Canadian Pacific Kansas City - Q3 2013

Transcript

Operator (participant)

Good morning. My name is Tracy, and I will be your conference operator today. At this time, I would like to welcome everyone to Canadian Pacific's third quarter 2013 conference call. The slides accompanying today's call are available on our website at www.cpr.ca. 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 star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I would now like to introduce Nadeem Velani, AVP, Investor Relations, to begin the conference.

Nadeem Velani (Head of Investor Relations)

Thank you, Tracy. Good morning, and thanks for joining us. 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, Senior Vice President and Chief Financial Officer. Before we begin, I want to 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 two in the press release and in the MD&A filed with Canadian and US regulators. This presentation also contains non-GAAP measures outlined on slide three. The presentation will be followed by Q&A. In fairness and courtesy to all participants, we would appreciate it if you limited your questions. It is now my pleasure to introduce our CEO, Mr. Hunter Harrison.

Hunter Harrison (CEO)

Thanks, Nadeem, and good morning, and thanks for joining us. I trust you've seen our press release last quarter. I have to kind of restrain myself, and some of my cohorts here will add some additional color, but this team did a hell of a job this quarter. This thing is really coming together and hitting on, if not all cylinders, it's awful close. And so I was obviously pleased with the results. I'm going to ask in a minute, Keith and Jane to offer some color on the operating and marketing side, and then Brian will convert all that to the bottom line of what it means to the numbers.

And then I'll have a few remarks at the end, and we're going to try to keep our presentation as short as possible so we can I would imagine there's going to be a lot of questions today in certain areas. I would like to highlight one thing. I think you probably saw in the press release that Brian Grassby, our CFO, has decided to retire at year-end. It's kind of mixed emotions that I make that announcement. I'm a little jealous, and I wish I was in a position to do the same. But we, Brian has been with this organization for 12 years, has offered a lot of loyal service, and has been the key the last 16 months since I arrived in this turnaround story.

So, congratulations, Brian, and thanks for everything you've done for the organization. I'm sure the rest of the members on the call will join me in that congratulations. So with that, let me turn it over to our President, Mr. Keith Creel, and he can give us a little color on the operating side of the business.

Keith Creel (President and COO)

Okay, thanks, Hunter. Let me start by saying, obviously, very proud that to report another strong quarter by this operating team, which you see in the operating performance measures. These are all key levers that drive our operating efficiency day in and day out, produce double-digit gains in train weight, train length, as well as higher car velocity and lower dwell. These results effectively reflect a lot of our whiteboarding session, ideas and opportunities we produced back in June and July, which has allowed us to optimize our train plans, reducing train miles by 13% in the quarter versus our first half run rates of about 6%. This is an area with precision railroading that will always be under review as we execute, we measure the performance, and we adjust to the ebbs and flows of our business levels by the operating lanes.

All right, let me move to provide a little quarter color on the quarter highlights. I'd be remiss, above all else, not to commend our collective operating team. That's across, across the board, from the folks here in Calgary, in the field, the RTCs, the engineering teams, mechanical teams, and the, the guys and gals that are actually running the trains day in and day out. This disciplined execution of our service plan enabled a car order fulfillment performance in excess of about 95% of our weekly placement plan across auto, forest products, grain, and the bulk commodities. In fact, we moved more export coal in the third quarter than ever on record with a transit time that's 13% faster than third quarter of 2012.

We've responded to the record Canadian grain demand, moving from a near dead stop through August due to the late harvest, to transporting record volumes by the month end. In fact, we moved 12% more loads than in 2012. This obviously sets us up extremely well for the bumper crop ahead of us, riding that momentum. As we move more cars with less, we're identifying asset monetization opportunities. We scrapped about 600 more cars in the quarter, with plans to scrap another 1,000 in the fourth quarter. This will get us to about a 2,700 car run rate for the year. You combine this with the lease turnbacks. We're on pace to reduce CP-controlled rail cars by about 11,000 since we started this turnaround journey. Locomotive productivity up another 18%. With the excess locomotives, this has created an opportunity.

This quarter, we're able to lease locomotives to industry partners, which is reducing our equipment costs and maintenance going forward, as well as, creating a little bit of a revenue opportunity. Fuel productivity continues to improve, using 7% less fuel this quarter versus 2012, while moving 2% more RTMs. This focus on continuing to lower our costs is obviously closing the gap with our competitors, which is key to allowing the company to compete in markets we've not been able to historically. This strategy opening, is opening revenue opportunities previously not possible by providing Jane and her team with an improved service product at a lower cost to sell in the marketplace.

To give you a quick recent example of this, we've now removed an additional 10.5 hours from the Calgary to Vancouver schedule as of the fourth quarter, so I'm confident this will allow us to continue to deliver additional domestic intermodal growth versus truck. This is the natural next step after taking over 20 hours out of our transit from Toronto to Calgary, which is driving meaningful domestic intermodal growth that Jane will provide some color to in her comments. As you're all aware, we continue. Safety remains a critical priority at Canadian Pacific. We're driving improvements in this area through our investment in infrastructure, investment in technology, safety process improvements, and the most important critical piece to success, our safety culture. In the third quarter, we improved our train accident ratio by 10% versus third quarter of 2012.

This performance is even more impressive when you adjust it for the 13% train mile reduction in the quarter, which dilutes the improvement. Year to date, in spite of the material train mile reductions and very tough first half derailment results, we've closed the gap to the point we're close to par with year-to-date 2012 performance, which is at or is currently industry best. Finally, as we look into the fourth quarter, I'm sure that you've seen our volumes have picked up considerably since Labor Day. We've recently had our operations team in Calgary to review our game plan. We're focusing on winter preparations. We're confident in this service plan. This team is in a very strong position to move the traffic in front of us with unprecedented service levels for our customers. We've built a strong foundation for success.

We look forward to leveraging this model during the growth period. With that, I'll pass it on to Jane to provide some color on how she's converting this to the marketplace.

Jane O'Hagan (EVP and CMO)

Good morning, everyone. I'm pleased to announce a record quarterly revenue performance with 6% growth over Q3 2012. This was driven by 2% RTM growth and strong yield and price performance, with cents per revenue ton mile up 4%, average revenue per car up 8%. Renewals came in again within our target range of 3%-4%. Volumes in the beginning of the quarter reflected some short-term shifts in some markets. Volumes picked up towards the end of the quarter, and we're seeing that momentum continue. We're improving the quality of our revenue. We're making good progress on delivering on our growth initiatives. So turning to the individual lines of business, I'll report revenues and price on a currency-adjusted basis. So starting with grain, Q3 results saw revenues up 5%.

While grain was slow in the early part of the quarter due to a later harvest and low on-farm stocks, our operations team did an excellent job as the Canadian harvest volumes came in to deliver very strong volumes in September. With the exceptional Canadian crop now estimated at 68 million metric tons, or 12% larger than the previous record, our Vancouver export program was a particular highlight of the quarter as we moved 11% more grain through Vancouver than the 5-year average. In the US, we had not seen the ramp up in September, as the wheat production mostly went into the bin and the late bean harvest pushed back this seasonal export program. Average revenue per car was up 9% as pricing gains were achieved in both Canada and the US.

In terms of our outlook for grain, given the record Canadian crop and the U.S. harvest well underway, we expect that grain volumes will be strong in a number of lanes. The West Coast will be at record levels. I also expect strong eastern movement through Thunder Bay, as well as the start to what I anticipate to be a strong winter rail program directed to the St. Lawrence Seaway. And finally, we will see robust demand from Canada to the U.S. The U.S.-originated exports that had been slow to pick up due to that late harvest will now move at more normal levels. I will note that as we see the recovery in short-haul DM&E-originated shuttle volumes and a reflection of the 1.8% reduction in the VRCPI for regulated grain revenue entitlement in Canada, revenue per car in Q4 will be down sequentially from Q3.

So turning to fertilizers and sulfur, our Q3 results were up 13% in revenue. We had strong year-over-year Q3 revenue gains in both potash and sulfur, supported by solid price increases, with average revenue per carload up 7%. Domestic potash led volume growth as an unsettled international market resulted in a decline in potash exports. In terms of our outlook, there continues to be strong fundamentals for fertilizer application, and both farm incomes and grain prices continue to support this application. However, delayed harvest will compress the fall season and defer some consumption to the spring. For export, many buyers continue to delay purchases while they assess the Uralkali market impact on international potash pricing. So turning to coal and building on Keith's comments, Q3 results, we saw revenue up 9% year-over-year.

I'm delighted by the excellent service from our operations team that led to very good cycle times and a 9% increase in export met coal volumes, matching our previous best quarter. U.S. domestic volumes were down as substitution of lower-cost natural gas continues to displace thermal coal. The revenue per car increase of 7% reflects that decline in short-haul thermal traffic and the increase of longer-haul export met coal. In terms of our outlook, we expect the shipping patterns of Q3 to continue into Q4, with continued strong movements at export metallurgical coal. However, holidays and seasonal winds in November affecting export loadings could mean we see a small sequential reduction in volume. In terms of Intermodal, our Q3 results saw revenue 7% lower year-over-year.

We're very pleased with the improved Intermodal product and the introduction of our new faster service from Toronto to Calgary, that's taking a day out of our transit times, resulting in double-digit volume increases in this lane in Q3, and sustained profitable growth in domestic. We continue to make additional improvements in our service and implemented a faster fourth morning Toronto delivery offering that also is providing enhanced service between Calgary and Vancouver. With respect to import/export, Port of Montreal improvements did not fully offset lower Port Metro Vancouver volume. We're growing in the right lanes with the right customers, aligned with our service capabilities and our network strength. We're taking advantage of our service improvements by growing where we have competitive advantage, pricing for value, and improving the operating income of the business.

In terms of our outlook, the overall book of business is shifting as the outcome of these changes are being implemented. The book remains strong as we continue to focus on the segments and the customers that drive the greatest value to both parties. I'll remind you that in Q4, we are lapping an international contract we chose not to retain last year. We still expect a muted fall peak, with ongoing strength in domestic Intermodal on the basis of the introduction of our new services. Now, turning to Industrial Products and Consumer Products, Q3 results saw our revenues up 13%. Our TMs were up 11% on gains in long-haul Crude Oil and on Frac Sand volumes. A moderation of Crude Oil was experienced through much of Q3 as the spreads were relatively tight.

Year-to-date, we've moved 65,000 carloads of crude, and we continue to develop our crude-by-rail model. Over time, we will see increasing volumes of heavy crude moving with different economics and drivers of demand than the lighter Bakken crudes we predominantly move today. Frac sand momentum continued to build in Q3, and we're seeing double-digit volume growth. In terms of our outlook, we're seeing orders pick up in October as spreads have widened recently, although we don't know how long this will persist. Our crude market will always be a combination of the consistent term volumes and the opportunistic volumes that respond to the movement of spreads. We expect to hit 85,000-90,000 units this year and continue to be on track to achieve the 140,000-210,000 carload longer-term estimates.

We continue to work with customers on facility developments that have commitments to volume, with the recent announcements at Hardisty, Alberta, and at New Town, North Dakota. Frac sand shipments from new mines will continue to ramp up, but other industrial products will trend with GDP growth. Moving to Autos. Q3 results are revenues down 11%. About half of the Q3 revenue decline is due to lower volume of one-time machinery movements. Lower volumes of finished vehicles accounts for the remaining reduction, where we saw some production shift away from a CP served plant, and we exited some low-margin, short-haul markets to improve the quality of the book of business. In terms of our outlook, we continue to make decisions about what freight earns its way in the automotive book as we price for the value of our service.

We've seen improvements in volumes in late Q3, and this trend should continue. So in conclusion, we have strong momentum coming out of Q3 that will continue through Q4. I would expect full-year revenues in the 7%-8% range. I'm excited to have a superior product to sell in the marketplace, and as part of the evolution of CP that started with operations, I'm nearing the completion of creating a new sales-focused organization with less layers, less bureaucracy, centralization of pricing, and incentive program that will reward those who excel at selling. This is with the intention of becoming the industry leader in the selling of service. And with that, I'd like to turn it over to Brian to give the financial picture.

Brian Grassby (SVP and CFO)

Thanks, Jane, and good morning, everyone. Hunter, thank you for your comments. It's been an honor to work with you, and it's been an honor and privilege to work at this great company. Now, let me get into the quarter. Keith and his operating team continued to deliver outstanding results. They recovered quickly from the floods in Alberta, and despite softer volumes, they produced strong savings while continuing to improve service. The results for the quarter show the power of our game plan, with or without volumes. Now, let me get you into the numbers. Revenues were up 6% on an RTM increase of 2%, with price mix and foreign exchange making up the difference. Expenses were down 6%, despite the 2% volume increase and an FX impact of 2%.

Operating income was up 39%, and our operating ratio came in at 65.9, an impressive improvement of 820 basis points. Our tax rate came in at 28.6%, slightly higher than the range I provided, as there was a CAD 7 million deferred tax item related to an increase in British Columbia's corporate tax rate. Absent this increase, our effective tax rate was 27%. Reported net income for the quarter was up 45%, and reported EPS was up 42%. Adjusting for the BC tax item, adjusted EPS was up 45%. On the FX front, I have previously given an FX sensitivity of CAD 0.02-CAD 0.04 EPS impact for every CAD 0.01 change in the Canadian dollar. For modeling purposes, I would use the high end of that range going forward, given our revenue mix and improved cost discipline.

Please turn to the next slide, and we'll give you some more details on our expenses. Operating expenses were just over $1 billion, down 6% from last year. This decrease was driven by efficiencies of just over $100 million, broken down as follows: Our workforce was down approximately 3,300 positions or 18%, driving a savings of $55 million. If you use July first, 2012 as a reference point, we are down close to 4,200 positions. Fuel efficiencies in the quarter totaled $16 million. As Keith mentioned, our focus on asset utilization has resulted in fewer cars and locomotives, driving material savings of $3 million and a $9 million reduction in rents. Purchase services saw $18 million in savings due to lower consulting and IT costs and locomotive warranty servicing costs.

These savings were partially offset by higher stock and incentive compensation of CAD 5 million as we continue to accrue for a larger annual bonus, given our performance to date. Wage and benefit inflation was CAD 11 million, and FX cost CAD 22 million, reflecting a weaker Canadian dollar. As you look to Q4, you can expect stock-based compensation to be higher as our stock price is up. And as well, we will be increasing our accrual for our long range incentive comp as we are tracking to be ahead of plan. Based on yesterday's stock close, the combination of these two could be in the CAD 10 million-CAD 12 million range. Our results are translating into solid cash generation. Cash from operations was CAD 1.3 billion, an increase of over CAD 400 million versus last year.

Year to date, we have free cash flow after dividends of CAD 318 million versus CAD 21 million over the same time period last year. Our balance sheet continues to get stronger, with debt and leverage ratios improving quickly. From a liquidity perspective, we're also well positioned, with no significant debt maturities in the near term, low cash tax payments, and stable pension contributions, given our previous pension prepayments. Let me wrap up. Q3 was another strong quarter, clearly showing the momentum we have. Our cash continues to build, and our credit metrics are improving nicely, all of which positions us well for a strong finish to the year. With that, I'll pass it back to Hunter.

Hunter Harrison (CEO)

Thanks, Brian. Thanks, team, for those enlightening presentations. Let me just kind of wrap up and make one comment. I mean, clearly, our guidance for the year, clearly, I think, I have a great deal of confidence that we will achieve those and probably realistically exceed all the guidance that we have previously provided. I think that Nadeem is considering, probably late spring, early fall, maybe having an analyst meeting, and at that point in time, we'll address, we've kind of this plan is about worn out. We've gone through the numbers, and, maybe it's time to put another plan out that reflects the different base that we're working off of. So, you can hopefully look forward to that. With that, we'll be happy to address questions you might have.

Operator (participant)

Thank you. If you would like to ask a question, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. As previously highlighted, please limit your questions to two. There will be a brief pause while we compile the Q&A roster. Your first question comes from Chris Wetherbee with Citigroup.

Ken Hoexter (Managing Director and Senior Research Analyst)

Thanks. Good morning, guys. Yeah, maybe just touching on the OR improvement, which is obviously very, very strong in the third quarter. And when you think about the progress that you've made today and the sort of layup that you have for the fourth quarter from a volume perspective, can you give us a rough sense of how to think about seasonality? You guys have sort of changed the dynamic here a little bit with sort of record performances. So just want to get a rough sense, kind of seasonally, how we should be thinking about the fourth quarter from an OR perspective, at least relative to the first three of the year.

Hunter Harrison (CEO)

Well, let me address that. Maybe Keith wants to add a little, some other comments, but, you know, it really depends on what weather we see in the fourth quarter. I mean, obviously, we've got line of sight on continued improvements in the in the OR. We're to a point that, with the exception of maybe a three or four-month period, that the seasonality factor is really based on the weather. I think we're in better shape to deal with that, and I think if you look at the third quarter results, and we have a quote, mild fourth quarter, you'll see continuing movements of positive on the operating ratio side. If not, then, you know, whatever impact the weather has, will make it-- those achievements a little bit tougher.

We're really trying to address some of the issues in first quarter from a weather factor, to get to the point where we can, as much as possible, smooth out and move away from the seasonality impact. Keith, I don't know if there's anything you want to add or?

Keith Creel (President and COO)

Yeah, no, the only thing I would say, a little flavor to that is on the weather, certainly, it's an outdoor sport, and that's it - that is the X factor. But I can tell you that this operating team has been seized with that challenge in front of us in prior preparations, and certainly, we'll go into this, this winter better prepared than we were last year, which when you couple that with improved assets, with a physical plant that's being improved, we got 8 sidings that are coming online by the time the ground freezes up, by the time, maybe not by the time snow flies, but certainly before it gets too deep in the winter, which will help us maintain velocity through the network.

So I'm very confident that these preparations are going to pay dividends for us to mitigate that X factor, but it's still to be determined how bad it is.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay. That certainly makes sense. Now, to get my second question, switching gears a bit onto the intermodal side, just maybe a question for Jane. When you think about the shifting of some business to the competitor and sort of how you think about the overall profitability of the business, I guess I just wanted to get a rough sense of maybe how we should be thinking about kind of basic modeling perspective for 2014, when we're thinking about sort of probably some carload declines, but arguably some pretty decent yield improvements, potentially from mix and otherwise. Just want to get a rough sense of maybe how we should be thinking about that piece of the business in 2014.

Jane O'Hagan (EVP and CMO)

Well, obviously, Chris, one thing we won't be doing is giving you guidance for 2014. But I can tell you that, you know, based on, you know, the momentum that we've had with an excellent product and service side, you know, and ability to sell into that, you know, we have seen, certainly overall in the book, double-digit growth in some of the key corridors in which we're selling intermodal, as well as, a single, high single-digit growth on the domestic side. I think that when you look overall, you know, in terms of, you know, what you should be thinking about is that, you know, obviously, chasing market share with price is, you know, not on our agenda. And, you know, while the pricing side really is a journey, you know, that we're on, we are improving the quality of revenue.

So, you know, I think that, you know, based on, you know, that overall perspective in terms of, you know, where we're growing, we're going to see that growth continue. I think that, you know, you should be thinking about, obviously, you know, improving our pricing as well as seeing growth in specific segments.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay, that's very helpful. Thank you for your time. I appreciate it.

Hunter Harrison (CEO)

Yeah, Chris, let me add a little bit to Jane's comment there.

Ken Hoexter (Managing Director and Senior Research Analyst)

Sure.

Hunter Harrison (CEO)

I think as I look at where we are today, I'm not looking at quarter-over-quarter, but looking out in the future. Effectively, what we're seeing is this: we've come to the point, as we speak, that the loss on the international side has been effectively almost made up totally on the domestic side. And that's a direct reflection of service offering. And most of, in my view, the numbers I've seen and looked at, most of this domestic growth has been off the highway. Those margins domestically are much better than international. I feel much more bullish going forward about domestic markets as I do international. You know, there's some numbers that we can't get to, and, you know, we've continually said that in the plan, that there's some business we're going to have to walk away from.

If that's the market, you know, at those levels, we can't be a player. But I think that Keith has really led this effort, and there's just been special emphasis added on service with this domestic intermodal. And it really boils down to how you value service. Now, I know some people, it's a politically correct thing to say, to talk about service, but they really say, "Look, it's not anything about service, it's all about price." I don't believe that, and we'll see. And really, the factor going forward, that's going to say, how far can we go, is going to be how quick and how effective we can be in converting service to the bottom line, given some of Jane's earlier comments with her reorganizations of that marketing sales function.

Ken Hoexter (Managing Director and Senior Research Analyst)

Sure. Just to clarify, the domestic intermodal moves are typically running at a higher revenue per carload per se, than the international moves would be?

Hunter Harrison (CEO)

Yeah, pretty significant.

Keith Creel (President and COO)

Yeah, I mean...

Ken Hoexter (Managing Director and Senior Research Analyst)

Makes sense. Great. Thanks very much, guys. I appreciate it.

Operator (participant)

Your next question is from Allison Landry with Credit Suisse.

Ken Hoexter (Managing Director and Senior Research Analyst)

Wanted to dig into the frac sand business a little bit. You know, you mentioned volumes were up in the double digits this quarter. So I was wondering if you could give us a sense of what volumes might look like, you know, in the midterm from some of the new production coming online next year, and, you know, where some of the primary destination markets are for that business. And I guess ultimately, what are your thoughts on the potential to move frac sand down to Mexico, should the energy markets open up down there?

Jane O'Hagan (EVP and CMO)

Well, you know, obviously, you know, I'll start with your last question first. That, when we look at the marketplace, obviously, our first intent is to take the breadth of our network and apply it based on our relationships to new markets as they emerge. You know, when I look at the Frac Sand market, and I think about, you know, where we need to be as a company, we've aligned ourselves, and you would have seen in our announcements, you know, we've aligned ourselves with very strong players that sell a very high-quality, product. I think at the end of the day, you know, this is an industry that may see some consolidation, may see some shakeout, just based on how quickly this ramped up and how quickly they responded.

We've basically aligned ourselves to players that will be in the long term, and we expect that these volumes will ramp up as they reach their production capabilities over the next year.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay. And then just a follow-up question. I guess it relates to your comments on increasing your accruals for long run incentive comp in the fourth quarter. Is there a, you know, should we use that sort of as a run rate for how to think about dialing that in for 2014?

Hunter Harrison (CEO)

Yeah, I mean, my comments on the 10-12 were made up of two comments.

Ken Hoexter (Managing Director and Senior Research Analyst)

Mm-hmm.

Hunter Harrison (CEO)

One is the share price impact, and I've given sensitivity on that, in terms of about $600,000 per dollar. The other part is the long range incentive plans. And so about half that amount you would build into sort of a quarterly run rate for next year.

Ken Hoexter (Managing Director and Senior Research Analyst)

Perfect. Thank you very much.

Operator (participant)

Your next question comes from Turan Quettawala with Scotiabank.

Ken Hoexter (Managing Director and Senior Research Analyst)

Yes, good morning. I guess my question is also on the volumes forward a little bit. I'm just wondering, in 2013, you have been working quite a bit, obviously, on improving operations, but have also been taking a big, quite a close look at your book of business, with repricing some business and obviously exiting some as well. I'm wondering if you can give us a sense of how much more of these opportunities are left within your book over the next 12 months?

Jane O'Hagan (EVP and CMO)

Well, I would say that, you know, this is a constant process because contracts come up, contracts renew. Obviously, you know, a key part in this journey is taking a look very carefully because it really is a cost takeout strategy. It's a look as we make those improvements, you know, what pieces of business become more attractive as that cost profile changes, and how we might upgrade the book accordingly. I would tell you that we don't have any legacy agreements left, that largely the contracts that we don't have anything large to price out in 2014. But I would say that, you know, obviously, a key part for us is that service is our strength right now, and this is giving us the opportunity to get into markets that we haven't been able to get into before.

As Hunter indicated, some of these marketplaces have better margins. So this process that we're going to be going through, you know, from an intense part of selling the service and also working at changing and upgrading the book, is really part of this continuous journey we have, where we've been making progress in improving the quality of revenue, but there's more for us to do.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay, thank you, Jane. And I guess, maybe for Keith, how much of the whiteboarding execution, I'm sure that's probably at the beginning stage right now, considering you was going through the planning here in the summer. Just wondering, can you give us a sense of where you are on that whiteboarding execution?

Keith Creel (President and COO)

I would say probably about 80% of it's implemented. The balance will be dependent upon capital investments we're going to be making over the next couple of years.

Ken Hoexter (Managing Director and Senior Research Analyst)

Great. But I guess a lot of the benefits of that will probably start to accrue here right now, right? I mean, it was implemented, but-

Keith Creel (President and COO)

Yeah, when I say 80%, I mean, you think about 13% train miles in the quarter, that's over 10,000 a day. That's pretty meaningful. So that's, you know, that will continue in the, in the future. But to have those kind of quantum leaps, no. So 80% of the benefit we're realizing day in and day out, we'll continue to tweak it, balance it, balance it against the business levels, and then that additional 20%, we'll see over the next year to two years.

Ken Hoexter (Managing Director and Senior Research Analyst)

Great. Thank you.

Operator (participant)

Your next question is from Scott Group with Wolfe Research.

Ken Hoexter (Managing Director and Senior Research Analyst)

Yeah. Hey, thanks. Morning, guys. Just first, real quick, Hunter, just want to clarify what you were just saying about the margins in fourth quarter. Were you suggesting that if weather cooperates, and I understand that's a big if, that you could see sequential margin improvement from three Q to four Q?

Hunter Harrison (CEO)

Yes.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay, great. So one of the things that we hear from people is kind of the Pershing and the them selling the stock and potentially as an overhang. To the extent that you're ahead of plan and free cash flow is starting to get really good, does that accelerate, in your mind, Hunter, the timing for when you want to start buying back stock?

Hunter Harrison (CEO)

Look, what, I don't know what Pershing is going to do. You know, you all can say better than I if it's an overhang out there. I do think this, I think Brian's comments to the strength in the balance sheet and free cash flow and, you know, we're not going to sit on a lot of cash, that, that will get us closer to, some buyback program. I would anticipate, this is, of course, a board decision, not my individual decision. I would anticipate that if we continue to have the kind of performance we talked about, that we would, we would probably be taking a strong, hard look at a buyback within the next 12 months.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay, that's helpful. And just last thing, Hunter. So you made a comment, and someone suggested a little jealous of Brian and his upcoming retirement. To the extent that you're ahead of schedule and based on your comments on an Analyst Day next year, maybe two years ahead of schedule, how does that change in your mind the timing for how long you're going to be here?

Hunter Harrison (CEO)

Well, if it's totally my decision, I'm not sure it's going to significantly change it. You know, we had kind of pointed that had this 4-year plan, but you know, that's 2.5 years away. A lot of things could happen between now and then, but you know, we're on a pretty nice roll here. I don't want to walk out too soon, although Keith is every once in a while suggesting that. No, I think that probably, if I had to make a guess, I think I'll probably be here, you know, 2.5 years, and then potentially, maybe I'll continue to have some seat on the board or and stay with the organization in that regard.

That's why we worked very hard, and really, Keith was the key that kind of strengthened us as far as the succession plan. So I think, you know, whether I'm here or not, you're gonna see this organization continue to produce these kind of results.

Ken Hoexter (Managing Director and Senior Research Analyst)

All right. I appreciate your thoughts on that. All right. Thanks, guys.

Hunter Harrison (CEO)

Sure.

Operator (participant)

Your next question is from Fadi Chamoun with BMO Capital Markets.

Ken Hoexter (Managing Director and Senior Research Analyst)

Good morning. If we can talk a little bit about, maybe framing the revenue picture, for next year. I know you're not giving, maybe specific guidance, but, if you can talk about how do you see things coming together, especially in light of some of the share loss that we've had in autos and intermodal, or, choosing to move away from a couple of contracts. Maybe where do you see the growth coming from and, and, the areas that you feel, that, you have a good, visibility on at this stage, maybe Jane or Hunter, take a stab at that?

Hunter Harrison (CEO)

Yeah, Fadi, let me, let me address that. I you know, number one, I would say this, given a lot of the comments I've read, you know, our guidance for this year, year-over-year, for revenue growth was, high single digits. We're gonna hit high single digits, in not the most robust economic times. To be at high single digits, I happen to think it's pretty damn good performance, and I can say in my career as CEO, there's a lot of years I would have loved to have high single digits growth. Having said that, clearly, you have as much knowledge as we do relative to the commodity. So, you know, let's just, you know, we think our position with, with grain and with potash and with the, the, the bulk commodities is gonna be good.

The big area that we have, that strategically we're attacking, is what I would call the merchandise side and domestic intermodal. Now, are we gonna, are we gonna try to gain international? Obviously. But, you know, I'm a firm believer that the market gives you the price. We decide whether we want to play or not. We don't set the price. The market plays out there, and the price is, that's an area we don't want to play. So, you know, I think our longer range guidance has been, five to seven percent CAGR over the next, four years. And I think that's probably gonna turn to be a very conservative number, because I happen to think that this issue of service is gonna play a big part in our growth.

When people see the service, they actually see it, it's not what we're just talking about. They can understand the what it does to their fleets as far as asset turns and their inventories and so forth. Plus, the fact that during this time, if we see interest rates go up, and I think we're gonna see them go up, we're not gonna stay where we are, and the cost of carrying inventory and so forth is gonna go up. All those things create value to service, and that's gonna be really the kicker that says, how strong can our growth be?

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay. Only one clarification, maybe. So, given some of the business moving away next year, you still think realistic we can be in that 5%-7% in 2014?

Hunter Harrison (CEO)

Yes.

Jane O'Hagan (EVP and CMO)

Yeah, I'd, I'd say that, Fadi, you know, we've always had our expectations with our guidance that, you know, we would see that contracts could flip back and forth. And I think to Hunter's point, that, you know, we're obviously confident, you know, that we have the service that creates opportunities, and we're gonna win those opportunities. So there's nothing that's happened so far that has changed any belief that we have in our guidance as we set out on our 4%-7% on the CAGR.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay, that's helpful. Thanks.

Hunter Harrison (CEO)

Thanks, Fadi.

Operator (participant)

Your next question is from Bill Greene with Morgan Stanley.

Ken Hoexter (Managing Director and Senior Research Analyst)

Good morning,

Hunter Harrison (CEO)

Good morning, Bill.

Ken Hoexter (Managing Director and Senior Research Analyst)

So, very impressive results. Hunter, one of the things that you mentioned in your prepared remarks is you'll address the guidance, some point, long-term guidance, some point next year when you do the Investor Day, if you, if you plan it.

Hunter Harrison (CEO)

Right.

Ken Hoexter (Managing Director and Senior Research Analyst)

But something else you've also gone on the record to say is you think you can get this company to be the most profitable railroad in North America. And the competition sort of stepped it up with a pretty impressive OR yesterday. And I'm wondering if you think there's anything about the CP network that says that comment that you've made in the past, maybe you have to kind of reassess?

Hunter Harrison (CEO)

Well, I'm always reassessing. Look, the competition had a hell of a quarter. You know, they did a great job, outstanding performance. But I would also... Let's take a look back a little bit. And by the way, I congratulated them for that performance. You know, where we started this journey 16 months ago, they were somewhere around 17 points ahead of us. Now, they're 6 or so. So we've made some gains. They see us in the rearview mirror, but really, look, it's not about who's the, who's the lowest. When I made those comments, I didn't think they were gonna be going to those kind of levels, so maybe I underestimated their abilities. But I think the market would be pleased if they're at 59 and we got to 60, everybody would love it, I think.

So, you know, if somebody's gonna, in 18 months, somebody says, "Hey, you missed it." Well, so I missed it. But I still think we're gonna go down, we're gonna go down further. If we're at 65 now, with all the things we got in the blender, that sure is not the end, okay? So and there ain't a lot of space in between, and so we're gonna stay after them. Just that, you know, it, it's not a driving force here. I said early on in this game when I got here, there's plenty of business for both these railroads to do well and take business off the highways and put it on the rail and both of us to be very successful.

Ken Hoexter (Managing Director and Senior Research Analyst)

Yeah, that makes a lot of sense. Great. Second question, just, Hunter, something you said recently as well, was that you think that there's probably in the range of CAD 2 billion or so in assets that could be monetized. Can you offer some color about how we should think about that kind of flowing into the cash flows? What sort of the timing on monetizing some of that? That'd be helpful. Thank you.

Hunter Harrison (CEO)

Yeah, thanks. You know, that's a hard one to answer. We are now reviewing that further. We're trying to get the right model to optimize those assets. And there's several alternatives that we're considering and exploring. But, you know, it's not gonna come all in, obviously, in 2014, and it might be, you know, 2015 before you start to see the full value, depending on which way we go. But it's nice to know that we've got something that's convertible, that's got value, that's in that $2 billion range, that's kind of gravy to this whole plan.

Ken Hoexter (Managing Director and Senior Research Analyst)

Yeah. Appreciate the time. Thank you.

Hunter Harrison (CEO)

Thanks, Bill.

Operator (participant)

Your next question is from Tom Wadewitz with J.P. Morgan.

Ken Hoexter (Managing Director and Senior Research Analyst)

Yeah, good morning, and congratulations on the, you know, really impressive results. It's, it's, you know, impressive all around. Wanted to see if you could help me think about 2014, and it's just when the pace of improvement in the margin is so strong as you've had this quarter, and, you know, in second quarter as well. It's hard to know, you know, how much can you keep delivering in 2014. There's an assumption that it would slow down. Well, how would you think about maybe the absolute margin level you might be, or OR level you might be able to achieve in 2014, or the factors that would affect what kind of a pace is realistic for margin improvement in 2014?

Hunter Harrison (CEO)

Well, let me make some comments, and then Keith can fill in the gaps. Clearly, you know, we're non-seasonal factor. We're at the 65 level now, 65, and whatever the fraction was. We've got line of sight on a lot of areas that we've had improvement, but it's not over there. So I think every initiative that we've undertaken, there's some more to wring out. We've talked about, for an example, headcount. I think we're right now at the 42 range. I would expect by year-end, we'll be 45, on the way to potentially a number of six, and you can do the math there.

So clearly, Tom, we ought to have the opportunity to move with, particularly second and third quarter, to move in the, in the range of lower than 65, and you got to get to the low 60s or shame on us. And can we go below that? We'll see. And that's probably gonna be dependent upon how well we convert on the revenue side, the service conversions. And so, you know, would I rule out the possibility that we could get to low 60s and have a little more aggressive growth? Absolutely.

Ken Hoexter (Managing Director and Senior Research Analyst)

So, I guess that when you originally rolled out the plan in December last year, it was kind of a 65 midpoint in 2016. I think your comments have indicated, you know, along the last, whatever, through this year, maybe it'd be 65, a year early. It kind of feels like it could be 65 full year, even in 2016. Is that, or excuse me, in 2014, is that a reasonable way to think about it?

Hunter Harrison (CEO)

Yes.

Ken Hoexter (Managing Director and Senior Research Analyst)

Oh, okay. And then I guess a quick one for Jane. On the crude by rail, I know there's some spread sensitivity, but you've had some new loading terminals, unit train loading in Western Canada. How would you think about the impact of those in 2014? How, you know, how much volume might those drive in 2014?

Jane O'Hagan (EVP and CMO)

Well, I think, you know, as we think about the profile of the book, I mean, I'm not gonna speculate on, you know, where we think the volume is gonna go, except to say that we're feeling very comfortable about, you know, the guidance that we've provided, regarding our plans, you know, over 2016. I think that what we can safely say, though, is that as we see these new facilities rolling out, they're largely on the heavy side. And so, you know, as we think about those markets and we think about that business, we certainly expect that, you know, the production and the construction of the facilities are going as planned.

But we also expect that these growing shipments of heavy from the West Coast will also, you know, from the western, western part of Canada, will also help us in making sure that we're not as susceptible to the spreads. So I think that, you know, we feel confident that the people that we're working with, we have line of sight to the expansion. And again, we'll give you more detail in Q1 as we see that roll out in terms of where we think we'll be with our crude rates.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay, great. Thanks for the time.

Hunter Harrison (CEO)

Thanks, Tom.

Operator (participant)

Your next question is from Walter Spracklin with RBC Capital Markets.

Ken Hoexter (Managing Director and Senior Research Analyst)

Thanks very much. Good morning, everyone.

Hunter Harrison (CEO)

Good morning, Walter.

Ken Hoexter (Managing Director and Senior Research Analyst)

Just following up on the market share question. I know that there has been some shifts here, and Jane, you mentioned that there's no significant contracts coming up in 2014. Let's flip it around a bit, and Hunter, you mentioned that as your service improves, there's opportunity to gain market share. Is there any areas that you do have your sights on, in terms of a specific, let's say, groups of areas or even specific companies that you would see the contract coming up that you might be able to leverage that improved service to gain market share back in 2014?

Hunter Harrison (CEO)

Oh, yeah. I mean, the list is extensive. I mean, if we start to really produce the service door to door, effectively, where there's value to the customer, and one of the issues that Jane and her staff is addressing right now is training, coaching, mentoring our people on how to sell service. They've been price sellers. They didn't have a service to sell. They sold price. And so this is, you know, this is not something that happens overnight. Number one, the market doesn't like change to begin with, and people are resistant to change.

But if they start to see value in it, as we've seen with the domestic, you know, I think we'll see on the domestic intermodal and this merchandise book, excluding crude, that's where we're gonna, in every one of those areas, as far as products, metals, minerals, you name it, I think we're gonna see some growth, and that's without any boost in the economy. If we get a little bit of boost with the economy and convert this service, you know, could, could we exceed the, the, 7% CAGR? Yeah. Are we gonna have some losses? Yeah, because, you know, it's a competitive world out there, and there's some places we can't play. But I would point out this, you know, there's more places we can play when we're at 65 than we were when we were 80.

The margin, obviously, is the marketplace is opening up to us as we, as we make these improvements. So, you know, in spite of the fact, I mean, and we said this in the plan, that we weren't gonna chase price, we weren't gonna chase market share. We were gonna go after it, and we're gonna provide a bad service and try to make a buck, but that's all in the plan. So, you know, I'm I think that, obviously, the revenue stream is gonna trail the operations, the operating performance and the expense control. But, you know, and that's gonna have a leveling factor. We're not gonna see these kind of improvements ongoing. But I think when that tails out, the revenue will pick up, and I'm, I feel very bullish going forward.

Keith Creel (President and COO)

If I could, Hunter, let me add a couple of comments, Walter. I, I can tell you this, not anecdotally, but factually. You know, customers that in the past, the value service, be they rail, be they road, that historically would have never given CP an opportunity because we didn't provide that compelling service offering, they're calling. Conversations I've had, conversations Jane have had, you know, we've got to earn our street credibility by our, what we produce, which we're doing. You know, the service that we're offering between Calgary and Toronto is unparalleled. It's not just rail competitive, it's truck, single driver truck competitive. So we're exercising, and we're sweating, and we're leveraging the franchise strength that a lot of people before, even internally, didn't recognize. We've got the shortest route, period, from Toronto to Calgary.

If you leverage that and you actually convert that, how do you compete with that? Be it truck, be it rail. We've got the shortest route, Vancouver to Chicago. If you leverage that and you compete with that, it's compelling. So if you're into asset turns, if you own your own equipment, if you care about service, if you got to get the product on the shelves, who are you going to give your business to? It just takes a little bit of time for us to earn our keep, earn our reputation, and once we establish that, the business is going to come. I'm not nervous about it at all. And we're going to earn a return, and through this reduced cost, we're going to leverage it right to the bottom line.

Ken Hoexter (Managing Director and Senior Research Analyst)

No, I appreciate that. One area that I think is a good test on that would be grain. I guess, you know, you've got a big crop coming up. We know it's not price sensitive. There's revenue caps in place, so, you know, pricing doesn't really come into play. Typically, it's a market you've shared roughly 50/50 with C, you know, with CN, but it has varied by as much as 10 points. How do you see your market share capture and what's shaping up to be one of the best crop years ever, when you leverage that service that you're now enjoying? Can we see more than 50% market share in the grain for this year's grain crop, given that pricing is not going to be a factor?

Keith Creel (President and COO)

Yeah, I would-- I'll let Jane provide some color, but short answer is yes, you can expect it. I mean, there are certain elevators that are in play for CP, that are in play for CN. That's jump ball business. If we've got the assets, the cars available, and we're making the turns to the West Coast, where most of this grain is going, then we're gonna be in play, and that opportunity is there, and we expect to try to convert some of that. I mean, as we said, we ramped up fast. Numbers that are staggering compared to what's happened in the past, and it's not just what we've unloaded at the port, it's what you loaded in the prairie, so to speak. You convert those too, you provide the customer in a non-regulated environment.

Now, with the Wheat Board gone, some of these customers want to get that product to market. You keep their export elevators full, and you're going to be rewarded with business. That's what we're seeing.

Jane O'Hagan (EVP and CMO)

And I would just add to that, Walter, that, you know, when we look at our franchise, you know, we're really, you know, I would say, arguably, have one of the best franchises in North America when it comes to origination, and certainly the range of destinations that we provide, you know, in the last year, we've shown that when, as the markets have changed or as they're dynamic, we've gone to the market with pricing, we've gone to the market with opportunities, you know, where we've been moving Canadian grain to U.S. ports and U.S. grain into Canadian ports. So I think that when you look overall and you think about what we can do, not only on the regulated side in terms of, you know, working with our customers, working with our operations team, finding ways to improve asset utilization and velocity, that's step one.

But when we add into that, the opportunity that we have to take advantage of the destination, reach, and origin capabilities we have, this is what really gives us the opportunity to really focus on moving, you know, the record volumes of grain that we're at today.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay. Appreciate that color, and congratulations on a very good quarter.

Hunter Harrison (CEO)

Thanks, Walt.

Keith Creel (President and COO)

Thank you. Thanks, Walt.

Operator (participant)

Your next question is from Ken Hoexter with Bank of America.

Ken Hoexter (Managing Director and Senior Research Analyst)

Great, good morning. And again, congrats on a great quarter, and Brian, good luck in retirement in the next phase. Just a clarification, Hunter. Maybe just on, you know, we've heard a lot about how customers were upset at, I don't know whether it was your pace of change or what have you. Was it what... You know, back in the CN days, and that was Claude's big thing when he stepped up to do a smoothing of service. What, when you step back, and you look at the loss in their intermodal business, do you have a feel, was it just on price? Was it on service? Was it the pace of change? When you kind of do a postmortem look at it, what was that look back?

Hunter Harrison (CEO)

The recent losses in international?

Ken Hoexter (Managing Director and Senior Research Analyst)

Yeah, I guess on the international.

Hunter Harrison (CEO)

Yeah. Strictly, in my view, it's strictly a price decision. And, you know, look, they're going. Look, some of them, you know, are saying to me that, you know, they're cutting back the speed on the high seas to save fuel. You know, if you go to some of these intermodal facilities, there's containers stacked 20 high. They're dwelling in. So service is not a factor there, at this point, I mean, more globally. So when, you know, when service is not a factor, and it's just who's going to give the lowest price, you know, that's when you win the business, and we've decided not to go that low.

Ken Hoexter (Managing Director and Senior Research Analyst)

Okay. And then, so when you, I guess, look forward, has the mix between pricing and volume since you started in terms of your outlook on that top line growth, or maybe that's more a Jane question, but has that shifted at all since you set those original outlook targets?

Jane O'Hagan (EVP and CMO)

I would say that, you know, basically, Ken, if you can look at it this way, I think that, you know, we obviously want to grow the business in a sustainable, profitable way. You know, when we set out and looked at how we want to look at revenue growth, obviously, you know, our pricing is a journey. You know, we're out there selling value. We're going to get that much better and command better value for, for the price that we put out there. So when we look at overall in the mix, and we think about the book of business, it's our job to continuously adjust and improve that quality of revenue. And I think to Keith's point, and to what Hunter said, you know, we're our service is really our strength right now.

You know, getting into the market, being able to sell that service, and focusing on how we bring that to the bottom line, that's what we're doing, with the emphasis being on improving that quality of revenue and commanding the price for the value that we put in the marketplace.

Hunter Harrison (CEO)

But Ken, it's really a timing issue. You know, we started off, first goal was we had to get our costs under control and get our act cleaned up and build a foundation to build service on. So that took us. That's taken us nine or 10 months to make the first big breakthroughs there. So now we're starting to see a really better product out there. But the market's not going to change overnight based on the fact that you go out and blow your horn about your service. They've got to see it. And so there's going to be some lag, a year or so, and it'll dribble out over time till people convert and make this change. So, you know, I think you'll see the revenue growth start in 2014, but it's not...

But probably 2015, we'll really see a big jump on the service side if we're right in what we're saying.

Ken Hoexter (Managing Director and Senior Research Analyst)

Appreciate the insight.

Hunter Harrison (CEO)

Thanks, Ken.

Operator (participant)

Your next question is from Thomas Kim with Goldman Sachs.

Thomas Kim (Senior Industrials Equity Research Analyst)

Continue on the line of this improving the service. First off, can you give us an idea of the service improvement on existing services versus adding or expanding services to improve the network? And then as you think about improving, expanding the overall services, to what extent should we be thinking about the impact for CapEx as there's going to be anticipated reinvestment in the network and equipment? Thanks.

Hunter Harrison (CEO)

You know, right now, I don't see any need where we're talking about these issues is going to be affected [by] the capital spend. If it does, it'll be modest. But you know, I think one of the things that we'll concentrate on to some degree is, you know, rail is typically said, if you had somebody 6 or 8 years ago with intermodal, you had to have an 800- or 900-mile haul before you could make a buck. Well, I don't think that exists anymore. So I think in some of the domestic markets in Canada that aren't huge markets, but hopefully will grow like the Edmontons, Calgary, those, Regina, those type markets, we're going to really go after from the highway perspective.

So there's going to be creating better, as to keep the example of improving Toronto to Calgary, and those big lanes that we have domestically, but at the same time, offering new services to the shorter haul intermodal.

Thomas Kim (Senior Industrials Equity Research Analyst)

Thank you. If I could just switch topics with regard to financial leverage and capital structure. Can you give us a sense of what sort of target you, you're looking at in terms of your overall financial leverage, whether it's a net debt to equity or a net debt to EBITDA number? And, you know, how should we think about that in terms of the capital return? Thank you.

Brian Grassby (SVP and CFO)

I think, Thomas, without being specific on the ratios, we're targeting to be solid mid investment grade and looking to have, although it's a conversation with Hunter, but sufficient cash on the balance sheet. So the ratios that you would see for solid mid-investment grade would be the ones that we're aiming to.

Thomas Kim (Senior Industrials Equity Research Analyst)

Yeah, thanks a lot.

Operator (participant)

Your next question is from Brandon Oglenski with Barclays.

Brandon Oglenski (Director and Senior Equity Research Analyst)

Yeah, good morning, everyone. I know it's been a long call here, so I'm just gonna keep it to one. But Hunter or Keith, you know, I think it's good to benchmark yourself against the best-in-class here. And your peers out east are running with labor expense at about 20% of revenue. And the way I see it for your network right now, closer to maybe 23%, but that's improved by about 300 basis points this year. Should we be assuming, you know, a similar progress in labor productivity for 2014 and 2015, to maybe match that benchmark?

Hunter Harrison (CEO)

Well, you know, I hadn't looked at those numbers specifically as compared to the competition. But if you look at the headcount numbers, for example, and some of the other initiatives that we had, clearly, our comp and benefits line is going to go down relative to revenue. Now, as comparing it to the competition, you know, I don't know, there's a different mix, and there's potentially different operating agreements that will be signed. But I think that we will continue to make improvements to those areas. And as I kind of said to them jokingly yesterday, you know, they've become a moving target, you know? So, you know, congratulations to them, and you know, I think we understand what we need to do, and we're going to drive to get that done.

Brandon Oglenski (Director and Senior Equity Research Analyst)

Thank you.

Operator (participant)

Your next question is from David Newman with Cormark Securities.

David Newman (Equity Research Analyst)

Good afternoon, gentlemen.

Hunter Harrison (CEO)

Afternoon, David.

David Newman (Equity Research Analyst)

So you had CAD 2, 2 billion in potential asset sales here overall. Is that inclusive of the DM&E, and where does that stand at this current juncture?

Brian Grassby (SVP and CFO)

David, that's not. The CAD 2 billion is not the DM&E. We're-

David Newman (Equity Research Analyst)

Land sales, right, mostly?

Brian Grassby (SVP and CFO)

That's right.

David Newman (Equity Research Analyst)

Yeah.

Brian Grassby (SVP and CFO)

But no, we're on track for the DM&E West. The process is going well. The parties have done due diligence, and we'll update you when final decisions are made.

David Newman (Equity Research Analyst)

Okay, so two billion in cash, and then you sell the DM&E. Besides buybacks, dividends, any strategic uses of the assets or the money, Hunter, that you could anticipate, other, you know, other rails or supply chain? Like, how would you like to augment the franchise, I guess, in the future?

Hunter Harrison (CEO)

Well, I mean, one thing we're looking at right now, for example, is we're looking at our position with short lines. And we've got some agreements out there that I really don't like, that have been signed and we're looking at should we reacquire some of the smaller short lines? Should we terminate the lease? Should we not extend it when it comes up? So, you know, we'll be looking at the short line network. You know, I think we'll move to the point, and hopefully I can lay a foundation for the rest of the team, that you know, anything that's in the quote, we hear this term somewhat, supply chain, the more we can control, the more effective we can be.

So we would look at anything in that supply chain that's up for sale that we think at a reasonable price, that we can get a return on. We'll take a look at it. Now, as far as any major big acquisitions, anything strategic, I don't know of anything. I don't think we're in that position right now. We do have an Eastern property that we talked about initially, that there's a potential opportunity to do something with it. But that's about what's in the bucket right now.

David Newman (Equity Research Analyst)

Okay, now you've got a 65 OR potentially for next year. As a result of your whiteboarding exercise or brainstorming, have you identified anything sort of chunky or, you know, beyond what you've already anticipated in your first plan? I'm sure we'll get an update at the Analyst Day, but any thoughts as to how you might get this down to, you know, where your competitor is today?

Hunter Harrison (CEO)

Well, I'll let Keith add to this, but, I mean, I'll just mention a couple of things. You know, we're gonna, we're going to a, what I call a stable workforce with our maintenance, the way people that, that maintain the track. We're not gonna have a case where we're, you know, hiring in the season and laying off, and we're gonna have a stable, and that's provide savings. We had a big effort that we've talked about before, that Mike Redeker is heading up with IT. So we think that at the end of 2014, it's kind of a bubble, and we'll take a significant amount of people, mostly outside contractors, out of... So that's, that's kind of all gravy. Plus, there's a lot of initiatives right now. You know, the game's not over with increasing train size, so which lowers train starts.

And so it's just doing, in addition to that, it's just doing all the things we're doing, trying to do now, do them a little bit better. I mean, our managers out in the field, you know, are going through a big learning curve. This has been a hell of a change, is a hell of a change for them. So they're gonna get better every day. They're gonna get smarter. We've come a long way from optimizing this. I mean, the competition shows us where the numbers can be, you know, and we've experienced before numbers that started with five. So, you know, that's, I'm, I feel pretty confident that we're gonna be able to produce those kind of results.

David Newman (Equity Research Analyst)

Excellent. Go ahead, Keith.

Keith Creel (President and COO)

Yeah, the only thing I would add to that, you know, this is about, this isn't about grand slams on a go-forward basis, singles and doubles, but there's some key opportunity levers in there. I can tell you now that the safety culture in this company is nowhere near where it's going to be. This is a journey. It's an evolution. As we evolve and as we create a culture where more and more employees comply day in and day out, as we increase the robustness of our infrastructure, some of these derailments, which we've experienced and certainly, can draw concern to the company or and has drawn some naysayers to the company, we'll reverse those trends, and you'll start to see an improvement in that area, and that, that goes straight to the bottom line, both in the revenue and asset turns.

It goes way beyond just the tangible direct costs that are associated with these incidents. So that's another area that to me is gonna be a significant performance enhancer as we go forward.

David Newman (Equity Research Analyst)

Physically, if you look at the franchise, we were told for years that there is a, you know, a gap between your other Canadian competitor, just because of the physical layout of the infrastructure of the network. I mean, you've been on the property for quite a period of time now. I mean, do you still think that holds true, or do you think that's just a fallacy?

Keith Creel (President and COO)

I think it's a case-by-case basis, and quite frankly, I think it was an excuse. You can look at any franchise, any network. I can look at theirs, and there's some benefits to theirs, and I look at mine, there's some benefits to mine. So all that offsets, it's how you execute with what you've got. I can say the more meaningful opportunity, if you want to compare apples to apples, that we're on this journey at CP, is are these extended sidings. You know, we're putting eight in this year. That allows us to run longer trains to make effective train meets. We're not done. That's a 2-3-year journey. There's a meaningful part of this railroad that doesn't have CTC, that gives you incremental impact as far as velocity and productivity. That's something that we're on the journey.

That's a 2- to 3- or 4-year plan for us. So all those things are in the blender, and that's how you get to that number that we're talking about as we go forward.

David Newman (Equity Research Analyst)

Excellent. Great quarter, guys. Thanks a lot.

Keith Creel (President and COO)

Thanks.

Operator (participant)

Your next question is from Cherilyn Radbourne with TD Securities.

Cherilyn Radbourne (Managing Director and Senior Equity Research Analyst)

Thanks very much. One thing I noticed in the quarter was that your average revenue per RTM took quite a jump in Q3 versus the first half of the year, to kind of $0.0431 versus the low $0.04s. It looked like maybe there were some mixed impacts in sulfur and fertilizers, industrial products and grain in particular. Could you just address that issue a little bit and, you know, help us think about whether we should assume the mix prevailing in Q3 continues?

Jane O'Hagan (EVP and CMO)

Well, I think, Cherilyn, you really hit the nail on the head. I mean, obviously, we did have some impacts that were there from mix, largely with the long-haul industrial products, some of the certainly the domestic potash, and the overall impact on the grain side. I think that, you know, what you should do on a go-forward basis is, you know, obviously, our grain remains strong. You know, we're gonna see some with as the spreads widen, we're going to see some of that return on the oil side. And as you know, a lot of our RTMs and our average revenue per car is impacted by those volumes as well.

So I think that, you know, overall, I think that, you know, the mix should be pretty much in line with what you're seeing, this quarter into Q4. So that's how I would model it.

Cherilyn Radbourne (Managing Director and Senior Equity Research Analyst)

Okay, it's been a long call, so I'll keep it to one. Brian, I did just want to say good luck to you.

Brian Grassby (SVP and CFO)

Thanks, Cherilyn. Thank you.

Operator (participant)

Your next question is from Jason Seidl with Cowen and Company.

Jason Seidl (Managing Director and Senior Research Analyst)

Hey, everyone. First off, Brian, congratulations and best of luck to you. I'll keep it brief since it has been a long call. Going back to the crude rail, you guys were talking about your sort of mix between some of your more contractual business and the, quote, unquote, "opportunistic business." What is that mix currently between the two?

Jane O'Hagan (EVP and CMO)

What I would say is that about 50% of our crude contracts have volume commitments, and this is pretty much consistent where we started in the business. And as I said, there's also a percentage that's going to move with the spreads. But, you know, as we expect, you know, greater volumes of heavy crude to be developed, obviously, given some of the investments that people are making up in the north, we expect that as the heavy crudes will form a larger part of the book on a go-forward basis, then we'll have a greater portion of those term commitments that are locked in as well.

Jason Seidl (Managing Director and Senior Research Analyst)

Fantastic. I appreciate the color. Thanks, as always.

Operator (participant)

Your next question is from Matt Troy with Susquehanna. Your line.

Matt Troy (Director and Senior Analyst)

Thank you. Keith, just a question for you, pretty straightforward. The RTMs were up 2%. Gallons consumed were down 7%. That's a very impressive spread. Just wanted to ask, is that... Was there anything unique in the quarter, or is that really intuitively, as it would seem, just the culmination of a more fluid network, a more steady state network and the progress you've made, you know, across operations?

Keith Creel (President and COO)

You answered your own question. That's exactly what it is. It's a combination of all those things.

Matt Troy (Director and Senior Analyst)

It's great. It's been long. That's all I got. Thanks.

Keith Creel (President and COO)

Thank you.

Jane O'Hagan (EVP and CMO)

Thank you.

Operator (participant)

Your next question is from Keith Schoonmaker with Morningstar.

Keith Schoonmaker (Director of Industrials Equity Research)

Thanks. Operations question for Keith. Strong double-digit improvement in train weight and length, and I heard Hunter say that this is not done yet, but how far along is the improvement? And perhaps you could comment on, in this system with the current mix, what are the practical constraints?

Keith Creel (President and COO)

Well, you know, we won't make those kind of quantum leaps quarter after quarter after quarter, but certainly there's still more upside. You'll see incremental percentages on a go-forward basis. Those sidings are key to this. As I said, there's eight sidings that come on. They allow you to—effectively, you're limited by how many double saws you have to make if you're going to run long trains in a territory that doesn't have appropriately spaced long sidings. So as we go forward, that will allow us, as we convert them, to increase. So it's a combination of all those things. We'll continue to invest strategically in siding. In some of those pinch points we've got, you'll see some improvements between Edmonton and Calgary, which will allow us to take some train starts out.

You'll see some improvements from some siding investments next year, west of Calgary to the West Coast. Again, that will allow us to increase train size and take out train starts, so we'll be incremental to our progress.

Keith Schoonmaker (Director of Industrials Equity Research)

Is the long-run goal, Keith, to get to zero double saws?

Keith Creel (President and COO)

Well, I don't know if you'll ever get to zero because there's some territories, you got to have traffic density to justify the expense. We're not going to make foolish investment decisions. So, you know, I don't think we'll ever get to zero if we're going to be operating the railway efficiently. If there's an opportunity to do a double saw, increase train lengths, and take out train starts, we're going to convert it.

Keith Schoonmaker (Director of Industrials Equity Research)

Thanks, Keith.

Operator (participant)

Your next question is from David Tyerman with Canaccord Genuity.

David Tyerman (Director and Equity Research Analyst)

Yes, good morning. A question for Jane. Jane, if I take your comments on the yield, it sounds like it's not going to change a whole lot in Q4. The RTMs are obviously going to be a lot higher, given opportunities you have in the quarter. It sounds like you could exceed the 7%-8% revenue growth you're giving for the year. Is that a fair assessment?

Jane O'Hagan (EVP and CMO)

Well, I think that the one thing you should keep in mind that I gave you guidance on is, obviously, you know, we're pricing for value in the market, but we do seasonally price, and I've asked you to keep a careful watch on the sequential price on the grain side, given what the VRCPI is. You know, I would love to see us come in above our 7%-8%. I think that, you know, when we look at, you know, the carload volumes, you know, that we need to achieve to set those targets, I feel that, you know, we're in a pretty aggressive place. But, you know, our operations team continues to do astonishing things for us each and every day.

You know, as long as they're capable and able to move it, and we're in the marketplace out there selling it, we're obviously going to do our level best to challenge that target.

David Tyerman (Director and Equity Research Analyst)

Okay, thank you. And Hunter, on the CAD 2 billion of assets, that's quite a lot, and you only have CAD 16 billion total. I was wondering if you could just shed some light on what you're talking about, where you would get all that, and if there's much EBITDA or EBIT or whatever attached to that CAD 2 billion.

Hunter Harrison (CEO)

No, it's, it's basically all what I would describe as surplus assets. A lot of it's been a result of of the closing the hump yards and movement and consolidation of yards and terminals, and it's opened up, you know... For an example, in Chicago, we, we put all our intermodal business into Bensenville and closed the other facility, and it's just a lot of that. And then, you know, the company had not focused a lot on what we owned. In fact, I don't think there had been a very extensive look at all those properties for probably 25 years. So we found properties in Northern Ontario that I didn't even know we owned.

So as we took all these structures, all these, the land that's been made available, which that makes up a high percentage of it, that's, at, at this point, our best estimate of what the, you know, quote, "appraised value" might be today. Now, I'm not a big-- I don't think appraised value gives you a lot, but, but I think that we got to, we got to figure out how the best way is. And I, and I can tell you this, I don't think we will do it in some traditional way of just selling off properties at a discount rate like a typical railroad. We're going to look and, and optimize this to the best of our ability to reward the shareholder.

David Tyerman (Director and Equity Research Analyst)

Okay, thank you.

Operator (participant)

Your next question is from Jeff Kauffman with Buckingham Research.

Jeff Kauffman (Senior Analyst, Sector Head)

Hey, well, you guys got a lot of analysts that follow this stock.

Hunter Harrison (CEO)

What'd I tell you, Jeff?

Jeff Kauffman (Senior Analyst, Sector Head)

Well, congratulations. This is fantastic, and Brian, best of luck in all your future endeavors.

Brian Grassby (SVP and CFO)

Thanks, Jeff.

Jeff Kauffman (Senior Analyst, Sector Head)

Hey, I got to be honest, my questions have been answered. I'll just ask a quick one to Jane, and that'll be it. Jane, I mean, when we look at the yield, and I think you've done a very good job explaining this, basically, either we can charge more to carry the same car to the same place, you know, maybe because it's better service, maybe because it's just price increase. We can carry more high-value stuff versus low-value stuff, or we can move stuff further distances. If I had to break out how you think the yield growth plays out going forward, how would you throw it into those three buckets?

Jane O'Hagan (EVP and CMO)

Boy, that's a, that's a tough question because of the fact that, you know, it's always a combination. I mean, I think that, you know, what you're doing on a regular basis is, you know, when you're looking at your marketing and sales, at your portfolio and your book of business, you're trying to capture and align opportunities as they appear, you know, with the best combination. I think the one thing that we've learned from Hunter overall is that you really have to start thinking about getting focused-... you have to start to simplify the service and to sell to that.

I think the other thing you have to do is that when you move away from being a price taker, as he said, and we're selling service, we've got to get really focused on not just the customer's whole book of business, but where can we hard largely be successful without trying to dilute that down to just one, you know, combination or package. I think I'd love to give you a combination, but I think that you really kind of hit the nub of what it is we have to be at every day. Thanks.

Operator (participant)

All right. Good luck, everybody. Thank you.

Hunter Harrison (CEO)

Thanks, Jeff.

Operator (participant)

Your next question is from Steve Hansen with Raymond James.

Steve Hansen (Managing Director and Equity Analyst)

Jane, as it relates to the new domestic service offering that you're starting to sell here, can you help us understand the relative importance of speed in this new offering and how that might rank versus some of your other key selling criteria? Because it does seem that the subtle message coming out of your competitor is that speed is becoming, slightly less relevant, to at least relative to some other, perhaps, criteria that are out there.

Jane O'Hagan (EVP and CMO)

Well, I think that, you know, back to Hunter's point that he made, that speed is a different element, that when you think about, you know, the international business and the extent to which, you know, containers move across the sea at a certain pace and, you know, the extent to which they move into terminals, et cetera. But when you get into the domestic business, you know, where we have really achieved our growth, speed is one of the core components that we're selling to.

I think that when we look at customers that are in the domestic market, that are looking at stocking, you know, distribution centers, replenishing inventory, thinking about inventory turns, all those things, these are the key core components that when I look at my team and the enthusiasm they have, you know, selling this Toronto to Calgary service, is this ability to sell into what a customer's proposition is for how they want to manage, and knowing that, you know, this is going to create real value to them in terms of managing inventories and getting product out on customer shelves. So it's very important, and I think there's a bit of a distinction between what market you're talking about.

Hunter Harrison (CEO)

Steve, the other thing I would add there is, you know, maybe you would debate what speed's worth, but and once again, if interest rates are at zero as opposed to 20%, there's a lot of difference in what speed makes in inventory. But I think it's a bigger factor maybe than others. But I would also say that one of the issues that sometimes we overlook is it's also the low-cost way, because when we took the first 20 hours or whatever it was out of the transcontinental schedules from east to west, that saved us about 40 locomotives, because by turning the assets quicker. So it's. I'm a strong believer that good service and low cost are compatible. They're not opposing forces.

Steve Hansen (Managing Director and Equity Analyst)

Very helpful. Thank you.

Hunter Harrison (CEO)

Thanks, Steve.

Operator (participant)

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

Hunter Harrison (CEO)

Well, hopefully, we've covered all the ground, and we're very pleased, and we're... But at the same time, hopefully, there's a little humility in this shop, and this journey is far from over. And I think you're going to continue to see the type of results that this group has produced. And, thanks for joining us. And Brian, once again, congratulations and good luck in the future.

Nadeem Velani (Head of Investor Relations)

Thanks, Hunter.

Hunter Harrison (CEO)

Thanks.

Operator (participant)

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