Canadian National Railway Co (CNI) 2009 Q3 法說會逐字稿

Welcome to the CN third quarter 2009 financial results conference call. I would now like to turn the meeting over to Mr. Robert Noorigian, Vice President, Investor Relations. Ladies and gentlemen, Mr. Noorigan.

Thank you, and thank you for joining us for CN's third quarter 2009 financial results conference call. I would like to remind you about the comments that have already made regarding the forward-looking statements. With us today is Hunter Harrison, President and Chief Executive Officer of CN, Luc Jobin, Executive Vice President and Chief Financial Officer, and Jim Foote, Executive Vice President, Sales and Marketing. Also with us today, although they are not taking part in the formal presentation are Claude Mongeau, Executive Vice President and Chief Railroader-in-training, and Keith Creel, Executive Vice President of Operations. After our presentations, we will take questions from those of you who are on the phone, and could you please identify yourself when you are asking the questions. And in order to be fair, can you limit the questions to two, and we would appreciate that, and that way you will be fair to your colleagues too. With that, it's my pleasure to introduce CN's President, Chief Executive Officer, Hunter Harrison. Hunter?

Thanks, Bob and thanks to all you for joining us this afternoon. If you will, let me, let me just take a moment to kind of address an issue that we normally don't talk about here, and that's my future with the organization. I think most of you are aware that I'm retiring officially effective December 31st. This will be my last conference call doing the quarterly results. And I want to take this opportunity to thank everyone of you here that have shown this organization the confidence that you have, and the reliability and credibility that you have shown the group. And I am certainly appreciative. And it has been a nice experience working with you. One other note, I am proud to be able to report today. Most of all know that Claude will be replacing me come the first of the year, but also the Board this morning at our Board meeting officially elected Claude to the Company Board of Directors. So Congratulations, Claude for that recognition from the Board. And I will look forward to turning the keys of the office here over to Claude some time in late December, and I don't think you will ever see him miss a beat as we go down.

I was really pleased that from our last quarterly conference call that I -- that we can talk about a quarter that I was very, very proud of particularly with the conditions and some of the headwinds we have had to face with the economy, and Luc and Jim are going to go over the numbers in detail, and just a couple of the highlights. The revenues were down as reported 18%. There will be some more explanation of that. The operating ratio, really pleased with is 62.7% OR, which is essentially flat year-over-year and our earnings are diluted EPS came in at CAD0.97. But what I really want to take a little bit of time today to do is to call your attention to the second panel of the presentation which is the highlights of some of the operating results. I think there are three important points here. One, is we can obviously not achieve the type of quarter that we did in this kind of environment without these outstanding operating metrics that are all once again records for this organization. The important thing, even going forward, is these things are all going to stick.

So if you take these types of numbers, these operating metrics which we will go through, and start applying some growth and some rebound in the economy, it is going to create a lot additional leverage of this Company starts going off some record kind of numbers I think in 2010 and 2011. I will just highlight and go through them a moment. The gross ton per train mile was up 7%. One again, 7% on a world record. The cars per yard switching hour were up 29%. And effectively if you look at the -- our terminal cost which is all end, they're down on a system basis, 32.5% when our business levels down measured on RTM basis, the kind of run rate are running at about as we speak down about 11%. So that is -- this whole issue of smart yard and some of the initiatives of the pipeline have flowed to the hump at Edmonton and New York and Memphis are all starting to really allow us to take advantage of some of the opportunities we saw there, the well time at terminals, a big important factor with terminal cost and congestion, was down 9%. Gross time outs available horsepower was 320. And I can remember we are talking about that the ceiling was at 250, and now we are at 320.

Car miles per car day was up 16%. Biggest individual quarter I think that has jumped in that regard. And train velocity which Keith has been spending a lot of time with the regional operations was up a whopping 11%. I would emphasize that I understand a little bit about operating costs. I have been dealing my whole life dealing with them. I tell you it is a regard but it is extremely difficult to set these kind of records, but it's extremely difficult to set these records when your revenues are down to the degree of what we have experienced here. So congratulations to the operating team. With that having been said, let me turn this over to Luc and Jim to give you further in depth explanations here. Luc?

Thanks very much, Hunter. I'm happy to be here today to report -- to do my first report on the financials for the third quarter of 2009. It works out good because the results are actually quite good. So despite the difficult economic environment which Hunter has referred to, we feel our volumes have bottomed out and Jim will certainly have a lot more to say about that. We have seen gradual improvement in the third quarter. In fact, sequentially, our RTM's have grown 4% from Q2 to Q3 of 2009. Our car loads for the third quarter, were down 15%, while our RTM's was down 11%. Obviously, handling this kind of top line pressure is difficult for any business with a high fixed cost, but we continue to make the most of it.

Back to what Hunter mentioned, we reported EPS of CAD0.97 which is down 16% versus last year. However, if you exclude the deferred income tax credits in the quarter, our adjusted EPS came in at CAD0.94 which is down 12% versus 2008. Our revenues came in at a CAD1.845 billion, which is down on an FX adjusted base of 20% in the third quarter, mostly due to lower volumes and lower fuel surcharge revenue which actually was CAD250 million on an FX adjusted basis. Fortunately, this was partially offset by some mix, some good mix and some pricing.

Looking at the expenses, they were certainly well behaved at a CAD1.156 billion. They were an improvement in the reduction of 20% on an FX adjusted basis from 2008, which translated into an operating income of CAD689 million, down 20% again on an FX adjusted basis. Our income taxes expense came in at CAD152 million, and for those of you who are keeping tabs, this translates into a 24.8% effective tax rate. However, adjusting for the deferred income tax items which I referred to earlier that will translate 27%, and that's much closer. And we maintain for the longer term our effective tax rate will be hovering somewhere around 28% to 30%. So net income CAD461 million, down 16% and EPS adjusted EPS of CAD0.94, down 12%. We once again had outstanding cost management and our operating ratio came in at 62.7%, potentially flat to last year.

In terms of foreign exchange, just to give you a picture, it still created a little bit of a tail wind in the quarter, and amounted to roughly CAD0.03 favorable in the third quarter. Turning to expenses, here the story that has been unfolding throughout the year continues. We have managed our costs very tightly, while at the same time supporting initiatives to prepare and handle the recovering volume. Our expenses were reduced 20% on an FX adjusted basis versus 2008. Biggest contributor was the fuel costs, which was down 53% from last year as the WTI came down from CAD118 last year to roughly CAD68 during the quarter. We also had very good fuel productivity during this quarter, up 5%. So our GTM's for US gallons came in at 985 million versus 939 last year.

There was a lag -- a little bit of a lag effect during the quarter, roughly CAD10 million worth of revenue. And that compares to last year where we had an unwinding, if you wish of the fuel lag, which actually was a positive to the tune of CAD0.04 per share. So net quarter-to-quarter comparing 2008 to 2009, we had a fuel headwind, if you wish of CAD0.06 during the quarter. Labor and fringe benefits were down 4%, a favorable reduction of CAD17 million. However, if you exclude the acquisitions that we have made during the last year, the CFQ and EJ&E, and the one-time costs associated with higher stock-based compensation resulting from a higher stock price, the decline would be 10% or roughly CAD40 million. And that has been achieved through a number of means, but mostly reduction in man power. The average man power used during the quarter was down 5%, and again adjusting for acquisitions it was actually down 7.5%.

We also had some favorable adjustments or favorable results in the purchased services and material. Our expense was CAD227 million. That was a favorable CAD47 million, or 18% on an FX adjusted basis, mostly resulting from third party services, transportation and material. The other area where we had a favorable adjustment or favorable performance was in the casualty and other. Our expenses for the third quarter were CAD64 million. That's a CAD31 million reduction from last year where it was CAD95 million. That CAD30 million or so improvement was principally resulting from our adjustments to provisions for US personal injury and other claims. The last few years I should mention that this type of actual review and update of our assumptions typically occurred in the fourth quarter. And so if you look at it last year, you will see a similar amount taken in the fourth quarter of 2008.

All in all, 2009 the expenses a CAD1.156 billion, and that's a 20% improvement over 2008. This was also achieved while maintaining a very safe and fluid operation and network. A couple of statistics which I think are worthy of mention, our injury rate actually improved from 2.13 to 2.1 compared to last year, and our accident rate is actually down to 1.98 from 2.16 from last year. We also, as Hunter mentioned, achieved outstanding operating productivity results. And just to name a few, our GTM's per train mile improved by 7%, our cars per yard switching hour improved 29% to 39.8 cars per hour. Our terminal dwell was improved 9%, and down to 7.4 hours, while the main line GTM's available horsepower was also favorable 6%. Car miles per day, up 16% and train velocity up 11%.

Now, looking at the year-to-date free cash flow, we continue to generate some very strong free cash flow. Year-to-date, we registered CAD657 million worth at the end of September and that's actually slightly higher than 2008, even when you back out the CAD157 million which is attributable to the sale of the Weston sub in the first quarter to go transit. We are clearly focusing on cash flow, and managing very tightly the cash. As an example, is actually DSO is down to 23 days versus 27 days at the end of the year. We continue to focus in investing our capital expenditures, our target remains at CAD1.4 billion to CAD1.5 billion for the year, and we have to date spent CAD838 million. We are focusing those investments in the productivity, safety and service areas. The net debt at the end of the quarter stood at CAD6.3 billion or CAD6.4 billion, and our balance sheet ratios were very good, very strong and healthy. Our adjusted debt to total cap was at 38.8%, while our adjusted debt to EBITDA was 2.13. Now those numbers were well within our target objectives of 45% for debt to total cap, and 2.25 in terms of debt to EBITDA.

To wrap it up, maybe a few words on the current outlook. As you can see, we have delivered some very solid results in the third quarter, both on a relative and absolute basis, in what can best be described as a difficult and economic context. We believe we have seen -- we've been through the worst, and we are encouraged by the signs that we see of gradual recovery. Looking at the fourth quarter, we are cautious, however, that some of our shock absorbers are becoming headwinds. As an example, the foreign exchange in the fourth quarter of 2008 you will recall really came down and stood around CAD0.82, CAD0.83, versus we're currently running exchange in Canadian dollars at about CAD0.95. So this could translate into a headwind of roughly CAD0.04 per share. Also, and more importantly, the fuel lag is a key item. Last year again, there was a very steep correction in the WTI from CAD118 in the third quarter down to CAD58 in the fourth quarter. Now this unwinding of the lag contributed to our fourth quarter results to the tune of CAD100 million pretax. That's roughly a CAD0.17 or so headwind compared to what we are looking at this year.

I will also remind you that we did take the positive adjustments for casualty and other legal claims this year in the third quarter, as opposed to the fourth quarter of last year, and that, in itself is roughly a CAD0.04 per share difference. So in a nutshell having said that, we are remaining very focused on locking in the productivity gains which we have achieved, and gradually adapting to the progress that we are making in terms of the volume, and the business coming back. We want to ensure that we have the right level of resources to balance the service versus the productivity of our assets. So we are focusing on the smart capital spending. We continue to maintain a prudent financial management of the Company, while obviously running a safe and efficient railway. We look forward to the next quarter in the future with a high degree of optimism, and on that note I will turn it over to Jim.

Great. Thanks, Luc. I would like to go through a couple of slides quickly here, talking about the revenue performance. First slide, really just trying to put things in perspective. The Company's performance during the quarter really from a volume standpoint, car loads were 15% below the same period last year. However, volumes were 11% better this quarter than the previous quarter. Volumes clearly hit bottom in late May, and showed steady sequential growth throughout the quarter rising above the preceding week 10 out of 14 times. Sequential growth was experienced in the vast majority of our commodity groups.

We take a look at the next slide. We will go through the Company's revenues and dig a little deeper into the various segments. Total revenues were down 20%, excluding the positive impact of CAD50 million in higher revenues due to the year-over-year weaker Canadian dollar. Price increases of approximately 4% could not offset lower year-over-year volumes and reduced fuel surcharge revenues that contributed about equally to the reduction in revenues. When compared to the previous year, the decline in petroleum and chemicals reflects the lower operating rates of chemical producers, and weaker demand for petroleum based products. However, Con ags continued to show strength versus the previous year, as did new movements of jet fuel and consistent shipments of LPG's. Although car loads improved sequentially this quarter, the metals and minerals group continues to reflect weak overall markets when compared to last year.

Iron ore volumes improved throughout the quarter, as did steel products. But they still have quite a ways to go to get back to normal. Forest products also showed sequential improvement this quarter versus last, but car loads were still down 22% from last year's third quarter. Pulp mills showed the best upward movement, followed by lumber and panels, which also showed improvement, but paper continues to decline. Moving to the bulk segments, our coal volumes were higher on a year-over-year basis due to increased Canadian originated metallurgical coal shipments, as outputs from several mines increased, a mine re-opened and we started a new destination move. This was offset by reduced steam coal volume in the US, which remain very weak due to reduced demand.

Grain benefited from a strong Canadian export program for wheat and barley. However, this was off set by slow US corn and bean shipments. Fertilizers, primarily potash, continue to be impacted by the farmer's decision to delay putting down the product. Reduced north American consumer demand continued to impact overseas intermodal . Improving volumes over the port of Prince Rupert are being off set by ongoing, significant year-over-year declines through the port of Vancouver. An improving export program through the port of Halifax has started to have a positive impact there. Our domestic volumes remain stable when compared to the previous quarter. However, they are down when compared with last year, reflecting lower US and transborder shipments which are typically shorter haul lanes, and more susceptible to truck competition when fuel prices are lower.

Automotive volumes have stabilized but continue to be down significantly year-over-year. Our other revenue line item which is impacted by the economic slow down and reduced activities in the non-rail transportation businesses. We take a look to the next slide, the market drivers share, taking a look at the merchandise side of the business. It appears many commodities have bottomed out in the second quarter. As I mentioned, we are seeing sequential improvements in steel, iron ore and chemicals. Lumber and panels and automotive markets appear to be stable, albeit at a significantly lower levels. The bulk side of the business is really a tale of two countries. In the US, both the corn and bean crops are very good. In our draw territory, corn production is estimated at 6.9% ahead of last year, and 9.2% ahead of the five-year average. Soybean production is at 4.6% ahead of last year, and 1.7% below the five-year average, so very, very good crop conditions there.

On the Canadian side, the Canadian crop grain production estimates have recently improved somewhat. Wheat is expected now to be down only 1% from the five-year average, and canola up about 6%. Even though production will be down from last year, a much larger than normal carry-out should put supplies near the five-year average. In terms of coal, US thermal coal is expected to remain soft., but Canadian metallurgical coal shipments should remain positive. In terms of potash, we are not really expecting any type of a recovery until we get into 2010. Moving over to intermodal. International volumes continue to be supported by the growth at Prince Rupert, which is helping to offset the weakness in Vancouver. On the domestic markets, although down on a year-over-year basis, are clearly stable sequentially. And for all of our segments, and intermodal in particular, the Company's quality service that we've talked about is really helping support us grow volumes during these difficult economic times. So with that, I will turn it back to

Thanks, Luc and Jim, both were very informative reports. So let me just finish up this way. As Luc mentioned, and rightly so, that our safety performance during the quarter also did not deteriorate. It is all productivity gain. In fact, if you look from a dollar and cent standpoint, our (inaudible) cost I think through the year so far, is about CAD20 million improvement over last year, which was a big improvement over the year before. And the other thing I would hasten to mention is this. This was all achieved while we were having -- setting records for service, there was virtually no complaints. We are filling 99% of the car orders on a timely, guaranteed basis. And so this puts us in a position, these productivity gains, to maintain service, not taking our eye off safety, none of this is new -- to Jim's point now -- to sustain pricing discipline which positions us for long-term sustainable growth and it really excites me from a shareholder's perspective, the opportunity that as we see the rebound, as we see what this organization will be able to produce in 2010, and out years. So with that, we would be happy to answer questions the group might have.

Thank you.

(Operator Instructions)

The first question is from Bill Green from Morgan Stanley. Please go ahead.

Yes, good afternoon. And Hunter, I wish you all the best. The question I have to start is on currency, so when the Canadian dollar was last at parity, it -- we certainly saw a suffering of the transborder trade. And the economy was quite a bit stronger at that point. How do you think about how this will affect your volumes from here? Does parity actually mean you will see loss of customers and they actually can't afford to operate anymore? How do you think that will affect the business?

Well, Bill, this is Jim, the biggest area where we saw impact when the dollar moved towards parity was in the forest product business. And that business right now, is really I think to the point where we are not going to see any type of material change due to a dollar move from where they have become more accustomed in the CAD0.80 to CAD0.85 range up to a dollar. They were accustomed and had focused more on the actually higher CAD0.60 low CAD0.70 range. And so the move was much more significant, and it took them time to adapt. I don't anticipate -- certainly not anticipating the kind of issues that we saw with the move of last time.

So currency, you don't think affects growth at all at Prince Rupert? Because that's primarily, originally was designed as a US destination port anyway, is that fair?

US dollars, we priced that traffic in US dollars.

Okay, and then the second question, I don't know if this is better for Hunter or for Claude, CN's already incredibly efficient. So how do you think exploiting that going forward? You talked in the past about maybe letting the operating ratio creep up a little bit, just in terms of trying to win some new business? Is there another way to exploit that? Does it make sense to try to think about acquiring anything that is maybe non-contiguous and sort of improving their operations? Or how do you think about the best way to exploit your already beating costs?

Let me -- we will both comment. Bill, I think -- I'm not sure I agree with the term "letting the operating ratio creep." I want to move away from the -- we are not obsessed with the operating ratio. And I much rather in a high fixed costs capital intensive business like this, I much rather convert to growth and be a CAD20 billion Company than a CAD10 billion Company, just simply do the math. But there is a lag between when we announced initiatives, and ideas and concepts, and as we did short, smart yard before they kick in. And I can tell you that the pipeline is not dry of initiatives, from an operating leverage standpoint.

I guess one of the best examples I would say to you, is one of the things that we talked about earlier in year, that Claude was kind of cautious in all of that, is that if we could produce cash flow, positive cash flow like we're going to produce this year, in this kind of environment, we can be opportunistic. And so, we are going to be able to do things like probably acquire some locomotives. Year-end, I think that the board approved this morning. We got the locomotives at a pretty good price. So we are sitting and able to take advantage of those type opportunities, and there will be others like that. Now look, I am not going to walk out with the last good idea, I can tell you this. This group is too bright, too smart, and too sharp. They got a lot of things that they are going to bring to the table. I'm sure Claude has got a set of ideas that is going to take this Company to different levels. And so, I think that you are going to see the Company continue to perform and be the leader of the sector.

I would echo that and I think we have a very full pipeline of great true initiatives whether it was on the growth side or productivity side. And I think the sweet spot is, as the economy is recovering we are going to have volume working for us. And so we certainly view the next few years with a very bullish set of eyes, and we are confident that we will be able to continue to drive performance. And Hunter and I have a deal, he told me he would come out of his grave if we don't continue to perform, or if we cut the dividends, so I have no intention of having that sight come my way.

Okay, fair enough. Thanks for the time.

Thank you. And the next question is from Jason Seidl from Dahlman Rose. Please go ahead.

Thank you. Hunter, best of luck in the new endeavors, and Claude, best of luck going forward here. My question here is for Jim. Jim, you mentioned the Canadian coal being positive. If you took out the new business from tech, are there still growth drivers, would still be up?

It will be -- probably not up, but close to flat. There's the new [Holbed] mine opened, although it is much smaller and the production out there is ramping up, so it is more than just the new tech business.

Okay. And Jim, as you look out, obviously the coal markets are weak particularly in the thermal side in the US, and demand is down and natural gas is cheap, and stockpiles are high. But there is also the mountain top mining issue, that we don't know which direction it's going to go. But if it does go against some of the eastern producers, they are going to have to force coal from either the PRB or the [Elmoy Basin]. You guys have the joint venture on mid American corridor, that down the road was supposed to potentially source new lanes for Illinois basin coal. Any chance of moving time frame up, given any potential action by the US government?

We are positioned and ready to go, as soon as the need and the demand for the Illinois coal grows. And the producers there are ramping up and bringing on more mine capacity. So we are very optimistic for the Illinois basin, as well as positioned to move more central aps south and east. Or I mean more PRB coal, south and east as some of the Appalachian mines become under pressure.

So you could ramp it up quicker if need be?

Yes, we are ready to go now. Okay, gentlemen, thanks for the time as always.

Thank you. The next question is from Edward Wolf from Wolf Research.

Thanks. Again, Hunter, we will miss you on these calls. Best of luck.

Thank you.

Luc, just a little bit more clarity on the casualty. You said that you took a CAD0.04 benefit. Let's call it CAD25 million or so. I think, is that a fair pretax number? That's in third quarter. And then in fourth quarter, if we take the CAD64 million for casualty and other, and basically add that 25 back, that's more of a normal run rate?

Yes, I think somewhere around the low 90s is probably a decent run rate, yes.

Okay. Jim, can you talk a little bit about pricing, net of currency and fuel, where we are at, and what you are seeing as you start to negotiate contracts for next year, what you are expecting?

Well, I think we will stay consistent in what we expect to achieve in the 4% to 5% range. That's where we have been, with the slight variation, and we have somewhere between 55% to 60% of that locked in already for next year. So we'll maintain our focus and discipline, and that's what I would expect.

Just as a follow-up to that, within that 4% to 5%, where is international intermodal on that scheme? Is that on the high end, low end, below that? Where do you expect that to be?

Over a reasonable period of time, there is very little difference between the commodity groups in our pricing strategy. We have for a long time been focused on pricing, and have rebased or readjusted all of our contracts a long time ago. So now, and now it is more a factor of what we think is appropriate, than seeing some variations.

So for 2010, you feel the same way or do you think it is different in 2010 the longer term it evens out?

No, I think 2010 should be in a similar range.

Okay. Thanks so much, I appreciate it.

Thank you. And the next question is from Tom Wadewitz from JP Morgan. Please go ahead.

Hey, it is Michael [Weins] filling in for Tom this afternoon. Hunter, on Tom's behalf, we would like to wish you a long retirement.

Thank you very much.

I got a couple questions on the casualty line, why are you taking this adjustment this quarter, and not just waiting until next quarter?

Simply, the timing for the actual review that was performed. It was teed up and was actually completed in the quarter, so we didn't want to delay that and we just put it through.

Okay. And then on the purchase side -- purchase services side. How much of that improvement was volume related, and how much do you think is sustainable going forward?

That's probably difficult to have a precise number on that. I would say most likely half of that is probably volume related. The other half stems from the fact that we have changed some of our practices, and we have done things a little bit differently. So we have insourced a little bit more, and we've done different things. So I would say, about half and half probably.

Okay. And if I could just ask one more real quick one. Could you talk a little bit more about train length, and how close you might be to starting limits? And how you view -- how you could handle train length as volumes pick up coming out of the recession?

Yes, number 1, as you saw the metrics, we have had real top-notch performance in that area. We are building the network to effectively 11,000 foot, 12,000-foot size. Our average train length now has been in the high 7s. So we still have capacity there. All the locomotives that we are acquiring now are DP equipped. So the DP, gives us the opportunity to maintain that much more so in the winter, than we have in the past. Because the train lines which will affect our over the lake operation, where, we were looking at possibly doing the siding extensions on the over-the-lakes, two or three years ago, and it is pretty rugged territory. It is a long way. If I remember, the capital calls for somewhere in the close to CAD200 million range. And we said to ourselves, we couldn't justify it. And I'll be doggoned it, if we figured out a way to double saw up there, and you got to be a railroader to understand that term. But that group up there has, without spending -- minimal capital, less than CAD5 million capital up there, increased train speeds to 37 mph which are all time records, handling fewer trains. And so-- there's a lot of opportunities still on the train length side. And we run trains up to 20,000 tonnes on parts of this railroad. And I can tell you that that 8000 -- that last 8000 feet, and then the 9000 feet, margin on that business it is awful damn good. There is a lot of opportunity there.

Great. Thank you for the time.

We will have a quiz on the double saw, next time we have an investor meeting, Keith will explain that to you, and have a quiz after.

Thank you. And the next question is from Matt Troy with Citigroup. Please go ahead.

Yes, Thank you and excellent comments, Hunter. Best of luck. Wanted to ask a question on incremental margin, which I think you were just touching on. And specifically, as we think about volumes recovering on a slow growth or gradual economic recovery, what you would describe or quantify as an incremental margin per car load across the system. I know the averages are tough, but what is your sense for that first 5% or 10% of improvement that comes. What is the incremental margin there?

That is a pretty broad question. It's a -- let me answer it this way. If you see what we are producing today, with the volumes we are at, and we are at 62 kind of OR. And you got a high fixed cost capital business, you are going to bring additional businesses on and spread it more. That business is better than the business you got. It is good. And the next 5% is even better. And the next 5% is even better than that. So that's some pretty exciting numbers. I mean you can run the numbers better than I can. You know our all time records of quarterly OR performance. If there is not opportunities to take that cash and do something else with it, you will see some record OR numbers as a result of the incremental margins.

Right, and echoing the comments on the cash build up, certainly good cash flow numbers. You have talked about transition for focus for CN Hunter, from being the best railroad to the best transportation company in the world. And I'm wondering, with the cash you are building up, might it be time to look at investing that cash in businesses that aren't necessarily related directly to rolling stock, iron and ties, beyond the network. Might we see a strategic shift there, or should we look for money to go back to the asset-based business in the rails?

Well, a couple things, Claude should comment on this. I don't have a lot of time to focus on the long-term here. But I do think this, I think you will continue to see this kind of organization with the same kind of discipline that we've had in the past. The railroad is our core business, and we are going to take care of that first, unless something else comes up that I am not aware of. But I do think this group will be smart enough, that if we provide the cash, that if there is opportunities to go into other lines of business that the board (inaudible) the rail effort, I'm sure this group will take a hard look at it. So all these things, these ABC's that are producing these kind of results give you a lot of opportunity for Claude's team to be able to take advantage of the weaknesses in the market out there and be opportunistic. Claude, do you want to comment here?

Yes, I would echo we love the rail business. We think it is a very good industry, it's structure, and we are at the beginning of secular shift with the economy rebounding. And we believe we can improve our rail offering and differentiates what we have to offer by being willing and able to take on last mile activity, that are non-rail and help us put a a package together that makes sense to the customers and help us grow our business. That's the direction we will continue to focus on, and the opportunities are there going forward.

Great, and just a follow up to that on the CapEx side, you articulated your budget. It seems to be heavily weighted towards the fourth quarter. Can you just tell me, in terms of what if -- are there two or three big projects in the fourth quarter that will put you into the full year range? That would be helpful in just quantifying spend in the near term. Thanks, guys.

Thank you.

And the next question is from Walter Spracklin from RBC Capital Markets. Please go ahead.

Thanks very much. Good afternoon, guys. And congratulations, Hunter, and all the best on your retirement.. And just a first question on the -- you are currently in some negotiations right now with your union. It seems to be on again, off again. Could you talk a little bit about the tone with the -- it seems a lot more conciliatory compared to last time, obviously. But can you give us an update as to how those negotiations are going, and what your -- how optimistic you are that they will finish up sooner rather than later?

They are negotiating as we speak, as we sit here. I think it is fair to say the two sides are not far apart. I would certainly characterize it that way. I think both sides want to reach an agreement. We don't want to see -- neither one of us want to see a work stoppage, God forbid, in this kind of environment. So I think that -- I'm hopeful that we will be able to put out good news in a week or so, or two, that we have an agreement to the ratification.

Second question here, on your project decisions note, Hunter, you mentioned had a you -- you guys invested in some locomotives in the quarter. I am just wondering, given the amount stored in going -- switching over to DP, and taking opportunity in pricing there. Given the amount that gets stored, I would of thought you would have put off locomotive for now.

No, I think its -- there are some pressing issues there. If you look at our storage lead and you look at the productivity of those locomotives, as opposed to the newer locomotives, from a fuel standpoint, where fuel prices are and where they can potentially could be. If you look at the DP and the opportunities those give us, if you look at the lower maintenance costs, and if you look at the lower purchase costs that we were able to do it, you can't turn your back on it. It's just too compelling and too opportunistic. Now, at the same time I would say to you, that the locomotives that we think are not very efficient, that we don't want to have to put to work, we are not just sitting here have them stored, we are going to to take right-sizing opportunities when they are there, to sell those locomotives, monetize them, lease them or do something with them. But that's not -- and we have done a pretty good job in this organization of getting our fleet with our acquisitions and all, the age of our fleet had gone up. And now we are down to about the average age of our higher horsepower is probably about 11.5 or 12 years, pretty good. And it is a clear, compelling issue to replace, and go ahead and buy a locomotive.

Thank you very much.

Thank you. The next question is from Chris Ceraso from Credit Suisse. Please go ahead.

Good afternoon. This is Allison Landry in for Chris. Congratulations, Hunter. Just a couple of questions. I guess now that you are guys are done with the Memphis yard, can you maybe talk about the projects you will now tackle in order to integrate with the EJ&E into the network?

Yes. We are going to -- Claude and Keith and I will meet next couple weeks in Chicago, to try to talk about the longer term opportunities for Chicago, get our arms more wrapped around that. And there are a lot of opportunities there, further in Chicago when we make our final decisions on which is going to be the operating yard, and which ones we will have an opportunity to convert to potential industrial centers, or to use Claude's term, the last mile facilities. But there are several other opportunities. I mean, you need to think about, for an example, there is a wonderful initiative going on now in Vancouver, and their productivity at the Vancouver terminal is up about 35% or 3*%. Which is about, just that one terminal is about CAD11,000 to CAD12,000 a day savings.

So we closed Edmonton hub, the productivity is up dramatically there. The back yard is probably the highest producing yard in the world today. And every time you can do that, you open up more opportunities. So all the yards that we said we would rationalize and take advantage of those opportunities, as I told the board this morning, I looked at my list, and my final one got done when I got Edmonton done. And my final effort in those regards will be to help assist Keith and Claude with the so-called Chicago plan to try and open the door to more opportunities there.

One other question. We have heard anecdotal evidence from manufacturers in China, that US and European retailers were placing some last minute rush export orders, because their inventories were so low. Have you guys seen any of that in your international intermodal volume?

Our import volume difference in Prince Rupert continued to be very good, but Vancouver is down.

Okay. That's it. Thank you very much.

Thank you. The next question is from Jacob Bout from CIBC. Please go ahead.

Good evening. I think I at the end of last quarter, Hunter, your comment was that it felt like a bottom. Is your current thought that still things bottomed in the second quarter? And any thoughts about, is there any evidence here of a double dip in recession in your mind?

No. I mean -- I looked --that's not my cup of tea. I know a lot more about operating railroads than I do about the economy, and what will happen in the recession. But my experience and evidence of what I have looked at in the various trends, and our loading reports of the sequential growth, I think we have bounced across the bottom, and now we are starting to float to the top, how fast are we going to float? I can't tell you that. I just know that we are going to go up I think, and the higher we come up and the faster we go, the better it's going to be. And I'm not worried about the bubble popping , and going back to the bottom. And that is something that I don't have concerns

And my next question is about Prince Rupert, just thoughts of another ship visiting there, I'm not sure how early that discussion would be. Maybe you can talk about the export versus import volumes. Are we still running about 35%.

To answer your second question first, our export volumes are much higher than that, over 50% and continuing to grow. In terms of additional volumes coming through Prince Rupert, either with our existing steam ship partners or with a new customer, I think there is great interest across the board to increase that volume there. And I hate to keep saying it, but I'm very optimistic that that could happen. And I think, it's easy to look back, had we not hit the bottom with the markets 12, 18 months ago, I think we would have had it sold out. And I think what I said then, once business starts to come back, I hope to be in a position to say that we will do that in 2010.

And then, just a quick question on the EJ& E. There has been some talk about the Illinois Department of transport being able to modify the merger agreement there. Can you provide any type of an update on that?

I can tell you they can't do it. That's not their jurisdiction. We have -- we passed all the tests with flying color,s but I would say to you -- certainly we can work with them. If there are issues they have we need to deal with. To give you an update there, I think we are correct there, we have mitigation agreements now with 19 -- I think which represents about 65% plus of the population. We are kind of, no pun intended, over the hump there and moving forward with those projects. We continue to get a little opposition, but we knew that was going to happen, and with due respect we are trying to work with those people. Some of them, they said we have -- we got a correspondence this week that said, that they thought the dialogue was counter productive. There is no use having a dialogue if it is counter productive. The But EJ&E is going to move forward, and it's going to produce everything that and plus that we anticipate.

And the only thing we have asked for Jacob, is to extend the date for the start of the construction of those two grade crossings. And in actual fact, the SBD has already ruled on a similar request previously. So, It is in the hands of the SBD but doesn't impact the merger.

Thank you. And good luck Hunter, on your retirement.

Thanks, a lot.

Thank you. The next question is from Ken Hoexter from Merrill Lynch. Please go ahead.

Great. Good afternoon, hunter. Great quarter to go out on and good luck in your next phase. Just a quick number question. The other income, the CAD21 million, was -- does that include real estate in there? Is that the station that was sold? What was that bump up for?

No. The reason -- the principal reason for the difference is we sold our equity investment in the EWS back in 2007, and as part of that transaction, there was an escrow account which was kept to meet some potential indemnities. And so after a couple years, we had an amount that was released. So there was about CAD8 million or CAD9 million that came in in the quarter as a result of that. That's the real issue there.

Alright, and just jumping up over to Jim if I can on a follow up. Jim, how does the grain crop look? And I guess, a follow-on to that is the regulated grain, how is the relationship with the board following the last cost increase to the rails that went through? Any additional changes they are looking to take on the horizon, just thinking about the profitability of the business and kind of the economy we are in? Just wondering if it is getting more antagonistic or less? Thanks.

First question, the grain crop in the US is exceptional. Both corn and bean are exceptional in our draw territory, and it is going to be very strong. We need some pricing to increase so that product will begin to move. But we are going to be sitting on a tremendous amount of stock there to move. In Canada, the crop, the wheat crop, the estimates are improving for that. And although it's going to be down compared to last year, because of a significant carry forward of the crop that didn't move, it's about 13 million tonnes carry forward, versus a normal 8. When you add the crop with the carry, we should have a 5 year average. So we are sitting very good on both terms of the border of what we have available to move, when and if the pricing returns and it moves.

In terms of a relationship with the regulators, I think our relationship with the regulators is much, much better today than it was than when we were working through some of the regulatory and cap issues. We don't have a problem with that now. We understand the mechanisms, and how the prices increase and are comfortable working within that regime, and don't have any problems with it.

Thank you. The next question is from Randy Cousins from BMO Capital Market. Please go ahead.

Jim, just looking at your weekly car loads chart, you got a really nice recovery coming out of Q2, and it looks like we are not far from crossing over on the 2008 number. And again, your RTMs are performing better than your car loads. Can you give us some sense or whatever sense you are getting from your customers about the prospects for volumes for Q4? Do you see a situation where Q4 volumes are going to be better than Q3? How can you sort of shape that up for us?

Well, if you look at October, that trend lines it continues. And don't see anything in the future that would lead me to believe that what we are seeing is a gradual growth, that all of our customers seem very comfortable with. We clearly from an operating standpoint are pleased with, and its something we can get our heads around and manage through. We much rather see this, than some kind of volatile up one month, down the next, up one month, down the next. So I think that's what everybody is looking for. And yes, I would hope that -- those lines will cross hopefully sooner rather than later, but they will cross in the fourth quarter. And it is kind of a coin flip now as to whether or not we will be a plus or minus in the fourth quarter. But that's where the trend line appears to be heading.

Okay, and Hunter, your productivity numbers are spectacular and the train velocity is just amazing. As you add the volume back, can you sustain these metrics? Have these metrics been improving over the course of the quarter, or has there been some sort of ebb and flow? In other words, we see good Q3 sequential. Are we going to continue to see improvements into the fourth quarter in terms of these metrics? Or as the volumes come back, are these metrics going to kind of stall out?

The metrics should improve. Not the seasonality like the holiday period when things are going to be real soft, when you start comparing fourth quarter to the third, year-over-year is fine. But this group -- this operating group has worked very, very hard on this. They have learned a lot in a short period of time. They have gotten very, very good with DP power. They got very good with meeting long trains over the lake. There are a couple other initiatives we have got, we got one spot on the railroad where we got almost a 2% grade, that requires a real high horsepower for per trailing ton. I think Keith is working on an initiative there to get around that. So you will continue to see the productivity gains go up. If you go back -- you really want to mess your mind up -- go back and look at where they were at 10 years ago, and it is pretty staggering. But it's there and I think it will continue to get better.

So the real take away here is the productivity it is not a function of the fact there is less load on the railroad. We can add volume back without using any productivity whatsoever.

Yes, from a productivity standpoint, yes.

Okay, and on a related question. In terms of head count, labor costs are the single biggest cost that you have got. How much volume can you add to the railroad before you have to start adding people back in?

Well, I mean -- we have done a lot of things differently than others. If you look at our head count, I don't know if it is down, maybe 4% to 5%. But you take into account here we made the acquisition of short line here in Quebec, and we have the EJ&E. And we have done a lot of things for example with the hire maintenance workers, Keith took train and engineman who were going to be in laid off status, and offered them jobs in engineering. And we, to be able to keep us in preparation for a rebound, we insourced a lot of work where we used to contract it out, we are doing it ourselves.

So I think we would like to be worried that we couldn't handle all the business that came back. So that's not going to happen for some period of time. I hope it does. The only cap, the only cap that I see is they got to be miracle workers to figure a whole lot out more of terminals. I have spent all my life in terminals, and I don't know what more we can do there. But if we can sustain that level where we are now, that is powerful. But its more, the over-the-road metrics that will continue to improve.

So is it possible to add 5% or 10% volume without adding to the head count?

Absolutely, 5% or 10% is a non-event. It's effectively a non-event.

Great, and thank you and all the best .

Thank you, Randy.

Thank you. The next question is from Bill Mackenzie from TD Newcrest. Please go ahead

Thank you. My question is for either Luc or Claude. And I'm just wondering what your thoughts are, or maybe what the board's thoughts are in terms of share buy backs, as we get into sort of a better environment. This question might be premature. What is your thinking about use of cash flow? You talked earlier about invest in the railroad. And possibly looking at some opportunities outside of the railroad if those become available. But in the event that sort of that latter scenario doesn't play out, could we see buy backs return in 2010, or is it still too early for that?

As I mentioned earlier, we have got some very good cash flow up through the end of the quarter. And we foresee that to continue on, and in fact, to build momentum. Our balance sheet ratios are very healthy, so we are in good shape. And I think we will watch and see how the economy performs over the next few months. And we continue to have the same sort of sequence in looking at things. First, meeting our CapEx requirements and making sure our net worth is in top shape. I mean that is always the first call on our cash. Then obviously we look at what strategic projects that we have out there, that could make significant demands on cash. And last but certainly not least, we look at dividends. And historically, we have had a very good clip of increase in dividends ,and the last issue is stock buy back. I think those are things that we will take a little bit of a closer look at in early 2010, as we'll see where the fourth quarter actually ends up. We are in pretty good shape all things considered. So we will see.

Bill, my two cents worth, I think if the economy stabilizes, maybe that is a good going away gift to Hunter in the beginning of January.

Thank you. The next question is from Cherilyn Radbourne with Scotia Capital. Please go ahead.

Thanks very much, and good afternoon. Hunter, when we were down in Memphis, you did point to the port of Vancouver as a place on your network that might benefit from some investment to improve efficiency. And I think you alluded to a project that Keith got underway earlier in the call. Could you offer some more color on what you are up to there?

In Vancouver?

Yes.

Well, there is -- first of all, just improving raw productivity at Vancouver. We have had some -- that can from time to time be a rather congested port, particularly in grain season. So we put a new leadership in Vancouver, made several personnel changes. And there are several new initiatives going on with the CP -- we made some changes where we are not hauling from a couple of intermodal terminals. We are trucking that because of the very low volumes. And all of those things have worked pretty well to start to clear up, until they improve dramatically in Vancouver which is by far our highest cost terminal. Chicago and Vancouver are the two high cost centers we have. So to make like a CAD12,000 to CAD13,000 improvement a day in Vancouver is a huge, huge breakthrough.

There is also a couple of pinch points that will be addressed with the gateway investments of the government of Canada and stakeholders have announced that will be helpful going forward, a few road crossings, a few track extensions, pinch points in that terminal, that will help that more fluid operation going forward.

Okay. Thank you. And my second question is I presume that you absorbed the 4% sequential increase in your RTMs holding train start constant. Just wonder if you could confirm that? Did you absorb that volume with the same number of train and yard crew starts versus Q2?

There were less train crew starts. I think in the numbers were pretty close, someone will correct me if I'm wrong, but I think the road crew costs were down 12% to 13%, which probably is effectively the same, road crew starts were down 22% year-over-year. So, yes, and we can absorb more of that growth without additional train crew starts.

That's where DP comes into play. As we are rolling out., we are training our employees to be able to run DP trains across more of the territory. As we are getting the units that we are converting from the ones we already own that we are converting from DP. And the ones we will receive from early next year, of the forty that we had ordered, we are getting more DP Power Steps. And that will allow us to continue to add to our grid, those higher and longer and more efficient trains.

Thanks very much. That is all from me.

Thank you. The next question is from Benoit Poirier from Desjardins Securities. Please go ahead.

Good afternoon, gentlemen. My question, obviously you show very good strong financial performance this quarter. You talked a little bit about the NCIB But I was wondering if there is any other business ventures that you are looking at that could positively impact free cash flow generation? Could you maybe provide more color on that?

We are always looking to a highest best use approach. There is some little transaction in the real estate side whereby we are working, our operating people and real estate people are looking at the assets we own, and are basically focused on highest best use. This one transaction earlier in Toronto, was a good example of that although a larger one. And it is possible as Go Transit continues to want to own more of its network to improve its service, we certainly are willing to sit down with them and do transactions that make sense for both of them.

My second question, you talk about the DSO performance down to 23 days from 27. Just wondering if you can provide more color about how sustainable it is going forward.

I think it is quite sustainable. I think we made a number of improvements in terms of the way in which we relate to some of the customers which have had historically more longer payment terms, and so on and so forth. And keep in mind, this has been a difficult environment as well. And to do 23 days in this environment has been bit of a daunting task. So, I think it will probably hover around 23 or 24. I don't expect it to go back up to 27. On the other hand, it will be tough to bring it any lower than this.

Okay, perfect.Thank you for the time. And I wish you a good retirement, Hunter.

Thank you very much.

Thank you.This concludes our question and answer session. I would now like to turn the meeting back to Mr. Harrison.

Well, thanks again for joining us. Pretty outstanding quarter to finish on. And it's been a great run and lot of fun, and I will hopefully see you down the line.

Thank you, and the conference has now ended.