Canadian National Railway Co (CNI) 2008 Q2 法說會逐字稿

Welcome to the Canadian National Railway second quarter 2008 financial results conference call. I would like to turn the meeting over to Mr. Robert Noorigian, Vice President, Investor Relations. Ladies and gentlemen, Mr. Noorigian.

Okay. The way I would like to start is just by reminding you of the comments that have already been made regarding the forward-looking statements. With me today are Hunter Harrison, our President and Chief Executive Officer; Executive Vice President and Chief Financial Officer, Claude Mongeau; and James Foote, Executive Vice President, Marketing and Sales. After our presentation, we'll take questions from you that are listening by phone and could you please identify yourself when asking the questions and in order to be fair, can you limit the number of questions that you are asking to a reasonable two. With that, it's my pleasure to introduce, CN's President and Chief Executive Officer, Mr. Hunter Harrison.

Thank you, Robert, thank you to everyone for joining us to discuss the results of the second quarter, which overall I was very pleased with, given the challenging environment we're facing out there with the economy and Canadian dollar and the impact of foreign exchange, housing starts, probably most importantly, the real volatility we're seeing with the -- with fuel.

Let me just make a few highlights before Jim and Claude get into more of the details. Our revenues were up 4%. If you adjust for exchange, they were up 8%. Operating ratio came in at 66.3, which shows as reported year-over-year deterioration of 6 points. But I would point out a couple of items, mostly the fuel lag which accounts for about 4 points there. The diluted EPS came in at C$0.95, which includes a 5% income tax recovery.

I think probably the most important thing in the quarter was that -- from an operating standpoint, we had outing performance. Just about any metric you can look at across the board, exceeded previous records, whether it's train productivity with the train size, load factor, whether it our locomotive miles per day, whether it was car miles per day, productivity in the yards. Our car inventory, I think on a quarter-over-quarter basis of rolling stock was down about 6%, and -- and as we go into third quarter, those numbers are moving up even higher. We have several initiatives that are coming together in the third quarter that will affect productivity even further. I think we'll see our car miles per day in the second half go up to a world record level of over 200. We're going to have the final touches on the new yard at Memphis sometime before the third quarter is over, and those two things will serve us well as we go forward, from an operating standpoint, excellent performance.

And so with that brief overview, let me recognize Claude to bring down the financials even further.

Thank you, Hunter. Overall indeed it was good quarter, especially given the challenges that we face. Our operations bounced back from what was a tough winter with very solid operating metrics, and you mentioned the key ones.

Basically, if you look at our results, those operating metrics helped us offset the head winds from a weak economy, very high fuel prices and the appreciating Canadian dollar. We turned in C$0.90 versus C$0.95 last year of EPS. If I exclude the gains on deferred taxes of basically C$0.05 during this quarter and C$0.06 last year. This is only a 5% reduction in EPS, in what was a sluggish volume environment with a number of sectors facing recessionary conditions, this is pretty good. Especially when you consider the depreciating Canadian dollar alone cost us roughly C$0.05 or 5% of EPS and the lag impact on our fuel surcharge cost us from C$0.07 to C$0.08, or basically 7% or 8% on a year-over-year basis. So if it wasn't for these two two items alone, our EPS would have been growing on a year-over-year basis in the mid-single digits.

But at the end of the day we have to take the good and the bad, and our results came in the following. Our revenues performed well with a 4% increase as reported, or as Jim will explain 8% on a year-over-year basis FX adjusted. On the expense side, the story is obviously fuel with record prices, an increase of nearly 70%, driving our overall expense increase of 14% as reported or 19% FX adjusted, as I'll explain a little bit further in a minute.

As a result our operating ratio came in just above 66%. This is a 6-point increase, largely driven by the impact of fuel, which has Hunter said, explains about 4%, or 4 percentage points increase. Below the line our other income came in good with C$9 million. Was helped by realized foreign exchange gain of roughly C$7 million or C$8 million. So the large part of our other income is the foreign exchange gain on a realized basis.

Our taxable income was lower because of the impact of the C$23 million gain from reduced deferred income tax. This is potential jurisdiction in Canada that have announced future income tax reduction. At 27% tax rate on the book basis, this is obviously lower than our guidance that I have provided you before, which still stands around 30% to 31% on a book basis, the effective tax rate. So all in all, pretty good results.

Let me turn to the expense, overall, as I said, an increase of 19%, FX adjusted. However, if I exclude fuel the increase is closer to 6%. Let me talk about fuel first. During the quarter, we paid roughly C$124 per barrel for oil. That compares with C$65 last year. The crack margin were not -- we're basically on the same story, paying at CN roughly C$25 per barrel versus C$15 last year. So you're talking about a 70% increase in the price of fuel. This was offset by slightly lower volume, and productivity gain for a total increase of 68%, adjusted for exchange.

Casualty and other is the other expense category that saw a significant increase. Here we were benefiting in 2007 from a significant reduction in your legal claim due to the actuarial study that we do in the second quarter. We do -- two actual studies, one in the second quarter and one in the fourth quarter, and as you recall last year we had significant legal claim pickup in both quarters, the year-over-year increase about C$45 million due to those legal claims, so you could see that we were able to offset this with a few other areas, where expenses increase offset by good performance in the area of accident cost.

The other expense category were well BA labor and fringe benefits. Basically our pension expense reduction helped offset wages and a slightly higher headcount, the reduction of roughly C$38 million is explained by lower stock-based compensation, with our stock price coming down from the high that it was in Q2 of last year. Purchased services -- also an increase of around 11%, C$20 million, largely because of the third-party expense that we have to accommodate for the growth of CN worldwide activities. We also have higher repair and maintenance costs during the quarter.

Equipment rents, up only 2%, basically very good velocity, as Hunter pointed out. Our velocity increased by roughly 10% during the second quarter, but this was offset by lower -- offline income as in many of our cars, particularly in the forest product areas, are not -- are no longer attracting offline income on the other railroads. Depreciation and amortization, up roughly 7% exchange adjusted, as a result of our CapEx spending, but also the impact of our new depreciation rates with the study we completed in the first quarter.

If I turn to free cash flow, we generated year to date C$225 million. That's C$174 million better than last year, lower income -- was reduced by much significantly reduced outflows for working capital. The story here, however, is the C$360 million outflow that we had last year to pay for the 2006 tax installment. If I exclude that item, our free cash flow on a year-over-year basis is actually down on the order of C$190 million. During the second quarter, we used our cash to buy back C$345 million worth of shares for 6 million shares exactly. That brings our total program to 31 million shares or C$1.6 billion from July to July.

And I'm pleased to announce that our Board of Directors earlier today approved a new program starting this July until next year for 25 million shares. If you look at it, is about 5% of our float, it represents at current prices, something on the order of C$1.3 billion of cash outflow, which, if you adjust for the fact that we plan to acquire and pay for the purchase of the EGNE of C$300 million, keeps our current share buyback at around the same level as this year, that is C$1.6 billion minus C$300 million for the acquisition, will bring it back to C$1.3 billion or 25 million shares.

Now that should bring us in line with our broad guidance in terms of use of cash. We expect our adjusted debt to capital to move from the 42.2% that it is now to the -- somewhere in the range of 45% or 46% with this buyback program, and for our adjusted debt to EBITDA coverage ratio to move from the 2.1 times that it is now, to the 2.25 times or there about in a year from now. This is in line with our guidance and consistent with our approach for use of cash.

Let me say just a few words to wrap up with -- perspective on what is ahead of us. It's clear that we're facing a near-term environment that's very challenging, but the good news is some of the head winds that we have been facing in the first six months we are hoping will taper a little bit in the balance of the year. A good example is the fuel surcharge, during the first half, the fuel surcharge lag alone cost us in the range of C$0.11. The foreign exchange impact is another element which during the first six months costs us roughly C$0.11. As you look out to the balance of the year, if fuel prices does indeed stabilize around C$135, which is the assumption we are using at this point, the fuel surcharge lag should be a lot less in the first -- in the next half. In fact, it should be -- you know, basically only a penny or two.

Similarly for exchange we are -- last year the Canadian dollar was at or around parity for the second half of the year. Our assumption of a dollar that stays around parity means that we should not have a head wind on this front. We are expecting the economy to not -- to go through a tough period, and to start to recover in the second half.

Now that is a tough one to call. There's obviously signs out there of consumer confidence continuing to deteriorate of housing starts having difficulty, and real estate pricing continuing their way down, but we do believe that the fiscal stimulus in the US, the convergence of growth on a global basis should provide enough of a support base for the economy to avoid a deeper recession, and for it to start recovering in the balance of the year. If it does, we would expect North American GDP growth in or around 1%, and they should allow us the command for the full year in terms of EPS, around the guidance that we have provided you before, which is mid-single-digit range for the full year.

Now there's a lot of uncertainty, there's a lot of volatility, but we're focused on generating the efficiency and on capturing the market-share gains that are available to us, and that is our near-term outlook for performance. Longer term, the good news is this economy at some point will rebound, and when it does, we are well positioned. We have a great franchise, we have a low-cost model, and our ability in a high fuel price environment to gain market share from trucks is proving itself. That is the conditions that we believe are going to be there for railroads in general, and for CN in particular, because we do have a significant portion of our business that is susceptible and sensitive to the rate of economic growth.

With that, I'll turn it over to Jim.

Great, thank you, Claude. I would like to do through the second quarter results, again, on an exchange-adjusted basis.

In the second quarter our total revenue grew by 8%. The pricing environment remains positive. Our same-store prices on a per-unit basis, increased over 4.5%. With crude prices almost doubling since last year, higher fuel surcharge recoveries also added 5% to revenue growth. Off-setting the gain from price and fuel was lower volume. RTMs were down 2%, carloads were down 1%. I'm actually pretty pleased with these volume numbers when you consider that our second quarter lumber and piano carloadings were down 42% from two years ago, and auto carloads were down 25% since last year to have volumes close to flat shows the strength of our diverse franchise.

Let's break these revenue numbers apart by commodity group. The first line, petroleum and chemicals up 13%. Petroleum-related markets continue to be solid. The volumes in to the Western Canadian oil sand region continue to grow. Sulfur shipments, both dry for offshore markets and molten to the US are high due to global demand. Biodiesel shipments from the US Midwest are up as production increases, and partially offsetting those gains were lower shipments of plastic pellets. On the chemical side, chemical shipments increased from a new waste opportunity, but were lower for industrial chemicals tied to the panel and auto-production businesses.

Metals and minerals which was up 12%. In the metal segment, there was strength across almost all finished metal products and scrap. Not only are we benefiting from good demand, but we are also gaining market share as new distribution patterns evolve as steel companies continue to consolidate. On the minerals side, again, a good quarter there, big driver there is sand associated with oil and gas development, moving both to the US Southwest as well as in to Western Canadian, and new volumes of aggregates in the Edmonton area, associated with the upgrader development projects ongoing there. Iron ore car loads were also up, revenues were up there as iron ore shipments remain strong.

On the forest product side again down 8%. Lumber and panels continue to have the difficulties that we have talked about from quarter-to-quarter now, associated with lower demand and lower housing starts. Pulp and paper the record wrapping paper and log showed positive results this quarter, but this was offset again by the closure of a significant paper mill in Eastern Canada, which occurred in August of last year.

Automotive side down 8%, reduced shipments there, both finished vehicles and parts to some degree associated with the strike of a supplier by one of our larger customers, as well as lower motor vehicle sales which progressively got worse as the quarter went on.

On the coal side of the business there in the US, we were up there and carloads 2%, again, as the new mine that we have talked about in the Illinois basin has come on line. Most of that gain being offset by another fine there in the Illinois basin, which is having problems with production. And then on the Canadian side of our coal franchise, increased volumes there, Petco, from the Alberta oil sands project were offset by lower volumes due to some mining issues in Canada.

Grand Fertilizers in the US -- US corn, soybean and related products were up on the strength of shipments to expert from processors and of increased ethanol shipments. And in Canada, we were down lower volumes of wheat for export primarily due to lower available stocks to move. On the fertilizer side, good strength continues there, shipments of both liquid and dry fertilizers were up on demand.

And in intermodal, up 15%, on the overseas side of the business, very strong shipments to the West Coast, Vancouver as well as very good volumes coming in through Prince Rupert, offset as slower volume on the East Coast, principally driven by there trade with Europe's ship manufacturers were down, and on the domestic side, very good numbers on the domestic side. There is intermodal services there as -- especially the products associated with our Canadian retailing offerings, as well as border shipments have grown. Other revenues just worthy of mention up quite significantly there, up 28% in the quarter, reflecting our non-rail transportation services, which we talked about on prior calls.

The outlook in terms of the commodities, again, using Mr. Noorigian's slide chart higher to show what is -- showing a negative and a positive trend, petroleum and chemical, the outlook there is pretty good, with shipments associated with oil sands projects continuing to grow, as well as the alternative fuel opportunities. In the metals and minerals, again, good solid outlook there, very few, imports of steel products were down moving in to the US, so our opportunity continues to grow as well as the market share gains which come really -- from truck, as the industry has consolidated and the mergers have occurred, shipping patterns, which favor rail versus short-haul truck continue to evolve. On the lumber side, all I can tell you is, you know, the comps get better. The lumber loads, really if you look on a quarter-to-quarter basis, about, I would say, beginning to bottom out in the fourth quarter, and instead of these big numbers that we have been looking at in terms of decline -- kind of ballpark lumber declines of maybe 5% in the fourth quarter. Coal new mine developments both in Canada and the Illinois basin will continue. The outlook there is very strong.

On the grain and fertilizer side, the Canadian crops should be up about 10% from last year, which was a smaller crop, which we're seeing lower available stocks to move right now. While I qualify that a little bit, obviously while our crop is going to be good, we're going to have a small carry in -- both in Canada and now the US once the flooding in the Midwest has stopped, and I think that -- the crop outlook there is being revised upward, kind of hourly as growing conditions in that region have improved quite significantly, but we'll have to wait and see for the next USDA projection. Rupert intermodal, I think everyone saw our press release during the quarter, where Costco has brought in a second vessel call now. You know, we're continuing to look for growth from our existing customers, as well as new customers. On track there meet the numbers that we have talked about for -- for '08 and are very optimistic for '09, and while US in the auto sector, in the US we have to continue to watch what is going on with auto production there, but our import traffic through both the East Coast and West Coast is doing very good.

So the outlook, I'm very confident with -- the pricing environment continues to perform in the range we have talked about in the 4% to 5% and we talked about moving closer to the 5% the high end of that rage that seems to be taking place. Our volume growth under the circumstances with the two declines in the business units being there -- we should see a pick up with some of these other initiatives in the other business segments in the second half. And overall, my sense is the economy, clearly getting away from US housing and autos right now is doing pretty well, so we're still continuing to focus on delivering the top-line growth results that we talked about.

Hunter?

Thanks, Jim and Claude for those presentations. Given what Claude and Jim have just talked to us about in spite of some of the head winds, I'm very, very encouraged about the second half of the year, in spite of what appears to be less than a robust economy. We are clearly making some market share gains, vis-a-vis the truck. We are seeing organic growth where our customers have gained market share, and we're picking up market share given the fuel prices we're seeing, and the issues dealing with the environment. And I think those trends will certainly continue.

Let me mention briefly a couple of the strategic initiatives that are starting to come together. Jim mentioned a couple of them. We have got the second ship calling on Prince Rupert now. I think the first one was July 8th, I believe. The service is working very well there. That puts us to five trains a week, and we're probably at 65% or so, Jim, of capacity there at Rupert. We're probably a signature away from filling up the rest of that capacity. We started moving some of our aggregate shipments in to what has been characterized as "Upgrader Alley" in Alberta.

We were very, very excited about the [Capitence], announcement to add about 11 million tons of capacity to the West Coast. I think most of that capacity, I hope and think will be -- will go to prince Rupert. It's a significant investment on their part of C$0.5 billion, and give them the ability to about double their capacity, so I'm sure we're going to participate in that growth, and to what degree will be determined as we go forward. And there is a chance that we will be even handle some of the pot ash and material through Prince Rupert with seeing worldwide domestic operations, and we're very, very hopeful there.

I should give you an update on the -- the STB transaction. We are waiting any day now anxiously for the draft report on the environmental impact study from the STB. My personal view is, that the pendulum is starting to swing a little bit. We've had some more people endorse the transaction. There appears to be a more balanced approach in Chicago. I think people are starting to understand the "not in my backyard" mentality and I am very very -- let me put it this way, I am cautiously optimistic that we'll have this transaction completed by year end. And so, with those comments, we'd be happy to take questions the group might have.

Thank you. (OPERATOR INSTRUCTIONS). Tom Wadewitz of J.P. Morgan. Please go ahead, your line is open.

Yes, good afternoon.

Hi, Tom.

Let's see, I wanted to get your sense -- you mentioned, Hunter, on the Memphis yard opening relatively soon, and wanted to see if you could give us a sense of where we would see the impact from that and perhaps how long it would take to see a meaningful impact from that whether it's on the volume side or whether it's something on the expense side.

The Memphis initiative is more on the expense side, and it affects more of the US network, and that was the plan with Memphis, and with the EJ&E, purchase, transaction, hopefully subject to its approval. Memphis and Chicago, probably Kirk Yard, will become the two and the only two switching locals of any significance in the U.S. So it will have -- some of it so already tipped in, because we're using the yard to the degree it is completed, but the full blown, all of the classification stripes will not be completed for a couple of more months. So it will have an impact on the expenses. It will have -- mostly in the US, although it will have some impact on the work that is required at Mac yard, and some work that is required in -- in [Winnipeg], and the down-stream effect is it will also have some impacts on the potential rationalization of another hump yard in -- in Canada.

Really see the impact from that do you need to have EJ&E in place as well, are they are essentially independent - -

They are certainly not linear. Memphis does one thing for us, and does X. The EJ&E transaction will do Y. But the best combination is X plus Y. But if we don't get the EJ&E -- Memphis will do what it is going to do and a little bit more given the synergies between the two.

Right. Okay. And then the second question, Claude, the comp and benefits side, you had a pretty significant -- C$38 million or C$36 million year-over-year, something like that. What do you expect in your guidance for the mid-single digits earnings growth for the year when you look at that in second half? I know it may be a little bit hard to predict, but are you assuming it is down pretty significant in second half, or are you assuming it is a neutral impact?-

We don't forecast our stock price, but we're expecting it to come down -- to come up as the economy rebounds, and so we are properly provided for, and can accommodate the -- a normal increase in our stock price from here. Its already up from where it was at Q2.

Maybe we should ask you, Tom.

(Laughter). It's going up.

Oh, good.

It was a meaningful impact in the quarter, and so I figured on what you were thinking in the guidance. Okay. Great. Thank you for the time.

Thank you. The next will be from Jacob Boot of CIBC World Markets. Please go ahead.

Thank you. A question on your guidance Maybe you can talk about -- you know, a 66% sustainable at C$135 oil? What are your expectations as that is going decline for the rest of the year. And then maybe you can talk a little bit of what was the actual impact of weather and flood for the half of this year.

In terms of the operating ratio, the fact we're operating at a higher fuel price is having an impact on the operating ratio. Its just the math of the fuel surcharge recovering the fuel expense, so-so you have a block of business that is effectively 100% of operating ratio. So, you know, last year we had lower fuel prices, and we also had the benefit of the casualty and other legal claim credit. Those things are -- you know, are of the past. Going forward, we see our operating ratio in or around the level that we have achieved for the second quarter of 2008, and with volume coming back and good pricing going forward, we'll have the ability to expand margin from there.

On the flooding we were much more fortunate than some of our other rails. You had some flooding in Iowa, and we certainly had some damage in some of delayed operations, and only outages, but they were not, what you would call real significant, and so we bounced back and operating people did a good job of getting us back in to service, and the impact to customer was minimized. It was not near the impact that some of the other rails experienced.

Okay. Thank for that. And just a question on the intermodal, you talk about some of the initiatives you have got going on in Eastern Canada right now to improve the volumes there. And I think in the -- while you were making your presentation, you also mentioned that -- the intermodals were down -- intermodal volumes were down in Eastern Canada, offset what we saw in Prince Rupert maybe you can talk about -- or give some order of magnitude with that.

Yes, in reference to the [Alafax] port operations principally due trade on an international basis from Europe. And obviously with the euro where it is right now, that trade is suffering. So our -- our volumes through [Alafax] on a year-over-year basis are down probably about 15%, even though total carloads or loads in that business group would have been up about 6%, 3% on the overseas, and another 10% or so on domestic. So that -- it is a smaller segment of our overseas franchise, but still the numbers -- the decline there is pretty big.

And any color as far as the second shipper in Prince Rupert?

You know, as I said before, I'm very happy to fill up this capacity with my existing customers, Costco and [ANGINE], that are extremely pleased the service we are providing to them, or with another customer, and right now, right now we're on or ahead of -- of the numbers that we had projected. There was a little slower start-up of the service than I had hoped for, but it's really gaining traction, and a lot of our customer shippers are clearly pleased with what we're doing -- I'm hoping that soon we'll get either another customer or further commitment from the existing shippers.

Thank you very much, guys.

Thank you. The next question will be from William Green of Morgan Stanley. Please go ahead, your line open.

Okay. Hunter, when you think about the network if we look at the volumes for the last two or two and a half years, they have been falling. That's a challenge on the margin front, but if we saw volumes rebound, should we think about the margins coming back in the same way? Sort of the incremental margin on the extra volume? Is that really powerful to the model here? Or have you been replacing it such that its going to come back in at sort of average margins, if you will?

No, its powerful to the margins. If you look right now, as we speak, not for the whole quarter, but our grain volumes are down in Western Canada. Now when grain volumes are down, our bulk volumes are down, that in itself just lowered the overall metrics of the productivity of the model. So, you know, we're positioned and postured, and that's why I'm so encouraged, is that with these various initiatives coming on, just volume itself at the same productivity levels, raised productivity just the mere numbers there. So if we look out in the future a little bit, and if and when housing starts pick up a little bit, if and when the economy has bottomed out or bottoms out, we get a little pickup in the economy, and maybe there's a little bit of weakening in of the Canadian dollar, you can see some powerful things taking place here. I mean, we had a heck of a run here in 2006, set world record 2006, and you can make the case that 2007 would relatively flat, the first half was kind of flat. Looks like we are going to be better the second half and year over, but I think you're going to see -- I can't tell you when, I'm not that smart. 12 months, 18 months, or something that the company moves away from this plateau and take another run again.

Okay. If I turn to EJ&E, just two quick questions, you said the pendulum is swinging back in your favor, is that not the case, in fact, do you ever walk from it? Or is it just too critical that this is going to work and you guys are going to stick it out? And then on EJ&E as well, are any of the Prince Rupert potential customers - - do you think they are waiting on that to see how that works, or is that not really part of the thought process?

No, I don't think they are waiting. I mean to Jim's point, you know, the service has not been an issue of what we have advertised, and we have been doing in spite of the fact that we still have the challenges at Chicago. And I think what we said earlier, Bill is clear, would we ever walk? Absolutely. We are good business people, we fell in love with this deal, we can run this railroad without the EJ&E. We can run it a lot more efficiently with it, but if it gets to the point where the mitigation costs or the timing of the issue is going to drag out for so long, and the mitigation costs can be better spend on another business deal, we're very good at turning our back and walking the other way and figuring another way to skin the cat.

All right. Thanks for your help.

Thank you. The question will be from David Newman of National Bank Financial.

Good afternoon, folks.

Hi, David.

Based on the guidance you have about a 20% recovery year-over-year over last year's second half numbers. How -- if you had to do -- how would you break that out in terms of factoring FX, fuel you mentioned a couple of cents, I think, Claude, and as well as volume and price? And what sort of pricing renewals are you seeing right now? So I'm just trying to get a sense of the various buckets, as you look out in the second half.

Basically, I think you put your finger on the two key issues. We had head winds in the first half that were quite significant. Fuel surcharge lag was a little bit more than a dime, and the same for exchange, so that's a C$0.20 head wind in the first half, according to our assumption at the moment we won't be facing in the second half. Number two, we're expecting volume to pick up with a stronger economy, and some of our tougher business segments to lapse and we're expecting continued good pricing environment as Jim mentioned. You put it all together in a fluid network and you have the makings for the earnings of the company to rebound, and allow us to come in on target with mid-single-digit.

Have you changed your free cash flow guidance at all? Or are you sticking with what you initially thought?

No, we haven't changed. We have our work cut out, obviously, with C$225 for the first half to come in on target, but we're not changing your free cash flow guidance.

Are you seeing in base -- are you seeing any sort of stabilization at all in the sort of the consumer-driven or merchandising, acts of auto and lumber, are you seeing stabilization there and perhaps even softening in the bulk side? Has there been any sort of shift that you can see at all?

No, ex US housing, and auto, the various business segments are still very strong. In fact, like I say in the metal and minerals area, just as an example, you know, we are working hard to meet the -- the growing demand of the consumers of steel in the US. It's very strong. Some -- some one-time issues associated with coal, which -- are going to -- that already are fixed and the volumes there are back. Grain, especially in Canada, we had a crop last year, which was about 10% below average, so the available stocks of grain to move are just not there, and when the crop comes in, it will move. Fertilizer outlook is very good. So I'm very optimistic about the other business segments, except the two that we talked and, that are going to do very well.

Excellent -- CN word wide is probably a lot of logistics assets that are very cheap right now. Would you guys look at that at all?

If an opportunity that made business sense came along, certainly we would look at it.

Thanks, gentlemen.

Your next question is from Ed Wolf of Wolf Research. Please go ahead your line is now open.

Thanks. Claude, a couple of things, one, just for clarification, when we look at the mid-digits earnings growth, are you including C$0.90 or C$0.95 as to second quarter?

No, C$0.90, the deferred income tax is in our reported GAAP results, but given that we have excluded last year to C$280 million of deferred income tax gain, so give you an apples-to-apples basis, we're working on the basis of C$0.90.

You haven't backed off of the free-cash flow, as you just said, but it's been two quarters in a row now where working capital has worked against you. Is there something that is going to reverse here?

Well, you know, a lot of our working capital, you know, issue this quarter is because of the payable that I talked about, the tax installment of last year. We do have our work cut out to furnish the year on target with free cash flow, but I'm reasonably comfortable we'll be working on all cylinders, income has got to come back and grow on a year-over-year basis. Working capital has got to improve, and we got to stick with the budget in terms of capital expenditure and if we do all of that, we should be on target.

Jim, you said you are back on track, even ahead of schedule in terms of Prince Rupert. I believe the guidance was C$100 million in revenue for the year?

Yes for the year. We were a little bit behind in the first half of the year, and now a little bit ahead, so it kind of nets out to the number that we have talked about in the past.

But it feels like then you are on a run rate of above 100 right now, if this was the beginning of the year?

Considering the fact it is a few months later than I had hoped, yes.

The headcount was up a little bit. Not sure of the number --

2% increase?

I'm sorry?

It's a 2% increase.

Yeah. How do we think about that going forward with volumes down? Is the idea that volumes are going to pick up, so you are getting in front of that at some point, or is just one quarter and we shouldn't worry about it?

I think we have found some more initiatives with contracting in roaded and contracting out, if the net bottom line is better off, but I do think if we looked at some initiatives, and looked at some things and prices out there, we think we can do some things, and bring them in, and do them cheaper and more effectively. The headcount number is not significant, but could certainly go up in spite of volume. Now that would all be on the maintenance effectively, but you should be sensitive to that as you see going forward.

Thanks, that's helpful, Hunter. I appreciate it, everybody.

Thank you, the next question will be from Walter Spracklin of RBC Capital Markets.

Thanks very much, good afternoon, guys.

Hi.

Back on Prince Rupert, if you were at 100 million run rate with 300 million capacity, the new (inaudible) -- with -- coming on now, where are we in that sort of 300 million utilization now?

I think Hunter said kind of ballpark we are at 65% of capacity right now.

When you are looking forward, I guess you going to be breaking ground on Phase II next year. Any thoughts on the marketing there, and how you are going to be approaching the marketing on the Phase II project?

I don't think breaking ground next year is in the works. You know, clearly the expansion, the increase of capacity in Prince Rupert is something we're working on, and we're pretty confident that once we get to this, kind of run rate that we talked about, that we would be able to take the necessary steps in order to add additional volumes through there. Whether that's reconfiguring with additional capital expenditure on the existing footprint, whether that is capital expansion in to Phase II or another terminal? All of those options are being studied, but the first goal here is to fill up the terminal that we have. We're on track to do that, and we're actively working on being in a position to put more volume through there, when -- when we get this Phase sold out.

Okay. Second question then on the [Capetence] great win for you guys over there. I was wondering how much of a commitment is going to be on CN's part -- obviously there is going to be a green-fill project for Prince Rupert there. If it goes up there, how much are you being asked for in terms of kind of contributing to the terminal?

Well, we are very excited about working with [Capetence] here, and we're currently involved in -- in activities with them on trying to look at layout, service, and, you know, when we get -- when and if we get to that road, we'll certainly sit down with them and talk about it. But there's no -- no commitment at this point in time on that.

Okay. Okay. Thank you very much.

Thank you. The next question will be from BIll Mackenzie from TD Securities. Go ahead, your line is now open.

Thank you. A question on the other revenue line, very impressive growth there, and sort of second quarter in a row, I was wondering if you would get in to a little more detail on what parts of the business or the network, where you are seeing that growth? Are these sort of levels sustainable? And is there anything unusual this quarter, give in sort of 24%, sort of year-over-year growth, any real estate sales or anything to boost that? And are the levels sustainable going forward?

Well, whether they are sustainable for the long term at 28%, I'm not sure, but there -- they are certainly sustainable in aggressive growth run rates. The big contributor in this quarter is our trucking operations in the US and Transborder. We have talked about the fact we were very effective and had a very successful retail intermodal product offering in Canada, where we did the trucking, the pickup and delivery for our customers here, and then moved the box on the rail.

That traditional business model in the US is much more of a wholesale model, and so we are working very aggressively to roll out that model -- the Canadian model in the US, so we're doing more trucking down there, and see so you are seeing the revenue pickup associated with the truck moves at origin and destination in that line item, as well as the increase in the domestic revenues in intermodal that we talked about. And that clearly is something that we can aggressively grow. It's very light asset-operated business that we use owner-operators to do. And we're going to continue to do that. Our revenues in our bulk operation, our vessel operation, our iron ore dock operations are up as the volumes there have been very strong, but the -- big non-rail transportation increase is associated with the trucking.

Great. Thank you. That's helpful. And in terms of the guidance, when you go back and you look at, you know, your mind set three months ago before fuel ran up versus today, you know, obviously you brought your fuels surcharges up, but the guidance is unchanged, what has been the biggest swing factor in your mind to be able to keep the guidance at this point?

First and foremost, the strength of our Q2 results despite the head winds, I think the railroad is running very fluidly, and we're hopeful that the volume will start to pick up in the second half as the economy grows. As I said before, f you leave the head winds behind, and you have an operating model and good volume helping you that should help us start to show some earnings increase in this third and fourth quarter.

Okay. And just one final question on the pension expense. What was the year-over-year cost of swing in the quarter for pension expense? And what is the expectation for the second half?

The -- you know what we do disclose this in our notes when we issue them. It's around C$15 million to C$17 million, the decline in the -- in the second quarter, and it pretty much linear until year end when we fix our assumption for the following year, so up until the end of 2008, you should assume that it's in that range.

And that's C$36 to C$38 million number that you mentioned earlier, that was just - -

Yeah, that was just stock-base on a year-over-year basis, yeah.

Great. Thank you.

Thank you. Your next question will be from Randy Cousins of BMO Capital Markets.

Good afternoon.

Hi, Randy.

You talked about [Alafax] fax being down sort of 15% year to date. Forest products business is under some pressure. Have you guys thought about or are there opportunities to consolidate operations in the East and drive some costs out of the system? Or is the situation where you just tough it out and see how things play?

No, Randy, we have already done that. And we try to keep up as we go along. If you look at -- one of the things we ask the operating vice presidents in the field to do is to adjust their expenses relative to revenues on their individual territories and RTMs and GTMs, and it's very difficult to do, but that's the challenge that we have been able to meet with. For example, we have recently taken a pair of trains off between [Alafax] and Montreal, Toronto, as a result of the down-turn of the 15 to 18% in the business at [Alafax]. So a pair of train there is a significant. And the challenge is to still move the containers, provide the service, with less volume.

There's initiatives all over Eastern Canada as it relates. Now, in the south right now we have got something different. We have got -- as we speak today the last 30 some days in the US -- predominant US region, Southern region, their volumes are up 7%. So these things move. We used to say coal was dead in the US, but now coal is booming in Illinois. So they have able to make those adjustments. They have already reduced at the GM and Ford facilities, and we're thinking about this whole network relative to finished automobiles might be a totally different model than it has been in the past.

And -- because one of the other things too, you guys have always been the standard in terms of labor productivity. I guess the question then becomes is if the GTMs start to grow can you hold the employment line? What percentage would question get, like 15%, 20% before you would have to start adding people.

On a net-net basis, we would grow 15, 17, 18% GTMs. We'd have to do something in some areas, but in the other areas we would have the capacity already on existing trains under the precision model to be able to absorb and deal with that.

Okay. Final question, I wonder if you care to comment on the CSX Dow division. You have a fair amount of chemical business in the southern United States. Do you see any implications on the decision in your book of business, or is there enough competition that it wouldn't apply.

I think the short-form method there of challenging rates is not something I'm really concerned with here. We have a pretty simplistic form of customer complaint resolution up here with the FOA, that we're very comfortable with dealing with. So I don't see any impact on us.

What about your US business?

No, again, I think I have got -- I think I'm a reasonable pricer and so I don't have to worry about those issues.

DuPont does a lot of business with us in the US, and we haven't had any issues with DuPont.

Okay. Thank you.

Thank you. The next question will be from Ken Hoexter of Merrill Lynch. Please go ahead, your line is now open.

Great. Good afternoon. Just wanted to delve in to the [Capetence] contract. Can you talk about what if anybody you move now, I thought going up to Vancouver it was mostly the other Canadian rail. And what level of volumes could this contract potentially eventually encompass?

Let me make a comment of comments and then Jim can fill in the gaps here. Right now we effectively haul no [Capetence] business. And we don't share very little if any of that business right now. So all of this is incremental gains and potential for us. At this point in time, they -- they indicated they are going to make this investment of C$0.5 billion or so, and they are going to add capacity of 11 million tons. To my knowledge they have not said how that is going to be divide up between potential Prince Rupert and some brown field improvements in Vancouver. I know what my druthers are. But I know that Jim and company have offered an array of opportunities. We'll put a facility in, run the facility, we'll do anything reasonable that they ask that we can do well at. So it's something we are very excited about, and it's all upside for us.

Okay.

I think that covers it Hunter.

And then just lastly on the casualty line. Obviously last year you benefited from a review. Should we look at the C$80 million level as kind of a run rate, down from the C$100. I know last quarter is a bit higher because of the weather and seasonality, but is this kind of the level you would look at going forward?

Yeah, I think our -- there is obviously a lot of volatility, but what we reported in the second quarter is as good of indication on a go-forward basis as you can find.

Okay. I do have one other question. Which is on the yield side that Jim had mentioned before, about 4.5%. Jim, can you talk a bit maybe about push back with surcharges where they are, obviously you are happy getting the top-end of your target range. When do you anticipate that moving down toward inflation-plus levels as you anticipate the next few years staying at this level?

I anticipate the demand for rail transportation to continue to be very strong, and therefore, I expect, you know, the prices to reflect them, and have -- you know, and my hope is that the -- that the outlook for next year will even continue on this trend, where we have gone from three to four now to four to five for a couple of years, and try to continue to gradually move in that direction. I see no reason why that it should -- that it should turn around.

Good so next year, we'll look for five to six. Thanks for the time Jim and guys. Thank you.

Thank you the next question will be from Matt Troy from Citigroup.

Yeah, thanks. To what extent are you seeing a shift in the north south transporter traffic flow as the result of the weaker dollar. Is there an opportunity as the scheduled railroad, which is known to be taking share motally from truck to actually now more tactically focus on some of the northbound trucking flows, given some of the idle capacity as the result of declining carloads?

We are aggressively pursuing traffic that has shifted from -- the US in to Canada, and our network, in some areas lines up beautifully to do that.

Okay. And again, just leveraging an earlier question, you talk about pricing gains in the 4% to 5% trending towards the higher end of that -- that range. What gives you comfort there? Is it the service offering? Is it the value creation that you are able to demonstrate to your customers? And if we're a couple of innings in to this, how is that sustainable over time? What are the opportunities, either traffic category or end-market industry, that see offering the greatest opportunity, let's say on a two to three-year basis? .

You know, on the -- across the board, the price increase is an average by these business commodity groups, has not been significantly different, and -- and so I don't look at any one group as saying that -- you know, I can extract a greater value there, than I can somewhere else, so -- so it's an average. I think, you know, there are certainly dynamic at work, especially associated with the high cost of diesel for us to continue to take market share away from the truck. And that's my principal objective, whether that's changing trade patterns between the US and Canada, whether that's me going to the customer and saying I can offer a complete transportation solution, rail and intermodal, save adding 6,000 carloads of forest product revenues to the rail system that before I didn't handle. So it's a complete array of initiatives that we're implementing to do this, and we do it all the time, and it's showing in the results.

Yes -- I guess shifting focus to the capital plan. Can you give us an update on your capital spending intentions for 2008? And to the extent you do have some externally driven impact from traffic flows - - And some of it cyclical, economic driven, some of it arguably maybe automotive side specifically comes to mind being more structural. Are you prioritizing -- are you shifting any of your capital plan under accelerating projects or potential deferred some out to 2009? Thanks.

Actually we are -- we typically look at these things on a cycle of one year, and we do adjust on an ongoing basis, but typically it's not like we'll being surprised by these big shifts. Our capital plan for this year is around C$1.5 billion. We are adjusting on the opportunities, prioritizing to make sure we spend in the right area, and we'll be taking a look at next year's capital envelope in the fall to see if we have that level?

As of now there's no material or visible opportunities to defer projects that you see in the network?

That's correct, we tend to focus on using our resources and carrying out the plans that we had -- that we had planned for.

Thank you.

Sure.

Thank you. The next question will be from Cherilyn Radbourne of Scotia Capital. Your line is open.

Thanks, very much good afternoon.

Hi.

Just wanted to speak about the opportunity to gain share from trucks. I think, Jim, you mentioned metals and minerals specifically. I'm just curious if that's the only place where you are seeing gains so far? And maybe you could just comment to what extent you are seeing customers treat current energy prices as a new, quote normal, and start making meaningful adjustments to their supply chain.

I think are opportunities across the board. Metals and minerals, that's obviously one that has occurred as the customers have consolidated and gone through mergers and acquisitions. Forest products is creating a great opportunity for us, but there are all sorts of products that move on the highway today that do all move in rail cars, whether they -- that doesn't have to be in trucks, but traditional boxcar-type commodities that are on the highway that we're also pursuing, and fuel prices, driver issues, all of these things are certainly a favorable, environmental green concerns, clearly are -- are out there, you know, everybody is looking to reduce their carbon footprint and maybe in certain jurisdictions even get credit for doing it now. So those economics are going to continue to drive traffic to the railroad at the -- at the expense of truck, and we're going to pick it up.

Okay. And from the perspective of your own operations, are we at a point in terms of current fuel prices where it makes sense for you to start adjusting train speeds in certain corridors to try to curtail your own fuel usage.

We're going faster not slower. I'm serious because of the opportunity with the asset turns and incremental increases from going 50 to 60, given your train size are not the way to go. I mean that's kind of a going out of business sale. You know, I think as we go forward, what is going to happen -- if -- depending on when this economy turns, if we see -- I'm not wishing for this, but if we see inflation continue to climb, if we see interest rates going up as a result of the inflation -- to fight inflation, you are going to see precision schedule railroading that creates way more value than it creates today, because people will be looking at their carrying cost, their inventory cost, and they are going to want things to move quick and fast, and that creates a better product than we have from a value standpoint -- and I'm a firm deliverer, the marketplace gives you the price, you just decide whether you are going to play or not, and if you start to slow down to conservative fuel, my experience has been your other assets start to cost you way more than what the fuel savings do. So we have kind of been there, done that, and we think that's the model. I will mention this. We have add lot of distributive power, where we're running locomotive at the head of the train and one maybe two thirds of the way and maybe go to the rear end, which gives us the leverage to move a lot larger train safely and control better in-train die , and at the same time pretty significant improves fuel

Okay. Thank very much. That's all for me.

Thank you. The next question will be from John Larkin from Stifel Nicolaus. Please go ahead. Your line is now open.

Good afternoon, everybody. I just had a question on Hunter's comment regarding the operating metrics, indicating that wanted to improve the average car velocity per day from 179 or there abouts up to around 200. In the third quarter, that's just about 12%, I think. I was wondering if you could maybe give a little detail on how you are going to accomplish that, and whether or not that will result in the opportunity to downsize the car fleet and/ or the locomotive fleet?

Yes. To all of the above. One of the initiatives now, which -- relative to the last question is, is increasing our train speed in a very effective way by better controlling delays, better dispatching things that we have recognized, better evenings the flow over days of the week, so -- and there are several other things going on. Right now we have car types that we thought we are short up, where we see behavior of some of our customers of holding cars in -- ordering cars in and holding them for a week or two at a time, which means to me that car type -- they are using us as warehouse, so divergence is going up, almost, kind of accounts will start to change that behavior, so we'll be able to handle more business with the cars moving more effectively, and all of those initiatives have already started. Our run rate today we have had days over the last two or three weeks, that we have been as high as 190 mile per car day, and one big adjustment here or there can push us to that. Intermodal cars right now do 500 miles a day plus, the potential of various car types is significant, and so if we start to do better by doing it with less cars and has got impact on locomotive and got impact on diverge and I don't want the diverge, I want the car and I want the asset and get it to turn. But if I'm being used as a warehouse, I want to be paid for it.

Is the 200 number, is that what you hope to achieve by the end of the quarter?

That's what I hope to achieve by the year end.

Okay.

On a consistent basis. I don't always achieve to everything I set out to do, but I'm going to get damn close.

That's very helpful. Had a question for Jim on the development of the oil project in Alberta. Have you seen an acceleration of activity with any increase in oil prices?

Well -- you know, that they could accelerate and build any faster than -- than they are doing. I mean it's between Fort McMurray, and the Edmonton it is C$70 billion worth of projects.

Maybe one last for Claude, if for whatever reason you are unable to get the EJ&E approved because of the NIBBI crowd, you know, carries the day. Would you shift that back in your share repurchase program?

We're going to get the deal before year end.

Not even going to consider that option? Okay. And then maybe just lastly, a general question, maybe for Jim, there has been a lot written about a lack of containers for export activity out of the US with the weak dollar, and given all of the incremental containers coming in over Prince Rupert, is there any way to capitalize on all of these empty boxes that would otherwise go back by loading in US exports.

Since the initiative started at Prince Rupert, we have always been involved in the back-haul potential, and that back-haul potential to date is about where we expected it, based upon the imports coming in. And that's why we've built facilities to stuff grain in Western Canada and the US and a facility to stuff lumber and forest products in Prince George, so we are actively working with the steam ship companies to make that product available, and it's working very well.

What percentage of the boxes heading back with loaded with revenue freight?

50 to 60%.

That much? Okay. That may be close to the max of what the steam ship operators can handle anyway?

Yeah.

Given the difference of density in the product?

Right. These boxes are coming from all over, and to date, there's a very small number of boxes coming through Rupert. As I said of the volumes coming in, it's the some -- you know, what is going back. About at 60%.

That's very helpful, thank you very much.

Thank you. The next question will be from David [Signburg] of Goldman Sachs your line is open.

Good afternoon. We saw some press reports roughly month ago about a private investor looking to build a brand new railroad in Eastern Canada. Wanted to know if you had any incite there, any commentary if there would be any capital requirements from Canadian National.

They didn't talk us to.

Okay. And on Prince Rupert, I wanted to make sure I had my numbers straight. You're on track to do C$100 million worth of annualized revenue this year, capacity for the port is at C$300 million annualized revenue number, and based on the two ships that are currently calling there, you at 65% capacity?

Those are good ballpark numbers, yes.

So then if I tie in your earlier comments, if you bring a third ship on line by the end of the year, that means you reached capacity, and if -- based on the answer to one of your earlier questions, the only capacity enhancements that you have on your radar screen right now is really shift-around assets? There's no new facilities? Is that accurate?

The question would be -- the question is not will we expand the capacity of Prince Rupert, but how will we expand the capacity of Prince Rupert and that as I said could be through expanding the -- or adding it to or building a new terminal, all of those which are under consideration.

Thank you very much.

Thank you. There are no further questions registered at this time. I'll return the meeting back to you Mr. Hunter Harrison.

Thanks, very much. Gentlemen, thanks for all of you for joining us. Those are stimulating questions. We hope to see you after the third quarter with the results that we predicted.

Thank you. The conference call has concluded. You may disconnect your telephone lines at this time. We thank you very much for your participation.