Canadian Pacific Kansas City Ltd (CP) 2006 Q3 法說會逐字稿

Welcome to the Canadian Pacific Railway 2006 third quarter results conference call. [OPERATOR INSTRUCTIONS] I would like to remind everyone that this conference call is being recorded on Tuesday, October 24th, 2006, at 11:00 am Eastern time. And will now turn the conference over to Ms. Janet Weiss, Assistance VP Investor Relations of Canadian Pacific Railway. Please go ahead ma'am.

Thank you, Evan. Good morning, ladies and gentlemen. Thanks for joining us on our 2006 third quarter teleconference. Presenters today will be Fred Green, our President and Chief Executive Officer, Brock Winter, our Senior Vice President of Operations, Marcella Szel, our Senior VP of Marketing and Sales, and Brian Grassby , our VP and Comptroller.

Before we get started let me remind you that 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 appendices, which can be found in the last section of the presentation material. The risks and uncertainties and other factors that could influence actual results are described on slide two in the press release and in the MV&A filed with Canadian and U.S. securities regulators. Please read carefully as these assumptions could change throughout the year.

All dollars quoted in the presentation are Canadian unless otherwise stated. This presentation also contains nonGAAP measures. Please read slide three. The slides are available on our website so please follow along. Here then is our President and CEO, Fred Green.

Thanks, Janet. And good morning everyone. Ladies and gentlemen our railway has just completed a strong third quarter, our scheduled railroad drove meaningful operational improvements and I'sm really pleased with the momentum. Perhaps more importantly we still have much more to accomplish and we have a team deeply focused on this opportunity. This quarter our team delivered EPS growth of 26%. And our operating ratio improved 320 basis points. Very importantly we accomplished this while posting substantial safety improvements in both personal injuries and train accidents.

And we've strengthened our team. Two weeks ago we announced the addition of Mike Lambert to our Senior Management Team. Mike, our new Executive Vice President and Chief Financial Officer, is with us on the call today. Many of you will meet and learn more about Mike at our analyst workshop next month. So all in a very good quarter with operating momentum, cost management discipline and continued yield improvements. Now I'll turn it over to Brock for the operations story, Marcella for a commercial update and then Brian to tie with the financials. Brock, over to you.

Thanks, Fred. Our scheduled railroad is delivering strong results. On slide seven you can see we continued to post some impressive year-over-year improvements in operating performance driven by our focus on execution excellence. In Q3 our train speed improved 16% as our operating process improvements, in coal production initiatives created greater operational fluidity. [inaudible] improved 11% with our relentless focus on velocity. In the bottom two charts you can see the impact of this success. We've improved our car velocity by 14 % and reduced our average cars on line by 7% which in turn has driven down our equipment [inaudible]. The railroad is running very well in line with our objective to be the safest, most fluid railway in North America.

Moving to slide eight. Our focus on execution excellence is creating value for our customers. Our service performance was excellent with our Intermodal and merchandise offerings at over 90% on time. Our customer service problem logs are now down to less than 25 issues per day, a 72% improvement. An impressive result when you consider that we have 11,000 shipments entering our network every day. We recently received American Hondas' performance excellence award. The award recognizing the railroads superior performance in four key areas, on time performance, damage prevention, equipment supply and equipment condition. Without a doubt our focus on running a disciplined balance and fluid railroad is working for our customers.

Moving to slide nine. A key objective this year was to achieve daily train balance in our primary corridors. Balance means operating the same number of trains in each direction in order to optimize power and crews. I'd like to talk briefly about the benefits we are achieving. First our true to train ratio improved by 33% in the quarter. This in turn reduced our taxis--our use of taxis to reposition crews by over 3,600 trips in the quarter, a reduction of 26%. The result is that we need about 100 fewer running trains employees to run the operation. Balance has also allowed the more productive use of our locomotives, resulting in locomotive dead heading being down 21% in the quarter. Our driving the benefits of balance and engineering services well, where our overtime fell 19%. Running a balanced scheduled railroad allows for more efficient deployment of track maintenance personnel.

Finally I should note that our engineering work programs are in the final stages of being completed, on time and on budget. And I am proud that we did all of this with the train operations safety record that has improved 44% on a year-to-date basis. We are the leader in train operation safety in North America. All of this positions us for a solid Q4 for operations. The railroad is running very well and we continue on track to hit our scheduled railroad expense reduction target of C$35 million by year end. With that I'll turn it over to Marcella to review our marketing results and outlook.

Thanks, Brock. Let's turn over to slide 11. Total revenues were up a little over 7% adjusted for exchange. Price and fuel pushed revenues up while mix and volume were basically a wash. Foreign exchange negatively impacted reported results by 3% resulting in 4% reported revenue. Strong grain and industrial product revenues and a rebound in export potash shipments drove revenue up. Carloadings were negatively impacted by soft coal volumes, 13,000 fewer loads as a result of the sale of the [latter] subdivisions and a few remarketing activities. Our continued focus on generating quality revenue continues to pay off.

On to slide 11 and I'll walk you through the results by line of business. Grain was a gain, a real success story this quarter driven by excellent service of strong Canadian export shipments. Total revenues grew by more than 18% compared to last year and, a double-digit increase in car loads. U.S. grain volume came in flat while Canadian car loads were up 20%. All revenues remain stubbornly sluggish with volumes off 28%. August and September were expected to show some turn around but did not. Softness in [inaudible] volumes has impacted both exports and eastbound volumes. In the sulphur and fertilizer portfolio revenues were up 10%. Potash was the main driver with September as a record month for CPR shipments.

The fourth product side revenues were flat reflecting shutdowns in the pulp and paper sectors and continued softness in the lumber and panel markets. Industrial product revenues were up 13%, we saw strength across most segments, fuel and energy was the strongest performance. Overall yield in industrial products was very solid with the average rate per car up over 13%. Our auto revenues grew 3% on the quarter with long haul imports offsetting softer volumes from the big three. Intermodal revenue was up almost 8% on relatively flat volumes. The strike affecting the terminal we used at the port of Philadelphia and a slow start to the fall peak tempered our Q3 handling. However, we continue to deliver good yield results in this segment of our business.

And turning to yield we expect to finish the year ahead of our 3% same-store price start up. Our third quarter contract renewals averaged price increases in the 6% range. Average revenue per car was up 11% exchange adjusted. Overall we're continuing to see good yield opportunities in the market.

Now over to slide 13 and I'll provide an update through the end of the year. On the grain side the Canadian harvest is basically complete. This crop is of very good quality and is augmented by a higher than normal carry over from last year. We're well positioned to handle these volumes. U.S., despite our previous concerns over crop yield, the balance of the year looks to be pretty solid, with good demand in the Pacific Northwest export and domestic sectors. Anticipate that grain volumes overall in Q4 will be up around 10 to 15%.

Now with respect to coal, Elk Valley has narrowed its sales forecast for 2006. They are not changing our outlook and are modeling our volumes within their 22 to 23 million metric tons sales range. Thus out looking on a full year basis and truing up for the [lattice] sales, we're modeling our total coal year end volumes to be off by 15 to 20% from last year. The sulphur and fertilizer sector should continue to make up ground lost as a result of the late start to the export potash season. Consistent with past out looks we're modeling export potash to finish the year within 85 to 90% of 2005.

Moving on to the merchandise portfolio. Starting with forest products the outlook remains weak. Industrial products side doubt closer of their [inaudible] plant will be a headwind. However we still expect solid growth in the industrial product portfolio and we will see continued strong Alberta activity. On the automotive side, overall 2006 volumes are likely to continue trending down. However, we're expecting to finish the year slightly above 2005 on revenues.

Finally the balance of the year for both international and domestic Intermodal looks solid. The market is now adapting to our balance of product offering, allocations have been increased at the port of Vancouver and we're now back in operation at the terminal we use at the port of Philadelphia. So to conclude we have an excellent Canadian grain crop to move, strong industrial products demand, natural strength in the Alberta region, very good service and continued yield opportunities. Over to you, Brian.

Thanks, Marcella. Please turn to slide 15 in the income statement and I will give you a quick overview of our reported earnings. Starting at the top, [train] revenues were up 4%. Other revenues were up 4 million. Nothing significant here and year end other revenues are now expected to be around 150 million. Please remember that in Q4 other revenues will be not as strong as last year. Total freight and other revenues were up 47 million or 4%. Excluding the 34 million impact of the strength in Canadian dollar total revenues would have been up 7%. Operating expenses were flat with excellent cost management and a stronger Canadian dollar offsetting higher fuel costs and inflation. By holding expenses flat we were able to bring the growth in revenues to the bottom line. As a result operating income was up 48 million or a 19% improvement.

Below the operating income line other charges were flat as expected and interest expense was down due to the impact of the stronger Canadian dollar on our U.S. dollar debt. Our adjusted income, which is before foreign exchange gains or losses on long-term debt and other specified items, was 168 million, or a 24% improvement versus last year. Went from adjusted income to reported income we generated a small foreign exchange loss on long-term debt in the quarter. This compares to a significant foreign exchange gain in 2005. As well as you will also recall we reported a partial reversal of an environmental accrual in Q3, 2005. So factoring in these two items, our all in reported diluted earnings per share came in at C$1.02.

Turn to slide 16 and I will reconcile our EPS growth. Starting on the left, wage and benefit inflation is running in the 3 to 4% range in line with expectations. Once you add the 10 million of increased pension expense, the total EPS impact is C$0.08. Depreciation dropped EPS was C$0.03. On the positive side our strong yield program offset slightly by our net fuel exposure added C$0.16. Our initiative, namely the headcount reductions, the scheduled railroad and coal production, a 27 million, or C$0.12 EPS. These savings are right on target. We expect these initiatives to continue into Q4. However, we will start to lapse certain coal production initiatives that started to gain traction in the fall of last year.

Lastly a fuel tax refund of C$0.03 and all other of C$0.02 brings us to the C$1.06. Overall our team performed well, both yield and our operating initiatives overcame inflationary pressures and delivered 26% adjusted EPS growth.

And let me give you more detail on our operating expenses on slide 17. Starting at the top, compensation and benefits expense was down on the quarter, I'll expand on this in a moment. Fuel was up 19 million or 14%. Driven by a C$36 million impact of higher WTI prices, refining margins and a reduced hedge position. Offset to a degree by the fuel tax refund I mentioned before. Materials were up 2 million or 4%. The schedule railroad improvements are having a positive benefit on the equipments rent line with expenses down 9 million or 18%. Moving down the page, depreciation expense came in as expected and will be about 5% higher than 2005 on a full year basis.

And finally improvements from coal production and our scheduled railroad are helping to lower joint facility through transportation and lodging costs and purchase services. Foreign exchange helped out the quarter by 26 million, and once you strip out the 36 million impact of higher fuel prices, operating expenses declined 4%.

Go to slide 18 and I will give you more detail on compensation and benefits. Starting on the left, wage and benefit inflation came in as expected and cost us 10 million. The 10 million increase in pension expense quarter-over-quarter reflects the current annual service cost of 80 million which is up from 40 million in 2005. Incentive based compensation had a positive 2 million impact. This is a combination of a 13 million positive impact of stock-based compensation compared with 2005, offset by a 2006 catch up in other incentive comps.

A program to reduce management and administration positions saved approximately 12 million. This is in line with our stated run rate. Our scheduled railroad efficiencies reduced crew costs by 6 million, and foreign exchange benefited the quarter by 6 million. All in all we're pleased with the quarter, delivering on our initiatives and managing to offset the low coal volumes. I will now turn it over to Fred.

Thanks, Brian. Now if you will turn to slide 20 I'll wrap up. The year is unfolding well on our scheduled railroad and focused execution are delivering financial impact. In spite of soft coal and the soft start, or slow start in potash we would-- should deliver revenue growth in the 5% range and healthy double-digit EPS growth. Operating expenses and free cash are all coming in as planned. Our share buy-back program is on track and 90 to 100% of our buy back program should be complete by year end. Expect us to continue to manage our costs aggressively while driving operational fluidity and operating ratio improvement. Based on the current trends it's possible that we'll exceed the top end of our earning guidance-- earnings guidance by up to C$0.10 and, of course, we'll calibrate 2007 expectations at our November 16th analyst workshop. Operator, I'll now turn it back to you and we can begin the Q&A.

Thank you. [OPERATOR INSTRUCTIONS] Your first question comes from Ed Wolfe of Bear Stearns. Please go ahead.

Hi, good morning, everybody.

Good morning, Ed.

When you talk about the comps both on the cost side and on the volume side, some of the cost benefits you're seeing now, can you talk about the line items in fourth quarter, some of the ones that are going to start to grandfather themselves? And then separately on the revenue side for potash and coal when you start to see those comps roll over a little bit?

Ed let me talk about the expenses and I'll let Marcella talk about the revenues. Really the initiatives will continue through the fourth quarter in terms of the FTE reduction as well as the IOP compliance. The one area where we are going to start to lap last year is on coal production and that you'll see in purchase services. You shouldn't see much movement except for volume in terms of comp and benefits as well as equipment rents in the fourth quarter.

And on the purchase transportation how much are we talking about that we grandfather?

Probably looking at about a 5 to 6 million.

Okay. On the revenue side?

Hi this is Marcella speaking, on the-- let me just first turn to the potash side, overall for sulphur and fertilizer portfolio which of course includes the potash, for the full year our revenue should come out flat. As you know we've got our big potash customer who wants to move full year potash, export potash in half a year and so we're going to try to move most of that, so that should bring us in flat. On the coal side we expect our revenues in Q4 to be down about 10 to 15%. But there will be an uptick in the volume with the revenue still down.

Does that starts to, I mean how do we think about that as we get to first quarter, are we still declining in coal or does it flatten out year-over-year?

I think today if you were listening to [Jim Popowiches] comments on supporting trust reports, he's not giving any guidance or indication about what's happening for the next year and so we won't either.

Okay so we should suspect that you're not going to give guidance until you hear it probably from [Fordine], is that how we should thinking about the timing?

I think maybe the better way to say it is that we have an analyst conference on the 16th and the 16th of November we will provide the best information we have available to us. Hopefully we've got greater clarity from our major coal customer by that time. But the best information we have will be provided to everybody at that time.

That's fair. And then, Fred, just kind of a bigger picture question, when you think about all the productivity that you, the capacity you added last year and the productivity you're showing this year, how does this play out as the volume starts to come back? Do you believe that some of the productivity is being maybe overstated because there is less volume on the track or do you think that you could handle the volume and continue the productivity? Where is the puts and takes there?

I think, Ed, if you look at the GTMs and the RTMs, in fact they are not substantially down at all, in fact RTMs I think are up slightly I recall correctly. We have an enterprise obviously that has created some capacity. What we said was that over the course of time that capacity would be available to generate EPS. In the short term we've had the benefit of improving our fluidity. And I would attribute the vast majority of the economic benefit generated by quote fluidity to be the process change although clearly the physical plant has helped somewhat.

What I can tell you is that we are very busy out there and we're not seeing any deterioration whatsoever in the fluidity of our business. So the fourth quarter is unfolding as we would hope it would which is a very, very busy time and we're getting both the benefits of moving more business and moving it more efficiently.

Without further productivity benefits from here or further capacity additions from here, and that's probably not a fair assumption, but assuming that how much volume do you think you could add to the railroad without seeing the decline from here?

And I can't do the math in my head but I think maybe the best way to characterize it is I've previously said that in the fourth quarter of this year I would expect that we would use probably less than or approaching 50% of the capacity that we created last year. In other words, we've got the ability to grow our business again in '07 and probably even into '08 without any substantial capacity improvements. We will continue to debottleneck in certain places where rifle shot improvements are appropriate as we would in any normal pattern.

Thanks a lot. Keep up the good work.

Thanks Ed.

Your next question comes from Randy Cousins of the BMO Capital Markets. Please go ahead.

Fred, you're setting yourself up for just a spectacular grain year. The current crop tends to move Q4, then one, two, three of the following year. Given where wheat prices and whatever feedback you're seeing, do you guys get a sense of whether, of how that crop is going to move? Like is a bunch of it going to move in the fourth or-- what's the distribution, is there going to be any shift in distribution given sort of current demand levels and current pricing?

Randy, it's Marcella, what we're out looking is that we're going to be moving the '06, '07 crop about 44, 45% this year and the balance next year; throughout the next year, so the strength we're seeing now we would anticipate would continue given the crop quality.

Okay. And with reference to equity linked compensation you guys talked about hedging off that equity linked compensation. I wonder if you've actually moved forward on that so that--because the stocks had a nice little rally here. Is that going to hit the P&L or is this, or is swing that's in the stock no longer a factor in terms of current-- marker-to-market type issues?

Randy this is Brian, no, we put in place the-- what we referred to the total return swap and it went into place mid Q2. It won't be a perfect offset but the vast majority of any swings in our stock price will be offset with this total return swap. So you will not see great volatility going forward.

Great. Thank you.

Thank you. Your.

Your next question comes from James David of Scotia Capital. Please go ahead.

Thank you. Good morning all.

Good morning.

When you had your conference last year, November you guided to 370, 385, but this was before had you any [inclining] that there were going to be some serious problems with met coal and potash in first half, and met coal continues to be a problem. So I guess the question is given that you're talking about exceeding that range, clearly the absence of these issues you would've had a tremendous year, not to say that the year hasn't been very strong. Is it--has it-- was it conservatism? Was it a positive surprise on productivity? Was it a positive surprise in terms of how much the asset gains generated, what was really underpinning what would've been very--quiet exceptional in that context?

James, it's probably a little bit of everything, but if you wanted to target one thing that we've been just, just absolutely pleased with it's the performance of the operations. Clearly we set some objectives for ourselves with regard to the fluidity of the railway and how that would manifest itself in train speed , in yard performance, in car miles per day, the asset utilization at the locomotive side, and we are clearly making some very big step function improvements. And additionally I think the one thing that we couldn't predict with any certainty but we were very delighted with, is the grain business coming on so strong to help neutralize some of the loss revenues on the other bulk. So it's a combination of those two things but the core in my mind is just how well the operations are running.

Do you feel comfortable, Fred? I'm sure you'll obviously spend a lot of time with this next month. You had a very good sort of year-over-year improvement on the fluidity side. Does this make it tougher for next year? Or can you maintain the pace?

Well the answer is of course it makes it tougher, James, but I have some pretty high expectations and the team is very excited about the things that they've learned during the course of this year and therefore obviously our expectation is we'll continue to improve. We'll calibrate that more about that when we get together.

Okay thank you, Fred. Just a quick question, Brian. Free cash flow after dividends in excess of 200 million, is there any risk you might top off, refund your pension again, somewhat to what we saw a couple years ago?

No, I think we're still waiting for the government to change the regulations with respect to going forward in terms of the amortization period for solvency deficits but, no, we're not looking to topping up the pension this year.

Okay thanks.

Thank you.

Your next question comes from [Walter Staklin] of RBC Capital Markets. Please go ahead.

Thanks very much. Good morning, guys.

Good morning.

Just on the west, if we could focus on your industrial products just for a moment, West Coast drilling activity looks like it's been weakening in the last few weeks, I think utilization is about half the level it was last year. Are you seeing that having an impact on your industrial products activity in this quarter and perhaps talk to what your expectations are sort of going into the, into 2007?

Walter, we're--we have not felt any substantial softness in the industrial products side. If anything it's proven to be quite a strong marketplace. Remember that even though drilling is very, very important to us, be it inbound [frack] sands or be it the pipe coming in, there is just this monstrous amount of activity on supporting the oilsands and related businesses that is drawing a huge amount of product in prefabricated product, pipe and other products, all used in the construction of these major, major enterprises. So you're right on the drilling people are getting a little bit more sensitive given the prices isn't quite where it used to be but as a portion of our activities we are not feeling the impact at all.

Okay and just second and last question, Marcella, you mentioned that renewals, price contract renewals are up 6%. That's overall of your products, I guess. Is there any, what areas would you characterize as being higher than that and where did you see some push back on pricing?

Walter, we've--we obviously price to the market. The number I'm giving you is an average pricing. Each one of our markets behaves differently. Each one of our markets looks for a different type of pricing, and compare a different price so it ranges from the low and the high. So I won't go into any more detail than that just to say that it's a good 6% price increase that we've had on our renewals.

Well that's great. Okay. Fair enough. Thanks very much for your answers.

Thank you.

Your next question comes from Scott Flower of Banc of America Securities. Please go ahead.

Yes, good morning, all.

Hi Scott.

Just wanted to see, in the past you've given us some sense as when we look at the all in price bucket what the blend might be, whether it's 70/30 price versus fuel surcharge or 50/50. Can you give us some rough proximate of how we might think about that in this quarter?

Yes, Scott. The price is about 4%, fuel's 3%.

Okay and then the other question, and this also I think would be for you, Marcella, is can you give us some update on what your coverage level might be on fuel surcharge? In other words I know there may be different mechanisms, your fuel surcharge, R cap, and then some of your business is regulated grain, but could you give us some update on how much of your business is covered and what those buckets might be, whether it's fuel surcharge or whether it's regulated grain or whether it's R cap?

Scott, our coverage is over 90% on all of our commodities. For instance, you refer to regulated grain. It in fact has coverage through the volume index factor, the VRCPI that the government looks at every year. So we're over a 90% coverage with respect to our commodities.

And then how does that rate though for [inaudible] between fuel surcharge versus R cap? Is it mainly fuel surcharge?

Mainly-- it's mainly fuel surcharge. You refer to R cap. We don't have very much R cap, Scott. We have different forms of [NDCs], [hippie NDCs] and other [NDCs] very little of our traffic goes under R cap.

All right. Well thank you very much.

Thank you.

Your next question comes from David [Nehman] of National Bank Financials. Please go ahead.

Good morning.

Good morning, David.

How are you doing?

Good thank you.

Good. Just on pricing, is your book completely rolled over? I think there was like 15% that you noted earlier this year that hadn't been executed at--they were still the older price levels. Is it completely rolled over now?

David, we still have 10 to 15%.

Okay.

Some of --10 to 15% of some of our legacy contracts that still need to be rolled over. They will not be rolled over this year.

David, if I can jump in you may recall in the past that I've made reference to the fact that although we may have rolled them over two years ago or three years ago, the tide is rising and as a result of that what we thought may have been very competitive prices at the time, or very appropriate prices at the time, even though they've been rolled over once or in some cases twice, there's another opportunity that will rise and we'll calibrate them up even further based on the competitive dynamic that appears in the marketplace today.

Okay so if we were to look at that residual part of the book that still is going to be priced up, could we look at an average of 6% on the new renewals, and are you seeing overall, is the pricing better than what you would have anticipated?

David, with respect to the 10 to 15% that's to be rolled over I'm not going to take, I'm not going to estimate what our price increase might be on that because it comes up at different times, in different markets, in different commodity accounts, obviously depend on the type of contractual relationship that we have with our partners. So I'm not going to identify what we might see for a price increase on those contracts. Rather we look at on a annual basis. In terms of our expectations we're hitting our price targets exactly where our expectations were both on the same-store price basis and on a contract renewal basis.

Okay very good, And just last one if I may, on headcount I notice it increased sequentially in the quarter, but car loads overall were down a bit. I would assume that you sort of rebuilt your running trades based on what you anticipated potash recovery to be and how you're thinking about headcount going forward.

Well it's Brock, David, we have added, as the volume has started to increase with the potash as we move to our heavy fourth quarter we have added some running trades employees back to handle the increasing volume.

Excellent.

Thank you.

Your next question comes from Ken Hoexter of Merrill Lynch. Please go ahead.

Great good morning. On that same question on the employees, though, the cost per employee was actually flat whereas last few quarters it's been up quite a large size. Is there anything in there or is that, I guess just more of a solid cost controls or are there other things thrown into that line?

No I think if you put aside the FTE reduction our unit costs are going up 6% if you take in fringe benefit and wage inflation pension. But that's offset to a degree with the reduction and the number of employees as well as with respect, and also lower over time as well. So other than those factors no other puts and takes in the comp and benefit line.

But he cost per employee, like I said was flat so that takes into consideration the decrease of the 3% of employees, so it's actually on a from employee basis, where in the first quarter it was up 7% second quarter is up 2% now it's flat. So is that again like you said just decreased over time, and the like?

That's right and also foreign exchange played a role in there as well.

Okay and if I can step back on to the coal issue. Maybe I missed it if Marcella did go over this but what is the ongoing issue now as far as what they're waiting for to get volumes up? Is it increased competition, is it they still can't get tires, can you enlighten us as to what your major customer is seeing out there?

The current outlook with respect to their issue that Elk Valley has largely around a substitution of coal. With the high price of the metallurgical coal over the last year and the continued high price this year, the mills, the steel mills that are using the coal are substituting softer coal for the hard coke and coal and mixing. The softer coke and coal prices is significantly lower the the metallurgical coal, the hard coking coal. So they're finding some of this mixing going on so the market is tough for them. The other thing that is just occurring at this moment in time is that there's a lot of new product coming from Australia into the market. So these are the two larger issues that our customer has to deal with in their marketplace.

And it's Fred, maybe just to round that, my understanding is the soft coke and coal prices are creeping up based on the huge demand for them, so as a result of that the gap is closing which is favorable obviously to the hard coal, hard coke and coal parties such as our customers. And we'll have to let the marketplace unfold but that is a trend that they've identified in the marketplace.

As you prepare to move locomotives and cars nothing that would get you to think that volumes would shift any significant way in the near term?

We're not getting any indication from the coal company that we should be concerned about a radical change. And they have just had their call nearly an hour ago, and my recollection of what the brief part that I understand stood was shared with me, was that they have guided right where they were last quarter which is in the bottom end of their bigger range but consistent with their 22 to 23 million tons of product, and they have made reference to the fact, and I stand to be corrected. but my understanding is that they made reference to the fact that even with the tire constraints that they face they still have 25 million tons worth of capacity that they can produce. So we're quiet optimistic obviously that over the course of 2007 and beyond that they'll want to produce and sell that product and obviously we are going to move it.

Okay and then just a last question, Marcella, what are your wheat crop estimates in tons this year for the market and are we back to the normal levels or are we running a little bit ahead of those?

Well we're looking at a total crop, the Canadian crop in Canada about 46 million tons. That is about normal. It's a little bit under normal but we've got an excellent quality of the crop plus we've got the largest carry over we've seen in a long time. So the blending between the carry over and good crop quality this year is accounting for about a 10% increase in exports off of that production and carry over.

Great, thank you very much for the time. Nice job.

Your next question comes from [Bill MacKenzie] of TD Newcrest. Please go ahead.

Thank you. Just I guess a point of clarification, Marcella. I'm not sure if I heard it right but on coal did you say that for Q4 revenues are expected to be down around 10 to 15% year-over-year?

Yes, that is what I said. Yes, that's it, Bill.

So that would-- last year in Q4 you did around 179 million in revenues which would imply about 155 in Q4, and you just did 140 million in Q3, so sequentially it looks like that would expect kind of a double-digit improvement versus what we just saw in Q3? I'm just wondering where are you seeing sort of signs of improvement on the coal side, like the car loads that you've seen in the last couple of weeks have maybe improved a little bit but not a whole lot, I'm just wondering sort of what's behind that?

Well Bill I'm a little bit cautious since I thought last quarter it was going to move but this time I reported a little bit different. We're seeing a couple of different things this quarter which is giving us a little bit more confidence. First of all, we do have vessels sitting at birth and at anchor at the port of Vancouver waiting to be loaded. We've see really tight inventories. Jim [Popowich] just mentioned earlier today they've got just over 2 million tons of inventory most of which is at the mine not at the port. That inventory as well as the new production have to move from the mines to the port to load those vessels. So we've got a lot of confidence that we should be seeing the double-digit increase over Q4.

And Bill, it's Fred maybe one other little tid bit because you may not be seeing the patterns unfold just yet in the quarter, is that the-- there have been a handful of fairly minor but unfortunately two or three different events, whether it's a broken rail or a small derailment, or whether it's some problems at the west shore with regard to the unloading facilities being down for six hours or 12 hours. So we think most of those have been cleared up and we think we're back into a pretty smooth cycle starting to materialize now, so my expectation is, based on Marcella's comments, that you should see a good solid flow of coal for the balance of the quarter.

Okay and inventory levels at the port have come down therefore, I mean if you're seeing a lot of inventory at the mines, there's no issues in terms of being able to get it into the port, there's been enough taken out that you can hope to start shipping stuff?

Yes absolutely, the port inventories are very low, some of the lowest they've seen in many, many years. All of the inventory is over at the mines.

Okay. Great. And then maybe for Brian, I think I heard through your comments a couple of I guess you can describe them as somewhat one timish items, one being on the fuel refund benefit, and the other it sounded like there was some catch up on some compensation expenses offsetting some of the year-over-year swing in the stock-based comp. And I'm just wondering if you could give us a little bit more color on those two items?

The first one was really a fuel tax refund that we received in the quarter. And that roughly C$7 million. That will have a continuing benefit going forward but at a much smaller amount. With respect to the incentive compensation we did have the run up in stock price the last quarter. As I mentioned before we now have the total return swap in place that we don't have much volatility. But given the strength of the third quarter we did have to accelerate our incentive compensation and so that's why I referred to a catch up. So really when will you line up last year and this year it really is a wash or a small decrease.

But that catch up in Q3 won't recur in Q4 or will it?

If you remember last year in Q4 our stock price came down a bit so you'll see a bit of a compare with the fact that we had a reduction last year but, no we should be steady state going forward from here.

Great, thanks. And then just one last housekeeping item, on the tax rate, if you strip out foreign exchange items it looks like effective tack rate would be around 30.5%. I think you've been talking about 32 range previously, just was wondering what we should be expecting on a go forward basis?

In our MB&A we've given a range of 30, 32%. And so we are going to be close to 30% or 30.5% by year end.

Okay. Great. Thank you.

Thank you.

Your next question comes from [Tom Wayland] of JP Morgan. Please go ahead.

Yes, good morning.

Good morning Tom.

Let's see, I wanted to ask you a little bit about fuel surcharge and how we should model yields going forward. Would you expect to see a pretty meaningful slowing in your yield in fourth-- yield growth in fourth quarter as the fuel prices have come down and you get lots of a boost from fuel surcharge or is there enough of a lag in your mechanism that that impact might not come til beginning of next year?

I think in terms of the fuel it depends. We've got a bit of a lag on our fuel surcharge program, Tom, and that will obviously even itself out as we see the fuel stabilizing. In terms of our overall yield program,which you separate out the price versus yield, we'll speak to that, you're talking about 2007 so we'll speak to that in November.

So I mean if-- and I look at kind of an unadjusted yield growth of something like 7.7% in third quarter, does that, is it realistic to think that that pace doesn't slow a lot in fourth quarter because you've got a pretty good lag in your own fuel surcharge mechanism, or should we see that tempering a bit?

I think Tom, it's pretty specific but I think it's probably fair to assume that with the-- although we have a lag and that lag tends to be, it varies but call it 60 days, and prices have already started to come down for the last couple of months, so I think you might want to temper expectations a little bit for the fourth quarter. Simply because the lag will expire and therefore we'll end up with, with the somewhat more moderate set of fuel or impact on the price from fuel surcharge.

Okay. Fair enough. And looking to, I know you don't want to spend a huge amount of time on the coal issue, but when you did the renegotiation of the contract, there were some, you tried to raise the I guess the floor of what you would get from [inaudible] valley, but there was still I believe some remaining sensitivity to where the fuel price-- or even the coal prices were set, is that a meaningful factor as we look to 2007? Because presumably if coal volumes have been so weak this year perhaps the coal price could fall net for [inaudible] valley next year.

Tom I think the best way to do that is for three or four quarters I've been very consistent in my commentary and I just kind of refer you back to those words. We will address as best we can both the volume expectations as well as an order of magnitude impact on price when we get together in November with regard to 2007 and beyond. It's obviously got a floor and a ceiling and as a result of that contract negotiations. It is important for the analyst community and the investor community to understand it as best we can communicate it with respect to the confidential contract and we'll do that on November 15th.

Okay. I guess if I can one last and I'll hand it out to someone else. But on Intermodal volumes any thoughts on why that's been somewhat soft and whether that looks like it's going to get a bit better or is that more kind of a multi-quarter type of thing where we would see some softness?

Tom, we've seen a bit of softness over this quarter. We've had a lot of strength in our domestic side. It was up over 7% and it was the international that was down. That was largely attributable to our strike at our facility that we serve in the port of Philadelphia that I mentioned to you. We had some soft expressway volumes that are tied to the forest products industry. That's about 7,500 units. So if we adjusted for those units we'd have our units up 2 to 3%. But that's largely what our softness is about. We expect to see that reverse itself into the fourth quarter.

Okay. Nice results. Thank you for the time.

Thanks Tom.

Your next question comes from [Cameron Jeffries] of [inaudible]. Please go ahead.

Thanks very much. Good morning, just a question for you, Marcella, on the pricing for next year, just following up on David's question, can you give us an idea of how much of your business rolls over for 2007 at least for contract renewal?

Hi Cameron, it's Fred, unfortunately it's kind of tough to get into the 2007 discussions given that we're going to get together in three weeks. But I think history would say about half of our business turns over and obviously over the last number of years as the economy and the circumstances have been more favorable to our mode versus the shipper world, we have tried to shorten some of our contracts on our nonstrategic accounts. So assume for today's discussions about half of our business will turnover and we'll obviously try and provide a little bit more light on that in November.

Okay. Great. Thanks. The rest of mine have been asked.

Thank you.

Your last question from the analyst is a follow up question from Scott Flower from Banc of America Securities. Please go ahead.

That question has been answered. Thank you.

We have no further questions from analysts. We are now ready for questions from the media. [OPERATOR INSTRUCTIONS] We have a question from [Alan Dought] of Reuters. Please go ahead.

Yes, just wanted to check on one thing, at the beginning of the call you made a point of stressing the safety gains that you've made. Given the problems that have happened over at CN in terms of a number of accidents, are you at all worried about any political fallout from that in terms of the Canadian government doing any kind of moves against railways in Canada on safety issues that might sort of change your operations?

Alan, it's Fred. I think the only appropriate answer to that is that we can control our destiny by running a great railroad and it really would be inappropriate for me to comment on anything other than that. We have very strong relationships with transport Canada, the Safety Board, the Department of Transport and we continue to try and ensure that all of our efforts on the street with our employees, with our associates, are as strong as they can possibly be and I think if you do your job and do your job well you can deliver some great results and we can't influence the policy makers in the company-- in the country other than by doing our job well and that's what we're going to do.

Thanks.

Thank you. Hello operator?

It will be just one moment, please, [Rich Kern]we are now ready for your question, just give me one moment, please.

Hello?

I apologize, one moment, please, we seem to be having a difficulty.

Operator, we can hear Rich.

Okay.

Hi, Fred? Yes.

Rich Kern here with Bloomberg. Just on the operating ratio you did push it down in this quarter and I know you've been attempting to get down to that sort of 70 level. What are you anticipating for the balance of the year on the operating ratio side and how much more can you squeeze out of your system, do you think?

Rich, I have to break the question into two. The first is with regard to the balance of the year, when we did our analyst call last year we told them that we were going to set an aspirational level in the 75s, so success for us this year would be to deliver an operating ratio that starts with 75, and obviously we're going to drive hard in the fourth quarter to fulfill that commitment to the investment community. With regard to next year, I am going to have to defer that question until we do our analyst call on November 15th when we share with everybody our perspectives on the market opportunity and all of our initiatives and how they manifest themselves in operating ratio improvement.

I guess just on a follow up I believe year-to-date you're at about 78 roughly?

I don't have that, I don't think that number is high.

Year-to-date we're at 76.2.

76 okay so, I'm sorry, yes I was looking at the year ago, so I mean you've obviously had improvement. Is the 75 achievable?

Well, it's our aspiration to do it and we've just provided guidance that would indicate that we think we could be up to C$0.10 above our original upside guidance so I'll have to let you guys do the math.

Okay. All right, thanks.

Thank you.

Mr. Green, there are no further questions at this time. Please continue.

Well thank you very much, operator. And I think that wraps up our Q3 teleconference. We look forward to speaking with you at our analyst conference in November. And thanks, operator. Bye now.

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