Canadian Pacific Kansas City Ltd (CP) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Canadian Pacific's third quarter 2009 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. (Operator Instructions) I would like to remind everyone that this conference call is being recorded on Tuesday, October 27, at 2:00 p.m. Eastern time. I will now turn the conference over to Ms. Janet Weiss, Assistant Vice President Investor Relations of Canadian Pacific. Please go ahead.

Good morning and thank you for joining us for our 2009 third quarter conference call. The presenters today will be Fred Green our President and Chief Executive Officer, Kathryn McQuade our Executive Vice President and Chief Financial Officer, Ray Foot our Group VP of Sales and Brock Winter our Senior VP of Operations. Also joining us on the call today is Brian Grassby our VP and Controller. The slides accompanying today's teleconference are available on our website. Before we get started let me remind you that this presentation contains forward-looking information, actual results may differ materially. The risks, uncertainties and other factors that could influence actual results are described on slide one in the press release and in the MD&A filed with Canadian and US 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 non-GAAP measures. Please read slide two.

Following the presentation, we will conduct a question-and-answer session. (Operator Instructions) Here is our President and CEO, Mr. Fred Green.

Thanks, Janet. This morning CP released its third-quarter results reporting adjusted earnings per share of CAD0.85. The impact of lower volumes continues to be a challenge. However the Company performed well, sustaining the operational improvements we realized earlier this year. Our long-term, our long train strategy continues to support our cost management efforts and our success is being reflected in key metrics. I am very pleased with our results in these circumstances.

This quarter we set some new records with average train lengths and weights beating out previous bests by 5% and 6% respectively. A huge accomplishment given the volume challenges. We also set a new benchmark in the area of fuel efficiency. Overall the team did a great job in executing the plan. As you will hear today, we have the challenges associated with today's reduced volumes firmly in hand. Our pricing performance continues to track well, and our balance sheet objectives are progressing nicely. I will you now turn it over to Kathryn for our financial results, Ray for an overview of revenues and then Brock for an operations update. I will come back at the end and wrap up with a few closing comments. Over to you, Kathryn.

Thank you, Fred. Good afternoon, everyone. First let me speak to the GAAP, non-GAAP earnings that we refer to as adjusted earnings and the items that reconcile between the two. During the quarter we completed two major land transactions, Windsor Station and a corridor in western Canada. The gains from these transactions totaled CAD68 million after tax. We also had a slight gain on our asset backed commercial paper. These items are included in our GAAP earnings but have been excluded from our adjusted earnings. These gains net of the FX loss on long-term debt increased diluted earnings per share by CAD0.31. The remainder of our presentations will speak to adjusted earnings that exclude these items. Q3 was another strong quarter for cost control, with our operating ratio remaining essentially flat despite carload declines of 18%.

Starting at the top of slide seven, I will focus my comments on the percentage variances. The far right column represents our FX adjusted performance based on a weaker Canadian dollar this year versus last year. As a heads up we are seeing a reversal of this FX relationship in Q4. The Canadian dollar has recently strengthened significantly. Where it weakened in Q4 of last year, based on a Canadian CAD0.95 per US dollar, FX will be a head wind of about CAD0.05 next quarter.

Now, turning to the details. Total revenues were down 20%. FX adjusted revenues were down 23%. Lower volumes and fuel prices were the key drivers of decline. Operating expenses were down 20%. Foreign exchange adjusted expenses were down 24%. A fluid railway, strong cost management, and lower fuel prices were the primary drivers. Operating income was down 21%, with most, with almost no impact from FX.

Other income and interest expense were in line with last year, but down versus Q2 due to both FX and the debt restructuring completed last quarter. Finally, income taxes were down 33% due to lower earnings and were in line with the 26% tax rate I discussed in Q2. Assuming there's no change in the current Ontario tax rate, Q4 should end in the same range. Adjusted earnings per share came in at CAD0.85.

Now let's go through each of our expense line items starting with comp and benefits on slide eight. We managed employee counts very aggressively despite some volumes returning and the need to cover summer vacations. Our average expense employee counts came in at 13,352, slightly better than the estimate I laid out last quarter. Looking forward, to the fourth quarter, I expect these expense employees will be slightly higher than Q3 due to Winter conditions and the flip over of some capital employees to expense employees. For modeling purposes, 13,600 is a good estimate. Volume and efficiency gains coupled with less overtime saved us CAD44 million, while the reduction in annual loss pension expense saved us CAD10 million. Offsetting these gains was a higher incentive compensation expense.

In the third quarter last year, we reversed CAD11 million of bonus accrual due to the softening economy. This year, our strong cost performance in Q3 triggered an accrual of CAD20 million, which includes a catch up of the accrual required through the first nine months. Other items including wage rate increases and benefit inflation added an incremental CAD6 million. Including a foreign exchange impact of CAD6 million comp and benefits declined by CAD11 million or 3%.

Moving now to slide nine, and fuel expense which was down CAD159 million or 54%. Price decline saved us CAD118 million as our all-in cost landed at US $2.07 per gallon down from $3.93 a year ago. Lower volumes coupled with record fuel efficiency which Brock will discuss saved us CAD61 million. Our mechanistic hedging program continues to move toward covering 10% of our fuel purchases by 2010 and had no material impact on the quarter. Gains from our prior positions were lower by CAD2 million this quarter, due to a lower WTI. We have provided some more detail in our appendix. Foreign exchange partially offset the gains from pricing and volume by CAD21 million. Putting fuel revenues and expenses together, we again had no lag or lift this quarter due to our responsive fuel program. We will have a significant head wind of CAD24 million in the fourth quarter, due to the lift we got last year.

Moving to slide 10, purchase services and others was down CAD26 million or 15%. The largest drivers of the decline in purchase services were lower volume related expenses in intermodal and lower crew accommodations and dead heading costs. Lower equipment maintenance costs saved us close to CAD4 million. However fewer AAR car repairs partially offset this netting a CAD1 million reduction. Within other, casualty expenses were down CAD9 million as we continue to improve our safety performance and we lapse some more costly incidents from 2008. A number of small items saved us CAD10 million while foreign exchange was a head wind of CAD5 million. We traditionally see seasonality in this line, with higher fourth quarter than third quarter due to winter activity.

Finally, on slide 11 materials were down CAD8 million due to lower locomotive and car maintenance and a reduction in non-locomotive fuel expenses of CAD5 million. Depreciation was essentially flat, while equipment rents were down CAD6 million due to fewer active assets online and fewer leased assets. Savings of CAD13 million were partially offset by an CAD8 million reduction in car hire receipts. Absent the foreign exchange head wind of CAD3 million our equipment rents would have been down CAD9 million or 19%.

As I have shown in previous quarters, here is a view of our variable cost management, by excluding the items considered noncontrollable such as inflation, lower fuel prices, and foreign exchange swings, management actions reduced expenses by CAD139 million. When compared to the volume impact on revenues of CAD244 million, we managed to save CAD0.57 of expense for every CAD1 of revenue lost, clearly showing that we have maintained our discipline around resources and cost management.

Now, turning to slide 13, and an update on our cash, and our capital plans. As previously provided our capital program is expected to complete the year in the range of CAD800 million to CAD820 million. We continue to focus on capital efficiency and will provide capital expectations for 2010 later this year. Our cash position is strong; as I mentioned in my opening, we did complete two major land sales that added almost CAD130 million in our cash position in Q3. We are on target to make the debt payments, repayments in 2010 and are focused on reducing overall indebtedness. The work we have done to strengthen our balance sheet this year has insured we have excellent liquidity and the flexibility to make decisions with long-term focus.

Now turning to the DM&E. As of October 13, we completed the integration of our IT systems which combines all DM&E train data and operating statistics with CP. The implementation of these systems gives us visibility to drive even more operating savings. Earlier this month, our total cars online as reported to the AAR began including the DM&E. Starting in January, we will also begin reporting combined train speeds and terminal dwell. The transition is now complete, and the team did a good job of keeping their focus on a smooth transition for not only our customers but also our employees. While still driving cost efficiency.

To summarize, we continue to face volumes that are below last year, though sequential quarter-over-quarter improvements in some sectors have occurred. Our financial results demonstrate that our focus on cost control, liquidity and sustainable productivity improvements are building flexibility in all aspects of our business. With that, I will turn it over to Ray for the marketing section.

Thank you, Kathryn. Good afternoon. Starting on slide 17, let's begin with revenues. While volumes continued to suffer from the economic downturn, its effects began to moderate. Volumes in Q3 were up 7% when compared to Q2 2009, and September was the strongest month of the year. We are hopeful that this uptick will prove sustainable. Reported freight revenue was down 21%, with the impact of foreign exchange removed, revenues were off 24%. Volume was the largest driver, accounting for an 18% decline. Lower fuel surcharge revenue also had a significant impact reducing revenues by 10% on the quarter.

This quarter we saw a reversal of the first half trend with revenue ton miles falling less than carloads. This resulted in positive mix of a couple percent. On the quarter, there were two noteworthy price items. One was the Teck coal rate decision, the second was the 7.4% reduction to regulated grain rates. Combined these two items had a negative price impact of approximately 1.5%. During the quarter, renewals came in at just under 4%, in line with our price strategy.

Moving to slide 18, I will now walk through the markets and give you some color on the quarter and the remainder of the year. For clarity I will speak to currency adjusted revenues from here on. Grain continued to be strong with Canadian volumes up 10% over last year. While US originations were up modestly. Overall revenues were up 3%. The crop across the CP network has benefited from a warm September improving both quality and yield expectations. The Canadian crop is now around what we would call normal levels which for comparison purposes is still 15% smaller than last year's crop. On the US side, although late production is forecast to be close to last year's record. As such we expect to run hard in the fourth quarter, in Canada and the US. But as we move through 2010, matching our 2009 volumes will be difficult given the lower Canadian production.

Next to slide 19 and coal. Overall coal revenues were down 27% on the quarter. In Canada, coal carloads were off 8% while RTMs were off 16% due to weaker eastbound shipments and the impact of the shorter haul Kamloops route. The revenue impact of decreased rates and shorter average length of haul totaled approximately CAD24 million in Q3. We are seeing some quarter-over-quarter improvement with volumes up over Q2.

On the US side, volumes were up 21% while RTMs were down 3% due to expansion in short haul movements. Looking forward we expect our overall coal volumes for the fourth quarter to look a lot like the third quarter.

Moving to sulfur and fertilizers, revenues and volumes for the quarter were down 39% and 36% respectively. This was an improvement over Q2 driven by spot export sales of potash. Export potash demand will continue to be weak until a deal is completed with China. The timing of a resolution is unknown, but we remain ready to respond when the demand upturn occurs.

In our merchandise portfolio, revenues were down 31%, while volumes declined 23%. On a positive note, Q3 volumes improved 11% over Q2, driven by the US Cash for Clunkers program and improvements across the portfolio. The Q3 run rate has continued in the first few weeks of Q4, and we believe the trend is likely to continue through most of the quarter.

Now turning to intermodal, units were down 26% and revenues were down 28% driven by soft North American consumer demand and weak global marks. CP's domestic volumes were down about 9% while international was off over 30%. Domestic volumes are showing some signs of life, with volumes in September and early October off only 5% versus 2008. On the international side, we are seeing softness across the whole business. Import and export volumes through the Port of Montreal have been particularly hard hit due to the fact that they're more directly related to the US economy than Vancouver shipments. At this time, we are not anticipating any appreciable improvement in international volumes.

Moving to slide 23, I'd like to touch on our short and long term growth opportunities. The platform for price and volume growth is a strong product offering. Our operations and product design teams are implementing lean processes to continuously improve the reliability and consistency of the product we offer to our customers. Although masked by the economic downturn we have seen some good growth results in 2009. Our energy sector including jet fuel, diesel and LPG continued to grow. Condensate movements have been particularly strong and recent and or soon to be completed terminal sites near Edmonton will ensure this growth continues as oil sands development expands.

Ethanol production facilities on CP, are ramping up to full operations. We have seen significant ethanol shipment growth in 2009, and expect continued growth in 2010. Our network expansion to Kansas City has also generated new business as well as extended length of hauls on existing volumes. A significant amount of traffic previously routed over Minneapolis and Chicago has been converted to a Kansas City route and we have landed new business over the gateway that on an annual basis represents a double digit growth rate over previous volumes. We have only just scratched the surface. These immediate wins when combined with our longer term growth prospects such as the industrial heartland, grain elevator expansions as well as intermodal growth provide us with a robust opportunity pipeline that our sales team will continue to build upon. Now over to Brock.

Thanks, Ray. Q3 was another very strong quarter for the team. You are seeing evidence of our ability to manage variable costs in line with volume, and we are sustaining our operational performance. At the same time, we have been making good progress to test in advance new ideas for efficiency. And our long term structural initiatives are moving forward as planned. I am pleased with our results from both our variable and structural cost management actions.

Looking more specifically at our results, let's start with safety on slide 25. Our FRA train incident frequency improved by 60% on CP and 8% on the DM&E. For the core CP operation, we continue to be the industry leader in train operation safety with the year-to-date improvement of 30%. This is driving significant benefits in reduced casualty costs. Our FRA personal injury frequency for the DM&E improved by 22%, for the core CP operation, we were up by 10% but this is a significant improvement from our Q2 performance, and demonstrates that our efforts are paying off.

Please turn to slide 26. We have had good success with our efficiency efforts; we have improved train speed by 8%, while disciplined execution of our long train strategy helped increase train weights by 9%. With GTMs down by 15%, our focus on productivity enabled us to reduce train miles by 21% resulting in 23% fewer crew starts. I want to take a minute to explain how we are achieving these results. We are already the industry leader in the development and implementation of distributed power or DP, with 70% of our locomotive fleet quipped with DP operations. Our most recent break through has come from the integration of DP technology with our new train area marshaling or tram software tool.

This is giving us the ability to safely run even longer trains, further reducing train starts, extending rail asset life and saving fuel. Our testing started in early July and you can clearly see the impact it is having on our productivity expressed in train weights. We are now running some of our Trans Continental intermodal trains consistently at 10,000 feet and we expect to maintain that through the Winter where historically we've had to reduce train lengths for cold winter operations. This productivity coupled with our program to finish equipping 200 locomotives by year end with fuel trip optimizer technology, has allowed us to improve fuel efficiency by over 4%. And achieve a new record.

Please turn to slide 27 and I will update you on our progress on yard efficiency. We have improved yard dwell by 3% and our active cars on line by 17%. These are good results given the actions we have taken to reduce road and local train starts. While still maintaining active velocity and network fluidity. We are driving more improvements into our yard operations. We have a lot going on in this space but let me give you a couple of key examples.

We are progressing a targeted investment at our Bensenville yard in Chicago to increase its capacity. This will allow us to flow more volume there for greater efficiency and reduce third party charges. Allowing us to rationalize satellite yards. We recently completed the roll out of our yard planner tool which will allow us to more effectively execute our IOP with enhanced decision support to maximum yard productivity. We are pleased with the efficiency potential of these and other initiatives.

Please turn to slide 28. With respect to our structural cost initiatives, we have now consolidated our Vancouver locomotive repair activity into our facility in Calgary. The efficiencies associated with this action materialize in Q3. On the freight car side we are currently reviewing our inspection frequency throughout the system. While not yet complete we anticipate that we will be able to increase yard efficiency, and repair staff utilization by consolidation of various inspection requirements. In parallel we continue to apply lean management techniques to our locomotive and car repair processes.

We are seeing improvements in our labor productivity of over 10%, improved availability of assets of over 3% and improved equipment reliability. Between these structural costs initiatives and our ability to quickly size up or down with volumes we have tightly managed our head count. As of today, we have reduced our crew and maintenance staff by 1800 employees and over the third quarter we ran with approximately 2,000 less employees representing 17% of our Unionized work force, however, these are highly valued employees that we will need for future volume growth, and to address retirement attrition. As such where we've had opportunity to advance value-added work, and manage employee retention, we have done so. For instance, we are currently completing a program for replace or recondition gates on over 4,000 covered hopper grain cars; benefits include reduced rework, improved customer satisfaction and reduce product loss.

Please turn to slide 29. In summary, clearly strong cost management actions are leading to improved efficiency, and creating flexibility to respond to sustained volume increases. Our success in delivering a reliable service to our customers has been key to reducing costs, commanding value for our services and protecting future growth opportunities. We are demonstrating our ability to be flexible and agile in implementing sustainable improvements that will lower our variable and structural costs.

I look forward to reviewing our performance with you next quarter and I will now turn you over to Fred for the wrap up.

Thanks, Brock. I'll summarize by saying that this quarter CP posted some good operational results, showing that our variable cost management efforts are working well. We are becoming increasingly comfortable that our ability to sustain our performance is solid. With the train design improvements and our lean process improvements we will not be bringing back resources on a one to one basis as volumes return. Our focus continues to be on flexibility in all aspects of our business, this positions us well to quickly respond to any volume recoveries.

As we complete 2009, and enter 2010, you can expect the team to continue to focus on our top five priorities. Preserving and pursuing growth opportunities delivering a reliable product that supports price increases, managing variable costs aggressively, pursuing our agenda of structural cost reductions, and managing our balance sheet. We are ready for volume recovery but we are not counting on it. With that let me open it up to questions.

Thank you. One moment. (Operator Instructions) Please lift the hand set if you are using speaker phone before pressing any keys. First from Walter Spracklin with RBC Capital Markets.

Good afternoon, everyone.

Afternoon.

Just on the grain you've been doing very well on that side, and I know you had some let or some pressure on your rate, given the cap. Can you update us on what impact the cap -- your grain business is having on the cap as you get some market share here, and it looks like actually, maybe I'm calculating a little differently here but it looks like your overall revenue per revenue ton mile was actually up compared to last year. So, can you just talk to where the actual negative implication on the cap came in on that number?

It is Ray. Let me answer that, and say first of all our product does continue to be very strong in the corridors so we are pleased with that. The issue around the VRCPI is basically it is a 7.4% impact to revenue entitlement over the 2009/2010 crop year. So, if we handle more business, it doesn't mean that we don't get the revenue for handling that business, it is just at a 7.5% impact overall. On the RTMs basically we had extremely good volumes and strong volumes to Vancouver, on the basis of that strong product offering, we had in the marketplace through the third quarter. Whereas some of our business within the US on the shorter haul lanes was down a bit. So that was the difference there.

That's great. Thank you. My second question is just on pricing, you mentioned you are just getting just under 4% on your renewal business, can you talk to us a bit about what percent of your contracted base is locked in for 2010, and the route, is it roughly around that 4%?

We would be locked in at around the 55% to 60% right now, Walter, and what I can tell you is that I think we have been pretty consistent in our comments over the quarters that we have been coming on renewals around the 4% range. So Fred has been saying for quite sometime our goal is to exceed inflation going forward. That's what we are targeted at.

That's my two questions. Thanks very much, guys.

Thank, Walter.

Your next question comes from Tom Wadewitz with JPMorgan.

Wanted to get a sense of your confidence in how you would think about the operating leverage if the volume comes back. Clearly you have done a good job in increasing train length and managing some of the expenses in the downturn. But if you see another sequential increase in volumes, looking the next couple of quarters, let's say 5%, will you have to put some inefficiencies in the system or do you think you can handle that and show operating leverage in response to that?

It is Brock. Yes, to your point, we do believe we can generate more operating leverage there. We do have considerable space on some merchandise trains to add more volume. In fact, where we can, we will even add bulk volumes to those IOP trains as well. So, from my perspective, Tom, I see that there's opportunity to gain more volume on our existing trains, on a go forward basis. There is an impact of mix of course with regards to bulk volumes, for instance coal where you would have to start an extra train, but for the most part, with the 5% growth on a general broad base we can accommodate our current train models.

Can you give a sense of where you are at in terms of average train length and what the constraint would be if it is a siding length constraint or just how to think about the parameters for that opportunity on train length, further train length expansion?

Our average train lengths are about 6,000 feet on average. It depends on the train, and clearly have, as I mentioned in my comments, we are now moving our intermodal trains at upwards of 10,000 feet and even looking for longer trains. So as I said I don't see new issues with being able to leverage our current train models to put more volume on existing trains.

Okay. Great. Thanks for the time.

Your next question comes from Avi Dalfen with Macquarie Capital.

In last quarter's conference call, you indicated that you were focusing about 80% of your efforts on cost cutting. At that time, you were not yet seeing a rebound. And now, listening to Fred's priorities, the five priorities, it doesn't seem to be weighted as much toward cost cutting. Is that a hint of something positive?

Well, it can be a hint I suppose, it is Fred. My view is pretty simple. Situationally as we went into a difficult environment, the organization was heavily focused as you would want us to be and as I think people expect us to be, on getting our arms around the cost management side. We have now delivered several quarters as the data is evidence of, of our ability to manage those costs effectively. And obviously at a leadership level. We can move our attention to making sure that we are not just preserving those growth opportunities, but actually stimulating the marketplace wherever we can through more active sales activities and better product quality to see if we can nip and tick some of the truck volumes or other volumes available to us. So it is fair to say that as the market stabilizes our own confidence in our ability to deliver materialized yes we are dialing up more sales activities and my focus is not as much on pure cost control but I want to also tell you that there's an awful lot of focus on cost control. Because that to my mind is a prerequisite for our future success.

Clearly based on what you are saying, you are going to be able to show improvement in operating ratio going forward, because you were able to hold it steady with the 18% drop in volume during the third quarter, with some improvement in top line and continuing some focus on cost cutting that will be better going forward.

I have to let each of you model the business as you see fit. What we believe is that there's operating leverage left in this enterprise, on the basis of the successful work we have done with TRAM II and the long trains; just two weeks ago we ran a 12,000-foot, 12,000-ton train across the continent, successfully. So we know there's more there. What we need to do is say now that we've proven that what are the other prerequisites for us to make sure we can do that consistently and reliable so -- sure, there's leverage there and that's what we are excited about.

If I can get a data point for you, on the labor expense your labor head count at the end of Q3 was 13,352, where do you stand now and where do you expect to be at the end of the year and in Q1 2010?

I think Kathryn said about 13.6 for fourth quarter is a good assessment on expense employees.

I am just going to jump in. In fairness to your peers I am going ask everyone to limit their first go around on questions to two and then if there's time you can requeue in line, we would be glad to do any follow up questions.

Thank you.

Thank you.

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

Morning or afternoon. Ray, you talked about -- you gave us a pretty descent run down of the components or how the performance, individual business units are going to perform. Can you comment in aggregate looking to the fourth quarter, do you see a situation where the RTMs are going to be up quarter to quarter, so from Q3 to Q4 given the strong grain offset by some to the other things you are looking at?

Randy, as I went through it there was a series of puts and takes there obviously. As we look forward to Q3, we don't see it being, I am sorry, as we look forward to Q4 we don't see it being materially different than what we saw in Q3.

Okay. And then with Kathryn, I wonder if you could comment on the deferred tax line within the cash flow statement, you got CAD117 million positive. What's going on there, how should we think about that on a go forward and I will loop in, can you speak to funding of the pension plan for the fourth quarter and what you're thinking about in terms of putting cash into the pension plan?

Okay. You have got a couple of things there. So let me talk on the deferred tax, I don't, I don't know off the top of my head. I mean we, on the total basis, the 26% tax rate is in line. We did in the second quarter, have the Ontario, which would have been (inaudible) deferred taxes, but offhand I don't have anything that I know about in this quarter. So if we can get back to you on that one, we will.

And then in terms of our pension, in the fourth quarter as we have stated we see that 2009 will be about CAD100 million. In terms of 2010, there's a lot of moving pieces, in terms of the assessment of whether we will use temporary regulation. Today they're supposed to be coming out with permanent regulation. There's a lot of things that is will determine whether we will do a valuation, not do a valuation. So it is too early to say. We do know that 2010 will be higher than it is in 2009. But, to what extent we don't know that at this point.

Okay. Thank you.

Thanks, Randy.

Your next question comes from Ken Hoexter with Banc of America. Please go ahead.

Great. Good afternoon. Can you just talk a bit about on the coal side, the losses that -- that you hand off the volumes at Kamloops? So are you expecting that to accelerate? Then on the US side with the short-term coal with the short term coal, I just want to understand, I guess the shorter haul, is that the run rate you would expect to continue, is that all in in the quarter, I guess, was there a new contract and can you talk about that at all? Thanks.

So in the US, it is Ray, Ken, in the US, we expect the volumes in the fourth quarter to be similar to what they were in the third quarter. So that run rate should continue.

And Ken I think on the Teck hand off, at Kamloops, it -- they weren't very active in the second quarter, but they pretty well moved to be near a normal run rate for the third quarter. That's what you should expect going forward, it might be I guess a touch heavier if they were a little slow in July.

So to clarify, the third quarter is a pretty good run rate of everything being in there as far as the Teck on the short haul.

Yes. We think so.

Okay. And then lastly, Kathryn, on the cost per employee was up 9% in the quarter. I know you ran over some of the costs but was there anything in there that would keep that run rate going going forward or were there some things that are more one-time in nature like on the catch up on the accruals there?

The catch up on the accrual definitely impacts that this time. That's probably the biggest item. So quarter-over-quarter, of course it is quite significant because you had the reversal last year and then you had the catch up this year. So on a run rate, for the fourth quarter, it would be more around the CAD10 million. That would be higher than the fourth quarter of last year since we had no accrual in the fourth quarter.

Okay. Great. Thanks.

Your next question comes from Matt Troy with Citigroup. Please go ahead.

Thank you. I was wondering if you can just refresh us on potash. I know we are somewhat captive to negotiating process there but in terms of sign posts, I guess consensus expectations have developed that we should get something in the next couple weeks but it feels like pushing on a string. What are you watching and if you could just talk about potentially what some of the pricing implications could be wherever that contract falls out. Is it completely price agnostic in terms of rail rates or are there sensitivities there, just trying to get a sense for 2010.

Matt, it is Fred. The story on potash will be whatever it is, we have no insight anymore than anyone else. Obviously, we are in contact with senior folks in the critical companies, but they're in the middle of obviously a global negotiation. So we are on standby ready to go, fully capable to meet their needs and obviously we hope they're successful sooner rather than later, and from a pricing perspective there's no impact.

No impact. Okay. Thanks. Fred, you have been a little bit more candid or conservative in your comments in terms of your expectations for the pacing and overall recovery. I am just wondering what are you hearing from customers and Ray if you want to weigh in, in terms of 2010, their capacity needs, where would you expect to see a demand recovery in earnest as opposed to just a simple math of using comps, what has you excited about 2010 in terms of what areas might recover first? Thanks for the time.

Thanks, Matt. Well, we would like to be able to spew off a bunch of things but quite honestly when we talk to our customers they don't have a very clear picture of it yet. I think Fred commented on that on potash. So when we look forward we are certainly hopeful as we said that the uptick we have seen and the trends that we have seen will continue but it is pretty tough to tell right now, lots of uncertainty, but we continue to work the markets and pick up business and hopeful to see that continue.

Matt, I will just jump in and say there's some that are unique to us. Obviously we will have a better potash year next year than this year. So obviously, we think we'll have one based on a recovery eventually. And I think on the met coal side, the first half of the year will probably be stronger than the first half of 2009.

So in addition to the general economy there's a handful of things that really whacked our Company in the first half of the year that probably won't repeat themselves at least not to the same order of magnitude. Then obviously the toughest part of the marketplace is that merchandise sector; it is not as important to us as a company compared to others but it is still a big chunk of business. So if the forest products doesn't materialize because of slow housing starts or the autos don't rebound, those are thing that obviously will give us a slow steady growth as opposed to any step function improvement.

The next question comes from Jacob Bout with CIBC World Markets. Please go ahead.

Good afternoon. A question on pricing. So for that book of business that you don't have repriced for 2010 you talk a little bit about the pushback that you've seen there on pricing, is that just a timing issue or is that a push back of pricing. Maybe some of the areas you're actually seeing a pushback.

Well, as we have -- Jacob as we have gone through 2009, we have had pretty in depth conversations with all the customers as we negotiate. As we have said in previous calls and as we continue to discuss with them, comes down to the value of the product that we offer and so we have a discussion around the value of that product and the price that it warrants. So there's no question there's difficulties out there in the marketplace but I think our first nine months of performance speaks pretty well and to echo what Fred's been saying, as we look forward we continue to look to exceed inflation.

How much pressure are you seeing in the intermodal side?

Our business if we think about those three quarters, we have a variety of business that comes up in each of the segments, and intermodal is included in that. So we have differences in all segments but we are continuing to track close to that 4% number that we talked about.

Jacob, it is Fred. One of the things worthy of note is when you put a container on in Vancouver, it is going 3,000-miles to the East Coast or you put on a domestic container in Toronto headed to the West it is going 2,500 miles. We are not in a lane or a series of lanes because of the nature of our East/West, the majority of our franchise East/West that is subject to the whims of a trucker having surplus capacity. You are seeing some of that in other lanes in particularly in the US, but it is not to say there's not truck competition. It is just that the nature of it tends to be on the shorter haul lanes and most of what we do on intermodal tends to be pretty long-haul stuff.

Last question -- your ability to ramp up volume at current head count?

Again as I said earlier Jacob, it is Brock. Again, we would look to wrap up and most of that volume -- again, it depends on the mix but certainly we would ramp up most of that volume on existing train starts. I wouldn't see a ramp up a large ramp up in head count.

So Jacob I will complement that just by saying that if we all have great news and the potash business pops they're going start running 125, 130 car potash trains so you are not going to be filling out merchandise trains without orders of magnitude, so Brock's opening comments was watch the mix. So if we are creeping back with some housing starts, some autos, then yes, we will fill out trains. If we pick up a few more containers we will fill out trains but if you see a big pop happen in one of our sectors like potash then obviously you are going to see some train starts. With that you will see some more people coming back to repair the incremental locomotives, et cetera.

Okay. Thank you.

You're welcome.

Your next question comes from Cherilyn Radbourne with Scotia Capital.

Thanks very much and good afternoon. Just a question on foreign exchange sensitivity -- you gave the head wind for Q4. Just curious as we look forward to the potential for dollar parity in 2010, is CAD0.01 in EPS for every CAD0.01 in the Canadian dollar still the right way to be thinking about that sensitivity, or has it increased somewhat?

No, Cherilyn, we are, we look at it right now we believe it is. But remember that is for the year. So you get some noise on a quarter by quarter basis. Depending on what it moves for but if you look out on a year it does tend to hold based upon the US dollars that we are generating in revenues and expense.

Okay. And then, with respect to your 2010 debt maturities I believe there's one that's a little bit chunkier. Did I hear correctly that your intention is to repay that versus refinance that?

It is at this point, yes.

Okay. Thanks very much. That's my two.

Thank you.

Your next question comes from Jason Seidl with Dahlam Rose. Please go ahead.

Thank you. Good afternoon. You guys mentioned that the incentive comp accrual was CAD20 million in the quarter but that a portion was catch up for Q1 and Q2. Could you break up the catch up portion of that CAD20 million, please.

Well, just earlier I mentioned you should look for about CAD10 million in the fourth quarter, which would be CAD10 million increase over fourth quarter of last year since we had no accrual last year.

Okay. But in that CAD20 million the accrual that you had was about CAD10 for Q1 and Q2 then?

We had a CAD10 million accrual in Q2. So and CAD20 million in Q3. So you can assume that CAD10 million would have been accrued in Q1.

Okay. You also talked a little bit about some spot business in the quarter for export potash. Is there anymore expected for 4Q?

I -- very hard to say, I mean we are modeling on Q4 for potash to be very similar to Q3. So, the big issue there is when will China break really.

The short answer, Jason, is we just don't know.

Thanks for your time as always.

Thank you.

Your next question comes from Umayr Allem with National Bank Financial. Please go ahead.

Good afternoon. For the third quarter, you mentioned that CAD0.57 of every CAD1 of lost volume had been taken off costs. So as volumes come back and (inaudible) going back recovering that CAD1 can you give an indication as to what type of cost reductions you would have, I'm just trying to get a sense to the permanent cost reductions that there are there.

Of course, we did take out price on fuel. So but for the most part what we are seeing is consistency around a good portion of our variability with volume. So I think Brock tried to answer that. We shouldn't see it coming up in the same level that when volumes come back because if we are not putting on and we are filling out trains then we should see some good cost management even as volumes start coming back.

Okay. Thank you. And then finally, how are your shippers or customers feeling about their prospects for recovery? And has their inventory been worked down so once they start shipping, when they seeing business you will see the volume right away? Is that something you are seeing right now.

I would have to repeat what Fred said when we talk to them. They just don't know. I mean when their looking at, really no expectation in terms of where their volumes are going to go.

What about their inventory levels do you have a sense on that?

If I thought about automotive the inventory levels there are definitely completed through the Cash for Clunkers program. We expect continued good production through the fourth quarter. But don't have a real good picture of it across the various lines.

Okay. Thank you.

Thank you.

Your next question comes from Bill MacKenzie with TD Newcrest.

Thanks. I just wanted to drill into the operating metrics a little bit more. Brock highlighted the improvements that you have realized quarter-over-quarter, but I wanted to ask a little more about some of the more recent performance. If I look at the train speeds, June, July when things were at their best, you were averaging around 26, 27 miles per hour the last four weeks about 25 miles per hour. Dwell times have ticked up by an hour or two from the lows. I am just wondering if you can comment a little bit more on some of the recent performance. Is that just a mix issue with bulk taking a bigger percentage of the overall volumes or with volumes overall coming back, is the network slowing down a little bit or just any other commentary you could provide on that.

Well, Bill, you answered the question, so you are right. It is --there's a mix issue. We are seeing a little strength in as Ray indicated in our bulk business and those trains tend to be a little slower. You know as we complete our capital programs this year, which are right on schedule. They usually ramp up very heavily in the July/August/September time frame. So that did have some impact on our fluidity in terms of getting the capital work done we need to get done. Those are the two biggest issues, Bill, impacting the train speeds.

So as the CapEx program winds down Q4, we should see numbers starting to coming back.

Yes, you should.

Secondly Brock sticking with you, can you talk a little bit more about the structural initiatives and where -- you haven't put out a dollar target. But I was wondering if you can comment a little bit in terms of where you think you're at in terms of realizing the benefits of the various different structural initiative that you have underway here and how much longer it is going to take to get through the other initiatives that you have got on the plate right now?

It is Fred. So I kind of put the kibosh on Brock here who would love to tell you stories. But where I'm at is we said we would do CAD100 million in variable costs and we are clearly going to do that. We also said we were going to attack the structural cost. We didn't know exactly how big it was but we thought it was probably at least as big as the variable cost component but it would take a couple of years to deliver that. All I would say is, directionally, everything is consistent with our expectations in that regard. As far as an upside or where we are in the program, we believe that we are off to a good start but our challenge is to ensure that the things we do, structural change has to be sustainable and I want to have a high confidence level and some evidence under my feet before we start making commitments and promises to the shareholders about the sustainability of the longer, bigger numbers. We are into it, we're working these files hard. The mechanical shop rationalization that you've seen some of, the longer trains, these are all ways and means to improve our long term structural costs and there will be more about that in the spring when we get together and talk about our longer term aspirations.

Thank you.

Thank you.

Your next question comes from Chris Ceraso with Credit Suisse.

You made an interesting point before about you can't just look at intermodal and assume it is truck competitive. Because some of it is going to be very long haul. If you look across your whole network, can you give us a ball park percentage of how much of all of all of your business is competitive either with truck or with another railroad or another form of transportation?

Well, it is all competitive in some way, shape or form. At the end of the day, whether it is a regulatory competitiveness or whether it is a modal competitiveness or an alternate rail competitiveness, there is not a piece of business out there that doesn't have some form of competition to deal with. I think what Ray's point is that the nature of the intermodal business is that we have got a very short haul business expressway running between Montreal and Toronto, that is pure us versus the truck in a 350-mile haul. We have got the vast majority of the intermodal is moving literally 2,500 to 3,000 miles. We would argue there's very few trucks other than in specialty nature of a service or a refrigerated product or something unique about it that can compete with us, and then when we move into the merchandise sector, we obviously have depending on the location of the mills and the destinations, for instance, in pulp or in paper we have zones where there are a lot of trucks and we have zones where there are fewer trucks. So we have to price in a fashion that ensures we are competitive. So it is a broad answer because the nature of the portfolio is that there's competition everywhere.

Considering that though I mean maybe if I rephrase it. How much of the business is where things are most competitive either because it is short haul or because of the type of traffic it is?

Chris I don't know how to answer that question to be candid with you because there's different forms of competition. I can assure you it is a competitive world out there and it is our responsibility to deliver a great product on a consistent basis that enables us to secure our fair share of the market.

Fair enough. Then just I am sorry if I missed this. But did you break out what actual price was in Q3 on a year-over-year basis.

What we said was that our renewals came in at 4%. If you walk down the components, we are saying volumes down were diwb 18, fuel down 10. Mix and the Teck kind of offset themselves, FX was 3 and price was 4.

Okay. Thank you.

Thank you.

Your next question comes from Edward Wolfe with Wolfe Research. Please go ahead.

Thanks. Good afternoon, guys. The renewal around 4%, does that include fuel or does that not include fuel?

That is exclusive of fuel.

And the goal of keeping above CPI, if CPI excluding fuel is flattish, does that mean that renewals next year could be below 4% as part of the plan.

What I think have been very consistent in literally for the last four or five quarters is I want the guys to go out with a 4% price strategy. I think that's a fair and balanced aspiration for us to have. We are assuming inflation has been in that 2.5 to 3.5 range depending on the industry, et cetera. And I think we ought to be commanding given the quality of product we have a slight premium to that. That's why Ray and his team are charged with going out with a 4% price strategy. Obviously if inflation drifts down a couple points then I would still like them to get 4 but the ability to get 4 may be influenced somewhat. So all we are saying is I don't want to ever see a time come when we are not doing something better than inflation. Then I want productivity out of Brock on top of that which is how we will build our margins.

I get that, Fred. But Ray just said that the pricing component of the quarter was up 4 give or take now. And you had mentioned earlier in the call that now you are very comfortable with the cost side of things and you have got cost in check, you might want to stimulate sales a little bit. I inferred from those two things that that might mean next year, going a little bit under 4 if need be. Am I interpreting that right or still not correct?

I think the full statement that I made at the time probably if you look back at it, I don't have it in front of me because I was answering a question but I referred to the quality of the product. I referred to the penetrating markets that we're not active in today. So my view is I don't think we need to be price stimulating markets at this point if time. I'm not convinced to be candid with you that knocking a nickel off of price is going to stimulate the housing market to go. What I want is for Ray and his team to be out there looking for markets that we're not active in. I want them to be stimulating further afar or going another 500 miles deeper into the states or deeper to the East that we haven't gone with our customers. So, Ray has got the responsibility to pursue the 4% price strategy and I am sure he will find the right balance. When we stimulate a market we're going to do it through sales effort and market development effort and value-added product offerings, and I'm convinced there's more opportunity for us.

Thank you. I appreciate those responses and the time.

Thanks, Ed.

Your next question comes from Benoit Poirier with Desjardins Securities, please go ahead.

Thank you very much. First question is when we look at your safety matrix obviously you show a very strong improvement versus last year but when we look between CP and DM&E, there's still a huge discrepancy. I am just wondering how long do you think it will take to close the gap, and what kind of initiatives are you putting in place in order to address the issue?

Benoit It is Brock. You know it is certainly as Kathryn has said in the past, we're working really hard to bring our culture of safety here at Canadian Pacific to the DM&E. It will take many years; again the safety culture doesn't change overnight but we have learned a lot here at Canadian Pacific and the team on the DM&E is doing a really good job of adopting the practices and procedures that we are now applying across our property, and I am very very pleased with how that team has accepted that. And moving forward with the improvements that you are seeing. We also, as we stated in the past made a commitment over a five year period plus period to invest in capital to improve the infrastructure of that property. And on the train incident front, that will have a large positive impact over that period of time. So Benoit, I would expect to see continuous improvement over a number of years but I have no doubt that the level of performance will match ours here at Canadian Pacific over that time frame.

Benoit, it's Fred, I will just jump in and reinforce that. The attitude, the receptiveness, the open mindedness of the people who joined us as the former DM&E and now are Canadian Pacific employees is outstanding. So whether it happens in two years, three years, or four years is a function of development, education and experience, we will go as fast as we possibly can but it's not for lack of effort on the part -- people's part down there or our own and we will get there probably faster than people think we will.

My second question is related to your cash position. When you look at the debt to cap ratio, obviously almost at a record level for the last six years, you have a good cash position but I understand that you want to pay down the debt next year. I am just wondering right now what's your -- are you able to take advantage of that -- does it change a little bit your strategy going forward -- any color?

Well, during these times, I have most companies have built war chests, and we have talked very at length about wanting to build financial flexibility. Our focus is on reducing indebtedness at this point and we will continue to focus on that but certainly look at opportunities whether it is capital opportunities to improve productivity, information technology capital that might also improve productivity, we will look at how to deploy that cash in the highest and best return for the shareholders.

Okay. Thank you very much.

Thank you.

Your next question comes from Jeff Kauffman with Sterne Agee. Please go ahead.

Thanks so much. Congratulations on a solid quarter in a tough environment. I apologize if you addressed this earlier because I got disconnected a little bit. But you had so much going on that affected the rev per car, the rev per ton mile. You had the Teck change, you had the grain rate adjustment, you had the mix issues on the potash and domestic intermodal, a fuel surcharge on top of it. You mentioned 4% pricing because that's what you are doing on renewals. But how do I sift through all of this and figure out really where yields are right now.

As I said, if you look at our renewal percentages, we are coming in at the 4% range. I think I took you through all the different components. Maybe--?

I apologize. I was disconnected for a little bit.

Okay. Sorry. Volumes were off 18%, fuel we were saying is at 10%. If you look at FX it was plus 3%. Our mix and the impacts of the Teck regulated grain sort of traded each other off at 1.5% and the price is 4%. Those were the components.

Okay. Second question, Fred I think you mentioned that you're not planning or promising anybody growth next year, if it comes great you had some new business opportunities, but of the cyclical businesses you do participate in. Is there anything you are seeing that gives you more encouragement than discouragement or is it really kind of neutral signals either way?

Jeff I think I mentioned potash just because it is so far down, it's inevitable absent yet another year of problems that we're going to see a rebound in that space and of course that's under contract for a couple of more years. The first half of the year on met coal was a very, very soft period of time and the run rate lately on coal has been more favorable so even if it stays where is it is at, it would be a bit of a boost for us. My bigger issues are not with those ones because they are quite identifiable. The bigger issue is just how long is it going to take for all the houses to get washed out in the States so that all of the foreclosures have occurred and the lumber market actually makes a legitimate and sustained come back. We don't see any evidence of that. We hope it happens we think it obviously will eventually. It's just that I don't have any signs right now that people are out buying cars and building houses in a big way certainly in the first half of the year.

We are heading into winter now. Congratulations and thank you.

Thank you, Jeff.

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

No media? Okay. Very good. Well, thank you everybody. Appreciate everybody's time and look forward to talking to you at the end of the fourth. Bye now.

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