Canadian Pacific Kansas City Ltd (CP) 2011 Q2 法說會逐字稿

Good morning, my name is Matthew and I will be your conference operator today. At this time I would like to welcome everyone to the Canadian Pacific second-quarter 2011 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions). Thank you. Ms. Weiss, you may begin your conference.

Thank you, Matthew, good morning and thanks for joining us. The presenters today will be Fred Green, our President and CEO; Kathryn McQuade, our EVP and Chief Financial Officer; Mike Franczak, our Executive Vice President of Operations; and Jane O'Hagan, Executive Vice President and Chief Marketing Officer. Also joining us on the call today is Brian Grassby, our Senior VP, Finance 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 2 and 3, 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 4.

Finally, when we do go to Q&A, in the interest of time and in fairness to your peers, I'd ask you to limit your questions to one primary question. As you know, we have a significant number of analysts covering us. If you have any additional questions that have not been answered you may re-queue and, time permitting, we'll circle back. Here then is our President and CEO, Fred Green.

Thanks, Janet; good morning, everyone, and thank you for joining us. This morning CP reported second-quarter diluted earnings of CAD0.75. Weather continued to mask the improvements we're making and our results reflect a very challenging quarter, pressuring both revenues and expenses.

On slide 6 we've included a chart that demonstrates good recovery capability but the successive nature of events clearly slowed us down. When we spoke at our New York City investor conference, which is denoted by the red star on the chart, we were recovering nicely. We then dealt with the Souris River flooding that left our primary north-south corridor to Chicago out of service for 23 days.

Some good news, our average daily GTMs have increased by 12% to over 700 million, up substantially from the 625 million GTMs depicted on the last bar in the chart when our corridor was reopened and similar to the gray bars in the week following the New York City event. Mike will add more color on our current metrics which is very encouraging.

It's been an extraordinary first half and, while we're all frustrated, the level of commitment has been outstanding. Marketing has been proactively working with customers, communicating and problem solving. Operations has been extremely nimble in implementing and the re-routes and detours. And engineering has been truly exceptional in their efforts to sustain and rebuild the parts of the network impacted by flooding.

As of July 12 our entire network was back in service. We're positioned and ready to deliver second-half earnings growth and productivity improvements. As you'll hear, we're ready for solid growth, resourced to deliver service and have incremental locomotives and new hires coming on stream.

Now I'll turn it over to Kathryn, Mike and Jane to provide more color on our results and outlook. Over to you, Kathryn.

Thank you, Fred, and good morning, everyone. The quarter was hampered by the residual effects of this year's difficult winter and prolonged flooding along our right-of-way. The flooding and multiple outages dragged on operational metrics resulting in lower train speeds, car miles per car day and higher cars online.

The conditions reduced operational capacity and consumed the resources we had in place (technical difficulty) business. As a result, productivity and asset utilization lagged typical second-quarter norms and our operating ratio remained well above our expectations.

As you will recall, we did have a major flooding event in the second quarter last year. However, the event was very different. It was a single event where a flash flood took out a portion of our main line for 11 days. In contrast, this year multiple flooding events hampered operations throughout the quarter. In fact, we had some part of our network down for 60 out of the 90 days of the quarter.

Quantifying the financial impacts of these prolonged abnormal operating conditions is not an exact science. In a network business once assets slow costs come on. Quantifying the revenue loss or deferral is even more complex. Portions of our carload and intermodal business temporarily found alternative routes. Bulk business is typically considered deferred, but in the case of strong grain markets it can and will go to other elevators.

On balance, we would have expected our carloads to be up about 3% and in line with the average car loadings of the other Class 1's before considering the loss of our short-haul coal movements that we've spoken to previously.

Please turn to slide 8 where we have quantified the direct cost attributable to flooding. The impact of flooding in compensation and benefits was similar to last year with higher crew starts and overtime. Total fuel consumption was higher by CAD5 million due to the start-stop operations from staging trains and extra miles from re-routes and detours.

Purchased services was flat to last year's flood impact and reflects CAD4 million in costs largely due to the payments to other rails for detours. Equipment rents were slightly higher due to reduced asset velocity. In total we estimate direct flood-related expenses were CAD16 million higher or CAD7 million more than last year's single event.

Let's move on to earnings on slide 9. Looking at the FX adjusted column on the right, total revenues were up 5% with price, mix and fuel surcharge revenues offsetting lower carload volumes. RTMs were 2.5% higher and Jane will provide more detail on our mix changes. Operating expenses were up 10% and operating income was down 14%.

Moving below the line, interest expense and other income net were lower. Income tax expense was essentially flat with an effective tax rate of 26% which is within our guidance. Last year the rate was 22% reflecting a tax recovery on foreign-exchange on long-term debt. Net income was down 23% to CAD128 million and diluted earnings per share were CAD0.75 or lower by 23%. The operating ratio deteriorated to 81.8%. This quarter the Canadian dollar strengthened to CAD1.03 and reduced EPS by CAD0.02.

Now I'll move to each line item starting with compensation and benefits on slide 10. In total, including an FX gain of CAD5 million, compensation and benefits was lower by CAD14 million or 4%. The decrease was driven by lower incentive and stock-based compensation of CAD30 million which more than offset increases in other areas.

The increase in GTMs drove workload-related expenses up CAD11 million. Wage and benefit inflation, including our higher pension expense, increased this line CAD11 million. Training was up CAD5 million as we continue to bring on crews to meet business demands and attrition.

Looking at employee counts, we ended the quarter at 14,067, up a little over 1% driven by higher T&E employees. For Q3 I expect the average active expense employee to be up 2% to 3% versus last year's Q3 as we continue to qualify conductors and engineers. This estimate also includes a slight increase in mechanical forces of 75 FTEs to 100 FTEs as we bring back in-house certain locomotive work previously outsourced. Other items were a net CAD6 million.

Turning to slide 11, fuel expense was up $59 million or 33%. Price increased this line $66 million. Our all-in costs were $3.50 per gallon, up from $2.55 in the same period last year. Total consumption was higher by $7 million, which reflects the flooding impact I've already highlighted as well as additional workload.

This quarter our fuel consumption rate was 1.14 US gallons per thousand GTMs. This metric is affected on both the numerator and denominator by the impacts of flooding with more gallons consumed as well as excessive miles or GTMs.

The new locomotives delivered this fall and the continued deployment of our fuel technologies will allow us to continue to improve our fuel consumption rate. Our hedging program provided a lift of $3 million and other items offset fuel expense $2 million. Finally, foreign-exchange was a tailwind of $9 million for the quarter.

Turning to purchased services and other, this line was up CAD24 million or 12% including the FX tailwind. IT costs this year are higher as we move forward with our programs to modernize our SAP and shipment management platforms. While these upgrades impact both expense and capital, you tend to see more expense dollars in the earlier planning stages.

This quarter IT costs were up CAD14 million off of a low 2010 base. Casualty costs were higher by CAD3 million. Intermodal expenses were also higher by CAD3 million due principally to higher trucking cost. While total intermodal volumes declined our domestic business, which includes pickup and delivery, was up.

Moving to the remaining operating expenses on slide 13, you will note that all had FX tailwinds. Materials were up by CAD6 million with most of the increase due to higher wheel change-out costs and lower scrap credits. Higher energy prices also affected materials with fuel for vehicles and work equipment increasing CAD2 million. Equipment rents and depreciation were both lower by CAD1 million primarily due to FX tailwinds.

Turning to slide 14, cash. In June I spoke to our priorities for cash and those priorities are unchanged. Our first priority is to invest in the franchise and high returning projects while maintaining investment grade for our debt and providing a competitive dividend rate. We are maintaining our capital guidance of between CAD950 million to CAD1.05 billion for 2011. But with the rapid payback of our infrastructure programs, if we can get more done we will.

The flooding has made some of the logistics difficult for the engineering team. But, as you will hear from Mike, they are driving to complete the program as planned. Finally, I will be repaying the $250 million US debt maturity due in the fourth quarter.

So my summary is brief. It was a tough quarter; we expected higher demand and had the resources in place to accommodate the growth. But line outages due to the weather continued throughout the entire quarter and into July. These start-stop operations hampered fluidity and mask the progress we are making with the productivity programs we have outlined.

Now I will turn it over to Mike to take you through the operational results and Jane will speak to the markets and the demand picture. Over to you, Mike.

Thanks, Kathryn, and good morning, everyone. At our June Investor Day we reviewed our program to drive improvements in service reliability, efficiency and safety. And despite the recent challenges we've had, we continue to drive hard on all those programs. I'm confident that our game plan is on track. We're focused on fully resetting the network as the impacts of the flooding subside and on executing our operating plan. Doing so will improve service reliability and drive asset productivity.

Let's get started on slide 17. As Kathryn noted, flood-related disruptions required rerouting and detouring of traffic which affected service and operating expenses. The staging of trains, along with the premium costs associated with detouring on other lines, drove our cost per GTM higher. The longer routings required additional locomotives and cars and our work program productivity was also impacted given the difficulty in providing planned blocks consistently.

And while we're slightly behind schedule, we still plan to complete all of our capital renewal and capacity expansion programs this season. The first half was difficult, but we have the opportunity to turn things around for the balance of 2011 as we put the detours behind us and get assets moving efficiently to meet the volume levels and service needs ahead of us.

I'm extremely proud of the team and the work they've done to keep the railway operating. The operating metrics have been showing steady improvement as the flooding and its impacts have subsided. You can see this in the car miles per car day metric which has started to recover from Q2. Let me take you through the rest of the numbers.

Please turn to slide 18 where we'll start with safety. Despite the challenges we faced in the quarter, train operation safety improved versus last year by 22%. We continue to be the industry leader in this area. And while we had a difficult second quarter in personal injuries, our year-to-date performance is only off by 9%. We're now seeing improvement consistent with the general improvement in the operation, however, and I'm confident our safety framework and its key programs will continue to yield long-term improvements in this area.

Please turn to slide 19. Track outages from flooding in the Canadian prairies and the US Midwest parts of the network affected our operating efficiency. Train speeds were down 14% reducing asset velocity and network capacity. We are now seeing good recovery in this regard.

Our fuel consumption rates increased as trains were staged during line outages. Fuel efficiency declined by 1%, but this was in comparison to our all-time best Q2 performance realized in 2010. Not a bad outcome given our challenges.

We start taking delivery of our new AC locomotives in August and this will allow us to cascade out older, less fuel-efficient units. These new locomotives will come equipped with fuel trip optimizer technology as well as distributed power capability which will allow us to further enhance the productivity of the fleet.

Terminal dwell deteriorated slightly by 1% driven by the staging of traffic. However, we were able to mitigate this impact with focus on our yard service reliability program. In fact, at our major yards we realized a 15% decrease in the cost per car handled compared to 2010. Our service reliability program also helped mitigate the decline on railcar velocity which was down 9%.

This past quarter we successfully implemented our local service reliability program in Edmonton. We're on track to complete other major Alberta centers in Q3, all of Canada by year end, and start our roll-out into our US operations later this year.

Let's go to productivity on slide 20. Train weights and lengths held up well despite the challenges we faced. Train weights were up 2% and train lengths were up 1%. And by way of a network infrastructure update, we've just put into service an important new siding in our western corridor which will now allow us to start moving longer coal trains as part of the strategy we covered at our Investor Day.

The noted choppiness in the network and the large number of trains staged impacted locomotive productivity by 4%. And we used more labor with the longer routings. And while employee productivity improved by 2% over last year, the additional GTMs were moved at a higher cost. We'll continue to focus on maximizing employee productivity through programs such as our locomotive reliability center changes and lean process application, as we discussed at Investor Day.

In summary, it was a difficult quarter as we dealt with the lingering impacts of winter in the form of record breaking the flood events. As Fred noted, however, we were able to restore our US Midwest corridor back into operation on July 12. And while it took another week of heavy track blocks to help stabilize the infrastructure and we continued with some rerouting, we quickly began resetting our operating plan.

Since then our key service and productivity metrics have shown improvement and I expect that trend to continue. Our game plan is to improve service reliability, productivity and efficiency and, of course, safety over the balance of 2011. I'll now turn you over to Jane to cover the markets.

Thank you, Mike, and good morning. Overall Q2 revenue showed 3% growth year over year while carloads were down 4%. About 2% of the year-over-year carload decline is due to weather-related service disruptions and, as discussed in Q1, 2% is related to lower US thermal coal volumes. I'll note that RTMs are up 2.5% driven by long haul coal shipments and by the strong growth in export potash, both of which have above average RTMs per carload. As I've spoken to previously, the extension of ethanol hauls to the US Northeast is also contributing to the RTM increase.

As noted, revenue improved 3% for the quarter. FX impact was 2%. So on a currency adjusted basis revenues grew 5%; fuel surcharge revenues generated 4% of that gain. Price and mix of 5% offset the 4% reduction in carloads.

On price specifically, same-store price came in between 2% and 3% and I expect it to be in that range for the remainder of 2011 based on anticipated traffic mix. Renewals tracking in line with our strategy of inflation plus pricing coming in on the quarter between 3% and 4%.

I'll now comment on the markets in the quarter and give some perspective on the balance of 2011. For clarity I'll speak to currency adjusted revenues. For Q2 grain revenues were down 1% with units down 3%. Our Q2 grained carloads were up 13% sequentially from Q1. This was despite the floods that impacted the farmer's ability to deliver grain into the collection network and our ability to move it. Over the past 14-week period CP's grain carloads and market share have returned to our five-year average and I'm confident that we'll continue this trend.

Looking forward to the second half of 2011, the Canadian grain revenue entitlement will increase to 3.5% on August 1 and will affect about 35% of our grain revenues. On the market side in Canada the Canadian Wheat Board estimates that due to wet conditions between 6 million to 8 million acres have gone unseeded. While lower than last year's 10 million unseeded acres, the impacts are more oriented to CP's rail network in Southern Saskatchewan and Manitoba.

Moving to our US franchise which is 42% of our grain portfolio, industry estimates suggest flooding impacts of 4 million to 6 million unseeded acres of predominately wheat growing territory in North Dakota versus 2 million acres last year. Our South Dakota, Minnesota and Iowa corn and soybean territory had strong plantings.

In both Canada and the US it's far too early to predict yields and total production. As we have in the past, we'll keep you updated as the crop progresses and we have more accurate projections.

On coal, revenues were up 8%; volumes were off 14% due to reduced carloads of short haul US thermal coal. Good fundamentals continue in the coal export markets and we're modeling a stronger second half than first half for 2011 consistent with Teck's production forecast. The positive average revenue per car changes in coal will continue through the year. As referenced in Q1, CP's thermal coal movements through Ridley Terminals in Prince Rupert on a joint line basis are ramping up.

Sulfur and fertilizers show continued strength with revenues up 34% year over year on the quarter and carloads up 26%. For potash Q2 2011 was the second largest revenue quarter in our history. Overall potash and fertilizer demand has returned to pre-recessionary levels driven by strong fundamentals in the global agricultural markets and higher North American grain prices.

As Canpotex recently stated, they are fully committed for sales in the third quarter of 2011 and have significant volumes confirmed for Q4. For modeling purposes on sulfur and fertilizers overall, we anticipate second-half carloads to be similar to the first half.

In our merchandise portfolio currency adjusted revenues were up 8%, industrial products were up 12% with forest products up 8%. Automotive revenues were down 2%. From a carload perspective merchandise volumes were down 1%.

Industrial products continue to be driven by energy. As we discussed with you at Investor Day, we expect energy to continue to be a strong growth segment for us. The Bakken, ethanol and Marcellus Shale all hold good immediate revenue growth opportunities while the industrial heartland is a longer-term play.

On forest products, increased Chinese demand for pulp helped us to realize moderate growth despite a still stagnant US housing market.

In autos our carloads were impacted by the short-term effects of the Japanese earthquake on both North American production and imports of finished vehicles from our new domestics. I will point out, we still recorded sequential carload growth of 2%. The new domestics expect to return to normal production in September. Looking forward, we're modeling GDP like growth and merchandise volumes in the second half driven by energy and rebounding auto production.

Moving to Intermodal, revenues were down 3% and units down 8%. Domestic volumes were up modestly, offset by a decline in import/export volumes. Overall this service sensitive market continued to be impacted by CP's weather-related operational challenges.

Having said that, we have excellent long-term customer relationships, a strong network of facilities and customer co-location and our service reliability continues to improve. We are confident volumes will return as we demonstrate a track record of sustained service improvement over the next several months.

Looking forward, I recently met with the shipping lines in Asia and heard some uncertainty surrounding future demand. There is surplus capacity in the transpacific trade lanes and retailers are cautious on inventory replenishment. Based on our customer input and recent declines in North American consumer confidence, we are modeling GDP like growth for domestic. Our focus overall is on delivering service to recover our Intermodal market share.

So in closing let me recap, in bulk we expect continued strength across the book. CP is well-positioned in grain, but it's too early to make a call on crop production and quality.

Moving to merchandise, we continue to deliver on the growth initiatives we've previously described. Based on energy fundamentals and a more normal auto production, we should expect better than GDP growth in those areas.

On consumer-based merchandise segments, with flagging consumer confidence there are some questions as we look forward.

Finally, domestic Intermodal volumes will improve with GDP like growth while in international it is about recovering share. I have met with most of our major customers in both North America and Asia. Going forward our primary focus is on increasing their confidence by delivering sustained consistent service. Now I'll turn it back to Fred to wrap things up.

Thanks, Jane. Well, as you've heard, with the return to more normal conditions we are delivering a significant sequential improvement in operational performance. On the market side we've been expecting a choppy recovery and today's mixed economic signals reinforce that view. Jane highlighted the strength in bulk, the variability in merchandise and Intermodal is the most difficult call with cautious customer signals supporting a positive but quite modest growth rate on retail sales.

Our priorities of service, safety and productivity are clearly established and I'm confident in the ability of this team to deliver sustainable improvements. The last several weeks have certainly been encouraging. Now with that I'll turn it over to Matthew and we'll address any questions that you may have.

(Operator Instructions). Chris Ceraso, Credit Suisse.

Thanks, good morning. Mike, I think you mentioned in your remarks that the flooding is masking the performance. Are there areas that you can point to or specific metrics that you can show us where we can see that if you'd have performance underneath the weather such that when you strip it away maybe we get a bit of a snap back in your operating ratio? How can we tell that you've seen improvement based on what you've done at the yards and so forth?

Yes, there would be a few, Chris. First of all, again I'd point back to things like train weights, train lengths where we actually improved quarter over quarter, so we were able to maintain productivity in that area. Our unit costs in our yards actually dropped. Our yards, despite some staging, largely remained very efficient in terms of processing and managing the flows.

In terms of other metrics, that you've already started to see that I noted are coming back, our speeds are coming back up, our miles per car day are coming back up. So those would be the kinds of things I'd point to in terms of holding the line, if you will, and what's being masked, what's coming back.

Okay, thanks. I'll get back in the queue.

Fadi Chamoun, BMO Capital Markets.

Good morning. So, you provided some color on this, I just want to sort of understand a little bit better the recovery progress. So if I look at your average weekly carloads before winter and the flooding impacted, you were doing something around 52,500 a week. Q1 you did 47,000, Q2 you did close to 50,000.

So my question is given the share changes in the Intermodal probably from other areas, do you think that the demand is there to ramp up towards 52,000, 53,000 going into the back half? And do you think that from an operation standpoint you're able to recover to handle that type of volume in a fairly short order?

Well, Fadi, to be candid with you, we don't do forecasting on the carloads as much as it's a derivative of RTMs, GTMs, etc. So I don't know that I can give you a specific number saying it's 52,000, 53,000, 54,000.

What I can say with certainty is that the back half of the year we anticipate that the demand will be there based on all the things that Jane said particularly with grain, potash, coal. We anticipate that with the production or the capabilities that we've already put in plus through our work programs and that we will continue to do over the balance two or three months -- the next two or three months, there's no infrastructure issues whatsoever that will be an inhibitor to being able to handle those volumes.

We have 61 locomotives arriving in August and September and we've got -- you heard Catherine's numbers, literally hundreds of [RTEs] coming on running trades people. So, capacity is not going to be an issue and demand appears to be strong. We're obviously a function of the economy. But half our franchise is bulk and certainly the bulk side feels strong, the other is a little less certain.

And with regard to share, you've seen the movie, we lost some in potash, it's been recovered; we lost some in grain, it's all been recovered. Intermodal will be next in our view; we'll just keep doing a great job and we've been doing this stuff for 15 and 20 years with these customers so there's no reason to believe that as the quality of our service goes back to what they became accustomed to that we won't see our share revert back to us.

Okay, thank you.

Thanks.

Chris Wetherbee, Citigroup.

Great, thank you. And I guess maybe a little bit further on that, a question about winning back some business, particularly when you think about the Intermodal side of the world. Given the service sensitivity do you feel like there may be any pressure on yields as you go forward trying to bring some of that business back on?

Or it just simply a function of service as you go forward? And just I guess the additional one to that, you mentioned GDP, kind of what you think you can grow at that level. Just give us a sense of what your GDP outlook may be for the next couple of quarters?

Yes, I would say that when we look at the Intermodal share and we think about where we need to be, as Fred said, if I use an analogy with grain, and as I told you before in the last 14 weeks, we returned to our five-year average market share in volume and grain. And this really boils down to a couple components, one being the strength of our network and our service performance.

So at Intermodal, while this has been certainly our most service sensitive segment and there have been some temporary shifts with respect to customers who needed to find a temporary route. Again, much like grain, this comes down to having a strong network and demonstrating that great service to our customers.

So in Intermodal we do have an excellent customer relationship, we have great facilities, we have great co-location. And, as I said, we're showing improvement in reliability. So this focus that we have right now is on demonstrating the sustained improvement over this longer period of time. And I think our Intermodal customers are going to be looking to us over the peak period to be able to demonstrate the sustained importance I would say around improvement.

And so we've already seen some of our volumes return. And I would say that we did model on the domestic side the GDP of 2% to 3%. But I would say on the international side and on that shipping line side, our real focus is on that sustained improvement. So I wouldn't want to call out a number because we're continuing to work that on a day-to-day basis.

Okay, great. Thank you.

Thank you.

Cherilyn Radbourne, TD Securities.

Thanks very much, good morning. I wanted to dig in to the Intermodal marketshare losses just a little bit more. I think if I understood your comments correctly, it sounded like more of the losses occurred on the international side as opposed to the domestic. And it sounds like you're expecting that -- it's going to be some number of weeks and perhaps months to sort of convince them that your service reliability is back where it needs to be.

I think, Cherilyn, you've captured it. Jane I think appropriately tried to describe the fact that this is a service sensitive business and we caused some apprehension amongst a subset of our clients based on our difficult first quarter in particular and then inconsistency in the second quarter when the floods came and went.

So I think it's only fair to them that they get evidence of our performance throughout the summer and the early fall period. And if we do a bang up job our belief is that we'll earn back the respect and earn back the right to participate at a level that we've historically participated at.

Obviously we have to prove that and obviously the numbers have to come in there, but we don't have any signal so far. And as Jane said, some people have already started to shift business back towards us. So we're quite encouraged by it, but it's a journey, it will take several months, maybe even a quarter or more as people test us during the early peak in the fall.

Okay, thank you. I'll get back in queue.

Thank you.

Ken Hoexter, Merrill Lynch.

Great, good morning. Fred, can you just talk a bit about on the employee side, what levels you ramped up maybe to help deal with the floods, what we can expect going forward? And then on the same build, kind of the expense per employee? If I go on the total employees it took a large dip in the quarter. Can you kind of address if there was some noise on that issue as well?

Sure, Ken. In terms of the numbers, we are up slightly on the quarter, but even more so on the train and engine side. So our road crews are up as we bring more people out of the training, that's when they hit the headcount.

In terms of the noise on the cost per FTE, if you go back to my slides you'll see that there was noise because of the incentive comp and stock comp was the cost of corporate performance down significantly year over year. So hopefully as we see performance coming back you'll see a more normalized cost per employee.

We are seeing inflation, wage inflation in the range of about 3% as well. So one thing to note on the headcount that I gave you, 75 to 100 in the quarter, third quarter will be transitioning from what was previously outsourced work, so it would have been reflected in our purchased services line and coming over into the compensation line. But on total you wouldn't see higher overall operating expenses.

Ken -- sorry, to your original question with regard to the flood impact on employees, there was a shift of existing capital employees from work programs to these emergent issues, there really was not an escalation in the number of capital employees of any substance during this quarter.

And as Mike pointed out, that all of those people since July 12 have now reverted back to the programs that they would have otherwise been doing. And hopefully, based on some good productivity, we'll be able to make for the lost ground in the course of the year.

So, to clarify, Kathryn, then the dip on a per employee basis, expense per employee, that was a second-quarter event that should rebound back to an inflation stance in the third quarter?

Well, again, the incentive comp is based upon corporate performance, so you have to take the incentive comp and the stock-based compensation on balance for the entire year. So I can't talk to it quarter to quarter, but what you should see in terms of, and what I gave you the details in the various slides, we have our typical increase in our pension expense as well as normalized 3% annual inflation on wages. And as well as training which is up year to date.

So you really have to look, there's no real average I can give you, there's a lot of moving pieces in it and I've tried to give you as much color into that. But in terms of wage inflation, 3% is fair to -- on an annual basis is fair to assume. Take into account that we'll continue to see higher training expense. Our pension expenses, which we've given guidance on, is exactly as we've given guidance. And then your stock based and incentive compensation will vary based upon corporate performance.

Understood. Thanks for the time.

Thank you.

Bill Green, Morgan Stanley.

Yes, hi there, good morning. I was just kind of curious about Jane's comments on some of the outlook here. It's a little bit more measured. And obviously, Fred, as you mentioned, there's going to be some time here to sort of win back on service some of the volumes that were lost. So what kind of volume growth rate do we need to be thinking is realistic to hit the long-term OR targets? Is that still sort of realistic or do we need to sort of adjust those given these challenges?

Well, Bill, I think if we look at the longer term we were, even as recently as our time in New York a month or thereabouts ago, thinking normal growth rates as in traditional GDP of 2.5, 3.5, 4 in faster growing years. All that Jane was trying to express is there is going to be a blip in the -- clearly in the third quarter, possibly part of the fourth quarter as we earn the right to get our share back.

It's reasonably modest on a relative scale, but it's still an important awareness which we're trying to provide insight into. We think we'll be successful in that. So call that a blip for a quarter or part of maybe a quarter and a half.

And then the key thing that I hope is clear to people is that there is a lot of uncertainty in North America. You kind of heard the full gamut amongst all the other rails with regard to their optimism. We, clearly on the bulk side, which is half of our business, feel very strong, very positive feedback based on the customers' expectations, that's great for us.

We're a little less excited by the merchandise side other than in specific areas like energy where we're just knocking the socks off it. But auto has got some upside. The housing side continues to be really tough. So we see that as a mixed one.

And the real issue that we seem to feel is a little bit more conservative than others is simply the dialogue we're having with our retailers, the dialog Jane had in Asia certainly indicate to her and to all of us that the growth of retail sales and the fall peak or lack of peak could be a little bit more muted than people -- others may feel.

So we're just -- we're quick to go big if the opportunity arises, but we're not, at this point, seeing the kind of indicators that would cause that to occur.

Okay. And then when you think about trying to win back from the -- given the service issues when you try to win some of that business back. Does price have to play a role in those discussions or is it really just you need the time and the consistency before they come back?

No, price is a non-issue. I mean we've got such a good strong track record of having been good, been -- having delivered consistent service for decades literally. That it's just a matter of people getting their confidence back that we are who we've always been, we're not the party that they experienced for a quarter and a half. We don't -- price is always part of the mix, let's not kid ourselves, but there's no effort in that regard. The effort is all about service.

Okay, thank you for the time.

Tom Wadewitz, JPMorgan.

Yes, good morning. I wanted to ask you a bit about the margin outlook and also kind of timeframe for getting to -- get some more representative performance on the margin side. Fred, how many quarters do you think we need to look at to say -- assuming you don't get hit by more weather impact, to say this is a representative quarter in terms of your capability to execute? I'm thinking particularly on the margin line. And then I guess related to that, do you think there's a chance you show margin improvement year over year in second-half or is that a bit too optimistic?

Well, it's certainly our objective, Tom -- I'll kind of answer them in reverse order. We do see good demand and the second half; we are seeing some great indications on the fluidity of the railway in the last 10 or 12 days. And the combination is favorable towards an improved margin for the second half -- relative to the second half last year. So we're certainly driving that way; we have to deliver it obviously.

With regard to your question, I think Kathryn was pretty clear in New York that we've got some headwinds in the sense of pension, as an example, that are pretty substantial. And we said we'd drive to the low 70s, but we didn't anticipate a rapid movement there as much as '11 and early '12. But as we work our way through that we start to see some pretty rapid recovery moving toward -- improvement moving towards it.

So it's not a straight line, it's kind of you've got to overcome the first I think it was two years, if I recall correctly, of pretty serious pension headwinds. But -- is it 3 -- sorry, Kathryn's telling me 3. But all said and done, the improvement opportunities that Mike outlined will neutralize those in the -- I'm talking about his New York presentation -- will neutralize those over say the first year or so and then we're into production that will enable us to get to those numbers in our view.

Does your comment on second-half margin improvement apply to third quarter as well or is that a little too optimistic given some weather in early July?

Well, I guess I want to be measured about that, Tom. There's only 12 weeks in a quarter and we had two weeks of outage and a week of recovery, as Mike said, with the engineering blocks, etc. So yes, we're digging out of a little bit of a hole, but at that same time the demand right now for bulk commodities appears to be pretty strong. So subject to the customers confirming the demand and actually delivering the demand, let's call it nip and tuck in the third and then a stronger fourth perhaps.

Okay, great. Thank you.

Gary Chase, Barclays Capital.

Good morning, everyone. Just trying to square some of the commentary here and see if I've got my arms around it right. You said, Fred, I think when you were answering the last one from Tom that you were hopeful for some margin improvement or that you thought that was feasible in the second half. And if I'm getting everybody's commentary right, it sounds like volumes are going to be up moderately when you consider all the puts and takes, similar pricing dynamics.

It seems to suggest that you're going to be able to move more volume -- somewhat significantly more volume with less aggregate cost. I mean, is that the way we should think about where the network is? That you've made enough progress as things have recovered here, we can actually move more volume with less cost -- you know, fuel neutral?

Gary, this is Kathryn. I think you captured it pretty well. I mean it's going to be a function of the some of the volumes, and Jane has tried to give some color on where we see it. But similar to what we've talked about for the last couple years, incremental margins all come on at different -- at kind of different levels.

So in terms of if incremental margins come on in terms of our merchandise in Intermodal, we've got lots of room on our trains to add those incremental carloads at very low cost versus bulk which tends to come on with new train starts. So there is different leveraging as the different businesses come on. And we are seeing probably most of our upside potential in the third and fourth quarter on the bulk slide.

We do have the headwinds that Fred talked to earlier. So, as Mike and the team resize the assets we've got adequate resources to handle the business that's coming to us. We need to use those resources efficiently and should the volumes come on you should see incremental improvement quarter over quarter to -- from second quarter to third quarter in terms of margins.

So, Gary, let me add just a little bit more color if I may. I think it is important that the theme that you've heard from all of us, and it kind of plays out in the intermodal dialog we've had, is that this is about service. So it would not be the appropriate time for us to be constraining resources.

The right thing to do is to have the right numbers of resources. You hope you get it perfect. If you're going to err over the coming couple of quarters it will err on the side of an abundance of resources so that we've got the ability to meet any upside opportunity and any upside service requests that our customers have to be establish our credibility.

So we're not attempting to be nip and tuck on trying to get it perfect, we're trying to make we have enough resources in almost any circumstances. We will recalibrate resources once we get our rhythm and once we have the confidence of the customers.

Should we be thinking that the cost structure has permanently escalated as a result of what's happened or do you think -- that might be the better way to ask the question? Or once you kind of got through the first half we're sort of going to be able to go forward and move the similar volumes [of the past] at similar cost levels?

Yes, I don't see that conclusion at all. I think consistent with the New York discussions of Investor Day, we see a lowering cost base over the course of time as we deliver on our long train strategies, our structural cost reductions and that everything that we've experienced in the last -- particularly the last quarter is just purely a situational thing where we were under the black cloud and we paid the price for it. But it could be somebody else's turn next year, you never know.

Obviously, just like last year, we will look at our physical assets and see if there is any pattern emerging. But quite clearly there has been no pattern, it's a one season event. But we'll be attentive to the fact that we might have to do something, but that would be more capital oriented, Gary, than expense oriented.

Thank you very much.

Thank you.

Matt Troy, Susquehanna Financial.

Yes, thanks. I had a question about the bulk franchise given a somewhat brighter outlook for you there. With respect to coal, you've always been very focused on one customer. I was curious with potential expansion at West Shore, Thunder Bay, Neptune and some of the other export facilities you serve, might there be the opportunity to handle PRB coal on an interline basis and start moving that off the West Coast and some of the facilities you access?

And then on the grain side, I appreciate the number on the 6% acreage decline in terms of plantings. But was wondering in your context of your comments where you say that that's skewed towards your network, could you maybe just give us some context around what that actually means, those 6 million -- or the decline in acreage being [key to your] network, what is that relative sizing to your overall grain book of business? Thanks.

we're going to break it into pieces. Jane is going to answer about 90% of that, Matt, but from a coal perspective, the reason we've been focused on one customer is one customer owns all the coal mines in the Southeast British Columbia. So Teck is our sole metallurgical customer for that reason. Maybe I can flip it over to Jane with regard to some of the success we've had in doing arrangements with other parties on thermal coal.

Yes, I would say that to your question, I mean the PRB side is an opportunistic market for us. And as I told you last quarter, we were going to move about 400,000 tons and we've seen an increase on that now where we'll expect to move about 650,000 metric tons by the end of the year.

And again, this is an opportunistic market where, again, it's one of those places where you find the opportunity to decide whether or not you're going to take it. And I think the question really for us over the medium term is whether this is a long-term sustainable market given the sourcing alternatives for thermal coal in Asia. And whether on a long-term basis if there is significant investment that would be required you'd want to have the right type of commitment to do it.

So I think my message to you would be -- is that we're looking at it, we're moving the volume now, it's opportunistic and as those opportunities develop we'll make our decisions.

Now with respect to grain, I believe your question was when we talk about the 6 million to 8 million unseeded acres, I'll just give you some context, last year it was about 10 million. And as I said in my remarks, the impact that we're seeing right now on the unseeded acres in Canada is that it's linked to our southern Saskatchewan and Manitoba area.

But again, being the fact that it's so early to call in this crop year, and given the fact that weather and all kinds of other factors can impact crop quality, crop yield, it's really too early to tell whether that impact of unseeded acres is going to effectively change the size of the crop.

So as I said, our focus is really on understanding how that crop dynamic continues over the next several months. And for us to basically be able to capitalize on the fact that 60% of the high throughput elevator capacity in Canada is on CP's lines, when grain is ready there to be moved, we're going to move it.

So, Matt, on grain, just to validate everything Jane has said, yesterday I was on a call with the most senior person in one of Canada's biggest grain companies and we had a dialog similar to this and the assessment was identical. That there's no way at this point in time that we should discount the possibility of very substantial yields given the moisture in the ground, given the sunshine.

And as such nobody is declaring that we won't see a crop as big as last year and nobody is declaring that our southern territory may not be almost or even greater than last year. It just depends on yield, bushels per acre. So it's too early to declare, we're just trying to be as candid and transparent as we can about the plantings.

Thank you for the very specific answers.

Welcome, Matt.

Scott Group, Wolfe Trahan.

Hey, good morning, everyone.

Good morning, Scott.

So, a lot of questions on how quickly the volumes recover. I want to talk a little bit about how quickly the costs go away. So, Kathryn, you talked about in your comments how costs come on when flooding comes. What's your view on how quickly these costs go away now that the network is reopened?

And then with that, is there a time frame you can give when you expect volumes and train speeds to turn positive year over year so we can gain some conviction that the network really has recovered and that the marketshare is starting to come back?

So -- boy, a lot of questions there that you asked, but all in one question. First of all on train speeds, I think you've got to be careful looking just at the aggregate train speeds because mix does play a portion on there. And we do have a higher percentage of bulk which is a slower train speed than what we have in terms of percentage of the merchandise and intermodal traffic.

So if you almost look at the mix right now, we are literally I think this week back, Mike, back to last year train speed levels. So when we do look at that we have to take into consideration a lot of things in terms of train speed.

My comments around cost is we're an asset-based business. Costs come on as your assets are not being used efficiently. So as Mike and the team start moving to improve locomotive utilization, cars -- reduce cars online and improve the turns. In the bulk business turning the assets is extremely important in terms of the profitability of that business. What we've tended to look at is those turns and the right sizing of our assets to the level of business.

So, it does take time for him to reset the network. You have to reset it across thousands of miles as well. So, and as Fred, I think, pointed out, we have residual effects of flooding way through the middle of July. So it will take some time for them to reset, but clearly the metrics are moving in the right directions, GTMs are coming up nicely and we should see more normalized operations for the remainder of the quarter.

So, Scott, it's Fred again. I'm going to be a little bit of the black cloud and just reinforce the point I made that we are -- the way this is going to unfold is we are already seeing the pretty rapid recovery on the metrics that Mike referred to, Kathryn just referred to.

But given my determined focus on recovering sustained service levels, even though we produce these surplus assets we're not necessarily going to get rid of them immediately. We may go through a period of putting them into storage so that they are there at our fingertips should anything of this nature occur again.

It's really our primary obligation to illustrate to the client base that we can deliver what we've delivered for the last several decades -- consistent, reliable service. And that may require us to keep a handful of assets in surplus storage capacity so that we can be there should we ever face any other issues -- or upside opportunity as well.

That makes a lot of sense. Thanks, Fred. Appreciate it.

Thanks, Scott.

Scott Malat, Goldman Sachs.

Hey, good morning, thanks. I just had actually a separate question. Just I'm wondering how important, from Jane, your thoughts on how important the US Senate vote last month to remove ethanol subsidies. Have you talked to customers on the potential impacts? How do we think about the risk to the business? And then if we did see a change in US government policy on that?

Scott, the place that I would start at first, as you know, we talk to our customers about this on a regular basis. And again, the customers that we have that are shipping ethanol are really high-quality low-cost producers. Their view is that the mandate is still going to be there. So at this point, again, their focus and where we're lined up, policy always at some point has some sort of impact. But what we're hearing from the customers is they feel they're well positioned to compete in the market.

And anything on -- would there be other residual impacts to fertilizers or any of your other businesses?

I mean, I think the answer to that I would say kind of is no, because I think that when we look at corn and we think about the global demand for it, and just the demand for corn for us as a company, whether we're moving corn for ethanol or moving corn for export, the significant issue that we have at play here is that the overall demand for corn plantings is going up because the market is there. And so our fertilizer customers see that as strong too.

All right, that's helpful. Thanks.

Thanks, Scott.

Walter Spracklin, RBC Capital Markets.

Thanks very much. Good morning, everyone. My question is on pricing here and, Jane, you pointed to sort of 2% to 3% same-store pricing. Your 3% to 4% renewals. When we were talking to the other railroads, some are talking about inflation at 3.5%, some up toward north of 4%. My question is, even on the renewals, which we'd like to see that 2% to 3% come up to the renewal and perhaps you can touch a little bit on when that happens. But even at 3.5%, is that the right rate and to what extent did your flooding and the impact on service deter you from being able to get higher rates if the view was that the service wasn't there?

So, Walter, this is Kathryn. I'm going to start off and then Jane can talk to specifically the pricing questions. But in terms of inflation, I think you are hearing a little bit higher inflation levels coming from the US carriers. And one of the things that it is really driving when you look at the index is healthcare costs. So healthcare costs in Canada are quite different than what you have in the US, so we are not seeing quite as large of inflation as what you are intending to hear from the US carriers.

Where would you put your inflation, Kathryn?

We are looking at more probably about a percentage lower than what they are saying.

Okay.

So, what I would add to that, Walter, is, again, we have been real explicit on our renewals, on our 3% to 4% and I would just add to that, with respect to our book of business, over 40% of our book is in multi-year contracts, which have inflation, have different indices that include inflation. So from that perspective, if we see renewals coming in at 3% to 4%, again, we are going to be capturing that level of inflation.

So I mean I think at the end of the day, as we have said, our same-store price in and around the 2% to 3% range, again, these both in combination are capturing the type of inflationary environment that Kathryn was speaking to.

Okay, and the timeframe that you think that the same store will equal the 3.5% once we flush out some of these kind of timing issues, is it in 2011?

Well, again, you know what --.

Walter, sorry, it is Fred. It will be purely a function of when inflation rises because there is just like a time lag, right. It is an indexed set of input costs that drive the index pricing. So if inflation rises rapidly then you'll see the 3% to 4% on the renewals to match what you're getting on the -- sorry, on the indices ticket to match what you're already getting on the renewals.

Okay, thank you very much.

Thank you.

David Newman, Cormark Securities.

Good morning, just two questions, one just being a real housekeeping one. But with the government moving forward with the deregulated wheat and barley market, how is your positioning and the large high throughput grain handlers versus some of the smaller players? And what other opportunities do you think you might have like specialty grains and things like that? So, as this all comes in -- comes to pass next year how are you guys positioned?

Well, I think that if you look at the CWB process and what they're doing by August of next year is that this is largely a political process that deals with the single desk selling aspect of the business.

Right.

Plus for us the demand and what it is and how we move grain doesn't depend on new markets, I mean it's who moves it. And I'll remind you that at this point the CWB basically doesn't have any assets. So wheat and barley at this point move through grain company elevators and through their port terminals. So for us it's really about the excellent relationships that we have with the grain companies because it doesn't matter to us who markets it, we're just going to move it.

But it does -- they do it direct flow, right? I mean -- so, I mean the Viterras of the world and larger players like that can push flow to their own network, can they not?

So, David, it's Fred; let me just maybe put two little twists to that, the first of which is every ton of grain that moves, whether it's CWB or anybody else, already goes through an elevator and already goes through a railway and already goes through an export elevator controlled by those grain companies and/or the railways.

Right.

So, there's not going to be anything different from the physical movement, it's just who controls what. So let's go back to basics. The key thing is that Canadian Pacific has 60% of all of the concrete high throughput elevators located on its assets.

Okay.

So that gives you pretty good indication that not too much is going to change dramatically, if anything we might have some upside as we build upon the relationships we already have with the three majors and a really important group of others -- medium-size customers as well.

Perfect. And just a quick housekeeping one. Last year -- this year there was no adjusted number. You had an adjusted CAD0.92 last year. It likes like it was negligible in the quarter, but was there any ex FX gain/loss on the debt?

It was very minor. That's -- we announced even at Investor Day and several times, we're going to move away from that type of reporting as long as it's not a material impact.

Got it, perfect. Thank you.

Thank you.

Jason Seidl, Dahlman Rose.

Good morning, guys. Real quick on the Canpotex contract, can you talk about where you're at in terms of negotiations phase? Because your competitor had a couple comments on their own conference call that they were ready and more than willing to pick up some of that. And also maybe if you will, we're sticking on the potash and stuff like that. Can you talk about some of the new mines that might be coming on that might not be a part of Canpotex and the business that could be generated from those?

Well, let me start off by saying that there's over 11 months to go on this contract and that our focus with Canpotex is always on operating a world-class supply chain, developing the type of supply-chain that maximizes the use of their assets and delivers the product that they need to get to their world markets.

With respect to CN and their aspirations, I mean that's not anything that I can speak to. What I can speak to is that our focus is always on improving that and working in partnership with Canpotex to make that better. And you'll recall from the discussions that Mike had at Investor Day, we're also looking at making some investments in our infrastructure to work on the continuous improvement to make those markets better for them as they look at their Vancouver and at their Portland markets.

I'm glad you asked the question about greenfield development and we recently had some news that's been published about BHP, which is one of the newcomers. I would say that we certainly feel optimistic. They've had kind of a new milestone in their approval where they got Saskatchewan government environmental approval. And they've also set aside CAD480-million-plus to do some of their what I would call pre-commitment capital to start working. So we feel that's going to go ahead.

And of course Fred has also talked to you about those very real investments that the existing players of Agrium, Mosaic and PCS are already making in their facilities. Also remind you as well just in case I might have skipped over this with BHP, I think it's a really important point that we already have an MOU signed with BHP to move their potash from their Lanigan mine to Vancouver, Washington. So obviously to Fred's point he made earlier, we're feeling pretty bullish about this market and its future.

Okay, great. And real quick, Kathryn, on the incentive comp, obviously you had lower incentive comp this quarter. Any projections for 3Q or is that just going to depend on how the railroad service trends?

It depends -- you know, our incentive comp is based on full-year performance and I encourage you to read our proxy because it kind of goes into that. So it's going to depend on how the rest of the year plays out. But it's going to be tough to move the needle because of the first half.

Okay, thanks for the time as always, guys.

Thank you.

Benoit Poirier, Desjardins Securities.

Yes, thank you very much. Now that your network is back on track since July 12, you talk obviously with the improvement in your efficiency ratios of car mile per car day, everything. But if you look in terms of carload for week 28, week 29 carloads were still almost flat and even down 1.6% in week 29. So my question is when should we expect to see some positive numbers on the carload front and maybe provide some color about the magnitude? Thank you.

I think, Benoit -- it's Fred, you're hearing from Jane the strong demand the customers are telling us about with regard to bulk. We know for a fact, and Mike might have to correct me here, but we've been doing about 5,000 carloads of grain plus or minus a couple hundred, high 4,700, 4,800. I think we'll hit 5,000 this week. We'll probably run in that range all the way to the end of the season.

And I think that would probably be -- for July it's probably similar to last year but for August it will probably be bigger. So you may start to see some differentiation there. The coal volumes have been a little soft lately as they go through a little bit of summer shutdown stuff. But I think you're going to start to see those ramp back up probably around August 1, so again in August you're going to see some incremental activity relative to what you're seeing these days.

In potash, we're actually running ahead of the forecast with them. So I don't know how much more we can drag out of those mines. We're kind of going as fast as -- they're going -- we're owing as fast as they need us to and then some.

So I think the real issue is remember short-haul coal loads? Those are big numbers of cars, not RTMs but cars, and recognize that we lost particularly some prairie destination off the Port of Vancouver on the international side. So again, a lot of cars, shorter haul, shorter RTMs but a lot of cars. And those things, again, I think mask a little bit about the robustness of the activity.

And I would only add that we're also seeing a later, flatter fall peak with respect to the intermodal side. So there's a little bit of a different change in kind of some of what we would expect on the normal seasonality here.

Okay. And maybe if I may, just a quick one. What should we be thinking about the spread between RTM and carload going forward? Because if you look at the quarter it was a big difference versus Q1, so --.

I think -- we probably have to take that one off-line, Benoit, just because we've got -- there's a lot of moving parts, as you well point out, with the longer haul potash and the short-haul carloads going away. I don't see a dramatic difference (multiple speakers) what you experienced in Q2. But we can validate for everybody.

Perfect. Thank you very much.

Thank you.

Elliott Waller, Jefferies.

Hi, good morning. A quick question for you. In your repaired remarks regarding coal you talked about a strong average revenue per car to continue. That would imply similar -- CAD1,700 to CAD1,800 per carload, is that the right way to think about that?

Yes, that's the right way to think about it.

Okay. And then as we look into 2012, how should we think about the sustainability of that and what's going on in your coal business?

I would say that that would probably be a good way to think about it; it will carry through.

Remember, Elliott, that the rates are indexed. So as you make your way into -- I think it's an April 1 contract start. As you get past the end of the first quarter there will be some form of indexed increases, so the revenue per carload will reflect inflation.

But directionally it's correct.

Yes.

Right, okay. Very good, thanks.

Thank you.

David Tyerman, Canaccord Genuity.

Yes, just on the compensation and incentive comp. So I just want to understand how this works then. Are you accruing what you think is going to be the annual profit and that's essentially what's driving this? So therefore if H2 comes in differently the incentive comp will change again?

Well, the way you accrue for incentive compensation is you have to estimate the year. And you then look at the performance requirements that are needed to be delivered upon to trigger it. There are different levels of triggers. And then you essentially adjust for the overall performance.

Then of course you have the other factor in your stock-based compensation which is also performance-based as well as share price-based. So you have a lot of moving pieces there, but you have to -- like even your performance shares, you may be looking over a one-, two-, three-year period as well as the current period. So a lot of moving pieces, but needless to say, the first-half results do impact what we anticipate getting paid out for this year's performance.

So is there any rule of thumb you can give us at least on the -- excluding the share which you've already -- share price you've already given us? Any kind of rule of thumb that we can use to get an idea like if the earnings are coming in ex?

No, I really can't do that. The rule of thumb only that I can really hold to is the share price on the incentive comp -- I mean on the share-based compensation. But even that doesn't apply to the performance-base of the share price compensation.

So, David, it's one -- we're not giving guidance, so as a consequence it kind of ties our hands on a lot of what we can say publicly. You can be assured that the Board's expectations are that we would improve the property, the financial results of the property. Obviously based on the first half on an annualized basis that's going to be a tough trigger (multiple speakers).

For the whole year.

On an annualized basis. That's our reality and it's frustrating, but our job is to go like stink in the second half, see what we can do. And if we're really, really successful we can perhaps overcome the first half and at least trigger the bottom end of comp. But there's no evidence at this point that we want to be making those kinds of statements.

Okay, and then very quickly on IT planning, that pushed up purchase services a fair bit. Is that kind of a good run rate to think it's going to be high for the remainder of the year in that sort of order?

Well, you know, I've been talking about this now for about six, eight months. As we look at the renewal we do have -- every IT project goes through various stages. So what you tend to have is a higher percentage of expense coming in in the planning stage because that's not capitalizable.

So as we move the various projects forward you do tend to have, and what we are seeing in 2011, higher IT expense dollars that I think ultimately turn into more capital dollars over the longer term. But along with bringing on additional projects, you do have higher operating -- IT operating expenses. So there are some things compounding here. But I don't think the quarter-over-quarter comparisons start to mitigate in the -- as time goes on. But probably for the third quarter it's not a bad run rate.

Okay, great. Thank you.

Mike Baundendistel, Stifel Nicolaus.

Thank you. I just had a question thinking back to your Investor Day in New York, you talked about improved flexibility in your work rules as one of many things that could improve your productivity. Just wondering if you're seeing any benefit from that already and was there anything you had to concede to the unions in order to get those improved work rules?

Yes, short answer is yes. We are seeing benefits from improved work rule flexibility. I think I mentioned at the Investor Day we saw benefits accrue to our engineering track programs. We've seen some great productivity improvements in our new 7/7 work cycles, for example, in our prairie rail gangs. So that was a change in the scheduling of the -- of that work program.

I also mentioned that we were seeing greater flexibility in terms of how our mechanical staff are being used at shops with respect to servicing and maintenance of locomotives. And we're seeing that improvement in terms of our shop cycle times as well as people are able to do different kinds of work on different locomotives.

So short answer is, yes, we're seeing the benefits. And in terms of giveaways, it's all part of the big package. But of course as we negotiate our way through these agreements, there's always a bit of a trade-off with the unions. But we think on balance we are seeing the benefits flow materially to our production and efficiency rates.

Thank you.

Keith Schoonmaker, Morningstar.

Hello, at the June event you (technical difficulty) progress you've made (technical difficulty) I think you also shared a near-term target of 11% (technical difficulty). I think we also heard that mainline train sets are already [DP] equipped. Could you please comment on how much room is left to expand and what are the next steps in building longer and heavier trains?

Keith, you broke up a little bit, so we're going to -- we'll speculate on the question. It sounds like it was about train lengths and how fast can we get there.

Yes, and the next step.

Okay, so I think the short version is -- in simple terms is we have three different types of trains -- bulk, merchandise and intermodal. And the book trains, as we outlined at the New York investor conference, is a pretty systematic march towards those numbers that we provided of 142 then going to 152 on the coal and up to 170 on the potash.

The reason I'm saying it this way is they are dependent either on our own investment in sightings which are well progressed, Mike made reference to the first sighting and now we've got I think six trains as up to the higher end on coal. And investments at some terminals such as the potash facilities. So that's a pretty systematic march and I don't think we have time on the call to go through the whole thing.

And then Mike referred to the ability to go on both merchandise and intermodal trains. We already have a large DP equipped fleet, we'll have another 61 of those and another 30 in the first quarter of next year, which just gives Mike and his team that much more flexibility to take every train up.

So we're not -- we haven't provided any specific insight with regard to intermodal and merchandise train length growth other than directionally it's going to get longer. And I think the early evidence that Mike showed you even during these difficult times is favorable.

Long run are siding lengths, even the extended sidings, is that the greatest constraint in the long run?

Well, it's the physical constraint, yes. With the amount of locomotives we have today and the crew capabilities and the agreements we have we can go forward, we just have to systematically march our way through the critical corridors with these siding extensions, yes.

Thank you.

Thank you.

Jeff Kauffman, Sterne, Agee.

Thank you very much, I know it's been a long call. Fred, there's not much you can do about the kind of weather that you've had thrown at you this last year. But going back to when this all began with the flooding in Saskatchewan, what have you learned and, in retrospect, what would you have done differently?

Well, I think, Jeff, the frustration of it is that it's almost -- it's dropped on completely different territories. If you look at where we had our floods on the mainline and on the Manitoba -- I'm sorry, the Saskatchewan/Alberta border last year, it's got absolutely nothing to do with the Souris River which has got nothing to do with the Red River.

I think it is fair to say that the theme of flooding is certainly bigger and is there a pattern emerging to be determined. So we got caught in a window which I think we fully acknowledged at Investor Day and other times where we had -- because of the rapid 17% growth last year, we had consumed a lot of our redundant resources to beat market expectations and then we got hit with these extraordinary events. And as a consequence we were unable to respond in a way that we've historically been able to and will be able to in the future.

So everybody learns something in times like this and I think it's fair to say that Mike and the engineering team have already begun and will go through and kind of do a deeper evaluation of a handful of low spots or patterns that, even though there's no history of it, there would be concern if something did arise. And that would lead to some spot capital to take track up a foot in certain places or to do something of a nature that would prevent preventive efforts I guess.

I'm not -- the challenge is that you just don't have a pattern at this point in time. So putting a CAD1 billion series of snow sheds in place in case you happen to have avalanches because you had them one year is not necessarily the wisest thing to do.

The last thing, and again I think this is a real lesson for us, as we learned the value of routing redundancy, which is not new news to us, but the efforts that Mike described in New York about rebuilding the north line which runs from Winnipeg to Edmonton as an alternate route. And also some of the crow's nest activity on expansion that we're doing kind of south of Calgary and below the coal routes.

Those are all redundant routes and the Emerson, which runs south of Winnipeg, would be a redundant route. And I guess if there's a key lesson in all of this it's the value of the redundancy. And so we're upgrading some of those lines to give us the ability to handle stuff that's not necessarily there every day.

Thank you.

Pleasure.

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

Okay, thank you, Matthew. And thank you, everybody, for spending time with us. Look forward to talking to you next quarter. Bye now.

This concludes today's conference call. You may now disconnect.