Canadian Pacific Railway Limited
Q2 2015 Earnings Call Transcript

Published: 21 Jul 2015

[Operator:]

Good morning. My name is Aaron, and I will be your conference operator today. At this time, I'd like to welcome everyone to Canadian Pacific's second quarter 2015 conference call. The slides accompanying today's call are available at www.cpr.ca. [Operator Instructions] I'd now like to introduce Nadeem Velani, AVP, Investor Relations, to begin the conference.

[Nadeem Velani:]

Thank you, Aaron. Good morning, and thanks for joining us. I am proud to have with me here today Keith Creel, President and Chief Operating Officer; Tim Marsh, Senior Vice President, Sales and Marketing; and joining us today for the first time Mark Erceg, our Executive Vice President and Chief Financial Officer. Before we begin, I want to remind you this presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties and other factors that could influence actual results are described on Slide 2 in the press release and in the MD&A filed with Canadian and U.S. regulators. This presentation also contains non-GAAP measures outlined on Slide 3. The formal remarks will be followed by Q&A. In the interest of time, we would appreciate if you limit your questions to two. It is now my pleasure to introduce our President and Chief Operating Officer, Keith Creel.

[Keith Creel:]

Thank you, Nadeem. Let me start with wishing everyone a good morning. Thank you for joining us this morning. I know most of you sitting there now expecting to hear from Hunter, which you normally would. Although, we may be from the same neck of the woods, as we say in the south, you obviously know that I am not Hunter. So with that said, Hunter can't be with us today. He recently had to undergo some minor maintenance procedures to his lower extremities. His recovery process has obviously been slower than I know that he hoped for. And although Hunter has many great attributes, patience is not one of them, as we all know. He knows one speed, which in our terms in the railroads is throttle 8, it's wide open. You combine that with the fact that he doesn't really take instructions well. He's not really accustomed to being told what to do, so he didn't exactly follow the doctor's orders with his recovery time. He jumped right back in the seat less than a week after his procedure. He's been very active since, especially last week, which frankly has impeded his recovery, and finally his doctor has put his foot down and said no work, no travel. He has insisted that he take some time to fully recover to get back to 100%. I've spoken to him several times. I actually spoke to him yesterday a couple of times. He obviously trusts me and our team to carry on, which is exactly what we're going to do. So it's business as usual at CP. We expect him to return soon. In fact, I told him we'd save him a boxcar or two for him to switch with his new and improved bionic legs when he gets back. I'd also like to say a few words about the news this morning, regarding our changes in the Board, including the appointment of Andy Reardon, as our new Chairman, who is in town. He was kind enough to take his time out of his schedule to join us here this AM, so welcome Andy. I know that I speak for the entire Board, when I say that we're extremely fortunate to have an individual, the caliber of Andy Reardon, become our new Chairman. Andy has been involved in the railroad industry for decades. In fact, Andy and Hunter date back to the mid-70s, when they both worked for the Frisco Railway, where they first started working together. They served together again for Illinois Central Railroad, a little later in their careers. And then, again, as Andy transitioned to CEO of TTX, Hunter was a Board member on TTX and had an opportunity to work again. Andy is a well-known and extremely respected professional across all the Class 1 railroads, who has greatly contributed to our industry over the years. I know for a fact Hunter has the utmost respect for Andy and appreciation, as do I, and there is no doubt in my mind that Andy is the right leader at this time for our Board. Rest assured, he will continue to help guide the new CP in the best interest of our shareholders. So welcome to the Chairman's position Andy. In addition, as we advised in the press release this morning, Gary Colter and Krystyna Hoeg have tendered their resignations over disagreements relating to corporate governance matters. That said, I can assure you that the Board of CP is united. We are focused on our job, which we take very seriously, servicing the best interest of our shareholders. So with that said, there is not anything more I can add on these matters. Let's move on with the financial results of another record-setting quarter for CP. As Mark will take you through shortly, CP produced an operating ratio of 60.9% in the second quarter. That is a 420 basis point improvement, second lowest in the company's history, which is a strong testament to this team's ability to adapt to a fast-changing business environment. Our reported earnings per share of $2.36, which on an adjusted basis equates to $2.45 per share, represents a 16% improvement. The team obviously responded to the changes in the business environment, which you can see reflect in these results. That said, as we head into the second half of the year, you'll see additional benefits from the actions we took in the second quarter, rightsizing our asset base as well as our ongoing focus to constantly align our resources lockstep with our business demand, be it people, be it locomotives, be it cars. This operating model is one that works in any environment. It allows us to adjust our assets, control costs as business demand reduces and be prepared with assets in a lower cost base to leverage the bounce back rapidly when that increases. So I'm going to give you a little color on some of the performance, which we're extremely proud of, in what was clearly a challenging environment from a volume and a topline perspective. With volumes at about 6% this quarter, I am proud that this operating team were able to adapt and respond to these conditions by controlling what we can, sweating our assets and executing this operating plan. The team was quick to make changes in our daily operating plan, changing our train design to match the business, and then more importantly executing it to mitigate the volume weakness and reduce our train miles by 7%. So despite this volume weakness across the bulk and the crude portfolio, which by nature has a greater proportion of unit trains, our train length was still up 3% year-over-year. Now, Hunter told us, advised the team as well as advised the market, at the beginning of the year that 2015 was going to be year of the terminals at the CP, and I'm particularly proud of our performance to date in this area. We vastly improved our terminal productivity and throughput, helping to lower our cost structure; reduce our CapEx needs with greater asset utilization. We've improved our product offering at the same place in the marketplace; we've reduced dwell; we've reduced assets and costs, while driving productivity; level improvements in all 10 of our major terminals in the network, in spite of this business softness. This is an area, myself, I truly enjoy rolling my sleeves up and digging into. I can tell you I firmly believe to run a high-performance operation, you have to create and maintain a constructive tension of operating accountability within the culture, which requires as a leader to be validated. So I'm personally spending time in our yards across the network. In fact, I recently took a validation trip in one of our major yards in Canada a few weeks ago, arriving unannounced about 2 o'clock in the morning with my rental car and my handset, my radio in hand, monitoring the activity in the yard. Needless to say, after I watched the team work for about an hour, I went to the tower and spent the next 16 hours in the operation. I was able to identify quite a few productivity improvements that they are converting now, which is saving us thousands of dollars a day, while improving our service offering to our customers. This isn't to say that things weren't going right there. They've done a lot of good things right, but it obviously says that the work is never done. As much as we've done at this company and as many opportunities as we've converted, there are still many more left to do from a process standpoint as well as a culture standpoint and leadership development standpoint. That's one terminal. We've got over 30 in the network. So there is more work to follow there. Another excited step improvement we started implementing this quarter is the use of remote control locomotives in our switching operations, which allows the conductor from the ground to operate the locomotive and switch the cars, rather than the traditional method of relying on the locomotive engineer in the cab of the locomotive, plus the conductors and the switch persons on the ground to do the work. So we've got a reduced headcount demand for engineers with step improvements to matching safety and productivity in the switching operation itself. This initiative will be completed by the end of the third quarter, which will result in a minimum annualized direct labor expense of $12 million, plus additional benefits that are harder to put in absolute number to, with increase in safety performance as well as productivity performance. Another area of impressive performance where we led the industry improvement is velocity and network speed. As you may recall, back when we rolled out our multiyear plan last year, speed and velocity is a key theme in this plan, calling for a 20% improvement over the four-year plan in network speed. So far this year we've already achieved that goal and we're accelerating the operating performance. We've been able to take out, as a result, over 20% of our locomotive fleet and made about a 6% headcount reduction with more opportunities ahead. And we're gaining momentum in the third quarter as we speak. So while we may have hit some unexpected business demands, macroeconomic headwinds in the short term of our multiyear plan, we're much further along from an operating point of view, which creates powerful leverage when the business demand comes back, growing at a low incremental cost. I'm going to turn it over to Tim, to provide some color on the revenue front.

[Timothy Marsh:]

Good morning. Thank you, Keith. This quarter CP reported a year-over-year revenue decline of 2%, broken down as follows. The volumes, as measured by the RTMs, were down 6%. Our price was up roughly 3%. We also received a 1% lift from other freight, offset slightly by the impact of the negative mix. Our fuel and our foreign exchange or our FX impacts were essentially a wash. Couple items I need to bring up that are relative to our original expectations were the weakness in the U.S. grains and energy-related volume. The U.S. grain saw volumes, as the U.S. farmers elected to sit on their crop, given the strength of the U.S. dollar to global supply and the lower commodity prices. This is largely considered a timing issue. And as we look to the second half of the year, we expect these volumes to right size. The numbers are already starting to move in the right directions, as our sightings of trains have doubled since the lows of May. And our dedicated train services have been ramping up significantly in the recent weeks. Our lower commodity prices and tight spreads hindered the energy-related commodity, like the crude, the frac sand and the steel. With additional pipeline coming online over the quarter, movements of the heavy crude were particularly challenged. As we look to the second half of the year, the recent widening of the crude spreads has us cautiously optimistic that things may improve. The key is the sustainability of these spreads. We're currently modeling the 10% to 15% reduction in our energy-related commodities for the year. Our domestic intermodal had some puts and takes this quarter, with the carloads down 4%, but the RTMs up 2%. This is largely a reflection of our lower expressway traffic short-haul and our longer long-haul Canadian traffic. It's also fair to say that we did see some regional softness as a result of the slowing economic conditions as well as a tough compare for 2014 in the domestic business. I'd like to point out that the year-over-year decline in cents per RTM is largely a reflection of the lower fuel surcharge revenues. And with all that said, we are positioned for a stronger second half in the intermodal space. RTM's up 7% in June. July is tagging along pretty good. And we do believe that we're off to a good start for half two of 2015. So to sum it up, there is still a lot of uncertainty in the marketplace today, and we thought that it's prudent to revise our revenue guidance to reflect that. Based on the trends we see today, we're assuming negative volumes for the remainder of the year, while we expect pricing to remain strong and disciplined. With that, I'd like to hand it over to Mark. Mark?

[Mark Erceg:]

Thanks, Tim, and good morning, everybody. I'm very excited to be here with all of you for my first Canadian Pacific earnings call. During my first 60 days, I've done everything I can to learn about railroading from the ground up, which includes visiting a number of yards and terminals across our network. And as part of those visits, I've had the good fortune to meet with and interact with many of the dedicated men and women who under Hunter and Keith's strong leadership are transforming Canadian Pacific into a world class railroad. I've also had the opportunity to ride along in the cab of a locomotive, and just for the record, it really is as fun as it looks. So I count myself lucky to be receiving the best railroad education from the industry's best railroaders, and I look forward to working with all of you in the years ahead. Turning to the matters at hand, and since Tim has already provided plenty of color on the revenues, I'll jump straight to the bottomline. CP's second quarter adjusted earnings per share was $2.45, up $0.16 versus years ago. Reconciling back to our reported earnings per share of $2.36, we adjusted for two items. First, we excluded a $10 million non-cash gain of $0.05 per share related to FX translation on our long term debt. As you know we're excluding from adjusted earnings per share the non-cash revaluation of U.S. dollar denominated debt on the balance sheet resulting from changes in the CAD-U.S. dollar FX rate. That said, our adjusted earnings per share continues to reflect the CAD equivalent debt service cost for the U.S. dollar denominated debt, which we do have outstanding. Second, we excluded a $23 million one-time non-cash discrete tax charge of $0.14 per share due to the reevaluation of the company's deferred taxes, which resulted from a change in Alberta's corporate tax rate this quarter. Importantly, in spite of the change in Alberta's provincial corporate tax rate going forward, we are leaving our 2015 effective tax rate guidance unchanged at 27.5%. Operationally, Keith already mentioned that this was a strong quarter with significant improvements in network speed, terminal dwell and locomotive productivity culminating in an OR of 60.9%, an improvement of 420 basis points and the second lowest OR in the company's history. Against, this backdrop, there are a couple of items I'd like to provide some additional details on. First, comp and benefits was down about 10% this quarter, with lower stock-based compensation and the efficiencies generated from headcount reductions, more than offsetting higher pension expense, wage inflation and FX headwinds. Nonetheless, for modeling purposes, we expect comp and benefits to trend higher in the second half, reflecting the payout of long-term incentive targets that were established back in 2012. Second, we experienced an uptake in equipment rents in large part due to FX, but this line item was also impacted by the return of some locomotives we had previously leased to another railroad. Finally, purchased services were also up in the quarter with efficiencies from in-sourcing activities outweighed by FX, higher legal and facility costs, as well as a tough comp period on causality items. Moving on to cash flow, we've generated $485 million of free cash flow through June 30, which is slightly down versus last year. However, the year-over-year comparison is distorted by the $236 million cash we received from the DM&E West sale in 2014. Putting that item aside, along with the $60 million of asset sales we've generated so far this year, cash flow was up sharply behind higher pre-tax earnings and favorable working capital balances. And while we're on the topic of asset sales, I should mention that we have received STB approval on the D&H transaction. So you can expect to see an estimated $215 million of proceeds from that divestiture flow through during the second half of the year. From a capital standpoint, we've invested $618 million in capital projects year-to-date. Despite the pressure from the higher currency, we remain on track to spend the $1.5 billion we guided to at the beginning of the year. The last thing I would like to comment on today is our capital structure. As many of you are aware, we amended the debt covenant on a privately held secured note earlier in the quarter that had a 60% debt-to-capitalization covenant. This covenant was out of step with the debt covenants in place for CP's other secured notes. So we amended this particular note of 65% in order to align it with the debt-to-capitalization covenant on our other secured notes. As a result, we now have approximately $250 million of U.S. denominated secured notes with a 65% debt-to-capitalization restriction. At the end of the second quarter, our debt-to-capitalization level was only 56%. So while we've still got plenty of room on these covenants, we also have the option to take them out at a future date, if we determine it's advantageous to do so. Now, admittedly, these amendment negotiations delay the start up of our share buyback program, but due in large part to the execution of several private share repurchase agreements, we were able to complete one-third of our existing NCIB program during the quarter, buying back just over 3 million shares at an average price of $193.10 per share. That means we have approximately 6 million shares remaining under our existing share repurchase authorization and at our current trading price, we are very comfortable being aggressive buyers of our shares. So to wrap things up at my end, I'm extremely excited to be here. Over the summer, I plan to focus my attention internally, learning as much about the railroad as possible and strengthening my team, but I'll be looking forward to meeting all of you later this fall. So with that, I'll turn the call back over to Keith.

[Keith Creel:]

Thanks Mark. So in closing to wrap things up here, I can tell you before we open to questions, in face of market uncertain, which we spoke to, we thought that obviously it was prudent to revise our guidance for the year. So if you look forward to the balance of '15, revenue growth 2% to 3% for the year, which was previously to 7% to 8% rate. We still anticipate having an operating ratio below 62%. Adjusted EPS of $10 to $10.40, which still equates to earnings growth of roughly about 20%, and arguably still the best earnings story in the sector. Now, some of you are going to think low wind on the conservative side on $10, so we wanted to put a wide range out there to be responsible. We obviously do not expect and we're not shooting for that lower number. We're striving for the higher number, but we are not accustomed to adjusting, revising our earnings and we don't intend to do it again. So that's the reason we put the range in the market. And finally, before I open it up to questions, as I'm sure most of you saw our announcement in early July, unfortunately Steve Tobias had to resign from the Board for personal reasons. Steve has made an invaluable contribution to this Board since he joined in 2012. He is not only a great railroader and a leader, but more importantly, a great friend to myself, to Hunter and to the Board. I know that you'll all join me in wishing him well. Rest assured, this Board is committed to Steve. There will always be an open chair at the boardroom table for Steve should he wish to return in the future. So with that said, I'll open it up for questions.

[Operator:]

[Operator Instructions] And your first question comes from the line of Bill Greene from Morgan Stanley.

[Bill Greene:]

Keith, I wanted to ask you about the OR. So obviously, in spite of the revenue challenges, very impressive improvement, and of course, I'm sure you saw the competition's number in the mid-50s. So as we see kind of the macro change, the cost story still looks pretty powerful, but if we go back to a world where we're getting growth, are we setting new normals for OR now or are we going to have to sort of anticipate that the OR will move higher with revenue over time? How do you think about kind of how this could play out over a longer period time?

[Keith Creel:]

I think the way it plays out, Bill, is dependent upon the market. So in an upside market when the economy comes back, we obviously can leverage and lower the operating ratio by growing the topline. But I think this performance shows you that even in a downside market, we still can produce -- I'll will give you for instance, the $10 million multiyear plan, let's just say nothing changes, it's not billing at the end of 2018. We don't have proved growth, which we had anticipated that plan. Taking that into account, we're still going to get a tailwind from currency. We're still going to get a tailwind from fuel surcharge. That's 2 to 3 points, if you do the math, so what would've been a 60% arguably could be a 57%. So I think it works either way. This model works on the upside, it works well on the downside. It's one for the long-term, Bill.

[Operator:]

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

[Scott Group:]

So just to kind of follow-up on the operating ratio question, so obviously, we saw really good numbers from CN and the prior two quarters you guys had kind of best-in-class numbers. Why do you think they were able to see a bigger improvement this quarter relative to you? And do you think that there is a timing issue here where maybe some of the cost reductions can be incrementally coming for you guys?

[Keith Creel:]

Well, I'm not going to speak to CN's results, but I'll tell you at CP we did not have any tailwind from fuel, and obviously, we did not have a lot of tailwind from crop adjustments on the management side. So I'm not sure, but those two could explain the difference.

[Scott Group:]

I guess, I was thinking, Keith, not asking you to explain CN's results, but do you feel like you've got all of the cost reductions that you wanted to get in the quarter or is that more to come?

[Keith Creel:]

I would say no. I would say, in all honesty, we anticipated a stronger demand environment the first month of the quarter. Two or three weeks into it Teck made their announcement. We obviously are very hands-on guys, we get involved, and we started taking immediate action. So there's a little bit of lag there. And then several of the things that we have done, the initiatives that we have enacted are going to pay dividends in the third and fourth quarter, so there's more to come from those for sure. We definitely left some money on the table, if I'm being completely honest with myself about it.

[Scott Group:]

Just a follow-up and last point here. I think you guys have talked in the past of bringing the headcount down to around 14,000 by the end of the year. Does this change now given the weaker volume environment? Can that get materially lower than that?

[Keith Creel:]

It absolutely does. Right now, second quarter, if I think year-over-year we're down 700. Again, back to the point of some of the initiatives we've implemented they are going to payoff in the third quarter and the fourth quarter. Additional reductions are going to take us down another 200 to 300 people in lockstep with the demand. So we're going to continue to pace demand. If business goes down and demand reduces, then obviously headcount is going to go down in lockstep with it and labor expense is going to reduce.

[Operator:]

Your next question comes from the line of Fadi Chamoun from BMO Capital Markets.

[Fadi Chamoun:]

Keith, one big part of your long-term goals was pretty dependent on securing topline growth. Now, we're pretty assured that you're doing pretty good job on the cost side. But for you to get the topline growing, do you feel like you have to change or improve the connectivity of the network with the U.S. carriers or make big step function improvement in terms of your first mile-last mile operation in order to get the ball rolling on the topline side?

[Keith Creel:]

Network-wise, I think standalone the way we are, we're strong. Fadi, I think there's things that we can do that we're acting on now to work closely with our short-line customers to extend the reach of the network, to create some additional topline opportunities. This lower cost basis allows us to leverage to be able to do that. Hunter has spoken to this point before about dynamic pricing, and dynamic pricing is effectively yield management. So we've got our base cost structure on trains that are running today. Every incremental car that we add, we can add it at a much lower freight rate, so to speak, and still be positive on the combined contribution of the income with the train. So those are initiatives that we're rolling out. We're in the process of doing it. I think it's going to continue to allow us to exceed and grow this company topline. I mean, in the face of what we've done, if you take out energy and you take out U.S. grain, right now, and look at our numbers in the face of a negative GDP, we still have positive growth. That tells me the story is working. And if the business comes back with the leverage that we're creating with a lower operating cost structure and improved service, you're going to see pretty powerful leverage at the bottom line.

[Fadi Chamoun:]

If we drill in a little bit on the intermodal, whether it's domestic or international; but maybe a little bit more on the domestic side. I know the economy is a little bit weaker now, so the volume aren't what they could be. But you've been going to market with these new product and new service improvement and all this for a while, do you feel that you've got more to do on that last mile servicing side or you think you've got the product that you need to grow this and grow sort of share from highway over the next two to three years?

[Keith Creel:]

The product is definitely there. We still have work to do, converting market share and competing. But again, in a negative GDP, if I look at domestic intermodal in Canada, negative GDP for two quarters, and we've got positive growth. That says that this story is working pretty powerfully in the face of some pretty stiff competition, be it truck, be it our competitor. So I think there's more work to do for Tim and the team to convert the product. If the product is solid, I'll stand it up against the truck, I'll stand it up against my competitor any day.

[Operator:]

The next question comes from the line of Tom Wadewitz from UBS.

[Tom Wadewitz:]

So, Keith, I know you touched on this at the beginning of the call, but I was just wondering if you had any additional color. The Board changes that you mentioned, can you give us a little more insight on maybe what the issue was and to the extent that you feel like that's behind you? And also, I guess, in terms of kind of Hunter and how quickly you might expect him to be back at work and just a little more, I guess, on his situation.

[Keith Creel:]

If I can, I'll touch on the Hunter comment. And given that Mr. Reardon is here, I think it's appropriate that he address the Board question. I can tell you this, Hunter will not be gone any longer than he has to be. My concern and my influence on him as much as I can is that he's gone as long as he needs to be. Just last week, Thursday, I think, I was on the phone with him for six hours with half the team. He's roaring like a lion. His will and his drive and his tenacity has not been tampered a bit. But his body, obviously, has got to heal from the procedure that he went through. So contrary to his belief, he's not Superman, he's a railroad guy, so to speak, but he's not bulletproof. And I'm extremely pleased for the benefit of this company long-term and this team, and for our shareholders and our customers, that he's actually taking the time now and listening to the doctor to fully recover. So my call is it's short-term, it's not long-term. So with that said, I'll turn it over to Andy to address the Board questions.

[Andrew Reardon:]

With respect to those Board questions, let me answer your last question first. Specifically, yes, it is definitely behind us. And to your first question, we've got a very engaged and a very passionate kind of a Board. I cannot speak to the details of the issues, but I can assure you that our Board remains united and committed to serving in the best interest of our shareholders.

[Tom Wadewitz:]

So you feel confident though that whatever the points of disputes were are behind you, the Board is -- you wouldn't expect further Board changes, things are stable and you're kind of focused on things and go forward?

[Andrew Reardon:]

Absolutely. Correct on all three statements, yes.

[Keith Creel:]

Fully confident.

[Operator:]

The next question comes from the line of Walter Spracklin from RBC.

[Walter Spracklin:]

I guess, if I were to look at your volume growth underpinning the revenue side, I see that you're in the 2% to 3% for revenue, but if you're getting about 4% pricing, there's obviously foreign exchange in there. What kind of volume growth underpins that new revenue guidance for 2015?

[Keith Creel:]

I guess, let me point out, pretty strong comparable last year, because we had a grain season that didn't end, we didn't take a normal shutdown in automotives. So we had a lot of movement through all 12 months last year recovering from that winter. So if I look at that comparable, it's about a 3% to 4% area of magnitude on the downside from a volume standpoint, Walter.

[Walter Spracklin:]

And then longer-term, stepping back, I know in your Investor Day you had indicated some growth rates for four years of 14% merchandise, 12% intermodal, 5% bulk. If you're to take a stab at under the new environment and perhaps throwing foreign exchange in there, how might that look? And specifically, with the lower fuel price, does truck become more competitive and therefore is the intermodal 12% growth still achievable, given a more competitive cost structure on truck?

[Keith Creel:]

Let me speak to what I feel confident about, some of that I would be guessing as far as taking a stab and changing it. But specific to the intermodal, that growth rate absolutely is achievable, even in the face of competition from truck or competition from a competitor. Our costs are down, our service is improving. Our domestic side in the face of these headwinds still grows, which is a positive trend, that with a little bit of tailwind and help from the economy is just going to increase, and accelerating on the international side, given that we have an adjusted cost basis. We're competing head-to-head with our competitor for those contracts, as they come back for renewal. So even in a world where energy is a little bit less, again in that growth story, with the help assuming that energy is down, FX is going to be at similar levels as today; you're going to have lower cost on fuel. I still think it's a very positive story.

[Walter Spracklin:]

And please send my best wishes to Hunter for a speedy recovery as well.

[Keith Creel:]

Will do it. Thanks, Walt.

[Operator:]

The next question comes from the line of Allison Landry from Credit Suisse.

[Allison Landry:]

First, I guess how do we think about the longer-term targets that you laid out last October within the context of basically a dramatically different operating environment? In other words, if we're going to see the topline grow at a slower pace than the double-digit revenue CAGR, can you still double earnings by 2018 with the better cost performance that you were talking about?

[Keith Creel:]

Absolutely, and that's nearer that I talked about earlier; just say it's an ongoing dollar revenue story. You get some tailwind from currency and fuel surcharge on your operating ratio, you do the math and that puts you -- the new normal, so to speak, isn't 60, its 56, 57. You put our buyback with that and you still double the EPS by 2018. So it's definitely a very doable story.

[Allison Landry:]

And then I just had a clarification question on the pricing. I think that you mentioned it was 3% during the quarter, was that inclusive of mix? I'm just trying to compare to the 4% that you talked about in the first quarter.

[Keith Creel:]

The 3% was more renewals. Yes, absolutely. And we see a little more strength in that in the second half than we did in the first half for the balance of the year.

[Allison Landry:]

So thinking about sort of on apples-to-apples basis on a core pricing number relative to what you talked about in Q1, is it roughly similar?

[Keith Creel:]

That's similar. 3% to 4%, it's in that range.

[Operator:]

The next question comes from the line of Chris Wetherbee from Citi.

[Chris Wetherbee:]

When you think about the outlook for the rest of the year, I mean, what do you see as sort of the biggest potential variables? And with spreads widening out, is it crude by rail, I mean is that an area where you could be potentially surprised to the upside? I just want to get a rough sense sort of what within the commodity mix is, what are the key areas that we need to be focused on in terms of variance around that sort of $10 to $10.40 range you've laid out?

[Keith Creel:]

Well, I can tell you this, when it comes to crude, we're extremely cautious. We've have seen some movement in August nominations for increased crude movement, which is encouraging. But at the same time, I'm not going to assume that for September, October, November and December. So should that happen that'd be a nice challenge to have. We certainly have assets parked in idle, waiting for that business to come. We can move it. That's not an issue. I think you're going to see pick up in U.S. grain, obviously, back to more normalized shipping opportunities. The Canadian grain side, right now all the final numbers are not in yet on the harvest, but we're expecting an average, maybe a little bit on the low side of an average, a five-year average as far as the harvest. Depending upon how the weather does, there may be upside even in that number, given that there may be some demand to move corn product, which we serve well in our northern part of our U.S. operation up to the Alberta and Saskatchewan markets for feedlots. So there are some things out there that could turn favorable for us. We're just trying to take conservative approach, and again that's why we made the range as wide as we did it. We just simply don't want to come back and change any numbers again.

[Chris Wetherbee:]

And then just a follow-up on the buyback. When you're thinking about sort of -- there's a little bit of a pause, obviously, understandably so in the second quarter when you think about sort of the outlook. I mean, how do you think about sort of completing that up? I know you said by yearend, I mean, any opportunity to kind of take advantage where the shares are right now and sort of get this done sort of shorter-term? Just kind of give your thoughts around that.

[Mark Erceg:]

What I would say there is, look, one of the most important job we have is to deploy our capital in an efficient way, and at these share levels we're very comfortable doing that. We did had to take a slight pause. We did acquire 3 million shares during the quarter. We do have some private purchase agreements ready to go in the Q. And right after we get out of the blackout period, we'll execute against those, and then we will be active buyers at these levels. And that's why we're comfortable saying that we can complete the share repurchase program ahead of schedule.

[Operator:]

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

[Cameron Doerksen:]

Just this one question for me. I'm just wondering if you can talk about the practical implications of the change in the SEC reporting requirements. I'm wondering if this maybe portends a potential switch to reporting in U.S. dollars?

[Mark Erceg:]

What I can tell you is that, we've been contemplating this change for a period of time. The biggest difference is that instead of a Canadian 40-F, you would file a 10-K. Instead of doing a Canadian 6-K, you'd start doing 10-Qs. You'd have to do SBRL reporting on a quarterly basis versus annually. None of those are things that we think are going to give us any great pause or difficulty. Because of our revenue base being split as it is between U.S. dollars and Canadian dollars, there is an opportunity for us to potentially continue to report in CAD. And we're working through the SEC's process right now, as it relates to that. But in either event, we'll continue to provide accurate and timely financials going forward.

[Keith Creel:]

More to come on our ability to seek and obtain SEC's approval to report in Canadian currency. That's our desire. We just got to make sure they approve it.

[Operator:]

Your next question comes from the line of Matt Troy from Nomura.

[Matt Troy:]

Keith, to your earlier question, I just wanted some clarification. You talked about the technology, the remote control for switching and savings of about $12 million per year. I'm just wondering if you could maybe clarify what exactly that is. We know we had belt pack 10, 15 years ago and that was a big deal. Is this residual execution what prior management didn't do or what was the catalyst or what makes this possible now as opposed to previously?

[Keith Creel:]

Hit the nail on the head. It's an opportunity to converting, which previous management did not take an opportunity to convert.

[Matt Troy:]

And my follow-up would be, simply, I just want to clarify, in comp and benefits expense it look like stock-based comp was on a year-over-year basis favorable to the tune of I think $44 million. But in the comments it was offered that comp and benefits would trend higher in second half due to longer-term targets. I just wanted to get some clarification around that, if I could. Are you talking about higher sequentially versus 2Q or higher year-over-year in the back half versus year ago? I just want to make sure we're all thinking about that piece correctly.

[Mark Erceg:]

Your numbers are generally right. Stock-based comp in the quarter, we just printed, I was showing it was a $46 million benefit. As we sit here today and we look forward, there's really two pieces to the compensation element. One just relates to the stock price itself. And for every dollar increase in CP's trading value, there's about $1 million more stock comp. And I can't be predictive of what will happen with respect to that. But that aside, there are some performance share agreements that are in place going back to 2012. And based on where we think those are trending, we believe that there will probably be higher comp in the second half in the $20 million to $25 million range. [multiple speakers].

[Operator:]

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

[Brandon Oglenski:]

And I apologize in advance, because we've been having some telephone problems here. But Tim or Keith, I just wanted to come back to the growth outlook in the back half, because I think, Tim, in your prepared remarks you talked about things, if I understood it correctly, getting sequentially better, which is pretty normal I think for seasonality. But from a comp perspective, it does get more challenging, I believe, from an RTM basis. So are you calling for some sequential acceleration in some of your bulk markets, where we can get RTMs close to flat or are we still going to be looking at negative comps across the network?

[Timothy Marsh:]

Well, at this point in time, we believe that we're going to be coming in -- we look at the three different lines of business, and the challenge is on the bulk side. We hope to come in flat by the end of the year. On the international and the domestic intermodal, we do hope to come in just a little bit above our plan. And as far as -- probably not to come in above our plan, but to come in on our plan. And then as far as our merchandising side, we are still going to be challenged with different commodities. With the commodities not knowing the certainties of that market, we really can't give you any definitive answer at this point in time.

[Keith Creel:]

Look, we have line of sight to, we think from a volume standpoint, probably about sequentially year-over-year compared to second half this year to second half last year, which were very strong comps. It's about 3% to 4% less.

[Brandon Oglenski:]

And then, Mark, thank you for the compensation discussion, and I think when you said that $25 million that would be thinking sequentially from where we were in 2Q, right, in the answer to the last question?

[Mark Erceg:]

Yes.

[Brandon Oglenski:]

And on the purchase services side, I know last quarter there were a lot of moving pieces, but we jumped up to roughly $275 million this quarter. How do we think about that going forward, purchase, services and other?

[Mark Erceg:]

I would expect to see that trend a little bit lower into Q3, but it is an area that there is some volatile items contained within. So it's hard to be completely predictive. But I would expect to see that come down just a little bit in Q3.

[Operator:]

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

[Benoit Poirier:]

My first question is related to domestic intermodal. I was just wondering, so far in the quarter your carload trending kind of down 4%. So at this propensity versus international, is it more a matter of the western economy or is there any implication on the market share side? And I am just wondering, if there will be any change in the strategy, given the new management change in intermodal?

[Keith Creel:]

Yes. It's actually a mix issue, Benoit. So when you see from a volume standpoint on a carload basis, the business that's down is actually the stuff that's a little more suspect to the economy, which is our Expressway service between Montreal and Toronto. So carloads are down, but RTMs are not very significant. What's up for us, which is a trend that we feel very good about, is converting the long-haul service domestic. For instance, east to west, which is driving RTM growth. So it's a mix issue trying to understand that. As far as strategy, the strategy is not going to change with the leadership changes. Jacqueline has taken over the group. She is obviously a very well-equipped seasoned railroader. She certainly understands our network. She has been hit the ground running. She is out with Tim. She is meeting with our key customers. She'll drive the level of accountability in that team from a revenue standpoint similar to what we drive on the operating side. I feel very confident about that, and she'll convert this product. So I've got a tremendous amount of faith and support and very strong optimism that this is going to be a growth story that's going to exceed your expectations on the intermodal side. And also some additional additions you don't see at a more senior level, Tim has brought some of his knowledge to the table as far as talent. He's recruited some external candidates that are being very accretive to us on the international side that certainly understand the markets and understand the opportunities.

[Benoit Poirier:]

And my second question, if we look at automotive, you are down 17% on a carload basis quarter-to-date. But if I am right, you are overlapping the tough compare with Chrysler. So any color on the automotive side what we should expect in the near future?

[Keith Creel:]

Actually that's a little bit misleading. Let me just for the record, that contract ended end of July. There was a transition time, if I step back to last summer, we had a transition time with CN, who took that Chrysler contract or the lion's share of the Chrysler contract, which delayed and allowed us an opportunity to still move some of their traffic in August and a little bit in September. So to get a true, clean compare you're really going to have to get to a September number. If you back out, the noise from the Chrysler business were actually up to, so it's a positive trend as well.

[Benoit Poirier:]

And just on the coal side, you are up 15% in the quarter, so very good performance on the quarter side, but what should we expect given Teck's announcement of production slowdown in Q3? And any color on the expectation for Q4 for coal?

[Keith Creel:]

The growth that we have enjoyed has actually been on the U.S. side, which was not a huge piece of the overall portfolio in coal. But specific to Teck, we're expecting flattish volumes. So they are taking rotating shutdowns. They are doing maintenance, but at the same time, if I look at last year's numbers, the run rate and what we expect is around that 25 million metric tons. The positive story to that, the opportunity that we're converting both for Teck and for ourselves is reducing our cost base. So the contribution on the business is going to improve, has improved, and we're running that business now with 17 coal sets. The story before us, go back to 28 or 29, fewer locomotives, fewer people. The cycle time booked for Teck at the mines as well as at the port and on the railway are hitting record numbers. I'm talking numbers below the 100-hour cycles. A year ago there were probably 110, 115. Now we're down in the 90s. So another very compelling story that allows you to take this operating model, and while the revenue growth might not be there, you can certainly control the bottomline and still add contribution in operating income.

[Operator:]

Your next question comes from the line of David Vernon from Bernstein.

[David Vernon:]

Just as a first question on pricing, I think you guys mentioned that price mix was plus 4% on an RTM basis. Can you talk a little bit about how much of that was core pricing versus mix?

[Keith Creel:]

Sure, absolutely. About 2.93% was core. The balance was mix.

[David Vernon:]

And is anything changing on the core pricing side right now as far as kind of getting better, getting worse as you guys feel the market right now?

[Keith Creel:]

We actually see a little bit of uptick the second half versus first half.

[David Vernon:]

And then maybe just on the operation side, Keith, can you talk about how much of a role, if any, the lower volume played into terminal productivity and velocity improvements, and whether there's any risk that when volume growth returns you might have to give back some of that productivity gain?

[Keith Creel:]

Absolutely not. We're not going to give it back. The role that it plays is it motivates you to make sure you got people doing the right thing and managing all the costs, controlling their costs. It obviously motivated me to go to Winnipeg to take a look at what was going on and uncovered quite a few opportunities. Saw a lot of things that were going right, but a lot of things were still missing. I remind folks, Rome wasn't built in a day. We're not going to change this culture in three years. We've converted a tremendous amount, but at the same time this is a big network. So as we convert through leadership, as we teach consequence leadership, as we create this culture of accountability in our terminals, and in on our leads, and with our employees, in the finance shop and across the board, so to speak, and even in Tim's shop with revenue and accountability with our commission sales program, you're going to continue to drive additional opportunities. So from a productivity standpoint, there's still mountains of accomplishments left to achieve in this company.

[Operator:]

Your next question comes from the line of Ken Hoexter from Bank of America Merrill Lynch.

[Ken Hoexter:]

Keith, can you talk a little bit more, you mentioned briefly the dynamic pricing. Can you kind of walk through how that's been rolled out? Are you leaving -- do you find yourself leaving some more on the table given some other rates are being taken up maybe a bit more aggressively? And how you're winning business with that dynamic pricing trend?

[Keith Creel:]

The dynamic pricing trend, it's starting to gain a little momentum for us. So I'll talk in very simple terms about the way it works. So this isn't about going out and setting our price. This is about understanding where we have capacity based on existing trains, on a train-by-train basis, on a lane-by-lane basis and going to some existing customers. If they want to increase the share that they give us, then they'll recognize on a sliding scale a little bit of a rate reduction, but overall the contribution per car the bottomline is going to be positively impacted by it. And it's also locking on the customers that we don't enjoy their freight today, knocking on doors, converting truck through a lower cost and it's about controlling it. This isn't a long-term strategy. It's actually reacting to the demand market that we are into, so I'm talking specifically to about a salesperson going and knocking on somebody's door and say, listen, in exchange for a commitment to move your freight over the next 30 days this is what your rate is going to be. And we're going to add you to existing service, we're going to review this on a weekly basis, we're not going to allow it to add train starts. We're going to allow it and use it to grow the number of cars that are on our existing trains. So it goes almost straight to the bottomline, it's very, very powerful operating leverage.

[Ken Hoexter:]

If I can just do a follow-up with my second question. You talked a bit about the Board changes before. I just want a little clarification because you mentioned to start that the resignations were specifically because of corporate governance issues. And you obviously had one member of management that was old CP and one that was post the proxy battle. Just wondering if you can be maybe a bit more explicit, given that you did state they were Corporate Governance issues. Is that something we should be concerned with on the financial side, on the management side? Anything you can kind of extrapolate on that.

[Andrew Reardon:]

Andy Reardon, I will be happy to answer that question. No, it was purely a matter of Board governance. And the issues as I noted a few moments ago are clearly behind us. And Board governance is a very serious matter that this Board embraces and will continue to embrace, but no, there are no further changes contemplated, nor expected, and we are anxious to move on into the future.

[Keith Creel:]

If I could add a little color to that with this perspective, Andy was the Chair of the Finance Committee. He's now the Chair of the Board, so that should give you some assurance that there's no issues of concern in that area.

[Operator:]

The next question comes from the line of Turan Quettawala from Scotiabank.

[Turan Quettawala:]

Keith, just on the guidance side I hear what you said about not wanting to cut your guidance more than once in the year and also about what you said on the cost side and the catch up I guess on the cost side. I guess, my question is 2% to 3% topline growth that comes in weaker. Is it safe to assume now that there's enough flexibility on the cost side that the EPS numbers aren't going to change too much?

[Keith Creel:]

Absolutely.

[Turan Quettawala:]

And I guess my second question on the marketing side. You talked about competing with CN, I believe, on some market share on the domestic intermodal side on some contracts. Are you willing to share some maybe be with us what the hit rate might be for you?

[Keith Creel:]

The comments on competition with our competitor is more related to international intermodal. It's not the domestic. Obviously, there's a competitive market out there on the domestic side as well, but you can tell by RTMs that we're fit in well in that competition.

[Operator:]

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

[Steve Hansen:]

Just a single one from me as it relates to the crude and I guess more specifically the crude mix. Just trying to get a sense for where you might be seeing some of those cautious signs of optimism in which lanes, whether it'd be to the Gulf, et cetera, and how you sort of the distance evolving here over the next 12 months or so?

[Keith Creel:]

No visibility to the distance. I'm a little bit apprehensive about looking beyond August, but the strength that we are seeing, some of the signs of hope are actually on the heavy side, more Gulf destinations.

[Steve Hansen:]

And are you seeing weakness, conversely, in any of the Bakken or the Dakota originations?

[Keith Creel:]

We're partnering with very good players there, low cost producers. We are seeing sustained demand there, so we are not seeing any weakness.

[Operator:]

The next question comes from the line of Brian Ossenbeck from JPMorgan.

[Brian Ossenbeck:]

So just to follow-up on crude-by-rail, it seems like there's a bit of a shift maybe in the market structure in the Western Canada region. You had a high-profile rail terminal that changed hands basically at a sizable discount to what was originally constructed for. I heard some discussions of cutting transportation price in order to stimulate some demand. So I don't know if you can speak to that, if that's a source of any of the caution, or if it's just more on the spreads and waiting for those to stabilize and remain at healthy levels?

[Keith Creel:]

It's all tied to the spread. So if the spreads improve the appetite and need and the economics are there to move to heavy, so that's what we're seeing.

[Brian Ossenbeck:]

And then just a quick second one. Keith, last time we talked about the ECP brake mandate that actually went into effect shortly after we spoke on the last conference call. So I'm assuming your view has really changed on that, but is that something that that you feel CP and the industry really have to start prepare for implementing? And I guess, the two questions that come to mind is how much pressure would that put on the crude-by-rail spread if you start to have more equipment that is mandated to move it? And then is this something you need to basically equip the entire locomotive fleet to ensure interoperability or can you kind of segregate hive off your crude-by-rail by hazardous flammable trains into one section versus the other ones that don't need that sort of equipment, if it comes to pass?

[Keith Creel:]

Segregation and trying to isolate locomotives would be extremely disruptive to the network. It would be extremely disruptive to the industry, so that's not something that I would be encouraged about doing in any regard. We've got to have interoperability. We've got to have an ability to take a locomotive off a crude train and put it on a freight train, put it on an intermodal train, so I'm not going to create a dedicated set of locomotives for crude. With that said, the ECP initiative, although it was mandated, it is being debated now. It's currently, I don't want to speak out of context here, but there's some changes which differ that that are included in the bill that's being debated at Congress now on the U.S. side. So suffice it to say, that that side is not done yet. I happen to believe that cooler heads will prevail. Once people truly understand how disruptive it will be to this industry, how disruptive it will be to all freight movement, not just crude movement, I just don't think that that's going to be followed upon. We would much rather take the money, take the investment and spend it on safety enhancements that truly benefit the public, not something that's been created by some misinformation that allow that to get passed in the first place.

[Operator:]

Your next question comes from the line of Jeff Kauffman from Buckingham Research.

[Jeff Kauffman:]

I just wanted to get clarification on something you said earlier, and then I have an operating question for Keith. Did you say that mix was a positive 3 to the quarter or negative 3 to the quarter, when you were talking about price mix on an earlier question?

[Keith Creel:]

It was positive 1%.

[Jeff Kauffman:]

Keith, you have a lot of track projects coming on. In a slower volume environment, you said you were losing a little bit more unit train business than manifest. Can you talk about the next phase of getting to longer train lengths and heavier trains? I know the near-term environment is slowing that down a little bit, but what capital projects do you have going on and where do you think you can take train lengths, say, over a 12-month period and further out, say, over a two to three year period?

[Keith Creel:]

Look, it's obviously slowed us down a little bit, but over the two to three year period I don't see a lot of change, not quantum leaps, but certainly if I am running trains today at almost 7,000 feet on average aggregate, there's going to be 72, 73, deploying that we've had some of this reduced business. We're still spending money. So we've cut back some of the capital. We're not adding the capacity where we don't need it, but we are still driving our investment with that $1.5 billion number, adding the sidings, increasing track speeds, putting ballast down, that will create an ability to create additional operating leverage. In some other areas that still have yet to become that's going to bore additional opportunities. I will give you a for instance, right now we run export potash trains we've got two different models. So Canpotex is the customer. We're running 170 car models on the West Coast to their export facility. We're running a 130 car model to the U.S. West Coast via our connection with UP. If you can get those homogenized and increase that length and get one solid set there is definite ownership synergies for Canpotex. There is cycle turn synergies for both Canpotex as well as CP and UP, and that's an area that we are continuing to invest in. So in lockstep with our investments, UP is investing. They are currently under a capital expansion plan at the facility where it goes in Portland, Oregon. 2016. You will see, in spite of the headwinds of the business, you will see that get homogenized and you will see another stepped improvement that will be accretive and help us on improving train length, so that's just one of many several initiatives that we've got in the multiyear plans that are going to allow us to continue to increase it.

[Operator:]

Your next question comes from the line of Thomas Kim from Goldman Sachs.

[Thomas Kim:]

Management has done a fantastic job driving down OR, despite pretty modest volumes over the last few years. And as we look forward to 2016, I am wondering how comfortable are you with consensus revenue assumptions of sort of a rebound back to that 7%, 8% level. And then, to what extent do you actually need volumes to grow to see your OR improve further next year?

[Keith Creel:]

Well, I'll take the OR question and I will let Tim handle the revenue question. We can have various conservative growth on the demand side. And with the synergies we're creating on the operating side we can still improve the operating ratio. I feel very confident about that. There's still much more to be done. Even in a down environment, and let's just say, a similar environment to what we're facing today, you are going to see operating ratio improvement. Tim, do you want to address the revenue question?

[Timothy Marsh:]

Sure, on the revenue rebound, it's still too early to tell. All I can tell you is that we are doing 100% to go out and make sure we get everything that we can, but it's still just too early to tell if it's one time.

[Operator:]

Your next question comes from the line of Jason Seidl from Cowen and Company.

[Jason Seidl:]

Keith, I want to jump back on domestic intermodal. Obviously a little bit of pressure in the quarter. You mentioned that some of it was hard year-over-year comparisons, and I was just curious, do you feel you maybe lost a little bit back to the highway as trucking capacity has loosened up a bit?

[Keith Creel:]

Back to my point about domestic in the Montreal and Toronto market, we absolutely have. But overall, if I look at the base of the core network, the balance, I'd say no. We got to recognize and realize that last year year-over-year we grew about 15%, which was in addition to the 12% or 15% from the previous year, so we're looking at the last two years about 30% growth in domestic intermodal. So once you start comparing yourself to that, it's a little bit harder to make those kind of quantum leaps. But I'm extremely encouraged, again in the face of very uncertain economic times and in the face of a pullback in GDP in Canada, we're still growing from an RTM standpoint. So I think that's a very, very positive side that just says, assume the same, we're going to continue to compete. We're going to continue to win business. And if the economy comes back, it's pretty powerful leverage on the other side to take it straight to the bottomline.

[Jason Seidl:]

Just a quick clarification. You mentioned on the tax rate 27.5%. Is that for the year or for the back half of the year?

[Keith Creel:]

For the full year.

[Operator:]

Your next question comes from the line of David Tyerman from Canaccord Genuity.

[David Tyerman:]

I just wanted to ask about your comment, Keith, about expecting to maintain the EPS growth through 2018, even if volumes decline. So if volumes decline, obviously your topline is worse. As you point out the OR will come down, but that is mainly because, I imagine because of the fuel effect and that's supposed to be zero profit impact. So I am wondering wouldn't you have a lower profitability under a lower volume environment in that scenario?

[Keith Creel:]

Let me try to explain it this way. Our revenue story, in your model we talked about crude being a big piece of it, just say $1 billion of it by 2018, just discount that, take $1 billion out of it, so we've got effectively similar levels of crude that we move today. We're still going to grow on the merchandise side. We're still going to grow on the intermodal side. We're still going to convert the service, so instead of $10 billion it's $9 billion. Now, given the crude isn't there, I'm going to make the assumption that we are going to get the same help that we would today with FX as well as our fuel surcharge, that's 2 to 3 points, so if you do the model, a 60% operating ratio given those prevailing conditions in 2018 is not a 60% operating ratio, it's a 57%. It's a 56%, 57%, 58%. A range of numbers that are very low, that if you combine that with a $9 billion revenue base and our buyback program that we're executing you double the EPS.

[David Tyerman:]

It just seems to me that you would be losing something here. I understand the math you're talking about here, but it sounds like compared to the previous situation, that you are in a worse position if you lose $1 billion of revenue.

[Keith Creel:]

Not with currency. I'm not --

[David Tyerman:]

So the currency is the difference then it sounds like?

[Keith Creel:]

Well, the help from the currency. I mean, the difference is obviously our assumptions in revenue the topline is not going to be there. If it's at $9 billion, it's at $10 billion, crude doesn't exist, it's not the growth story we thought it was, with our operating performance and our leverage, we don't have it today and we're producing close to that 60% number. Do the math, I'm assuming, again that you've got the help from currency and fuel surcharge, a 60% to 57%.

[David Tyerman:]

I won't go further. Just the other question I had was on asset sales. Aside from the Delaware and Hudson, is there anything else that you expect in the second half on asset sales maybe related to the extra properties you have?

[Keith Creel:]

Nothing at this time.

[Operator:]

Your next question comes from the line of Steven Paget from FirstEnergy.

[Steven Paget:]

First question, Keith, given your comments to Fadi on revenues, are you starting to see comparable margins on the smaller and shorter hauls as you might see on bulk unit trains?

[Keith Creel:]

From a margin standpoint, I mean, it all depends on the line of business. On the merchandise side, we obviously have favorable margins compared to some of the bulk business, so it's a tough question to answer. I'd say in general, the margins are strong and they are even better on the merchandise, even if it's shorter haul. And effectively we still have the discipline when it comes to our pricing. Our cost base is lower. Our RCRs are improving with our costs coming down, so we still see margin improvement on the short haul as well as some of those longer hauls.

[Steven Paget:]

Second question, with terminal dwell down 22%, network speed up 21% what does this mean for improvements in car travel time? Could we say that a car got from source to destination 25% faster than in the second quarter of 2014?

[Keith Creel:]

That's a fair assumption. But obviously, what it allows us to do on the operating leverage side is take assets out. So effectively today, we have 20% fewer cars online than we did last year same time. So it's not exactly a one-to-one correlation, but it's very similar in what it allows you to take out. From a locomotive standpoint, again 20%, 21% fewer locomotives, that's about 250 less locomotives. And the terminal dwell story, as I said, actually this quarter it's improving over second quarter, but there's more to come here.

[Operator:]

Your next question is from the line of John Larkin from Stifel.

[John Larkin:]

There was a lot of talk earlier, mostly from Mark, about the notion of moving all the debt agreements, so that they had a common debt-to-total cap covenant of 65% and that currently the leverage is somewhere around 55% or 56%, so that implies you've got a lot of room to move. Does that suggest that without much of a cut, if any, in your CapEx program that you will continue to add incremental debt as you continue to buy shares back at roughly the same pace of about 0.5 billion a quarter? And at what point as you do that do the rating agencies start to sit up and take notice? And is there any point along that curve where there's a risk of a lower rating being achieved here?

[Mark Erceg:]

We finished the quarter with a debt-to-EBITDA ratio of 2.2. I mean, we're very comfortable operating in the range of anywhere between 2 to 2.5. For short-term opportunities, we could even see ourselves going a little bit beyond that. The cash generative abilities of this railroad are so strong that we can easily delever rapidly if we choose to do so. We have had conversations with the rating agencies. We've spoken with them very recently. We would explain to them the value that we see in buying our shares at these levels, and so we've been keeping them fully apprised. So we think we have a lot of opportunity within our current rating structure and to continue to be aggressive buyers of the shares.

[John Larkin:]

And then as the second question, with a big operating ratio drop here year-over-year, even with the decline in volume, how much do you figure, what percentage of that drop do you think was related to the big drop in the zero margin fuel surcharge revenue? It looks like it could have accounted for most of the drop. Is that a fair way to read it or is there something else going on here?

[Mark Erceg:]

No. The drop only about 200 basis points related to fuel directly. Over half of it was operationally driven.

[John Larkin:]

So roughly half fuel, half efficiency?

[Mark Erceg:]

Correct.

[Operator:]

Mr. Creel, there are no further questions at this time. Please continue. End of Q&A

[Keith Creel:]

So before we wrap up, there's one point I want to clarify on pricing, and maybe we can save you a little bit of confusion out there. Same-store pricing, first quarter we had 3.8%, second quarter roughly 3%, the back half we expect about 3.6%. The timing of the contract is what has the influence, so just for clarification for your models that's effectively a little bit more color and specific detail on where we stand on the pricing standpoint. So that's it. Thank you for your support. Thank you for the questions and the time spent today. And we look forward to sharing our results with you next quarter.

[Operator:]

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