Canadian National Railway Co (CNI) 2010 Q1 法說會逐字稿

Thank you for standing by, the conference is ready to begin. CN's first quarter 2010 financial results conference call will begin momentarily. I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's first quarter 2010 financial results press release and analyst presentation documents that can be found on CN's website. As such, actual results could differ materially. Reconciliation for any non-GAAP measures are also posted on CN's website at www.cn.ca. Please stand by, your call will begin shortly.

Good afternoon, ladies and gentlemen. Welcome to the CN first quarter 2010 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. Noorigian.

Thank you, Patrick, and thank you for joining us for CN's first quarter conference call. On the call today is Claude Mongeau, our President and Chief Executive Officer; Luc Jobin, the Executive Vice President and Chief Financial Officer; Keith Creel, Executive Vice President and Chief Operating Officer, JJ Ruest, Executive Vice President and Chief Marketing Officer. And after the presentation today, we'll take questions from those of you who are listening on the call. Could you please identify yourself. In order to be fair to everyone, could you please limit yourself to two questions.

With that and reminding you again about the forward-looking statements that we've already made, it's my pleasure to introduce Claude Mongeau, CN's President and Chief Executive Officer. Claude?

Thank you, Bob, and thank you all for joining this afternoon. Let me put it to you this way -- I am very, very pleased with our first quarter results. It is clear that the economy is on a recovery mode, perhaps a little bit faster than we anticipated up until now. We have good growth across all of our businesses. JJ will give you some of the details later, but just the top line, our revenues were up 6% on a reported basis, but effectively 17% on a net tax adjusted basis. That was driven by a fairly solid volume, 16% if you look at carload, 14% if you look at the RPM. And we are very pleased that this is not just about the economy recovering, it's also about our ability to serve our customers and help them gain market shares in their own market. We've done well at supporting our customers through the first quarter and we are very pleased of the top line in terms of momentum.

Top line is not all. We have to have a good railroad and we did just that during the first quarter. Keith and his team clearly show that they are intent on keeping the legacy of operational excellence going. All of the key metrics, and Keith will give you some of the details, but all of the key metrics that I look at from network velocity, to raw productivity, to safety and to service are going in the right direction. So good top line momentum, ability to grow at low incremental cost, helped us deliver an improved operating ratio at 69.3% That's roughly 2.4 points better than last year if I exclude the impact of the EJ&E acquisition cost last year.

In terms of bottom line results, EPS were up. They were up on a reported basis. They were also up on an adjusted basis. At CAD0.80 cents, this is 25% higher than last year, but if I exclude the impact of exchange, our EPS is actually up 40% on a year-over-year basis. Cash flow, the same story. We are coming in at just under CAD500 million of free cash flow for the first quarter. Pretty solid performance across the board. But we were also able to help our results with a timely sale of another corridor in Toronto. Luc and his team did well to structure a transaction which delivered close to CAD150 million of income to us on a before-tax basis. So Luc will give you some of the details that are driving the free cash flow results at the end of this presentation.

So clearly, very solid first quarter result and I'd like to just spend a minute before I turn it over to focus on something that I'm pretty pleased of, and it's the focus on improving service and innovating to improve service within the core principles of our precision railroading construct. The second chart in my presentation shows you two such key innovations. One is on our first mile focus in the merchandise sector. I'm using just year one metric, which is our order fulfillment rate or the actual number of cars that we were able to guarantee and to deliver to our customer on the day that we promised. So you can see for the whole quarter, our performance was much better than the last two years and above the 95% range. In fact, for the quarter, we delivered 96% as promised the way we guaranteed.

But that's not the whole story. There are the cars that we guarantee and then there are the cars that are ordered that we don't guarantee and how we actually spot even on orders that we are not able to guarantee. Overall, if you look at it, the percentage of orders that we guaranteed in the first quarter is 93% and as I said, we delivered 96% of those on the day that we promised. So effectively we delivered close to 90% of the orders of our customers on the day that we had promised. This is up from last year at 80% and up from the year before, which was a tougher winter in 2008 of 70%. So you can see how we are improving first mile execution, meeting more of our customers order and how this is helping us grow market share and grow our business one carload at a time in merchandise.

A similar story on the bulk side. This one a new innovation called the scheduled grain plan, which as you can see on this chart allowed us to very much increase our ability to actually spot in the countryside on the day that we promised. We are now scheduling fully 95% of our grain business in western Canada and we were able during the first quarter to actually deliver 80% of those orders on the day that we promised. The five weeks of the quarter were at above 90%. In fact, if I peer into Q2, we've been eight weeks in a row above 90% on the day spotting in the grain business. You can only imagine what that does to service for this important business of ours and we have rolled out this scheduled grain concept to the potash service and it is giving us also very, very significant improvement in service. In fact, I believe during the first quarter, we moved a record amount of potash, which is testament to this service innovation.

So clearly those are only two of the highlights in terms of what we're focused on and we'll be happy to answer questions later. But before we do that, I will ask Keith to cover the operational highlights. Keith.

Thank you, Claude. Your operating comments are appreciated. As Claude mentioned in his remarks, we had a very solid quarter performance to kickoff 2010. With that said, I'd be remiss if I didn't start by expressing some well deserved recognition and appreciation to our operating team for their contribution to this success. This quarter, as Claude said, is a testament that our operating legacy continues as we execute our precision railroading model. This is a mind set that's rolled in our DNA. It continues and will be always the foundation for ongoing improvements in safety, service and productivity.

So let's take a few moments and look at the numbers starting on slide seven. On the operational side as we reported numerous times, this chart represents some of the key productivity measures that provide the overall temperature of our railroad's performance. As you can see, the trends are moving in the right direction. Having said this, let me speak for a moment literally to the temperature issue or weather implications on these results. If I can start by answering a question I know that many of you likely have in your mind Yes, our operating performance was helped in some ways by general better weather conditions versus last year. We absolutely can't pretend that winter doesn't have an impact on operating a railway, especially the extremes. This year, it's true that Mother Nature was pretty good to us. But rest assured we did not take a pass and let these numbers produce themselves simply by riding Mother Nature's coattails or by letting our guard down. In fact, the opposite was true. We took this as an opportunity to maintain a relentless focus on safety, on quality, continuous improvement to our service plan and on the many initiatives I'll talk about in a few moments. And most importantly above all else is execution in this railway.

GTMs per train mile up 10%. Train load measure, as you know, is a wonderful indicator of operating leverage. Effectively we moved a large part of this additional business that JJ is going to speak to on existing train service during the first quarter. Key to this success was converting these investments we've made in the past into distributed power into our long sided network and we'll continue that pursuit as we measure, we identify our performance gaps and we target to improve and refine those areas that we identify as opportunities under our operating plan. Car (inaudible) per yard switching hour again up 27%, another powerful operating leverage story, which we were able to produce in the first quarter strengthened by some of the benefits of our specific yard productivity initiatives, which include, and many of these we talked about before, Toronto, Vancouver, Chicago, specifically Glenn/Hawthorne, as well as the year-over-year impact of our Walker hub closure which we told the community about last year which took place mid first quarter 2009. And again, this metric is very much a work in progress. Much more to come on this metric.

You can expect further improvements as we continue to integrate the J transaction into our Chicago operating plan, we realign those interchanges to match our new combined railway with the connecting carriers, and, finally, the last big step in 2012, at least in Chicago, is we move from Marcum yard into our newly established and built facility at Kirk yard.

Terminal dwell 2% better. That's another measure that if you don't manage it closely, it's easy to see deterioration in this number. We stayed ahead of the curve here by focusing and maintaining the same focus that we had pre the downturn in business, proper connections, on time train performance, and an aggressive car inventory management as it relates to our terminals. We simply just don't let cars sit in the terminal, take up additional track space capacity and have to double handle those cars. Main line GTMs per available horsepower, are again 10% improvement. Providing additional operating leverage. This is simple blocking and tackling fleet renewal, it's producing space for us. Quality focus again on our locomotives, not just having our locomotives maintaining record levels as far as our locomotive availability, running I think at about 93% for the quarter. It doesn't get much better than that when you talk about routine maintenance, and the things you have to do with our locomotive fleet. So kudos to our mechanical department. And in turn, on the operating side, when you have got locomotives that are reliable, and you go out and you run long trains, you don't have them dying in between point A to point B and you don't experience the congestion in your terminal. You maintain a fluid network. Velocity is driven by this. Finally, the discipline with the fleet size you're able to maintain as you keep those locomotive sized to the existing business.

Car miles per car day up 10%. This is another key measure. Simply put, car inventory management, if you get this right, you maintain your fluidity across your corridors, both in your terminals and your main line, and you drive the overall health of the network. Train velocity up 7%. This is something we got hot and heavy to about 18 months ago. This is a pure productivity measure. Train speed, you increase train speed, you turn those assets faster, you can convert additional revenue, you can reduce locomotives, you can reduce cars. And this is something, as well as we go forward, we're not done. We continue to identify any pinch points in our system, making surgical investments in 2010 and we'll do this on a go forward basis as well as we continue to optimize our network driving throughput and train speed velocity. Basically overall the productivity measures in the first quarter produced significant momentum which, as we all know, is carrying us into the second quarter in a very positive way.

Let's turn to slide eight for a quick wrap up on some of our continuing areas of focus. From the operational side, as I've said, this increased drive for productivity is far from over at the CN. We'll continue to create leverage as we roll out the next phases of the EJ&E plan, focus on quality, fuel productivity. As Claude mentioned, scheduling of potash, coal and US grain operations. We've got a mechanical facility rationalization ongoing. Engineering productivity enhancements, just to name a few. Suffice it to say the pipeline of our initiatives at CN is full and this leadership team will continue to add more to that pipeline.

This mind set of precision railroading, we continually challenge ourself in every initiative. And initiative has got to deliver on multiple front. It's got to deliver on the safety front, on service, on productivity and on people. And speaking of people, year to date, let me tell you that we've hired 777 employees, we've lost about 670 to attrition. As we go forward, our plans are built around growth, productivity and some very realistic attrition modeling. We've actually refined our integrated planning process which brings together as a team our finance department, human resources, marketing and operations together at the table as we go through and make our attrition planning. And this insight not only allows you to handle your work force requirements, but we're also using this same analogy and the same strategy on locomotives, cars and plant capacity.

Safety, at CN, as we said before as well, that's a tenet, that's a foundation of this Company. We can't be successful with our operating model unless we operate safely. We've had great success in 2009 and in 2010 as we go forward reducing main track accidents which tend to have the greatest impact for our operation, our people and the public. We continue to place our intense focus and scrutiny on the non main track accidents and personal injuries which we have an opportunity to produce and drive the similar results. Many of the initiatives in regard to focus on safety are a key component of our CN's culture. We continually engage our employees in order for them to work with us to address the main causes of these accidents and injuries.

Finally, we had the mechanical and transportation team do a full review of our locomotive requirements on a go forward basis, both road and yard. They came up with a plan which will cascade additional 3,000-horsepower locomotives to our transfer and yard service. We will continue our modest opportunistic purchase of highly efficient DP, capable road locomotives and will retire an entire class of yard locomotives. As a result, we'll see increased reliability, asset standardization, improved fuel efficiency among many of the benefits.

Wrapping it up, that's a quick snapshot of our low incremental cost part of the ops leverage equation you see at the bottom of the slide. Believe me, there are a lot more initiatives I can spend time elaborating on today, but in the interest of time, I'll turn it over to JJ to speak to the growing the business side.

Thank you, Keith. You now know how we moved 16% more carload than last year. We do it with excellent railroading, customer-centric first mile and last mile, and commercial agility to exploit the turnaround in this (inaudible) industry.

They say a picture is worth a thousand words, so look at page ten, the carload graph. You can see the sequential growth in both 2009 and 2010. The carload growth recovery started in the latter part of 2009. In Q1, 2009, we had a carload drop of 17% versus 2008. In Q1 2010, we gained back 16% carload and 14% revenue ton mile. The recovery has taken hold in most of our markets.

If we move to page ten so we can look at the revenue on the exchange adjusted basis, you can see that our revenue grew 17% in the first quarter of 2010. If I peel that into the volume, price, mix and fuel, the volume, especially expressed in terms of RPMs, allowed us to increase revenue by 14%. We experienced growth in all of our business segments with double digit increase in metals and minerals, coal, automotive, grain and fertilizer and the volume continues to remain strong into the month of April. Our carloads were over 90,000 for the first time this year during week 15. The last time this happened was in the fall of 2008. Now is the time for railroad to capitalize on the recovery. The fuel surcharge made an extra 3% of revenue of which, helped by the 14% increase in RPM, but also helped by the fact that the WTI was stronger.

Price came in just under 3% all in, including the drag of the Canadian regular grain, which is now currently at minus 6%, and the impact of the RCF related index and some of our legacy agreements, namely the iron ore where the industry produces minus 20%. The reason I mention that is because both of these commodities, Canadian grain and iron ore, generated very strong volume in Q1 and are expected to remain very strong volume for the full year of 2010. Still, we're aiming at a 4% same store price for the remainder of the year and we forecast regular grain to turn positive sometime in August in our estimate 6% to 7%. And this RCF index will eventually become double digit increase like, for example, in the case of the big haul agreements which become positive July 1 and in the case of iron ore, it will be July 1, 2011. The mix for our business was about minus 3%, especially because of the change in length of haul where iron ore is such a significant impact on our business this year. Iron ore is moving on a shorter mile than most of our business.

Now, let's review the same revenue on the exchange adjusted basis, but now looking at business by business. Petroleum and chemical was up 6%. The petroleum side was up by 5%, mostly on the back of strong molten sulfur going to North American fertilizer plants in the south of the US. At the same time we had three refineries which experienced some production problem in the first quarter and have not produced as much refined product as in the past. Chemical was up 6%, mostly on the back of improved industrial production, which translated into higher production in that segment. The metal market for CN was up 14%. Metals and minerals was up 22% in total and metals itself was up 14%, mostly flat rolled products, (inaudible) coil, which picked up, not in the beginning of the quarter but sometime in the quarter as the steel mill production were actually coming back into a bigger volume. Minerals was up 22%, especially aggregate as well as frac sand. Iron ore was up 39% in adjusted revenue basis. The North American operating rate for the steel mill is now over 70% and that has translated into railroad iron ore shipment for our franchise in Q1, 2010.

Forest product in total was up 8% for revenue on an exchange adjusted basis. Lumber and panel were up 18%. Despite no significant increase in US housing starts, lumber and panel volume had improved 16% as a result of restocking activities, as well as continued improvement on the carload on the case of lumber to Asia. China has changed their building codes now allowing wood frame construction and China has actually generated half of our carload growth for lumber to Vancouver this quarter. Pulp and paper up 3%. It's the tale of the true story. The paper remains weak and the industry will cause you to go through a structural change on declining North American demand. However, the wood pulp has actually been very strong, wood pulp as a very high price, and we are seeing in the first quarter and the second quarter some pulp mills in western Canada coming back to production. Most of it on the back of pulp being exported offshore, namely China.

Our coal revenue all-in Canada and US were up 38% on an exchange adjusted basis. US coal was only up 1% primarily because of the result of a long haul production problem with one of our big mines, but also because of soft demand for terminal coal as it relates to high end inventory and low natural gas price. Canadian coal, on the other hand, was up 91%, mostly driven by very high production rate with steel mills in Asia, especially China which is really driving the Canadian coal export, which is mostly met coal. But also in this quarter, which is quarter 2008, we have two new pieces of business, [orebed], which is a new mine, and tech, but also petroleum coal coming out of the burn upgraders has also picked up because of the price increase in the world market.

Grain and fertilizer up 15%. US grain was up 6%. We had weak corn export but that was partly offset by ethanol and DDGs. Canadian grain up 2%, mostly on the back of a strong wheat export Fertilizer up 70%, mostly on the back of potash. As well our revenue was up 15%, the strongest part was overseas. We've experienced very strong growth in Port of Prince, Rupert, improved volume in Halifax, improved volume in Montreal, and improved volume in Vancouver, all improving strength in the economy, the two economies that we serve.

Domestic was only up 5%, but we saw significant improvement in our domestic business, which is mostly Canadian on the second half of the quarter, and actually right now we have a decent run rate growth in our domestic business intermodal. Automotive was up 68%. Ford and GM in our Ontario and Michigan plant franchise have come back fairly strong as well as imports from the two coasts. Finally, other revenue were up 17%. These are supply chain revenue that were linked to iron ore, like the dock and a vessel or to the automotive business like the auto port.

Let's look on page 12 where we'll talk about the market outlook for these same different sectors. The stronger North American initial production will be felt for the remaining of this year. That means North American steel mill will restart and ramp up production rate, GM and Ford are doing much better in the automotive segment, plastics and chemical are feeding a wide range of manufacturing process in North America which should cause to improve. Of course our North American iron ore traffic will remain a very large factor of our carload growth. Jim Vena and his operating team moved 45% more carloads in the first quarter this year versus last year. The CN iron ore supply chain revenue docked vessel and rail could exceed past historical peak in 2010. We're also investing in some unit train fleet to support that renewal of that market.

Bulk in general looks promising for this year. Our scheduled grain service, as Claude and Keith have mentioned, has earned us raving reviews from our customers and we believe over time that will give us some market share points. Price and demand for offshore met coal is very, very strong and our Canadian mines are basically shipping at their production capacity. In fact, the excellent supply chain focus from mine to vessel, Mike Cory and his western operations team has contributed to one of CN's best quarters for coal ever with 108% growth in 2009. First quarter this year in coal, in Canadian coal has been a record. Petroleum coal from Alberta is also coming back and coming back in the world market. Again, it's a West Coast export and we're considering some investment in Fort McMurray for help with that pet coke export. US terminal coal will remain under a cloud. Natural gas is staying below CAD4.50, and gas will maintain its market share with electricity generation which therefore leaving utilities struck by a fluctuation and export as a potential ray of light for US terminal coal.

February and March saw a recovery of the North American potash sales in North America. Demand exceeded original forecast of our two last customers and CN exceeded the expectation of our two last customers in that market. The new operating plan that Keith put together for the potash, scheduled potash, has really helped our customers, as well as ourselves on the volume side. Our overseas business has never really slowed down. Rupert has shown some very strong growth. Halifax is showing growth. Our (inaudible) Montreal shares improve. Vancouver is also improving. We expect volume for the West Coast going forward to be improving and we have good news in terms of the level of capacity for the Port of Rupert in the second and third quarter.

Our domestic business (inaudible) has picked up momentum especially in March, partly because of the economy, partly because of the internal reorg and the rebalancing of our approach with customers. We expect this momentum to carry as we further tweak our IMX product and improve our wholesale service offering. The carload trend this month to date is good. We have significant growth versus last year in many segments, especially iron ore, auto, construction material and overseas. Just as important, we also experienced some sequential growth from quarter to quarter and month to month, for example, in domestic intermodal volume.

Wrapping up the commercial update, the marketing reorg is now solidly in place. You will meet the team at our June investor meeting in Chicago. We have met most of our customers in the last two months. They like the CN customer engagement approach. They like the first mile and last mile initiative. The mood is positive on the business outlook and the mood is positive toward CN. The recovery has taken hold in most of our market. We foresee our carload growth for 2010 to be in the low double digits and same store price to be in the range of 3.5%. Luc.

Thanks, JJ. I'm pleased to report some very strong financial results for the first quarter of 2010. As Claude mentioned earlier, our adjusted EPS has come in at CAD0.80 per share, which represents a 25% increase over 2009 and a full 39% increase when we exclude the impact of foreign exchange. As JJ pointed out, our revenue growth was solid, at 16% increase in carload volume and 14% growth in RTMs and GTMs. This translated into a 6% revenue growth which, when expressed again in constant currency, is a 17% increase versus 2009.

Our operating team under Keith's leadership delivered exceptional operating metrics and so our operating ratio came in at 69.3%. That's 2.4 points better than 2009. Now, what's impressive about this is that the team at the same time was adding flexibility in our precision railroading model with innovative first mile, last mile initiatives and scheduled grain and potash plants. This led to better service metrics and car spotting performance that Claude highlighted earlier. Our operating income was at CAD603 million, a 25% improvement over 2009. Again, an impressive 41% performance excluding FX impact. The reported EPS came in at CAD1.08, which is a 20% increase over 2009, a 29% increase on an FX adjusted basis. It does include CAD0.28 of EPS contribution from our gain on the sale of a subdivision in Toronto. In the 2009 results, we also had a transaction of the same type and other adjustments which contributed CAD0.26 to the reported EPS.

The FX head wind in this quarter was very important as we had mentioned earlier in previous calls. As the Canadian dollar exchange went from CAD0.80 last year to CAD0.96 this year, that had an impact of CAD0.09 on our EPS and our 2010 results.

Turning over to expenses on page 15, our expenses came in at CAD1.362 billion, which is an increase of 8% on an FX adjusted basis. The main area that saw some cost pressure were fuel, with an increase on an FX adjusted basis of roughly CAD100 million. The price of oil went from CAD43 in terms of the WTI in 2009 to an average of CAD79 for the quarter in 2010. Fortunately, this negative impact was offset in part by continued improvement in fuel productivity, which was up 7% at 244 GTMs per liter. That contributed some CAD13 million to offset the negative variances.

Labor was up 11% and this was largely the result of higher accruals for stock-based and incentive compensation versus 2009. Just keep in mind that the CN stock moved about CAD4 up in this current quarter. We also had a little bit of pressure in terms of US healthcare costs. However, we did not have to incur significant writeoffs in terms of deferred tax assets such as was seen in some US companies. Our lower casualty and other expenses was about 16% improvement and mostly due to some EJ&E acquisition costs which were incurred in 2009. Otherwise the only thing worthy of mentioning was a slight increase in terms of our actual accruals for workman's compensation on the Canadian side.

Turning over to free cash flow, very solid performance. We generated free cash flow of CAD493 million at the end of the first quarter. This was up CAD286 million versus 2009. This change was mostly driven by better operating results as well as lower tax installments. Point worthy of mentioning is our DSO which actually stood at the end of March at 18 days, which compares very favorably to 21 days at year end and 26 days in the first quarter of 2009. This is a record for us and a very strong contribution in terms of cash collection. We stood with cash on hand at the end of the quarter at CAD748 million, that compares to CAD352 million last year. Our capital and debt ratios are very healthy and our total indebtedness net is at CAD5.5 billion.

Turning to page 17, our revised 2010 financial outlook. On the basis of our first quarter results, which were very strong, as I mentioned, and also an improved economic outlook, we are now revising our guidance for 2010. On January 26, we expressed our guidance in terms of aiming for double digit growth over the CAD3.24 of adjusted EPS, diluted EPS. We are currently looking to, and we're actually aiming for now, some solid double digit growth over 2009, again starting from the same premise of CAD3.24 in adjusted diluted EPS. In addition to that, and as a result of both the asset sale and the better outlook for the year, we're raising our free cash flow guidance from around CAD700 million to approximately CAD1 billion. We also have improved or increased our capital budget for the year. We raised it by CAD100 million from CAD1.5 billion to CAD1.6 billion. We see opportunities out there to improve and accelerate our locomotive renewal plans as well as securing assets at opportunistic prices and conditions. This will continue to help us improve fuel productivity, distributed power rollout, productivity and also is part of our greener footprint.

So we have, again, strong momentum and we're looking for solid double digit growth in 2010 and on that note I'll turn it back over to you, Claude.

Thank you, Luc. It's a very good note to turn it over to me. As you can see, this team is geling together. We have our eye on the ball. We're focused on helping our customers deliver to their own end markets and we are helping them leverage this economic recovery, which is, as I said earlier, starting on a stronger note than anticipated. We are focused on protecting the legacy of operational excellence that was developed over the last several years under Hunter's leadership and you can tell that Keith has not missed a beat and is doing just that. So quality, top line growth, engaging our customers, running a fluid network, these are the conditions that are required to continue to deliver solid shareholder value, not just in 2010, as per the revised guidance that you heard, but well beyond.

And with this, I will be happy to turn it over for question and answers.

Thank you. We will now take questions from the telephone lines. (Operator Instructions). The first question is from Tom Wadewitz from JPMorgan. Go ahead.

Good afternoon. I think, Claude, you commented on focusing a bit more with customers, trying to be a little bit more flexible than perhaps the approach for a number of years. And I notice you mentioned the comment on some scheduled service with respect to cars in areas that you perhaps haven't done in the past. What do you think the financial result is and what kind of a time frame would you look for it just in terms of the direction? Is it just increased market share or is it a little more price or how would we look at the potential impact from what seems to be a little bit of a change in focus?

Tom, thank you for your question. I would just say that I think it's a continuation of our focus on innovation and operational excellence. We first had to get the hub to hub performance right and we believe we are leaders in the industry in terms of hub to hub performance. The public data that's out there, in fact, the Canadian Service Review Panel that is studying this will show that CN in terms of hub to hub performance is clearly a leader in the industry. So having that hub to hub component down pat, our focus is on the first mile, last mile. We're now focusing in terms of flexibility for the merchandise sector and how we can tweak our car, our guaranteed car order program to allow more flexibilities for our customers to be able to make orders as opposed to with a ten-day cutoff, they can do this on a seven-day rolling. For instance, we're focusing on our ability to be more precise in our spotting performance to the date or within the switching window. So these are incremental improvements, continuous improvements that are helping us grow the business. To the extent they provide better service, it will support our pricing over time, and it's very much a continuation of what we've been able to do under our precision railroading model for the last several years.

Now, the scheduled grain plan is perhaps more of an innovation. This is actually something that started several months ago, before I became the CEO at CN. This was incubated under Hunter's leadership with the very team that's managing today, Keith and Mike Cory out West, and it's really an extension of our same basic principles. It's about asset efficiency, it's about scheduling, it's about assigning our crews, it's about working with the customer to bring the cars on the day that we promise and have them load within a window of time so that we can keep the crew and keep the locomotives all tight and then get the cars right back out on the pipeline going to the waterfront. So, again, improved service, improved asset utilization, to the extent we have better service, we hope to be recognized in the market with a little bit more business. It's tough to put a number on these initiatives, but they are clearly long-term initiatives that will allow us to grow a little bit faster than the economy, to support our inflation plus pricing, and to keep our network fluid and keep our margins and strong operating metrics turning into bottom line.

Okay, great, that's helpful. Then I have a follow-up for Keith. You may have mentioned this, but I don't think I caught it in terms of the change in road train starts in the first quarter on a year-over-year basis. And then a sense of how much capacity is there in the current scheduled network you have?

Tom, number one, capacity is not an issue. I can tell you this. Train starts, we moved about 13%, 14% more GTMs. And actually train starts, which is a good measure from train miles, are only up about 2% to 5%, it all depends on the time period you're looking at. So essentially we've absorbed the business. And the difference in the train starts that are up, actually the merchandise traffic we've absorbed. We've got some increased potash business unit trains as well as some of the coal and some of the grain that's driving some of our numbers, which if it were not for those, our train starts as well would be down. So overall yard starts, yard costs are down, road starts, road costs up marginally, but not anywhere close to where the business is as we have absorbed, and if not for those bulking of trains, likely we'd be flat or better on that metric as well.

Okay. Great. Strong results and thank you for the time.

Thank you. The next question is from Walter Spracklin from RBC Capital Markets. Please go ahead.

Thank you very much. Good afternoon, guys. Just on the pricing question, I notice in the assumptions for your new guidance, you put in an assumption for 3.5% pricing. I was just wondering, is that a forecast, is that what you're expecting to achieve or is that just a conservative assumption you're putting in and you've got some flex on the upside? And perhaps relate that to how your core pricing did in the first quarter this year.

In the first quarter, we came in slightly under 3% all in. And as I explained, with that in mind, the heavy weight of the carload that we're experiencing in some of the segments, iron ore and Canadian grain and inn fact those two are working negative right now, this is all before the end of the year, be more in the range of 3.5% than the range of 4%. So, looking for pricing above the inflation, but with those two things in mind.

Okay. Second question here is just on rail service and, Claude, it was timely that you mentioned this. I think it is a focus of some concern, I think, on the regulators' side up here in Canada. I think, as you know, they've started a little bit of an investigation into rail service. You pointed out some very good metrics that show some promising results here. To what extent are you perhaps worried that your customers might be saying too little too late? Or maybe not even too little, just saying too late? And at what risk are we looking at potential regulatory changes that increase the burden on you from a service perspective from the regulators?

I think we have a good story to tell with the facts that are in front of the panel and our own submissions, which will expand on those in the not distant future when we put our submission to the panel. Again, I said earlier our hub to hub performance at CN is, if I can say so, world class. We clearly, from a transit buying standpoint, our performance in the merchandise sector is in the range of, order of magnitude, 25% better than other rail carriers for a given distance. So hub to hub, we have a good product. We have made a lot of changes over the years and you make changes and you make them fast and you create a little bit of ill will, but there's no question we made those changes for the right reasons, and the facts to date would show that our results are in line with the innovation that we brought to the table. Our focus on first mile, last mile, our focus on the customer engagement is the natural next step. And I don't know, quite frankly, I think the service review panel, I think government stakeholders, as they look at the facts, will realize that it's better to provide for the commercial incentive and let the deregulation policy that has been so successful to improve the rail industry in Canada and in North America more generally be the dominant factor going forward.

You're not concerned from a regulatory standpoint on the service issue?

No, I think we have our case to put forward, but I think the facts are speaking loudly. And I think we will be able to convince the panel and the regulators that the commercial incentives are there.

Okay. Thank you very much.

Thank you. The next question is from Bill Greene, from Morgan Stanley. Please go ahead.

Good afternoon. Claude or JJ, I'm curious if you've had any conversations with some non bulk shippers lately? Do you sense they're stilling running with lean inventories and will restock later, or do you think this is the volume level that's indicative of a new normal in inventory management? Is there a restock to go from here or how do you think about that? What are they telling you?

I think it's a combination of both. There is some restocking in some segments, like for example the service center in the steel industry, but at the same time there is also some fundamental increase in the total demand. So it's a combination of both and it's depending at which stage you are in the recovery for each of these segments, if you're the early stage or the late stage. Like I think in the case of Canadian coal, for example, they are running flat out. I think you get a combination of both, it's a question of which stage are you at in each of these different segments.

So if there is some more restocking to go throughout some of your customers, if I straight line your current trends on volumes, it seems like you would be much better than your guidance on low double digit volume growth. So what are you assuming will slow down then in the second half?

When you look at the second half, your comparable, especially the fourth quarter, the fourth quarter of last year, we were already in a recovery. You will see that the second quarter, it was basically the bottom of the recession and after that some of the segments, namely iron ore, for example, was tough to come back sometime mid second quarter last year. So it's a combination of your comparable versus the sequential run rate that we experience right now.

Right. But wouldn't you expect to see some pickup in the areas where you don't have the restocking having started in full swing yet?

Possible, but I think the way I would put it to you, Bill, is that there is still a lot of year to go and this economy, while it is clearly recovering faster than anticipated, and I believe out of a solid trend of demand, there's still uncertainty out there and some sectors are not doing good, like the housing starts, for instance, are actually coming down. There's still a lot of uncertainty out there. So we'll take it one quarter at a time and we believe our guidance at the moment is appropriately focused.

Okay. Just one quick one on PTC. Do you have an estimate how much you'll spend on that in 2010? Thank you.

2010 or overall?

Overall or even what's in your CapEx for this year.

The whole envelope for the project which will be rolled out for 2015 for us, order of magnitude, plus or minus CAD200 million and we'll spend about CAD13 million or CAD14 million of that in 2010 as we ramp up.

Thank you.

Thank you. Please note that we'll ask for you to keep your question to one plus one follow-up. The next question is from David Newman from National Bank Financial. Please go ahead.

Good afternoon, gentlemen. Just in terms of you mentioned that you're hiring ahead of the curve. Obviously volumes coming back. How much are you building in versus your planned growth, especially in the second half? Obviously volumes are surging at this point given easy comps. And overall in terms of cost structure, how much do you think you might be carrying and what will that do for your operating ratio as you head into the summer and the fall?

That's a mouthful but let me put it to you this way and Keith can add to it. We're into precision work force planning, so we do not want to hire too early, but we certainly do not want to hire too late. So what we are doing is just advancing a little bit our hiring ahead of the attrition. But we have a very good handle on exactly when we believe people will leave and we just want to make sure we have enough time to get them properly trained and get them onboard and available. And if we're surprised on the upside, we have the resources. If we're surprised on the down side and the business comes a little later, then we know we have to carry the resource for only a few months before we face other attrition. So, really, it's all part of running our business. You'll see this extending well beyond 2010 and we are trying to think about it as precision work force planning and make it right.

Do you think you'll exit the year flat, Claude, 2010 overall in terms of head count numbers?

I don't know exactly how we're going to go about it. We're certainly hiring one for one on transportation, but we do have opportunities to continue to hire in the other areas, hire not one for one, whether it's three for four or two for three, depending on the area. We're not hiring for every attrition that comes our way. So you should see us climb back up slowly. I would expect that we might be under last year still by the time we turn Q4.

Okay. And your pricing expectations for 3.5%, how much have you booked so far? And given that your volumes are obviously recovering and your service is improving, what do you think the run rate on price could be as you get towards the latter part of the year if volumes continue to come in the double digit range?

As JJ said, I think our focus is to price in mind with the quality of our service, to price ahead of inflation. Our core pricing assumption at the moment remains in the range of 4%. We do have issues with regulated grain and RCAF segments which have significant declines, but which this is temporary. So for the balance of the year, I think our assumption on an overall, on 3.5% is our best estimate at this point, but our core pricing is still to aim in the range of 4%.

Okay. And just a quick one on the housekeeping, tax rate was 24%. Any guidance on what it could be for the year?

We're still looking around 29%.

Okay. Very good. Thank you.

Thank you. The next question is from Ken Hoexter from Banc of America, Merrill Lynch.

Hi, guys, it's Scott Weber sitting in for Ken Hoexter. Just a quick question, a follow-up, in terms of an earlier question. You mentioned that capacity wasn't an issue. Could you quantify at all where you guys think you are in a utilization level and how much additional capacity you could take on before more costs come back on?

I can tell you this. We're not back to 2008 levels yet, which we're not at 2006 levels and in 2006 and 2007, there's not a corridor I would have talked about, whether it be locomotives, whether it be cars, whether it be people in our track and terminal capacity. I wouldn't have said we've got at least 30% or 40% capacity. So capacity is not an issue. We still have quite a few cars that are in storage versus the same time last year. Effectively our active cars online that we're moving this additional 13% of GTMs year-over-year, we've got a flat car inventory, which says that as we move this railway very efficiently and as we maintain our velocity and increased speed, we just create additional capacity. We expect to get better, not worse. I think we've demonstrated by our results this quarter, that as businesses came back and exceeded levels of last year in the first quarter, we've absorbed it. We've actually improved from a velocity standpoint and created additional capacity and that's where we will continue.

Okay. Great. And just in terms of potash, how much would you say so far this year, what would you say the split is between domestic versus export? And what are your expectations for how that ramps up throughout the rest of the year?

In the case of CN, the vast vast majority is domestic, North America, where participation on export on the west coast is nil at this point. So when we talk about potash, we talk about the North American market, by and large, except the one mine in New Brunswick was shipping offshore. It's short distance, it's not big revenue.

Okay. Terrific. Thanks, guys.

Thank you. The next question is from Jeff Kauffman, from Sterne, Agee, go ahead.

Quick question for JJ and Luc and one for Claude, as well. I was looking at the changes in your guidance and it was interesting because the housing starts came down about 10%, theoretically that's revenue negative. You're talking about the Canadian dollar rising in theory, that's revenue negative. You're talking about an increase in crude from 75 to 85 and that's probably worth CAD11 cents to annual earnings. So you have all these negatives, yet you're raising the outlook from high single digit to double digits, so arguably maybe it's CAD0.15, CAD0.20 hit you're taking on the guidance changes, but yet you're implying maybe CAD0.20, CAD0.30 plus of incremental earnings. That's almost a 15% jump from where you were and I'm just picking arbitrary numbers. But what is really driving the increased outlook? Is it more costs than utilization or are there components of revenue that I didn't hit in the guidance changes?

It's really a combination of all of the things which you've outlined. Perhaps with the exception of the price of oil, which really doesn't have much impact at the end of the day because that flows through with the fuel surcharge. We have, indeed, we're now looking at US housing to be lower. The volume is much stronger in terms of the overall business, the pricing was indicated in the carload volumes by JJ, I think, quite rightly. We did anticipate in our initial guidance some FX impact and that is pushing a little bit more towards the far end of that. So, I would say it's generally a stronger business in terms of volume, with a few exceptions, and otherwise just the good, solid operating metrics which we're delivering, and so we're able to take on the additional business at low incremental costs.

I think that's the story, Jeff, as we have more business coming our way, the economy is stronger, we're making good progress with our customers. And that top line, with a good, solid operating performance, we are able to bring it to the bottom line because we are growing at low incremental costs.

Okay. Thank you very much. Let me follow this through to your free cash change in guidance. You're raising your free cash estimate CAD300 million and your CapEx CAD100 million, so really it's a CAD400 million increase in operating cash flow that you're implying. If I raise my income estimates by 10%, 15%, maybe that's CAD100 million, CAD150 million. Can you help me bridge the gap for the additional CAD250 million to CAD300 million of incremental cash flow, whether that's coming from the big gain on sale that you mentioned that may not have been in previous guidance or whether it's working capital? What is driving the remainder of that free cash improvement?

I think Luc gave you pretty good guidance on this. Clearly our improvement is tied to the link to the sale in the first quarter. That helps us to the tune of almost CAD150 million and then the rest is the improvement in profitability and the fact that we've been doing very good on working capital management. I think the guidance is pretty self standing, Jeff, and I think you have to take it and run with it.

Okay. Guys, thanks so much.

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

Good afternoon. There's so many good things going on here. I was wondering if you guys could talk about, one of the things that sits out there is an opportunity, and you mentioned thermal coal being weak in terms of volumes. Could you give us some sense as to, you've got that mid-American project that you're working on with Norfolk Southern. What's the status with that and how much of an opportunity do you see in that thermal coal business, looking longer term as opposed to the issues that you're dealing with right now?

The mid-America initiative with NS is still on. During the recession. because of the recession everybody was conserving cash, including our partner, so the upgrade of the short line has been delayed by a year and a bit. So we're looking probably at 2011, 2012 before the service is actually offered to marketplace. We're doing some pre selling of that. It's only 2011, 2012 we'll see how the mid-America offering is received by power generation plants as it relates to our US coal. But it is a potential upside for beyond this year.

Okay. And, Luc, with reference to the comp, I wondered if you could give us some sense of the quarter to quarter? I guess it was up about CAD57 million. How should we think about what was the cause of the change from Q4 to Q1 and can you give us some sense of what you would think of as a normalized run rate for comp?

The biggest change in terms of the comp, as I mentioned, was the stock-based compensation. The stock price for CN moved a fair amount, over CAD4.00 in the quarter, so that's really what's driving it. So I would say, again, it all depends. There is some volatility around that and it all depends on where you see the stock going. We hope labor continues to go up on stock-based compensation in future quarters, if we can, Randy.

Don't we all. Thank you very much.

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

Thank you very much, gentlemen. First question on your balance sheet, when you look at your balance sheet it was pretty solid with almost CAD750 million of cash. You did some buy back purchasing 2.3 million of shares, and you increased also your free cash flow. But given this strong performance, should we expect more share buy back in the near future and what are the opportunities with your current flexibility on your balance sheet at this point? Thanks.

In terms of the share buy back, as we indicated, the plan, as been approved by our board, is to buy back 15 million shares. So far at the end of the quarter, we had acquired 2.3 million shares for roughly CAD129 million and so we continue on with the program and we have every intention to fulfill the mandate. As you've seen, from our revised guidance, we've got free cash flow around CAD1 billion so I think we do have quite a bit of flexibility. Our coverage ratios are excellent and so we don't anticipate any issues on that front.

Okay. And my second question is related to Prince Rupert. It seems that you made some very good numbers in the quarter. Could you maybe share with us some metrics and give your expectation with respect to Prince Rupert this year and maybe in the next two years?

The metrics that we look at first and foremost is the service metrics from Rupert and different cities we serve and the service matrix, as Keith mentioned, where the last haul has been excellent. So Rupert as well as services from other ports is really attracting share fraction by fraction. In the second quarter of this year, the current shipping line using Rupert are going to bring in a third port of call in a different service. They actually have this scheduled out right now and we hope that they'll be successful in the marketplace and the volume will slowly continue to ramp up during the course of the year.

Thank you, Benoit. And Benoit, as you know, because you're from Montreal, we are all gearing up here to, we have an AGM cocktail, but I have my eye on the Canadians game against Washington. And I hope there are not too many fans of Washington on this call because this team here is all focused on tying the series and giving ourselves a chance to perhaps go the long haul. Let me just wrap up this conference call to say that we are, again, pleased with the first quarter results. We have good momentum and we will be meeting you pretty soon in June, all of you that are interested. We will be organizing an investor day, so you'll have a chance to meet with the new marketing team, some of our new key people and more importantly listen from the CN leadership team what we're trying to do and how we're going to take this great Company forward. So thank you for this call and I hope you have a safe day.

Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.