that about half of the price increase can be attributed to the, uniqueness of the Elk Valley coal deal. So that puts us back in kind of the four-ish range, would be the net price increase that -- that we would attribute to the balance of our marketplace.

Do you think that 4% is sustainable in 2006 in terms of the total -- let me think, you already have rolling over, what's your inflation clauses on some of your older contracts, blended all, do you think 4%'s a realistic number?

I'm feeling good about the marketplace and the pricing side of the marketplace, Jim. We have, as I said in the call, we have nearly 50% of our business is going to turn over. And I am optimistic that certainly in the high threes or four-ish range is a good target -- a good target for us from a pure pricing perspective.

Good, and then if I can ask one other question on the pricing. The -- when -- at one point it came over, it was an analysts meeting or maybe prior meeting, but I think you had made a comment about how most of your intermodal contracts had rolled over in the last year. And that some of your auto contracts were rolling over there late last year, early this year. And obviously we know Elk Valley has rolled over. When you think about what's still left, how -- how big of a number is that in terms of the amount of total revenue that you guys haven't real he a chance to touch in terms of taking up pricing in this new pricing environment?

Jim, a little bit of a long answer if I may. I believe what I said in our December -- November analysts call was that probably about 15% of our business hasn't been touched over the last, whatever, 24, 36 months [inaudible].

That's 1-5, right?

Yes. Now that said, our expectations on price increase, 36 months ago, 24 months ago, I mean quite candidly, have been too modest. And as a result of that, although they have been touched in that time frame, I have reason to believe that as we go back and turn over those 36 and 24 and whatever, 18 month ago contracts, there could well be another nice bump in those -- in those contracts. So just because they've been touched once sometime over the last 36 months does not mean that we can't take a significant price increase, if the market circumstances allow us to do that.

Right. Thanks so much, guys. Appreciate it.

Thank you.

Scott Flower, Citigroup.

Yes, Scott Flower. Hi, all. Just, I guess a couple questions. One is, and I know Fred talked about this, but I want to get more color on the forest segment. Is that primarily currency driven on the -- on the paper and pulp side? Are you seeing in the lumber side? Are you seeing any impacts on the -- on the exports in the US relative to the slowing in the -- in the housing markets? I'm trying to get a little more color how you look at forest products and all the moving parts and pieces, why things are getting more dampened there.

Scott, I -- first of all just for clarity, the market in January has actually remained quite -- quite strong. So I don't -- I don't want to mislead anybody by saying that we -- we are experiencing substantial reduction. In fact, the market is -- is reasonably strong. What I do want to point out is I think I've been consistent on, is simply saying when you add up the combination of factors which is the escalating value of the Canadian dollar, the high input price in the sense of, say, natural gas for the production in pulp mills or heating other facilities or whatever use they might have, and you put those circumstances in place, it just seems inevitable that there will be a series of smaller, less efficient facilities that are rationalized. Now, we are starting to see occasionally exactly that happening with small mills here and there shutting down or people going from, whatever, three shifts a day to two shifts a day in certain circumstances. So overall, demand has remained quite strong. Overall we continue to move a large amount of forest products given our relative, modest franchise in that area. But when we look at the areas that could get soft for us, the combination of the factors I've described makes us weary about the ability of the Canadian producer to compete over the long term. So that's -- that's the only commentary I'm making in the forest products.

Okay. And the other question, and forgive me if this was covered by you, Mike, but in the release it talks about how there's a favorable 15 million after tax reversal I guess in labor restructuring and environmental. I guess I'm not quite sure where those reversals lay. Are they above the line, below the line, are they netted against your -- your current restructuring? I'm just trying to get a little clarity on that line in release because I'm not quite sure where that -- that runs in your financials.

Scott, with clarity, we reversed the labor liability in a previous period. They had to do with a liability we recognized actually over a year ago with respect to restructuring our US north east operations. We took the liability as was appropriate and ended up subsequently reversing that. That's what you're seeing in terms of -- of last year's numbers. This period just for clarity, we have taken a labor liability, this pertains to the reduction of the 400 staff, that was 44 million pretax with a C$16 million tax offset for 28 million after tax. The other C$15 million for clarity, that seems to be topical, is just the pretax swing in comp and benefits expense as a consequence of the swing in -- in incentive comp, the DSUs and the SARS. Does that help?

Yes. So basically the 15 million that's referenced in the release is actually last year's, so you're just making a comparison as to opposed to something that was reversal in this year's fourth qu -- fourth quarter?

Yes. We do refer to that as in last year's numbers, yes.

Okay, thank you.

Tom Wadewitz, J.P. Morgan.

Yes, good morning. Two questions for you. And I guess before I get going, good, good results for the quarter certainly. Let's see. Within the yields, I wanted to drill down a little bit further. I know you've had questions on intermodal and industrial yields were very -- very strong in both of those and accelerated quite a bit from third quarter. I'm wondering if you can give a sense of how much of that is -- fuel surcharge type of thing that really bumped them up in the quarter or how much of that is you reprice in business toward the end of the year, and that just is really kicking in in the quarter because those both were accelerated quite a bit on the yield side.

It's Fred. You know what, I don't want to get into splitting up fuel surcharges by industry segment. Obviously we're into competitive information when you start to -- to get into that level of detail. I will say that in -- in principle, we obviously continued to expand the numbers of contracts and the amount of business covered by some form of fuel escalation. So it clearly was a significant contributor. But I would also suggest to you that we continue to -- to pursue in the marketplace general price increases. And the market has been such that we have been able to secure those and maintain or grow our volumes.

So from a timing perspective then, with 20% increase in industrial yields, 10% in intermodal, those are pretty impressive numbers. I mean, can we expect those to continue for a few quarters in '06?

There's -- there's nothing on the horizon that I am seeing in the marketplace that says that we can't continue to commend the price references or the price points that I've -- I've referred to. So overall, collectively, we are aiming for the high threes to four. That's a reasonable and competitive price. Should there be unique circumstances as I referred to in my comments with Jim about contracts that have not previously been dealt with, then obviously there's some upside in those. Should there be unique and competitive circumstances that wouldn't allow us to commend that, we would address that with a particular situation.

Okay. And I guess, I think maybe I have a chance for one more here and then I'll pass it along.

Just, Tom.

Can you give a sense, you have coal production, you have potential for fluidity improvement, and I know some of these things probably get blurred together, but are there any cost numbers you can, roughly attribute to those -- those factors when you look at '06?

I think the way we close to deal with that in November I'm going to stick with, which is to say we have offered up orders of magnitude, if I recall correctly, of about C$30 million in benefits that we attributed to the fluidity of the railway, and the IOP compliance approach that we've taken to the scheduled railway. And, rather than attempt to break it into the components of what's coal production, what's this, what's that, I will tell you there's a significant pool of initiatives. And we have a team of people that are -- are running the wheels off the cars these days in an effort to really, really bring home that number. And if there's more upside than obviously we will indicate that as it becomes clearer to us that we can definitely deliver more.

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

Thank you.

[Chris Wetherbee], Merrill Lynch.

Hi. It's actually Chris Wetherbee in for Ken this morning. A question on the western expansion, I just want to get an update, If I could, as to where, sort of volumes are shaking out or where they can go? Any difference in your thoughts between November and now as far as how much you can get as far as quality volumes on that part of the network in '06?

Chris, it's Fred. I would suggest that because of the uncertainty and the seasonality shifting going on, the uncertainty that is around where coal is actually going to end up and the seasonality shifting in Pot Ash, it's tough for me to be any more specific than what I was. What I -- what I said in November, if I recall correctly, Chris, was that we probably consume about 15% of our new capacity in Q1, ramping up to perhaps as much as 50% by the end of the year. Now the grain business is strong and has -- has been strong. The international business appears to be going as we expected, which is a favorable growth. The coal business, we're all in it together, kind of waiting for clarity from -- from our major shipper, Elk Valley. The Pot Ash business, for those who monitor that industry, you may have seen some very, very strong statements made as recently, I believe, as mid last week by PCS about their -- their belief that after what is clearly a very quiet Q1 by their standards and ours that there will be a robust pickup quarters two through four. So, I guess at the end of the day what I'm saying is because of the coal uncertainty we might be light in Q1, Q2 versus my original estimates. But at this point in time it sure looks like Q3 and Q4, again, subject to what Elk Valley says could well meet the numbers I provided.

Okay, so there could be some pickup in the back half of the year?

I believe so.

Okay. And then finally one -- one quick other question on the revenue turn. You mentioned 50% of your revenues will be turned in 2006 are up for repricing. Give us perspective what that was -- what that number was in 2005?

Chris, I should have that at the tip of my fingers and the number that comes to mind for me, but I stand to verify this offline I think was in the 35 to 45% range. But I just, for whatever reason I don't have that with me. I apologize.

Okay. Great. Thank you very much.

Randy Cousins, BMO Nesbitt Burns, Inc.

Good morning, everyone. You guys have not given any sort of guidance with reference to Q1. Railroading is not a winter sport. We've had a very mild winter. Kind of missing some of the sort of minus 40-type numbers, which are negative for rails and lots of snow. On the other hand, you're not going to move the coal and the pot ash in Q1. Intermodal comes off seasonably. Can you give us some sense as to sort of how to think about sort of first quarter given the sort of to's and fro's working through the system?

Randy, it's Fred. You know, we're -- we're not going to do EPS estimates by quarter, but I can tell you that the railroad is running very, very, very well. So we'll continue to run this railroad as well as we possibly can, and -- and you guys can monitor as -- as I do obviously, the -- the seasonality to the two big bulk commodities. And you know, it's going to be what it's going to be.

I guess if there -- if there the potential -- if you have the excess capacity, because the bulk stuff isn't moving, is there's a potential to make up some of that differential in the first quarter with other products?

Well, there's always the potential for that, Randy. I think if you recall when we introduced in December, after the November analysts meeting we -- when we had new news from our major coal customer, we introduced the belief that the absence of some amount of coal, yet to be determined, but the absence of that could, at least partially be offset by successfully moving more international and more -- more grain. And international is moving as we thought it would move, and grain is moving quite strong, you recall my reference to the 50 million, 50 million-plus metric ton crop versus our original November understanding of about 47. So grain is, in fact, a little stronger than we thought it would be.

Okay. And then I guess just for Mike, can you give us how to model a tax line in the context of deferred taxes versus cash taxes?.

Randy, on a adjusted income, most of the tax that you see, as you well know, is currently deferred tax. We will become cash taxable in 2006. More so in the US than in Canada. But -- so what will happen is, two things from a cash standpoint. You will see the cash impact largely commence in '07 as there are a number of ways to have cash tax installed in Canada in particular. There will be a modest cash contribution there. But you'll start to see deferred tax reduce over the next few years. And on a normal run rate base, assuming, normal capital reinvestment rates and so on, I would say two to three years out, a deferred tax number of about half, about 50%, and so I'd put a -- a ruler between the two points and ramp it up on that basis.

So basically, if I may understand what you said, it's -- so if you're doing -- if you have accrued C$100 for taxes on -- on GAAP, in your income statement we should be probably be looking at, what, 60% of that, 70% -- excuse me, 30% to 40% of that being cash component, and then increasing to sort of 50%?

Yes, so -- but that will be over the next couple of years, Randy. So I'd -- I'd ramp it up.

Okay. Thank you.

Bill MacKenzie of TD Newcrest.

Thank you. Mike, just on pensions, I was wondering if since November there have been any changes to your -- your pension assumptions as you get to the end of the year and when you look at all of those assumptions and if you could remind us what you have included in, sort of '06 from a cash and accounting perspective?

We're in the process, Bill, of trueing up the pensions. I guess in terms of the assumption, the key assumptions, our expected return on plan assets, we've been returning an 8% number there. We don't anticipate changing that. We had very, very strong performance in terms of the asset classes, the DB plans in 2005. The major swing will be in the discount rate which, in the previous year, was 6%, and into 2006 will likely be subject to finalization, a 5.25% number. And I have to -- to jump in here with my normal speech on this. But you know that -- that means that our lia -- liability is increasing very significantly for every 1% change here a reduction, a 75 basis point reduction. But for a 1% reduction in the -- in the discount factor or 1% increase, our liability moves by C$600 million. What we're doing here is we're taking a snapshot of an obligation that goes over many, many, years into the future, using 50-year lows and interest rates. And so on the one hand I'm concerned about it. On the other hand, one is manageable for us, I think, to -- I think over time, this -- this type of number will reduce. In any event, having said that, 75 basis point reduction in the discount rate, you can do the math. But that would otherwise mean that we would see a significant increase in liability. Offsetting that is the asset performance. So we have yet to finalize the unfunded position. But it will increase.

In terms of cash in 2005, we put 140 million into the DB plans. Our current service cost numbers around 60 to C$70 million. Some fairly healthy funding. Still to be finalized for cash contributions in '06. That number will be order of magnitude C$200 million. But again subject to finalization. And we'll disclose that in our ND&A

And is that 200 million consistent with what you were thinking in -- in November? I'm wondering with your free cash flow, estimates that you've talked about for '06 before, has that changed at all?

No, it doesn't change the free cash flow numbers. In fact, it's interesting, as you know, Bill, it's the cash number that I focus on a bit more at this point in time. But that -- that number is consistent with the free cash forecast that we gave you in November.

Okay, great. And then just one other question, I guess, on cash again. Looking at the restructuring payments in '06 and '07. With these most recent restructurings in Q4 and '01, does that impact at all the payments they'd be making in '06 and '07? And can you just remind me again what -- what those cash payments will be in those two years?

Well prior to the 400 reduction, we saw those restructuring payments trending down to 70, 60, 50, C$40 million that's going through '05, '06 time frame. The 44 million, most that cash will go out during the first and second quarters of this year. That reduction had to do with early retirement. And -- and bridging programs. So that will tend to flow very quickly through '06. We have also taken that into our cash flow forecast for '06. Obviously we're working on this back in the fourth quarter. So no change again on the cash projection.

And just can you -- ?

We're going to have to move on. We have -- we're running out of time. You've had a couple of questions. Okay? Operator, next one.

[Aaron Ducksbury, National Bank Financial].

Hi, guys. Just a quick clarification. Of the -- you gave the breakdown by mix, volume, yield, and that, for that of the full year, but can you provide that for the Q4?

Q4, Aaron, was overall volume was -- or growth rather was 15%. Foreign exchange would have been another 2% to make it 17%. 7.5% was price. Fuel was 4.5%, and volume and mix combined was about 3%.

So I assume Elk Valley, half of that 7.5 again?

Thereabouts, yes.

Okay. And just moving on, I noticed on your web site, you made changes to your surcharge program with the new CP 9600. So I was wondering if you could break down first how many of your customers are on a surcharge and of those customers, what percent are on the new surcharge, which is quite a bit lower? And what percent was on the -- the older one?

Well, starting with the -- the first issue, Aaron, we -- we at this point time believe that about 96% of all of the documents that we have, and that's a combination of tariffs and contracts, etc., now include either a fuel surcharge specific or include an index. That represents, we think, just over 90% of the revenue stream. Now, with regard to your commentary about us moving to what is now our third or fourth iteration of a fuel surcharge, effective January the first, with each new piece of business we are introducing the different tariff you referred to, and as each piece of business gets renewed, we are migrating to the new fuel surcharge as well. So given that we're only 30 days into it, you can appreciate that at this point the number or percentage of business on what is now our new fuel surcharge remains fairly modest. And probably in the hundreds of millions of dollars at the most. But over the course of the year, obviously, if we're going to turn over 50% of our business, we would like to think that the majority of -- of that business could be migrated and will be migrated to the different fuel surcharge.

Okay. That's great. Thanks.

Thank you, Aaron.

[Walter Sprocklin], RBC Capital Markets.

Yes, thanks very much. Good morning. Question on your free cash-flow, y o mentioned a turning about, 200 million in 2006. Beg a question then, user proceeds on that, you talked about some of the pension funding and some of the draws on that but the 200 million is x that. Mike, you had mentioned that there was -- you're in line with your target debt ratios now. Is that what you see or in the 40% level as your optimal debt level? In other words, are we going to see more debt repayment here, and what is the target payout ratio in terms of dividends?

In terms of the balance sheet, Walter, I think the balance sheet looks strong. In terms of a target number, obviously we're committed to investment grade and -- and I would expect to see that that ratio in ordinary times 38 to 42%. So I don't see a need, in other words, to repay debt with the cash. The plan's in pretty good shape. In terms of the going forward, you know, the -- the free cash, I mean as free cash gets better, as earnings grow, that normally bodes well for -- for dividends. But that's for the board to decide. We have a board meeting in February, and I should stand down and let them do their work. But directionally good.

Okay. Second question, just on the co-production initiatives that you've -- you've announced. You'd mentioned that this is -- is having a positive impact on the quarter on your -- on your purchase services and other. Is there any way we can get a sense of -- of, the order of magnitude going into '06? given the ones you've announced and, whether this will be a strategy to, focus strategy for you to announce more, and what -- how does that work and in order of magnitude and how that will impact, that line item?

Walter, it's Fred. Again, our -- our approach to this has been, and I think should remain as -- as a cluster of -- of activities. So yes, we have a series now of four or five, I would argue, significant and series of other less significant but still important co-production activities. If you qualitatively, if you -- if you visualize that we're able to repatriate business that we had been paying other people to do, obviously that's going to be a good thing. And that's -- that's clearly what is being done as we have repatriated some business back onto our lines now that our capacity's in place. We've done the same thing in eastern Canada. So there clearly is some benefits from it, but it -- as I said in reference to an earlier question, I am not prepared at this point in time to kind of break down that bundle of benefits that we had committed to, to the shareholders that we would deliver by specific item because there's so many puts and takes in the business. It'sjust not -- not worth the effort. So apologies, but we're not going to go any more specific than that.

Okay. One housekeeping -- ?

Walter, we have to -- we have to move on. We're running out of time. Thank you. Operator, we'll take one more question and then go to media.

[Kevin Maxka, BB&T]

Good morning. Just a question on your service levels. And I guess the question on the industry and your Company specifically. With -- with all the money that's been spent and all the time that's been spent across the industry and at your Company addressing service levels, we've seen kind of some improvements in fits and starts but no real material improvements. I'm just wondering, you showed a slide on that in your presentation, but I'm just wondering should we expect at some point later in '06 to see that very visible material improvement in service levels in general?

Well, you know, I disagree with the -- your assumption that they haven't improved or improved only marginally. I think the industry's done a good job. Particularly when you consider the workload that's been presented to the industry over the last 10 years. You just can't look at service levels year-to-year or quarter-to-quarter. Now there's been some real stabs on some parts of the North American network, particularly from hurricanes in the last couple of quarters. So the coal production initiatives I think go a long way and I think show a desire on the industry to act more like a network, and to improve service end-to-end across interchanges. So I'm -- I'm very bullish that the industry' has this one by the tail and is moving strongly. We have not, as an industry, had a great pricing environment which has led to certain cash flow issues, but I think that's behind us. So I think we're -- we're moving. So Fred, you got anything else you want to add to that?

Kevin, first of all, I support exactly what Rob said. But more specific to CPR, I can tell you that you're not going to have to wait until the end of '06 to see an improvement in service levels. We do our own metrics, as you can appreciate. We monitor weekly the number of clients that are very satisfied, somewhat satisfied, and okay. And the odd one that's dissatisfied. I'd like to share with you that over the course of January, we have had I think three out of four weeks now where we've had zero or one customer that we would categorize as red versus a green customer, as in satisfied. So I believe that you are already seeing on our property anyway some pretty dramatic improvement in the quality of the service offering. And we're -- we're quite satisfied, as I said, that's going to position us well when we come to our -- our yield discussions going forward and our ability to repatriate our business from truck.

Okay, guys. Thanks a lot. I appreciate the extra color. We don't hear an awful lot from customers talking about excellent rail service in general. So thanks for the extra color.

Okay. Thank you. Well, that's it from the analysts' call. Strong exit to the year and a very good beginning to the new year. So we'll now, operator, go to the media.

Chris Sorenson, National Post

Hi, there. Just a quick question. There's been a lot of talk about the sort of gap in operating ratio between you and CN. And I was just curious if closing that gap is primarily a function of reducing costs like some of the headcount reductions that you talked about earlier, versus growing revenue? And also just what impact your expansion had on making improvements in the operating ratio?

Well, there are certainly two different companies. And although we both begin with the name Canadian, we're much different. And so obviously, there's al -- always this comparison. The -- if you take a look, we've made some consistent improvements. We were much different companies when CN was privatized, and I think CP has made some dramatic and heroic improvements since that time. We -- obviously have to improve both revenue and costs side of the equation. I think if you take a look at our cost side, CP's making some very good productivity improvements. Revenue side, I can't point to a better year than what the marketing folks of this Company have done. Excellent on both yield and volume. So I -- I'm very positive that CP has a -- a very good game plan. That's unique to the specific asset that this Company is managing. And I think as Mike pointed out, making a good return on a capital employed. We've also said we're going to continue to make improvements into 75% operating ratio. So steady as she goes from CP's point of view. I don't see us -- ourselves chasing some magic number because other companies with different assets have an ability to do different things. Fred, you want to add anything to that one?

I think Rob's covered the waterfront, Chris. Clearly as we go forward, as both Mike and I refer to in our comments, we have increasing focus on expense. We think that a we can -- we can continue to drive expense out of the business while providing a -- an ongoing, improving commodity. So Mike, comments?

Yes, it's interesting, we haven't rehearsed this part. Fred's talked a lot about simplicity. And -- and I've been hung up on variability. And I think to some degree, the same thing. Rob mentioned the SIO office. Clearly the staff reductions, to answer your ques -- question, are key parts of that. We have initiatives going on sourcing, that would include potentially some benefits in how we manage capital. The cost reviews as pertaining to yards and facilities, and then that combined with the work that Fred and Neil Footham and their people are doing in yard, fluidity, train balancing, demand management and so on. Clearly we see ourselves having some additional room to -- to lower our numbers. And that's -- those are examples of some of the work -- some of the work that's going on here.

Okay. Fair enough. Thanks.

Thank you.

[Allan Dow], Reuters

Okay. Can you hear me?

Yes, we can hear you, Allan.

When -- following up on that comment you made about the sort of switch tool, less centralized management or operational structure at the beginning of the year, can you elaborate a little bit on why the decision was made to do that, and why now?

Why don't I just start because I was here, and so was Fred. And -- when we moved from Montreal, we -- we really centralized in 95 to -- to get a grip of a decentralized unit, business unit-based railway. And I -- that served us well over the latter part of the 1990's, first part of the two thou -- the second millennium. But Fred took a look around since he was made President and Chief Operating Officer, and felt that given the staff that he had, the challenges and opportunities in the marketplace, that the Company could respond in a better manner. And Fred, I'll turn that over to you.

Allan, I would only add on Rob's point one key factor from my perspective. We -- we learned an enormous amount as a common team, largely based here in -- at the executive levels, largely based here in Calgary. We have one game plan. We know exactly what we want to accomplish. And we have migrated now from a lot of thinking and planning into the very, very important step of execution excellence. And I don't think you can deliver that level of execution excellence with all of your leadership centralized. So we are decentralizing to ensure that we've got the ability to be nimble and be quick and make the kinds of decisions in the field that one would want to have made. But remember that the people that are going out to do that come having -- having spent several years learning and understanding what it is we have as a single game plan for this Company. So I'm -- I am very comfortable. We're ready to go here. I'm quite excited about the kind of benefit that this -- that this change is going to bring our Company.

Thanks.

You're welcome.

[ Lisa Schmidt, Calgary Herald]

Hi, I just had a question on the job cuts. Where do most of those take place? In the head office in Calgary, and are they coming through attrition or -- retirements? How does that break out?

Okay, you are a little -- faint there, Lisa. So you're asking about the job cuts, are they coming mainly from the head office and how much are -- are -- is attrition?

That's right. Yes.

Yes. The -- the cuts are weighted to head office. But again, they're related will to what we're trying to do, I think, in a broader sense as a railway reducing variability, simplicity. Where there is less variability there's less need for support, analytics, and so on and so forth. So waited to the head office. But are broad based. The other part of it is obviously we'll take full advantage of attrition, a significant part, though, of these reductions are comprised of two components. One would be early retirement, and the others would be bridging. This is for people that are within a few years of retirement. And -- and we help them in terms of parting ways with -- with an equitable program.

Okay. Thank you.

Thanks Lisa.

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

Thank you, John. You run a good call. Thank you very much and good night or good-bye, everyone. And we will talk to you at the first quarter. Bye-bye.

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