Canadian Pacific Kansas City - Q2 2013

Transcript

Operator (participant)

Morning, ladies and gentlemen. My name is Martina, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Canadian Pacific Second Quarter 2013 conference call. The slides accompanying today's call are available on our website at www.cpr.ca. This presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties, and other factors that could influence actual results are described on slide two in the press release, and in the MD&A filed with Canadian and U.S. securities regulators. Please read carefully, as these assumptions could change throughout the year. All dollars quoted in the presentation are Canadian, unless otherwise stated. This presentation also contains non-GAAP measures outlined on slide three. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session.

If you would like to ask a question, simply press *, then the number 1 on your telephone keypad. If you'd like to withdraw your question, press the # key. Mr. Velani, you may begin your conference.

Nadeem Velani (AVP Investor Relations)

Thank you, Martina. Good morning, and thanks for joining us. My name is Nadeem Velani, AVP, Investor Relations at Canadian Pacific. I'd like to remind you that this presentation contains forward-looking information. Actual results may differ materially. I'm proud to have with me here today, Hunter Harrison, our CEO; Keith Creel, President and Chief Operating Officer; Jane O'Hagan, EVP and Chief Marketing Officer; and Brian Grassby, our Senior VP and Chief Financial Officer. The presentation will be followed by Q&A. In fairness and courtesy to all participants, we would appreciate if you limited your questions to two. It is now my pleasure to introduce our CEO, Mr. Hunter Harrison.

Hunter Harrison (CEO)

Thanks, Nadeem and Martina. Good morning to everyone, and thanks for joining us. You know, I think it's probably pretty appropriate today that, before we talk about numbers and dollars and cents and metrics, that we take a few moments to reflect on what the tragic, horrific incident that we had in Lac-Mégantic, which we were all taken back with. I know all our fellow railroaders here that are joining me from Canadian Pacific, join me in reaching out to all the families, the victims, the people that have been adversely affected by that horrific event. I mean, clearly, that community will be, some have reflected, would be, will be scarred forever.

And it's a solemn reminder to us of the inherent danger in this business and the responsibility that we have to the public. You know, in that regard, we have made a small donation, a $200,000 donation to the Red Cross to help in some ways. And certainly our prayers and heartfelt good wishes go out to all the families and the victims, and hopefully, we will never have to experience this type of event again. Having said that, we are working diligently and cooperatively with other rails, with the regulators, to see what additional regs, if any, need to be considered, potentially put in place. We have made some steps individually on our own.

I don't wanna go into that really from a technical standpoint any further, 'cause I'm not—I don't wanna put myself in the position of preempting the regulators. But I did think it was appropriate that we spend that time reflecting on what has happened in that community. With that, let me move and give you a real color on the second quarter from 30,000 feet. We're gonna try today to make our presentations shorter than normal, so, we can have time for more questions, because there were a lot of moving parts in the quarter. Both quarters, if you look back last year, we had the strike, and we had some obviously unusual issues this quarter.

But in spite of all that, it was a record performance by all accounts, whatever you wanna look at. Our earnings were up 138%, and operating ratio 1,060 basis points. And I think the one thing that I'm probably proudest of is that, with all the issues we had pre-flood, then to get hit with a 150-year flood, that I've never seen anything like it in my 50 years of railroading. And it's one thing to get knocked down, but it's really the way this team recovered and got back up, and there was minimal disruption to service to our customers. Our employees all responded in a yeoman's way, and so I'm very, very proud of them.

And I think you will see throughout the presentation today that really where that does is position us for a, a very strong, second half, and I'll have some more comments at the end relative to my outlook there. So, with that, let me let Keith spend a few minutes with you, highlighting some of the, some of the operating metrics and performance.

Keith Creel (President and COO)

Okay, thanks, Hunter. Let me start by saying, overall, I'm extremely pleased with the performance of this operating team. To say it was a challenging quarter, given the number of incidents which affected this network, would be an understatement. Having said that, I'm not gonna minimize the service and the financial impact to our operation, or the challenge they presented to our team responding to each. But I am encouraged that in those incidents, there was no commonality or systemic issues at the root cause of some of the challenges we dealt with. So, let me provide some color to some of those comments.

Contrary to what someone suggested or would like to assume, the root cause of our track derailments was not the result of or even remotely connected to cutting back assets, be they manpower or the capital we invest to keep our infrastructure safe at CP. The facts are, we have not reduced the workforces that maintain or inspect our track. We've not reduced our inspection standards, we've made them more rigid, and we actually increased our capital investment in basic infrastructure, which we reported earlier in the quarter, by an additional $100 million in 2013. Suffice it to say, this is not a team that takes our moral or our social obligation to run this railway safely lightly. Going forward, we remain seized with our goal to be the safest railroad in North America, which we've enjoyed for several years.

Our efforts are centered around people, and I mean more specifically, compliance, the way we carry out our jobs day in and day out, processed through our inspection procedures, and the way we deploy and apply our technologies to enhance them, and our physical plant investment, which are all paying off. Our current performance ratios year to date have continued to improve. Year to date, we're actually better than where we finished 2012 on the injury front on our ratios and actually have fewer train accidents year to date than in 2012, with the reportable accidents, as we said today, now at a ratio which is approaching our best-in-class finish in 2012. So, the gap is continually closing day in and day out as a result of those efforts.

And as Hunter mentioned, we face significant challenges with flooding, which included about 40 washouts in our western network in southern Alberta and BC. This was a weather event, to Hunter's point, that was monumental, a 150-year event that crippled our routes in monumental proportions. Just to grasp the order of magnitude, in a 24-hour span, we lost both our core routes west of Vancouver from Calgary, as well as our southern route through the coal territories. Our railroad was essentially cut off west of Calgary completely. To imagine a team that we'd be able to rebuild bridges, repair washouts, restore service, in most cases, within 48-96 hours, was beyond even my aggressive expectations. To think at the same time we'd be able to restore service within 24 hours of getting those routes open is unprecedented in all the years I've railroaded.

I'm extremely proud of the way this team, be it ops, engineering, mechanical, marketing, all pulled together, working tirelessly to restore our service and limit the impact to our customers and the products that they entrust us to carry. These monumental challenges required equally monumental responses this team delivered with heroic efforts, both individually in many cases, and certainly collectively as a team. So, enough said about the challenges. Let me focus my comments on what we've accomplished. Despite all of this, we were able to make continued gains on a number of productivity measures, a few of which are highlighted on your slides. These are some of our key productivity drivers from a list of 14 or so, that I pay attention to, that we measure, where we set best-ever second quarter performance records in 12 of those 14 metrics.

This has allowed us to continue to improve our cycle times and take costs out of the system, both on the locomotive front as well as on the car front, improve service at the same time, and improve capacity. This also has put us on a pace to return over 10,000 cars by the end of this year. In addition to this, as we mentioned on our last call, Hunter and I chaired whiteboarding sessions across the property with each of the regions, which have become an important driver for the next wave of breakthroughs, both on an operating and on a sales front. These comprehensive operational reviews involve a review of each element that goes with the movement of the rail cars, the customers, lines of business, sidings, car fleets, locomotives, yards, terminals, and mechanical aspects.

It allowed Hunter and I to communicate directly with over 200 members of our operating team to explain face-to-face, eyeball-to-eyeball, what Precision Railroading is, what it means to us, and at the same time, allowed us to evaluate the operational team and their abilities, and to learn the network at a very accelerated pace. Cost takeout and service performance improvements were the focus. I can tell you, on an annualized run rate, the cost opportunities we've identified exceed $100 million, which obviously will play a key role to helping CP realize our objective to enjoy the best operating ratio in the industry in the near future. I'm even more excited on the service improvement side, which we've created complexity, eliminated complexity in the network with the reduced train starts, train meets, et cetera.

But beyond that, a huge opportunity was uncovered to dramatically improve our domestic and modal service offering, to create a transit performance, which is not only the fastest rail alternative in the Toronto to Calgary market, it is single driver truck competitive with 3 A.M. ramp availability in Calgary. We now have a product in the market we have been successfully running into Calgary that offers any company paying for over-the-road truck haul to convert to rail and have substantial savings while we enjoy fair return for that superior service. Finally, on the sustainability front, this quarter, we solidified our operating team leaders, and we've realigned organizationally, allowed them to roll their sleeves up continually and dive deep into their operations daily, driving our service and operational improvement evolution.

Doug McFarlane, who many of you have heard us speak of in the past and have met potentially at presentations, I want to publicly thank him for 37 dedicated years of invaluable service to CP. He's recently made the decision to retire, which allowed us the opportunity to replace Doug with Robert Johnson, who's now the VP of our southern region, our U.S. operations. Robert brings a background of over 32 years of operational experience with the Burlington Northern Santa Fe. Robert and I, our history goes back over 22 of those years when I first worked with Robert as a young operating officer while employed at Burlington Northern in Tulsa Yard, facility. So, I've got a tremendous amount of respect, both professionally and personally, for Robert. He has fit this team well and has hit the ground running, producing results.

Another exciting addition to the team, we brought on Tony Marquis, VP of our eastern region. Tony brings us over 30 years of experience, and again, with Tony, 25 of those years I've worked with him at CN. So again, have a tremendous amount of professional and personal respect for Tony and his talents that he brings back to this railroad, which again, will be a key piece in helping us drive forward. These two gentlemen joined our already strong operational leaders in Guido and Scott. Going forward, this structure and this leadership will play a key part in leading our continued pursuit of operational and service excellence in this company, which we're seized with and which we're making tremendous progress toward.

With that, I'll pass it over to Jane to allow her to add some color on how she's converting this success in the marketplace on the revenue front.

Jane O'Hagan (EVP and CMO)

Thanks, Keith. We're very pleased to announce record Q2 revenue performance and our eighth consecutive quarter of double-digit growth in merchandise. Our revenue performance was driven by an operations team who worked tirelessly to restore service for our customers, earning their respect and their confidence. Outages impacted revenues in Q2 by approximately CAD 25 million. Half the revenue will be deferred to Q3. We're delivering on the diversity of our strategic initiatives and making good progress on improving the quality of revenue. And with that, let me review our revenue results. We reported a solid revenue gain of 9%, where volume, price, and mix accounted for 9% of the gain, and all other impacts were negligible.

RTM growth was 11%, and carload growth was 3%, and this was driven by a significant increase in the volume of long-haul crude oil traffic and a reduction of short-haul U.S. thermal coal traffic. Average revenue per car was up 6%. We delivered on the upper end of our price renewal target of 3%-4% and expect to deliver inflation plus pricing through 2013. Turning to grain, we were up 21% in revenue as we made our markets in grain, despite slowing towards the tail end of the current crop year. Our Vancouver export program yielded record results for service. Crop year to date, we moved 17% more grain through Vancouver than the pre-previous 5-year crop average, and we delivered on our strategic initiatives with the first greenfield elevator built in 10 years on our former Soo Line network.

We also reached a long-term commercial agreement with Cargill Limited to play a major role in providing transportation services for the movement of canola oil and meal from their new canola crush facility to be located at Camrose, Alberta. This facility is projected to have traffic coming online in Q1 of 2015. Our outlook is that plantings in our U.S. and Canadian territories are at or above five-year averages, and with this, we expect mid-single-digit year-over-year unit and revenue increases in the second half. Turning to fertilizer, we had a strong year-over-year Q2 revenues that included all fertilizers. Our efforts to overcome the flood-related disruptions allowed us to resume export potash service with minimal delay. Strong nutrient replenishment and heavy crop planting drove double-digit increases in domestic fertilizer volume. We developed and delivered a solid win in our strategic initiatives.

We reached an exclusive long-term agreement with K+S for the movement of potash from their greenfield Legacy mine near Bethune, Saskatchewan. Production is slated to start in the second half of 2016. We expect double-digit growth in units and revenue in the second half year-over-year, given easy 2012 compares. We're watching the exports closely as commodity pricing and Asian demand remain uncertain in the potash market, pending renewed international sales contracts. In coal, revenue was down 3% year-over-year, but Canadian met exports were up in Q2, despite a volatile global market. U.S. domestic volumes were down due to competitive natural gas pricing and unplanned outages at receiving power plants. PRB export shipments were down due to weak global pricing, but revenue per car increase of 6% reflects decline in the short-haul thermal traffic and the strength of met coal exports.

So, as our outlook in coal, we're modeling to Teck's forecast, and we'll be watching for signs of market volatility despite Teck's strong competitive market position, diverse customer base, and cost competitiveness. U.S. domestic delivered coal will remain lower than 2012. The PRB export continues to be opportunistic, and we will capitalize on it should it continue. So, we expect an increase in revenue in Q3 and low single-digit year-over-year decrease in units, largely because of the reduced short-haul traffic in the thermal coal sector. For intermodal, we're very pleased with the improved service and the intermodal product, as well as what Keith mentioned in terms of the introduction of our day faster service from Toronto to Calgary.

We took action this quarter to close down our Saskatoon facility, and we're very pleased with our domestic growth in targeted areas that's supported by service improvements through the whiteboarding and discussions with customers. We just won Lowe's award for 2012 Delivery Partner in Western Canada, and we're growing in the right lanes with the right customers aligned to our service capabilities. We're taking advantage of our service improvements, growing where we can create competitive advantage, price for value, and improve the operating income of the book. Our journey on renewal and rebalancing is continuing. We are creating value through more cost and service improvements, selling new services to new markets, being disciplined in our pricing, and ongoing book of business housecleaning. We do expect a muted fall peak.

We expect to see mid-single-digit year-over-year decline in the second half of 2012, as we lap the purposeful decisions, we made to let international contracts go and exited unprofitable, low profit, low growth markets to improve operating income. So, in merchandise, our strong growth story continues. RTMs were up 28% versus a carload gain of 9, representing strong gains for long-haul crude oil. Mix changes increased ARC by 7% and decreased cents per revenue ton mile by 10%, and as I've told you before, we expect this to continue as crude forms a larger part of our book.... In terms of industrial and consumer products, RTMs were up 34% in gains in long-haul crude traffic.

Our crude by rail model continues to expand, with growth momentum built on the expansion of our loading network, diversification of the destination network for optionality, and on the commitments of our customers to capital. The pace of growth has moderated in the last few months as spreads have tightened. Our term volumes moving to refiners have been largely unaffected, but we have seen volumes moved by marketers shift between markets, and in some cases, slow as spreads have moved and tightened. We're seeing orders pick up in the fall and beyond as spreads widen again. Our crude market will always be a combination of the consistent term volumes and the opportunistic volumes that respond to the movement of spreads. Frac sand momentum continued to build in Q2, resulting in double-digit volume growth.

So, in terms of our outlook, crude by rail remains a complementary and important supply chain option for producers, refiners, and transloaders looking to benefit from the flexibility of moving any type of crude to any North American market. Frac sand shipments from new mines will continue to ramp up, and other industrial products will trend with GDP. I expect another quarter of double-digit growth for industrial products in Q3. In autos, we had revenues down 9%, but two-thirds of the Q2 revenue decline was due to a lower volume of one-time machinery movements. The remaining one-third was due to lower volumes of finished vehicles. We exited low-margin, short-haul markets to improve the book, and through the whiteboarding that Keith referenced, we identified opportunities to leverage our network and reduce costs to drive sustainable, profitable growth.

On a go-forward basis, we will be making decisions about what freight earns its way in the automotive book as we price for the value of our service, and I expect to finish the year in automotive slightly below last year's revenue. So, in conclusion, we had strong results achieved in the face of two significant service outages. We've had success delivering on initiatives, which is highlighting the diversity of growth for CP. Our intermodal renewal is succeeding and gaining momentum, with volume and growth on a stronger foundation, with new service aligned to the network and our service strengths. We're continuing to press harder and faster on our work to strengthen the book of business and the quality of revenue, and I reiterate my expectation of high single-digit revenue growth for 2013. And with that, I'll turn it over to Brian.

Brian Grassby (SVP and CFO)

Thanks, Jane, and good morning, everyone. Keith and his operating team delivered another outstanding quarter, despite the difficulties we encountered, and the numbers show it, and let me take you through them. Revenues were a record for a second quarter and were up 10%. Despite moving 11% more RTMs in the quarter, expenses were down CAD 50 million or 4%. Last Q2, we had CAD 42 million in management transition costs. Taking these costs out, our expenses were still down 1%, an impressive result given the greater volumes. EPS was up 138%. If you strip out the management transition costs, proxy costs, and Ontario rate change we highlighted last year, EPS was up 59%.

Our operating ratio came in at 71.9%, an improvement of over 1,000 basis points, or taking into account the management transition costs last year, a decrease of 750 basis points. Our effective tax rate came in at the high end of our guidance at just under 27%, and I expect it will be close to 27% for the remainder of the year. Other charges totaled CAD 8 million on the quarter. This is above our normal run rate of CAD 5 million, reflective of the impacts of FX on working capital in the quarter. If you turn to the next slide, I will take you through comp and benefits. Overall, comp and benefits were down CAD 24 million, or 7%. Workforce reductions resulted in efficiencies of CAD 40 million in the quarter.

Fewer yard starts, longer trains, and overall efficiencies across the company resulted in a workforce reduction of close to 3,500. These reductions impact both comp and benefits and purchase services, as well as more efficient execution of our capital programs. Pension expense was a positive $2 million. The stock incentive compensation was up $19 million, largely a reflection of larger bonus accrual. On the stock compensation front, you can model a $500,000-$600,000 impact on a $1 change in share price. Wage inflation was a headwind of $11 million, and the impacts of the 2012 management transition expense and the strike net to a benefit of $10 million. Fuel was up $4 million, or 2%, on an increase in GTMs of 10%.

This increase in workload was largely offset by a slightly lower fuel price and fuel efficiency savings of CAD 24 million. The remaining expense lines have some puts and takes. Materials were up CAD 1 million this quarter, a reflection of higher volumes, mostly wheels, offset by efficiency improvements. Equipment rents were down CAD 12 million or 21% versus last year. Our focus on asset utilization resulted in efficiency savings of CAD 10 million. Depreciation rose CAD 6 million or 4%, mostly due to a higher depreciable asset base. And finally, purchased services were down CAD 25 million or 9%. On the favorable side, CAD 22 million related to the 2012 management transition costs.

... $7 million related to a contract termination in Q2 last year, and $14 million in efficiencies related to lower contractor and consulting costs. Partially offsetting these favorable items, casualty costs came in over $30 million on the quarter. This is much higher than our average run rate of $15 million-$20 million. In the quarter, we experienced a higher severity, especially on the environmental side. We are all focused on reducing these costs going forward. Other offsets include higher locomotive overhauls and higher intermodal trucking costs due to higher domestic intermodal volumes. So, let me close by saying Q2 was another record quarter despite the missed revenue opportunities due to network outages and the higher incident costs. Our operational improvements are driving real, sustainable savings, and there is more to come. Back to you, Hunter.

Hunter Harrison (CEO)

Thanks, thanks, Brian, and thanks, Jane and Keith, for those informative presentations. Well, I think if you, you can sort through all the noise here in this quarter, it, I think you can certainly see that it sets a pretty solid foundation for the second half that will go far beyond what we have, what we have seen before. As I talked about the plan, the 4-year plan, as we moved into this, clearly, clearly, we're ahead of that plan. You can argue whether it's 10 months, a year, but clearly, we're, we're headed there.

I have more confidence all the time, and despite these setbacks in the second quarter, we did not change our guidance for the full year, and I feel even stronger about the ability to achieve those numbers and possibly potentially move even beyond that. So, I'm pretty excited about the opportunity that some of these things started to take some real traction. And with that, we'll be happy to address questions the group might have. Martina?

Operator (participant)

Thank you. If you would like to ask a question, simply press star, then 1 on your telephone keypad. If you'd like to withdraw your question, press the pound key. As previously highlighted, please limit your questions to 10. There will be a brief pause while we compile the Q&A roster. Our first question comes from the line of Bill Green from Morgan Stanley. Your line is open.

Bill Greene (Analyst)

Hi there. Good morning. I'm wondering if we can talk a little bit on just coming back to some of these safety issues. I understand that some of this stuff is sort of maybe related to how we measure things and whatnot, but can you talk a little bit about how we should think about the fact that the train accidents were, were up 24%, and, and what kind of things you're doing such that we don't have a casualty expense that remains up at these levels? I think it's just hard for us not being railroaders always to understand kind of how to interpret some of this stuff.

Keith Creel (President and COO)

Okay, let me, let me take that one, if you will, Hunter. Let me, let me start by saying the 24% is an exaggerated number. I'm not making excuses, but if you understand the facts, when you reduce train miles, train miles is the denominator. The way that ratio is calculated, Bill, is based on, number of accidents divided by train miles. So, inherently, if you've reduced train miles, which we've done to the tune of about 4, 4.5% year to date, same number of instances is gonna give you a higher or an exaggerated frequency ratio, which is what's driving a portion of that, deterioration. The most important point, though, I made in my notes, that number is not the same anymore. The gap is closed.

We're back to a point on a go-forward basis where we're clipping our year-end performance last year, which was best in class. That's the other point. You're talking best-in-class performance and a comparable this year versus last year with the winter that we've had year to date, which bled over into this quarter, that is unprecedented. I'll just give you a case in point. Something as simple as one of those significant derailments that cost us a lot of money, caused a lot of concern that involved crude oil, Northern Ontario this quarter, was a result of a catastrophic wheel failure. When I say catastrophic wheel failure, the rim of the wheel exploded under the train. That is not a common occurrence.

This year, with the weather, and I wanna expand on this, we've had 12 of those failures versus 2 same period in 2012. The 12 versus 2, and of those 12, 3 of those resulted in reportable derailments, which are in those numbers. Now, what do we do about that? We've deployed and have invested and continue to invest and to enhance our capabilities, wheel detection impact systems across the network that identify these potential wheel defects before they become catastrophic failures. In this case, those wheel defect detectors did not identify the problem, and the end result was the wheel catastrophically failed under the train. Now, if you peel the onion back, a lot of people would say the reason that occurred in Canada, especially when you have a harsh winter, we have this thing called shelling on these wheels.

Shelling on the wheels occurs because the metal is broken down, generally because of heat and/or wear, and in this case, heat. What causes heat on wheels? There's two things if you really understand this business, and that's caused by sticking brake, that's caused by hand brakes, which are brakes that you manually put on a car when you secure the car, be it in a yard for switching operations, be it at a customer's facility for loading and/or unloading operations. What did we do as a result of that? It caused myself and my team to look at our procedures and how we drive compliance in applying and releasing those hand brakes. Unfortunately, those hand brakes, be it again at a customer facility or be it in a yard, are not always released.

If you don't have employees or if you don't have customers that understand what can happen as a result of not doing that and dragging that car and dragging that brake steel on steel, creating the heat that results in these shells, that eventually it develops to a point, especially in winter, when you get ice and snow and melt inside these, the shelling on these wheels, it compromises the wheel, and you have a catastrophic implosion. Again, it's a rare occurrence, but it happens, and unfortunately, that was part of what happened in the second quarter 2013 for CP Rail. So, it's not something that's going unaddressed. It's not something that should cause concern that's systemic, that's gonna continue to repeat itself, but it is something that caused us to take a look inherently inside at ourselves.

What more can we do, driving compliance, be it policies, be it procedures, be it technology, to dramatically decrease the likelihood something like that occurs again?

Bill Greene (Analyst)

Okay, well, thank you for a very thorough answer. Can I change a little bit now and just turn to kind of core earnings power? I think there's a little bit of difficulty trying to figure out on the second quarter, given all these puts and takes, how we should think about what the core earnings of the company is here in the second quarter looking forward. You obviously are ahead of plan on a lot of your cost cutting, which is great. But I don't know exactly what you think kind of the core earnings are, given these changes you've made to some of the procedures here that Keith just walked through.

How do you think about what the right, either EBIT or OR or whatnot is, that we should think about as a good run rate going into the third quarter? Thank you.

Brian Grassby (SVP and CFO)

Bill, this is Brian. I think, you know, in my remarks, if I look at the quarter, clearly, and we highlighted in Jane's remarks and the press release, about $25 million impact on revenues re the outages. The other item that I would highlight in the quarter or, and what I talked about were the higher severity and the casualties, and Keith talked about it. But I would, you know, in looking at the quarter, I would take those out in terms of looking at what is the sustainable run rate. We've also said we're at 3,500 down in terms of workforce reductions.

And Keith, and we talked about getting to 4,000 and beyond the 4,500 we talked about in November. And the final point is the whiteboarding sessions. You'll start to see some of the impacts kick on there. So, I think what you'll see in the balance of the year and the future years is, again, strong cost containments, cost reduction, and you'll see that in our numbers in the future quarters.

Bill Greene (Analyst)

Sorry, just a point of clarification. The $25 million has some cost associated with it, or it's just pure revenue number that we should sort of add back. Or how do you think about that number?

Brian Grassby (SVP and CFO)

I mean, in terms of the lower revenues, you'd have some costs associated with that, but it did mean just running fewer trains as well as you'll see a small reduction on the fuel side, so.

Bill Greene (Analyst)

Okay. Thank you for the time.

Brian Grassby (SVP and CFO)

You're welcome.

Operator (participant)

Your next question comes from the line of Tom Wadowitz from J.P. Morgan. Your line is open.

Tom Wadewitz (Analyst)

Yes, good morning. Keith or Hunter, wanted to see if you could provide a bit more thoughts on the whiteboarding sessions and what you identified CAD 100 million. What's underneath that CAD 100 million that you're changing, and what's the timing that we can anticipate that CAD 100 million coming in? Is there some of that in second half, or is that really a 2014 impact? Thank you.

Keith Creel (President and COO)

Yes. Tom, let me, let me, I can take this question. I can tell you now that the $100 million, and I'll stress, that's an annualized number. But there are certainly some immediate savings, and we're starting to see those in our metrics as we started to execute. Not all can be done immediately. There's some things we've looked at, opportunities identified, maybe potentially rationalizing part of the railway that we may or may not need on a long-term basis. But immediately, from an operational standpoint, it means the underlying factors are reduced crew starts. You know, we've eliminated assignments, road switchers, train starts, train miles, you know, to the tune of about 10,000 train miles a day. That's a meaningful number on a base of about 112,000 average daily.

Car miles, which allows you to turn in more lease cars, which falls into that number that I talked about, 10,000 by the end of the year. And in pickup on the revenue side, more loads with a reduced fleet, which means less maintenance costs, et cetera, et cetera, et cetera. And then lastly, the second part, the real leverage on this is driving the revenue side. We put a service in the market, and Jane can provide color on the opportunity here, but rest assured, as we educate our internal marketing department, because you've got to think about this as a marketing department that's learning how to sell service. We're giving them a hell of a product to sell, and they've got to go out and convert it in the marketplace.

So, part of that is educating internally, part of that is educating externally. If I'm a trucking company, and I'm spending a significant amount of my expense on over-the-road truck haul, and the premium for that versus equal service in a rail op, opportunity is about 40% or 50%, it's gonna cause me, if I'm doing my job, to look at that opportunity. So, as we get out and educate the market, and they understand that we actually have a service that is second to none, and that is head-to-head truck competitive, I'm confident, extremely confident, over the next year to 18 months, we're gonna convert some of that truck traffic to rail traffic and realize those revenues and, and the profit margins that we realize and enjoy on that as we reduce our cost structure base.

Tom Wadewitz (Analyst)

That, that revenue opportunity would be on top of the $100 million cost. That $100 million is a cost number, right?

Keith Creel (President and COO)

That's absolutely correct, Tom.

Tom Wadewitz (Analyst)

Okay. And then I guess for the second question on, Jane, on the crude by rail, can you give us, I guess, a little more granularity in terms of the, the spread impact? I think, you know, some of your business is probably on term arrangements, so if the spreads were gonna have an effect, it might be delayed, so maybe that's a year out or something. How would you think that your, let's say, in 2014, that your crude by rail business would grow, if you, you know, don't see a significant widening, widening in the spreads from where they are today?

Jane O'Hagan (EVP and CMO)

Well, I think that first off, what I'd like to say is that we do believe that rail is gonna be a permanent part of the transportation of crude to the marketplace. I think the basic proposition that it offers in terms of optionality, in terms of being able to move quickly between markets and the value proposition, you know, vis-à-vis pipeline that is complementary. You know, this is being supported by customers who have indicated to us, you know, we continue to work on delivering our longer-term initiatives to build out that infrastructure to deliver those volumes. As I've said to you in the past, the real key here is that, you know, we're gonna start to see, you know, more of our growth coming from the Canadian side.

So, when we get into the question around how does it work vis-à-vis, you know, term contracts versus those that, you know, that play the arbs, what I would say is that, you know, the industry ships crude really in those two ways. The larger producers and refineries ship volumes to basically support ongoing needs, and these volumes move on a term basis. And again, these have been largely unaffected by the movement of the spreads. We're seeing a lot of the larger producers and the refiners move into the rail market in this meaningful way with these assets and with these investments. And as I said that proportion of volume that moves under term will increase as we move these volumes and complete our strategic initiatives with these customers.

There's always gonna be a portion where a certain number of customers do ship crude to capture the economics of the spreads. And as these spreads move, the volumes quickly move between the markets, and this is part of the benefit of the rail model. So, in the last few months, as you said, you know, we've seen the spreads have tightened, and we have seen that the volumes between the players have shifted and, in some cases, reduced. But the overall rate of growth, you know, as it slowed in the last several months, as we look forward, we're still online to deliver, you know, our 2x to 3x our current initiatives by 2016 because we see power in the long-term benefit of this model.

Tom Wadewitz (Analyst)

So, it sounds like you're skewed towards the term side versus the other?

Jane O'Hagan (EVP and CMO)

Yeah, we have, the majority of ours are term contracts.

Tom Wadewitz (Analyst)

Right. Okay, thank you very much.

Hunter Harrison (CEO)

Thanks, Tom.

Operator (participant)

Your next question comes from the line of Jason Seidel from Cowen and Company. Your line is open.

Jason Seidl (Senior Transportation Analyst)

Yeah, Hunter, you know, you mentioned that you have a lot of confidence in the guidance that you guys just reiterated today, and then you kind of said that maybe even confidence in exceeding it. So, I guess, if you could just give us a little more clarity on what's giving you that confidence today?

Hunter Harrison (CEO)

Well, you know, if you look - well, if you look at the first two quarters, it gives you some directional indication. If you - to, to Brian's point earlier, you start to pull out some of these things, you can quickly get to some of the reports I've already seen this morning have done the math, plus the fact that, that did not include much of the whiteboard exercise, which is incrementally on top of that, plus the fact that one of the things that as I had fine-tuned and gone back through the model and, and my initial estimates, you know, I, I thought this would be more linear stairstep as we got into this phase.

I think you're gonna see that quarter over quarter, the difference in second quarter this year and third quarter are gonna be the biggest spread that you've seen in incremental improvement. So, if you start to lay those kinds of numbers on the back half with the front half, then, you know, you can get there easier than I can. I mean, you know, and I'm not so concerned at this point about the market. I mean, there's a lot of vagaries out there, a lot of issues. This is still a cost takeout, cost containment, improve the service. That's what we do best. And the issue that Keith mentioned earlier is this market, for an example, from Toronto to Calgary. You know, our domestic intermodal is having phenomenal growth. The international is soft by design.

The margins are a whole lot different between international. So, everything I look at just says that, you know, you ought to do your own whiteboard or you're gonna miss it.

Jason Seidl (Senior Transportation Analyst)

Well, thanks, thanks for a little bit of that clarity. If I could just shift gears here for a moment. Can you guys give us an update on any of the potential divestitures on the network, including the DM&E?

Brian Grassby (SVP and CFO)

Jason, on the DM&E, we're into the next round. We've narrowed it down to four to five interested parties, and we're going through a due diligence session. So, I would expect the end of the third quarter, I'll update you where we are on that. What was interesting during the whiteboarding sessions that Keith and Hunter and the team went through is looking at different parts of our network, and I think it's just gonna be a continual review in terms of making sure that we have the optimum network. So, bottom line, I think on DM&E West, I'll give you an update, but it's going well.

Jason Seidl (Senior Transportation Analyst)

So, with the whiteboarding sessions, did they indicate that there's any more potential divestitures out there?

Brian Grassby (SVP and CFO)

I think there are plenty of opportunities that came up, and I would leave it at that for now, Jason.

Jason Seidl (Senior Transportation Analyst)

Okay, fair enough. Thank you for the time, as always, guys.

Hunter Harrison (CEO)

Thanks, Jason.

Operator (participant)

Your next question comes from the line of Steve Hansen from Raymond James. Your line is open.

Steve Hansen (Managing Director, Senior Equity Research Analyst)

... Yes, good morning, everyone. Thanks for the time. Just was hoping you could speak a little bit to the K+S Legacy agreement. It strikes me as a pretty important win for your long-term potash franchise here, and we're just hoping you could walk us through some of the key factors or selling points that allowed you to get this exclusivity out there. I was a bit surprised, frankly, that they would lock up with a single carrier, but again, it probably speaks to some of your selling points. So, if you could walk us through that.

Jane O'Hagan (EVP and CMO)

I would say that, you know, first and foremost, you know, we have developed over the years a significant expertise in the potash business and a deep collaborative relationship for those that want to develop and manage their own unique supply chains, and K+S was certainly a candidate in this direction. I would say that by and large, when we look at this, and we do see this as a solid win, because it's the first greenfield potash play in the last 40 years in certainly in Saskatchewan. But our key value proposition that we had with them was, you know, we had the network capacity, we had the flexibility and the market access to develop a supply chain for them that included the potential for their export volumes as well as for domestic volumes.

I think that, you know, the team, I'm very pleased with the way that they worked with the customer and the fact that, you know, the negotiation and the outcome was such that it really underscored the collaborative approach that our team's been taking in the model to really deliver on the diversity of the growth prospects that this great franchise has.

Steve Hansen (Managing Director, Senior Equity Research Analyst)

Okay, that's helpful. Just maybe a follow-up here. The one line item that did stand out, as a large variance from our perspective, was the bonus accrual in the period. You know, given the strong operating performance and gains you've been achieving here, and I suppose the second half strong base that you described, can you give me a sense for, or help us understand what we should be modeling on a go-forward basis?

Hunter Harrison (CEO)

I think, I mean, what you've seen in the first and second quarter, assuming we're keeping on track of where we are, you'll see it in the third and fourth quarter.

Steve Hansen (Managing Director, Senior Equity Research Analyst)

Okay, helpful. Thank you.

Operator (participant)

Your next question comes from the line of Brandon Oglenski from Barclays. Your line is open.

Brandon Oglenski (Director, Senior Equity Analyst)

Yeah. Good morning, everyone. Jane, I wanted to follow up on your second half revenue outlook. You're maintaining, you know, your prior guidance for, you know, high single digit revenue growth, I believe. But if we look at your results the last few weeks, even outside of some of the derailments and flooding issues, it seems like volume trends have slowed a little bit. And your peer, you know, was highlighting a little bit softer outlook for the commodity market. So, I'm just wondering, what's driving your more favorable outlook as we're looking at it, and especially with, you know, the weakness in potash markets developing in the second half of the year?

Jane O'Hagan (EVP and CMO)

Well, I think that, you know, the softness that we've seen in the first several weeks is really a combination of the difficult, you know, prior compares to southern flooding and just, and there is some. But, you know, earlier in the quarter, we have experienced some moderation for some of our lines of business. You know, we have been flat year-over-year through to, certainly to, through July seventeenth. But my remarks that, you know, I provide to you on the market are really inclusive of this softness, which we expected to see, as well as, you know, we've looked and assessed what the upside and downside risks are, and we feel that, you know, our revenue guidance that we've provided is in line with the nature of the products and the franchise that we have.

I think that, you know, it's really too early to call the crop, but, you know, we really feel that we have good diversity, we have an excellent franchise, and that the, the trends are there in place. I think that the potash fundamentals are strong and that we do expect double-digit growth on the potash side. Certainly, there is some risk, but we feel where pricing is today, you know, that if there was any interruption, we, we hope and we sincerely expect that that would be short-lived. We also, you know, see some benefits on our side, on our met coal franchise. You know, we're modeling to Teck forecast.

They're indicating, you know, given the strength of that market, the product that they sell into that and their diverse customer base, you know, that we should be modeling to their forecast. I think, you know, our oil franchise, we continue to deliver on that side. We continue to deliver to the benefits that we've outlined around the projects. The timing of some of the projects, as I've told you in the past, could be a little slower coming online, but as we've always told you, we'll give you advice when that occurs. So, I think, you know, the intermodal side, as Keith indicated, this is giving our team a whole new potential set of products and service for us to get out to the market. Different group of customers, different targets.

People were very active in the marketplace. So I think from that perspective, you know, we're certainly optimistic, and, you know, giving you as much color as we can on how we think that'll move forward.

Brandon Oglenski (Director, Senior Equity Analyst)

Well, well, thank you, Jane. That was quite thorough. My second one, Hunter, I mean, CP is now in a position where, you know, it sounds like you're achieving the guidance even faster, by your own words. You're gonna have a lot of cash flow looking forward. What are the priorities at a board level? Is it— Are there discussions right now of increasing the dividend? Is there, you know, an idea that you could start repurchasing shares, or are there other capital projects that you'd like to accelerate for market opportunities or increased efficiencies? What, what are the priorities?

Hunter Harrison (CEO)

Well, I think on the shorter term, we'd still like to see the balance sheet be a little stronger. We would still like to see us be in a little better cash position than we are today. I think once we reach that level that we have kind of determined internally of where we'd be comfortable with from a cash position, and there's not a lot of opportunity from a debt standpoint now to do things differently, that once we reach that point, now, whether that's-...

Next year, first quarter or second half next year, whenever that is, if you look at, you know, our run rate for what we project cash flow will be, I think at that point in time, when we've got sufficient funds available, and gives us some, a great deal of flexibility, then at that point, we will look at those other potential options of buyback and dividend.

Brandon Oglenski (Director, Senior Equity Analyst)

All right. Thank you.

Operator (participant)

Your next question comes from the line of Sherilyn Radbourne from TD Securities. Your line is open.

Cherilyn Radbourne (Managing Director, Equity Research)

Thanks very much, and good morning. I'll start with a bigger picture question. I just wondered if you could speak about, as you reshape the cost structure, can you just talk about how you stay nimble enough to respond to a slowdown in the economy, if that occurs? And conversely, leaving a surge capacity to cope with a bumper crop if we get one, or a sudden surge in potash exports, as has happened from time to time on the network.

Hunter Harrison (CEO)

Well, you know, one of the things that we've done to some degree, and I don't want to overstate this, but is to keep as many of our costs variable as we can. You know, this, we've got a responsibility to our shareholders in good and bad times, produce returns. We have, I personally stay closely involved in the planning process going forward and our headcounts. You know, we've said many times that there's certain amounts of business at the top of that mountain that we can't go after, unless it's got just huge, tremendous margins there. So, as we improve productivity, less people can produce more. You know, we're looking right now at changing some of our crew districts.

We have the shortest crew districts in North America, about 120-125 miles, and I'm just making a guesstimate now, but I think probably you would see in North America, if you looked at the other carriers, they're probably more in the 190-200-mile range, at least. Some of them are running in excess of 300 miles. Well, if you improve the infrastructure, if you improve the precision of your railroad, and you're able to run people 200 miles as opposed to 20 miles, that's a whole lot of leverage there, that the same amount of people can do the same thing.

So, you know, there was policies here in the past that said, we wanted to have 125% of what we thought the forecast was. Now, that proved not to be a very good strategy because, for an example, there was tremendous cost associated with it, and the business didn't hit. So, you know, I, that's something that we stay right on top of. We try to stay on top of, you know, the market, the interaction between operating and sales and marketing, and so, that's not an area that I see problems with.

Cherilyn Radbourne (Managing Director, Equity Research)

And then I've got more of a modeling question for Brian. The purchased services line has been pretty noisy for the last couple of quarters. If I just take this quarter's number and adjust for the increment in casualty costs that you called out, is that sort of a reasonable run rate to think about?

Brian Grassby (SVP and CFO)

Yeah, I think, Sherilyn, you'll see some movement as we go forward over that line. Let me just give you. I would direct you to the MD&A, where we give some good breakdown as to what's in the purchased services line. But, I mean, the other movement that we saw in the quarter, which is the good news, is on the intermodal side, we saw our domestic business go up, so, that drives cost. But, a big chunk of purchased services, roughly $100 million, contains things like property taxes, which unfortunately go up year after year, but also contain a lot of IT consulting, or where we've outsourced service or certain services, as well as building maintenance and rent.

So, you'll see that portion come down over time as Mike Redeker, our CIO, is insourcing some or a lot of the services, and you'll see it show up in the comp and benefits. Also, on the building and maintenance and rent, at least on the rent side, you'll see that really start going down in 2014 as we move into our new headquarters in Ogden. So, I think in the short term, Sherilyn, I think you'll be close. In the longer term, you'll see purchased services come down.

Cherilyn Radbourne (Managing Director, Equity Research)

Well, that's my cue.

Operator (participant)

Our next question comes from a line of Ken Hoexter from Bank of America. Your line is open.

Ken Hoexter (Managing Director, Senior Equity Research Analyst)

Great. Good afternoon. Jane, during your at the end of your kind of run-through on the revenues, you noted that you're targeting inflation plus only through 2013. Was that? Is there a reason why you're bulleting the end of this year? Or maybe you can kind of talk us through your thoughts on pricing.

Jane O'Hagan (EVP and CMO)

Well, I mean, obviously, you know, we're pricing for value, and a big part of what this, you know, franchise is focused on is creating sustainable value. I mean, I just bookmarked it because it aligns up with our, our revenue, outlook. You know, as we look forward and as we think about the increasing value of the service that we put on this network, and we think about what our job is to continuously improve the quality of the revenue, you know, at this point, you know, we're targeting this range, you know, for this point in time. But, you know, over time, we'd like to be able to be in a place where, you know, we're reflecting those increases along with the quality of the service and what we're commanding in the marketplace.

Ken Hoexter (Managing Director, Senior Equity Research Analyst)

Okay, so, then it sounds like it would still be maybe even more than inflation if you're creating value from what you're improving service.

Jane O'Hagan (EVP and CMO)

Yes, that would be it.

Ken Hoexter (Managing Director, Senior Equity Research Analyst)

... Okay. Keith, on the whiteboarding sessions and your legacy contracts, I just want to understand. I think Brian was just throwing this out there on the outsourcing contracts. You've talked a lot of opportunities in the past. Is there still a lot of legwork on outsourcing contracts? Are there time limitations on waiting till they expire over the next few years? Can you kind of maybe just give a ballpark of what we could look for from cost savings on outdated contracts?

Keith Creel (President and COO)

Ken, let me just, Hunter, let me take a stab at that for a moment. From an operating standpoint, non-IT, we don't have any legacy contracts, I'm thinking out loud, that are causing us any issues there. In fact, we had two facilities that we were doing component work for engineering and mechanical. That was an odd setup. I'm not sure I understand all the background, but where it was our employees, and we paid the pensions and the salaries, but somebody else managed it for a management fee. Well, we brought all that back in-house, and so, we've cutting the cost there. And I don't know of anything from a contractual standpoint on the operating side that presents any hurdle to what we're trying to achieve.

Ken Hoexter (Managing Director, Senior Equity Research Analyst)

Okay. Helpful. Appreciate the insight.

Keith Creel (President and COO)

Thanks, Ken.

Operator (participant)

Your next question comes from the line of Allison Landry from Credit Suisse. Your line is open.

Allison Landry (Analyst)

Thanks. Good afternoon. If I remember correctly, the second quarter of 2011 was also a very tough year for CP with respect to flooding. And I understand there was a different management team in place back then. But I was wondering if you could give us some perspective on the key drivers or changes that were implemented that allowed the network to bounce back so quickly this time around?

Keith Creel (President and COO)

Let me take a stab at that. Well, there's no silver bullet here, but it boils down to focus, it boils down to passion, it boils down to understanding which of the steps that you can take proactively while you're out of service, while you're out of commission, and you don't have an ability to advance trains, that determines how quickly you bounce back. So, in the past, I can tell you, I don't know what they did then, but I can tell you what we did was due to the team this time, as opposed to just letting the train sit and wait for the line to be open, we took proactive steps to consolidate trains, reduce the number of trains, to do downstream blocking on the train.

So, in essence, if you're out for 2 or 3 days, to simplify this, and you've got a particular train that goes to a particular destination that might have 3 different blocks on it, instead of having 3 trains with 3 blocks, we consolidated it to 3 direct hit trains with solid blocks. So, the time that you lose in transit while you wait for the track to open, you pick back up on the other end by direct hitting at the terminals, as opposed to driving it to the destination terminal, switching the cars out and delivering it to those 3 locations. So, if you multiply that across the network, it's the difference between taking a week to recover and taking 48 hours to recover.

Allison Landry (Analyst)

Okay. That, that's really helpful. And then just as a follow-up question on the materials expense, you've talked about efficiency gains of about $10 million in the second quarter. Is that sort of a good run rate to use going forward?

Hunter Harrison (CEO)

Well, Allison, the $10 million I referred to was on equipment rents. And so that, and that really, and Keith talked to, you know, over 10,000 cars that will be returned by the end of the year. So, it, it was, on, equipment rents. Now, what you will start to see is in Q3, Q4 will start to lap, as we reduced our fleet last year. So, the, the $10 million, will reduce, although the absolute amount savings will, will go forward.

Allison Landry (Analyst)

Okay, perfect. Thank you.

Operator (participant)

Your next question comes from the line of Walter Spracklen from RBC Capital Markets. Your line is open.

Walter Spracklin (Managing Director, Senior Equity Research Analyst)

Thanks very much. Good morning, everyone. My question, I guess, is more down on the revenue side. We'll start with that one first, is on market share gains versus either your main competitor or on the trucking side, and how that impacts your yield progression. I know, Hunter, you talked about explosive growth in domestic, although international challenged. I don't know if, Jane, you have the breakdown between the two of those. You know, that kind of growth would not be something I'd expect in this current economic environment. So, where are you stealing market share if that indeed is the case?

Jane O'Hagan (EVP and CMO)

Well, Walter, I think first off, you know what I would say in the intermodal section, as I defined, you know, we certainly are lapping some of the changes that we made quite purposely around the international side and around getting our costs down. This really is a cost takeout story for us on the intermodal side. You know, obviously, you know, I want to grow market share, but I want to grow it in a way where we have sustained profitable growth. Our growth plan, you know, as Keith indicated, you know, is really around playing to our network strengths. It's where we can develop quality products and services. We can develop them, and we can price for them. So, there's always a component here, you know, from a competitive perspective, we're offering a different range of services to existing customers and to prospective customers.

Walter Spracklin (Managing Director, Senior Equity Research Analyst)

What is the split between domestic?

Jane O'Hagan (EVP and CMO)

You know, we both have domestic growth. This quarter, it was over 10%. So again, this is where we're really focusing on developing, you know, where we can have line of sight to profitable, sustainable growth and where, again, we can sell a really unique and premium range of services to new customers, to existing customers, and to customers that have the opportunity to make a mobile shift.

Walter Spracklin (Managing Director, Senior Equity Research Analyst)

Okay. And then switching gears, I guess, Hunter, on the expense side, you mentioned you're ahead of schedule, and absolutely, that's an impressive achievement. You'd guided us toward 4,500 headcount reduction when you first kind of laid out your plan from 19,500 to 15,000. Clearly, you know, having achieved, I believe you said 3,500 of that now, I guess on the flip side, are we—do we only have 1,000 left? Or now that you have a chance to, you know, get a little bit closer to the operation, is 4,500 the right number, or do—or can we go, or are we still sort of targeting that, or can we go higher than that?

Hunter Harrison (CEO)

We can go higher than that.

Walter Spracklin (Managing Director, Senior Equity Research Analyst)

So, in terms of order of magnitude, I guess where I would be coming from here is that if you've gotten to 3,500, and we're at a low-70s operating ratio, to get to low 60s, do we need another round of 3,500, or can we do it with less than 3,500?

Hunter Harrison (CEO)

No, you can do it less, but you know, this is not all driven on headcount. I mean, there's a lot of value creation. There's a lot of other things and initiatives that we're doing. You know, and look, we're not obsessed with headcount. You know, this is a kind of a byproduct. You create efficiencies, you take 500 locomotives out of the fleet, you take 10,000 rail cars out, obviously, you don't need as many mechanics. So, you spend more capital on the infrastructure and get it in better shape. You don't need as much maintenance costs, and you don't need as many people maintaining it. So, you know, kind of like I used to say, with the operating ratio, that it's a byproduct of providing good service and low cost.

You don't walk up and say, "I'm going to do whatever I got to get to this operating ratio." At the same time, the only reason why I really came out with the headcount issue is because everybody wanted to understand the plan, the detailed plan, but they had about five minutes to give me to explain it. So, nobody bought the plan until I came out with the headcount number, and everybody bought it. My sense is, going forward, we'll go... You know, we're on track to be beyond 45. And the initiatives we see now going forward will take us much beyond that. Now, if there were other contracting and opportunities where we could bring more work in, and that's going to adversely affect the quote, headcount, getting to 6,000, am I prepared to do that? Absolutely.

I just on the kind of a same store basis with this strategy, you know, there's been, you know, we'll have a critical decision. There's a couple of critical points here. This year, you know, I want to go to a stable workforce with our engineering forces. I don't think the ups and downs and the seasonality is the right way to go. So, but we—this wasn't the year to make the transition, to Keith's point earlier. So, I would expect when people are taken out this fall from the seasonal workforce, we're going to be in a position to say, "What do we need on a twelve-month basis to run the railroad?" And that will take additional numbers out of X. Next year, in 2014, we have the expiration of some of the IT commitments that we're contractually bound by.

So, those are two rather large buckets, if you will, that'll, that'll hit on the headcount issue. But look, we can do this with or without the headcount.

Walter Spracklin (Managing Director, Senior Equity Research Analyst)

That's great color. Much appreciated. Thanks.

Hunter Harrison (CEO)

Thanks.

Operator (participant)

Your next question comes from the line of Scott Group from Wolfe Research. Your line is open.

Scott Group (Managing Director, Senior Equity Research Analyst)

Hey, thanks. Good afternoon, there. So, wanted to just follow up on the pricing question. First, so you, you've got carload yields are up a lot and revenue ton mile yields are down a little bit. Jamie, do you have a sense on kind of what underlying same-store pricing is? And then maybe for Hunter, on the pricing side and this idea of opportunities to get more pricing ahead, any update you can give us on some of the longer-term contracts that you were hoping at some point, maybe you could do some better things with?

Jane O'Hagan (EVP and CMO)

Well, let me start off with number one. I mean, certainly, you know, average revenue per car was up and that our RTM was down. But again, you know, I'll signal that I've given you guidance in the past, that as crude oil grows as part of the book, because of its shipper-supplied cars, this unit train model, and certainly moving longer haul, this is going to have the impact of lowering our cents per RTM in this segment of the business. And again, this is because the growth that we've had in the crude oil segment has been significant. I'd also say that if you look at this quarter, we also had some of the impact that we had on decreased volumes on shorter haul, thermal coal, which obviously impacts cents per RTM.

So, I think when we look at where our price and where our yields are trending, they're where we expect them to be. I'll also tell you that in terms of our same-store pricing, it's within the same range trending with our renewals that I spoke to, at being at the upper end of our 3%-4%. So I'll turn it perhaps over to Hunter to talk, you asked a question, Scott, of Hunter around various components around contracts, et cetera.

Hunter Harrison (CEO)

Well, Scott, I would just add this. I all my career, I've learned one thing: If you provide better service, you can extract better price. Now, does it happen overnight? No. But if we can build and, and, continue to provide the better service, continue to improve that, we're going to get rewarded. I'm not sure exactly of the timing there. And at the same time, while our cost is going down, it opens up opportunities that internally wouldn't meet our hurdle rate, if you will, that now we've got a different set of obstacles, the issues there. So, I'm, you know, pretty bullish in the out years of this plan and, and going beyond, that we'll start getting the first portion of it is driven basically on cost.

The second half will get to a point where, you know, there's, you can go only, you know, so low that it'll be kicking back in on the revenue side, which will be the driver.

Scott Group (Managing Director, Senior Equity Research Analyst)

Okay, thanks. And just second question, the 10,000 railcar number is bigger than I've heard from you guys before. Is that incremental or cumulative? And then are there any kind of rough numbers that we can help think about the how to quantify what you save on every car that you return?

Brian Grassby (SVP and CFO)

So, I think, Scott, at the end of the last year, I talked about, 6,000 or, returns. So, the 10,000 is cumulative. And I've talked to, 15-20 million in terms of, lease savings, and it'll be, higher than that. But I, I do caution you, in, in Q3, Q4, we're gonna start to lap some of the returns that we started, in Q3 and Q4 last year.

Hunter Harrison (CEO)

Scott, this not only returns, this is also taking system cars out of the fleet that are not needed, that are old and obsolete, that are high cost, that we're scrapping, leasing, monetizing, or whatever. So that's an all-in number. As we see it now, 10,000, I think it will go higher over time. And, you know, it, to some degree, involves TTX with intermodal and how fast we were to turn that equipment. If we can turn more with less cars, and so it's all a cumulative effect.

Jane O'Hagan (EVP and CMO)

Okay, so an incremental 4,000 cars or 10-15 million, essentially? Okay.

Brian Grassby (SVP and CFO)

Actually, 15 to-

Scott Group (Managing Director, Senior Equity Research Analyst)

Thanks, guys.

Brian Grassby (SVP and CFO)

$15 million-$20 million over last year.

Scott Group (Managing Director, Senior Equity Research Analyst)

Okay, great. Okay, thank you.

Operator (participant)

Your next question comes from the line of Cameron Doerksen from National Bank Financial. Your line is open.

Cameron Doerksen (Senior Equity Research Analyst)

Yeah, thank you. Just one question for me on locomotives. You know, one of the operating metrics that really stands out in Q2 is that locomotive productivity was up 32%. Just wondering if you can update us on, you know, where you know the locomotive removal process is at the end of Q2, where that compared with a year ago, and where you expect to be at year-end?

Keith Creel (President and COO)

Rough numbers, year-over-year for the quarter, about 300. I would expect as we improve our service, continue to increase our velocity, barring any 150-year floods and things I can't predict, I expect another 40-50 locomotives to come out of that number.

Cameron Doerksen (Senior Equity Research Analyst)

Okay, and you expect that, that obviously to continue into 2014, right?

Keith Creel (President and COO)

Well, it all depends on the business. With the growth, of course, they take locomotives, so making those monumental gains, I'd say no, but continued incremental improvements, I'd say yes.

Cameron Doerksen (Senior Equity Research Analyst)

Yep, understood. That's all for me. Thanks.

Operator (participant)

Your next question comes from the line of Keith Schoonmaker from Morningstar. Your line is open.

Keith Schoonmaker (Senior Equity Research Analyst)

Thanks. Jane, a longer-term question for you. We hear a fair bit of chatter on industrial development on various networks, particularly concerning Mexico. Aside from truck conversion and growth of your existing clients, can you add some color on new business that may be coming onto your network?

Jane O'Hagan (EVP and CMO)

Well, I think, you know, we've been really clear in terms of, you know, where our volume growth is and how we intend to grow the franchise. You know, first, obviously, we're gonna make our markets, you know, given the proximity of the network that we operate. This means growing organically with our customers, improving service, and in terms of offering them a broader array of products and services. The second area, obviously, that we're growing is on the crude oil side. You know, when we look at the natural reach of our franchise, and we think about our origination, we certainly have capabilities, and we believe that, you know, given our partnerships with the other Class 1s, we can virtually access any North American market, that is out there.

I think the other area, again, as you know, in our bulk sector, you know, when we look at, you know, the quality of the bulk services that we offer, you know, think about the successes that we've had on the grain side, think about what we've done in potash, you know, our bulk team is continuing to press on that. You know, when we look at Mexico, obviously, we've got to have that aligned with our franchise. You know, we're always having conversations with other Class 1s on how we can extend that reach. But when I think about where our growth is coming from, I would say that you really want to be pointed on those three areas that I just suggested.

Keith Schoonmaker (Senior Equity Research Analyst)

Great, thanks. Let me turn to operations, briefly. It seems like these whiteboarding sessions and implementations of, learnings that you, that you had at these sessions were a critical step. One thing you've mentioned, I think Keith mentioned, is sales learning to sell this higher service, and I'm sure they're delighted to have that. But other than executing on takeaways from these sessions you've already had, are there more stepwise changes like these whiteboarding sessions that you've given so much attention to?

Keith Creel (President and COO)

Well, listen, the story is an evolution. It's not, it's not a destination, it's a journey. So, after you implement these changes and you bed this operating plan down, as the ebbs and flows of the business, as we bring on business in certain lanes, we've got to constantly reevaluate that. So, that's what Precision Railroading is about. You develop the best plan, you execute it, and through the execution of it or through the changes in business, be it up or down, you adjust it, with the end game being continual operational and service excellence improvement. And track record says we can do it, done it previously in previous assignments, and I don't expect any different result on a go-forward basis in this one.

Keith Schoonmaker (Senior Equity Research Analyst)

Thanks.

Operator (participant)

Your next question comes from the line of Turan Quettawala from Scotiabank. Your line is open.

Turan Quettawala (Director, Equity Research – Transportation & Aerospace)

Yes, good afternoon. Just a quick one for you, Jane. On the intermodal side, is it possible to give some sense of the total market that maybe you're gonna go at with this domestic new intermodal service that Keith talked about?

Jane O'Hagan (EVP and CMO)

... Well, I think, you know, Turan, obviously, the, you know, the issue that we have in front of us is this is highly competitive business. So, I think that, you know, from the perspective of, you know, what we're doing and what gives us the greatest sense of excitement, is not only that we have this opportunity to go to our customers and to talk about lanes of business that we previously have not, been able to participate, because we haven't had that consistency, we haven't had that reliability, and we haven't had this kind of premium service. That's number one.

But number two, I think, as Keith pointed out, there's a whole range of customers out there that have been underserved, and where when you look at having a service that's best in its class, clearly, you know, what we're going to be doing is taking advantage of all those opportunities, showing them what our track record is and being able to sell that service. So, I think that, you know, I'm not able to give you kind of an exact number of what that looks like, but I can tell you that we're very active in the market, and we're going to continue to deliver on that because this is a real source of opportunity for this company.

Turan Quettawala (Director, Equity Research – Transportation & Aerospace)

Great. Thank you very much. I'll limit it to one.

Operator (participant)

Your next question comes from the line of Chris Wetherbee from Citi. Your line is open.

Chris Wetherbee (Senior Equity Research Analyst)

Yeah, thanks. Good afternoon. Just maybe a question on the productivity measures. I think, Keith, you mentioned you're at records on 12 of the 14 that you kind of keep close eye on. When you think out into the second half of the year, obviously, probably better operating conditions coming here. I guess, where do you see yourself in the process here of improvement? How much left, I guess, is there to go? I know it's kind of an evolutionary scale, but just curious, kind of where you see yourself in that process.

Keith Creel (President and COO)

Well, as far as making monumental leaps, I think we're there. As far as making, again, continued year-over-year and quarter-over-quarter improvements, there's definitely some meat left on the bone. You know, they all have their own stories. You know, a couple of these, like this, fuel consumption story, that's a pretty, pretty dramatic increase year-over-year. Last year, same time, this company was about middle of the pack relative to our peers and our fuel productivity. We're knocking on the door best-in-class today. And don't think that I don't expect and require this team to excel and blow right by that number. So, that's something that we're going to continue to work on. Will it be an 8% improvement year-over-year? I'd say no. Will it be several points of improvement? I'd say absolutely yes.

So, and it's a similar story, looking at all the different metrics. So, it's something that, monumental improvements so far. You won't see the same double-digit improvements year-over-year, but you'll see continual single-digit improvements on a go-forward basis.

Chris Wetherbee (Senior Equity Research Analyst)

Sure. That makes sense. Thanks. And I guess maybe transitioning, you know, Jane, from your perspective, with the improvements that Keith and his team have been able to make, I mean, how quickly do customers kind of realize that, and how can you affect kind of change as far as selling the product? I'm just curious, kind of customer receptivity to that type of dramatic improvement we've seen so far.

Jane O'Hagan (EVP and CMO)

Well, obviously, the key thing that, you know, we need to get into the market and that the team is focused on is, number one, getting out there and selling the service and looking for the value and extracting that value. You know, I think that, you know, that transition, whether it's cultural or not, has moved away from apologizing for service. I think the other thing is that, the operations team has done a fabulous job of working with us to demonstrate the facts behind that. With fact-based information, with the track record that we have out there in the market, the aggressiveness of the sales team and enthusiasm to sell the product, those are the things that we're doing around that area.

Chris Wetherbee (Senior Equity Research Analyst)

Okay. That's helpful. Thanks for your time.

Operator (participant)

Your next question comes from the line of Benoit Poirier from Desjardins Capital. Your line is open.

Benoit Poirier (Managing Director, Senior Equity Research Analyst)

Good afternoon. Just to come back on the previous intermodal question, we are hearing some comments that it's not easy for shippers at this time. We also understand you provide some very good color about the intermodal in the second half. But I was wondering about the contracts that are up for renewals in the coming six or twelve months, and whether you feel you have the proper cost structure right now, and in order to be part of it, or any color on the intermodal dynamic at this point, Jane?

Jane O'Hagan (EVP and CMO)

Well, I would say, first and foremost, you know, this story, as we've indicated to you, is one of renewal and rebalancing. A big component of what we need to do as we look at each individual contract is to understand, you know, how do we focus on selling to where our capabilities are and where the network is? This is, again, made choices about, you know, when we look at a package, do we need to be looking at the whole piece, or do we need to sell into those components where we know we can be successful in those lanes? I think the other reality is, you know, about 20% of the book turns over on a yearly basis.

I mean, I think that, you know, given where we've come from, in terms of being able to sell to what this segment wants, which is consistency, reliability, and a demonstration of that, we have an excellent track record for us to sell to. So, you know, I feel confident that, you know, we're in a place where we're going to price for value. I'm certainly not going to use price as the means of developing market share. We've been very clear on that because our mandate's around sustainable, profitable growth. We're going to continue to focus and work with the operations team to make sure that the product we have is cost competitive and that we continuously work on that. So, you know, as Keith said, it's certainly not a destination, it's a journey, but we're feeling very good about the progress that we're making.

Benoit Poirier (Managing Director, Senior Equity Research Analyst)

Okay, a very good color. And my second question, you, Hunter mentioned color about the potential divestitures. Now let's talk about some M&A opportunities. You mentioned in the past that you were obviously looking for a short line. I understand it's maybe too early. You're building a financial position here. So, I'm just wondering if there's any comment about the opportunities on the short line, especially after the tragedy in Quebec?

Hunter Harrison (CEO)

...Well, I don't, I don't think there's anything in our, you know, in our sights right now. I mean, I've just simply said this: You know, we think we do a pretty good job of railroading. We're gonna get better and better, and depending on the price, if it's a fit, contiguous to our property, clearly, and we can get it for the right price, it's something we'd take a hard look at.

Benoit Poirier (Managing Director, Senior Equity Research Analyst)

Okay. Thanks for the time.

Operator (participant)

Your next question comes from a line of Jeff Kaufman from Buckingham Research. Your line is open.

Jeff Kauffmann (Analyst)

Thank you very much, and congratulations. Just two quick questions. One for Brian. Brian, you answered the question on capital redeployment, but what are you thinking in lieu of some recent events on the CapEx budget for this year, next year?

Brian Grassby (SVP and CFO)

I'm not sure what you're referring to, Jeff. I mean, Keith talked to we increased the CAD 100 million, so we've advanced it. But I think we're gonna be in the range of CapEx of between CAD 1 billion and CAD 1.1 billion going forward. So, I mean, we're gonna spend CAD 100 million dollars more this year. I'm very pleased with our free cash flow to date. But as Hunter said, we're we wanna strengthen the balance sheet, build cash, and look forward to other conversations next year.

Jeff Kauffmann (Analyst)

Okay. Hunter, as you've gotten deeper and deeper into this, I know you've talked a lot about the whiteboarding. I'm just kind of curious, what aspects of the plan have come easier or faster than you expected? What aspects of your plan have been a little more challenging to capture?

Hunter Harrison (CEO)

Well, it's clearly the execution part. I mean, it's pretty easy to go up on the board and draw X's and O's. And we have to be careful, and I'm talking to myself when I say this, that we don't get ahead of ourselves. So clearly, this whiteboard exercise, as Keith alluded to, to some degree, you know, we identified certain opportunities. We're in the process of executing those now, finding out where there's flaws and where there's efficiencies and where we need to beef up until we move to, quote, phase two of a whiteboard, which is kind of like getting your master's degree. So, but clearly, the toughest part is the execution part of changing the culture, changing the behavior, getting people to understand. That's the challenging part for all of us.

Jeff Kauffmann (Analyst)

Okay. It's been a long Q&A, so I'll just say thank you.

Hunter Harrison (CEO)

Thank you.

Operator (participant)

Your final question comes from the line of David Tyerman, Canaccord Genuity. Your line is open.

David Tyerman (Equity Research Analyst)

Yes, good afternoon. Two related questions for Jane. Jane, I was wondering if you could give us an idea of what the normalized increase in revenues were in the quarter, I guess, taking out the strike effects and also taking out the flooding. And then related to that, do you expect the growth rates in the second half of this year to accelerate, decelerate, or what, relative to the normalized Q2?

Jane O'Hagan (EVP and CMO)

I would say that if you wanted to adjust for the, for the impacts, you'd be talking about the 5% range. I think that when we look at, you know, the growth rates in the second half, you know, I've been pretty clear that, you know, you really need to, you know, refer to my remarks on the individual lines of business. But, you know, this franchise has always been a second-half company. We always have, you know, given where we're looking with the crop, you know, looking at the dynamics of how the bulk wants to move, looking at the improving quality of the service. I mean, again, you know, I've reiterated our guidance, again, on the revenue side, so we expect the growth to come in around that area.

David Tyerman (Equity Research Analyst)

Okay, thank you.

Hunter Harrison (CEO)

Okay, well, as Jeff said, it has been a long call. We've tried to accommodate all the questions, and hopefully, it's been helpful and informative to you. I just wish we were talking about third quarter tomorrow, because I'm pretty excited about those opportunities. Thank you.

Operator (participant)

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