Canadian National Railway Co (CNI) 2010 Q2 法說會逐字稿

Welcome to the CN second 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, Dave, and thank you for joining us for our second quarter 2010 financial results. I would like to remind you again about the comments that have already been made regarding our forward-looking statements. With us you today is Mr. Claude Mongeau, President and Chief Executive Officer; Luc Jobin, Executive Vice President and Chief Financial Officer; Keith Creel, Executive Vice President and Chief Operating Officer; and JJ Ruest, Executive Vice President and Chief Marketing Officer.

After the presentation, we'd like to take questions from those of you who are listening on the call. Could you please identify yourself when asking the question, and we really like to be fair to everybody so could you limit yourself to one question with one follow-up. Thank you. With that, it's my pleasure to introduce Mr. Claude Mongeau, CN's President and Chief Executive Officer. Claude?

Thank you, Bob, and thank you to all for joining us this afternoon. We're very, very pleased to announce our second quarter results. They are good results. The economic recovery is taking hold, and we were able to turn in both solid earnings growth and strong free cash flow generation on a year-to-date basis.

Our EPS for the quarter specifically is C$1.13 which is up 38% from last year on a reported basis, but if you look at it on an adjusted basis, it's up actually close to 50% on a year-over-year basis. This was driven by the top line. The economy, obviously, helping but also our service and our ability with careful planning to handle the business was key. Clearly, some sectors and I just mention a few here.

JJ will give you more details, but automotive at 52%, coal at 49%, and nickel and minerals at 46%. It takes a lot of solid work and careful planning to be able to help your customer handle that kind of growth in a short period, especially coming back from the deep recession that we all faced last year, particularly in the second quarter, actually of 2009.

So our revenues overall are up 18%. The volumes are up, 27% on a carload basis, and 15% on an RTM basis, the main difference between, between the two is mostly around short-haul iron ore movement, but both indicators show the strength of the recovery up to now in 2010.

We are trying to do our best it help our customers with strong supply chain focus and service improvement to accommodate that business growth. And we are doing so at the low incremental costs. Our operating ratio is improving quite significantly on a year-over-year basis, a little bit more than six points. Keith will give you some of the key details why we were able to do so.

Clearly, our precision railroading model, our focus on operational excellence and our goal to accommodate business at low incremental cost is clearly coming through, and that reflects itself in the earnings momentum and the improvement at the level of the operating ratio. I said earlier our free cash flow was very strong indeed.

Luc will give you more detail but for the first six months, we are at around C$958 million of free cash flow generation, clearly a strong performance, some of it driven by the sale that we were able to do earlier this year, but nevertheless, strong, strong free cash flow generation that bodes well on a go-forward basis to our ability to create shareholder value.

Just turning briefly to the next page in your presentation, I just want to say a few words about how our game plan is unfolding. This is the second quarter that we report as the new executive team here at CN, and we are basically firing on all cylinders, our strategy is working. Everything is with precision railroading at the core, but clearly our focus on accommodating the business at low incremental costs is coming through.

People were concerned that with an added volume, you would see some of the fluidity and velocity metrics suffering, and that's clearly not what we're seeing. We've been able to continue to improve in this regard, and that comes through in terms of our results. The more important point is we are improving in terms of velocity and fluidity and key productivity metrics at the same time as we're improving service metrics for our customers.

Our focus on first first mile, last mile, our focus on supply chain initiatives, and our focus on engaging to understand our customer's business is paying dividends, and we are continuing to focus in this regard. We call it deeper customer engagement or supply chain innovation. At the end of the day, it's about finding ways to work hand-in-hand with your customers so that we can help them grow and as they grow, help us bring the volume, the top line to our bottom line so that we can continue to create shareholder value for many years to come.

And at the moment, can do so as we accommodate the economic you can recovery which we hope will continue despite the uncertainty that it will continue into the balance of the year for 2010. And Luc will give you later a little bit more about how we see the world unfolding for the balance of the year. So with this I'll turn it over to the team starting with Keith.

Okay. Thanks, Claude. As you captured in your comments, solid team execution continues to be a key ingredient in our success story. As the operating guy, I'm honored to lead the team that executes this operating model day-to-day and we do it by ensuring we operate in an environment that above all else we protect the safety of our franchise, our employees and the communities we operate in and through.

In turn, this environment gives us a sustainable platform that allows us to deliver the superior service our customers deserve and expect, and do it at the same time with tremendous operating leverage that's allowed us to absorb the volume growth that we've experienced at a very low incremental cost. As you can see from the quarter's financial results, they indicate we've had some success in this area, but at CN we realize one thing, financial success is only the output of our efforts.

So let me take a moment to walk you through some of our key operating metrics and our initiatives. So on the operational highlight slide you're looking at, some of these metrics we share with you each quarter with a small addition I'll mention in a minute about our terminal dwell and training velocity measures that we've added to this portfolio.

Starting with the upper right side, you can see that we've continued our improvements in trainload measured in GTMs per train mile. This is railroad raw productivity at its best. Our highly safe and efficient eco-friendly trains, which I've heard some refer to as long trains, drive the best use of our crews, our locomotives, fuel and our network capacity resources and investments.

This 7% year-over-year improvement you see was driven by our careful management of our train starts as our traffic started to ramp up, continued to ramp through the year. Our Distributive Power initiative continues to pay benefits as more and more of our traffic is moved in our [safe, high efficient]. Approximately 35% of our road fleet is now DP equipped DP and that number will move to about 50% by the time we finish our 2010 and 2011 locomotive plans.

This goes hand-in-hand with our [rifle shot] capacity investments, speed enhancements in our network which I'll discuss in a moment as well. The net result is more traffic on the same number of trains which obviously provides the tremendous operating leverage that we benefit from.

Below that you can see that our locomotive productivity, measured as GTMs per available horsepower, continued its record improvement as well. This is a reflection of the increase in trainload that I just mentioned and our cultural of continuously matching our locomotive fleet inventory to the workload at hand.

And like any railroad a lot of our expense is generated in our yards. This represents a significant opportunity for delays, misconnections and service issues, so this is an area that we have always focused on and we will always focus on.

We measure the results here in a measure we call cars handled per yard switching hour. The key levers include minimizing your car inventories, you continuously adapt your service plan with a view to minimize your car handling. You match your yard resources to the demand and your overall network strategy that we've deployed which maximizes the workload at our low cost operating, or processing centers, Winnipeg, Toronto, Chicago, Kirk Yard, and, of course, Memphis.

Next is car velocity which we measure in car miles per car date. As you can see, this metric is basically flat year-over-year. There are a couple of things here that are happening with respect to mix. Some of the growth we've had with some of our slower moving fleets which impacts that number, and also the fact that we spent all the second quarter 2009 literally stuffing over 25,000 cars into storage with the economy.

And since then, of course, the rate that we've added service back in 2010 we've been very judicious with it, so we've not seen the stepped improvements that's driving the flat year-over-year comparison. Having said that, the main reason we look at car velocity to me day to day is a barometer of our proper inventory as far as our fleet management.

And here I can tell you the team did a respectable job. JJ is going to tell you in a minute we moved about 15% RPMs in the quarter versus last year. With active online inventory is was only 5% higher than 2009. And at the same time, our car order fulfillment rate was up two points year-over-year, as well as we focused on filling our short lead time orders.

On the note on the right hand side of the page you'll see that commencing this quarter we've adopted the industry standard AAR measurements for terminal dwell and for train velocity. In line with that change our measures are available directly on the AAR website along with those of our peers. You can see from the time series that our efforts to drive out all types of failures, eliminate network bottlenecks and increase track speeds in key locations are all having the desired effect.

So this year, for example, we're going to continue at extending two sidings at our Edmonton and Prince Rupert corridor, two others on the Winnipeg to Chicago corridor, one in northern Ontario, and at the same time build a much needed bypass track to run our yard in Saskatoon. We've also phased investment program to increase our track speeds in the Superior area which will allow our trains to tackle some of our most challenging grades on our system with our initial train velocity.

Operational overview, I would hope that you would agree that this team of railroaders has continued to deliver on the operating side. These productivity metrics we produce allow us to tell JJ and his team to keep selling and we'll move the business at a very low incremental cost, and we'll harvest it to the bottom as we recover through this economy.

In line with close leadership and our collaborative operations and marketing approach, this operating team is not satisfied with just helping JJ and his team grow in step with the recovery. We want more business than that. We want more customers. We want more from each customer and we're prepared to earn it one carload at a time. So both myself and my operating team have cleared time in our schedules to work directly with the marketing team and engage with our key customer accounts.

You've probably read about some of these supply chain collaboration agreements that CN has pioneered under Claude's leadership as well. Making these collaboration agreements will be more than just words on paper. It requires a significant amount of work and committment.

Rest assured, myself and my team are directly engaged with our supply chain partners, while at the same time standing side by side with our marketing peers in the key individual accounts. As far as our pipeline of productivity initiatives, those continue, we add to them. These include car shop consolidation. This quarter, we've closed the car shop at Centralia, we'll close Fond Du Lac in August.

Our locomotive fleet plan that we've talked about previously has come together with 62-8s now online giving us about a 15% fuel efficiency gain over the locomotives that they've replaced. DP, of course, continues to be a key piece of that strategy. So with that said, I'll turn it over to JJ for the marketing review.

Excellent. Thank you, Keith. If we could join me on page ten, the graph of the carload graph. The second quarter really began where we left it off in the first quarter and we continue sequential improvement in growth in our volume.

We've had [7%] sequential carload growth from the first quarter of this year. We've had 27% carload growth in the second quarter of last year and this really reflect the stronger than expected recovery in the North American GDP and the initial production. It is also reflecting of the impact in the marketplace of our improved services and some of them Keith mentioned.

Like for example (inaudible) sector, the scheduled service that we offer to our bulk customers, as well as our very strong focus on content, container velocity across the supply chain and [model] this when it's on the railroad. And not to say the least, we are all engaging with customers. You've heard Claude, Keith, Luc and myself, and all the senior leaders in operation and marketing spending increasing amount of time with customers and understanding their needs and what creates value for them.

We go through page 11, slide 11, you'll see the number for the second quarter. During the second quarter with the support of our customers our revenue were up 26% on an exchange adjusted basis. If we break this down, again, on an FX adjusted basis for the quarter it is explained as follows: [16%] of increase in revenue was related to volume, rail volume reflected by the [RPM] workload which was up 15%. [RPM] is a much better measure of our volume due to significant increase in our R&R business, which is (inaudible) it's our other [carload] business.

We've also increased our revenue from price, same-store price remain about 3%. However, when one adjusts for the Canadian (inaudible) grain and our legacy contract which have some RCF type price indices, our core pricing would have been up in about 4%.

We have also obtained 4% increase in our fuel surcharge revenue because of the significantly higher (inaudible) and highway diesel pricing compared last year. Also because of our industry leading 90% universal application of our fuel surcharge program, which is really it's up to 98% when you include [regulary] grain as well the RCF legacy contract that we have.

Other revenue were also contributing to the total, contributing 4% and these other revenue were driven by our vessel and dock, mostly iron ore as well as significant turnaround in our automotive business, (inaudible) as it relate to carload. Now going to the major segments, starting with manufacturing. The manufacturing sector contributed $216 million of growth on an exchange adjusted basis for the quarter.

Petro and chemical was up 16%, mostly because of improvement in industrial production and refined, refined product. Metals and mineral was up a whopping 46%, but that's because typically the major impact of iron ore but also because of the consistent recovery of steel segment which is now running up around 70%, it went up to close to 74%, went down a bit a bit, but fluctuating at a good pace.

All of this has translated to a very high increase in carload, not only iron ore but also flat roll product and [long] product. Also our success in metals and minerals is related to Keith's team effort and focus on the first mile which also produce some extra point of market share against the trucking, our trucking competitor in the steel market. Forest products were up 16%, in part because of the restocking activities in North America as well as export to China.

Automotive was up 52% because of the stronger production level from CN (inaudible) assembly plant that we have in Ontario and Michigan as well as our entry in the Chicago dealer market by the opening of an auto port back in (inaudible) Chicago at beginning of the year. Our bulk segment was up $73 million on exchange of adjusted basis, of which coal contributed 49%. We have very strong offshore demand from China, Korea, Japan, of Canadian met coal as well as Canadian [all pet Coke] products.

Our U.S. thermal coal carloads have also increased 19% in the quarter, which was a nicely thing to see. Grain and fertilizer was up 6% on the back of increased demand for fertilizer, mostly potash but also corn, however, this was offset during the quarter by volume of export feed grain, namely oat and wheat. Finally, but not least, our Intermodal business was up $91 million on an exchange adjusted basis in the quarter or 25%.

We had very strong import and export on the West Coast. In June, the Port of Vancouver volume reached a level similar to 2008, which was nice to see. Our activities at Rupert have also seen some new all-time high with its bigger three-vessel per week services.

Retail volume on the domestic side, continued to improve reflecting the improvement of Canadian economy but also as well as the traction of our very strong customers' engagement in the marketplace. All in all we had a great quarter, which we're pleased with it and pleased with support from our customers. If we move to slide 12 just for a short outlook. On the manufacturing sector, we expect carload to remain on the same pace or the same range.

The North American initial production anticipated to remain in the same range. We see some mill in the case of forest products to come back, whether it's for lumber or wood pulp which would increase carload available to us coming from our preferred customers. We also see some ramping up of construction aggregate, especially northern Alberta, whether it be the all-sand and activities in oil and gas is coming back significantly this year versus last year, as well as the result of our customers' engagement as we further roll out first mile, last mile initiative in the carload market.

On the bulk side, the price and demand for offshore met coal is very strong as well as pet coke. A warm summer has helped thermal coal in the U.S. which is expected to continue for the balance of the year. The Canadian grain seedings were very low this year as it relates to the past, but we expect the crop, therefore, to be lower.

We've had a good carryover from the last year and when you combine that with our new scheduled grain service, which will be this time ready for the beginning of the crop, we expect the impact of the smaller seeding to be mostly in our case of CN affecting us in 2011. The U.S. crop is promising (inaudible) late this fall. We're on standby to be able to handle one of our customers receiving those orders from their own customers.

Finally, in the Intermodal, the Asian container import in July considered to be very strong as well as the export of goods in empty containers in July also very strong. And the Canadian retail volume continues to improve steadily as our customers' business expands and we caution you to focus on our service and environment where we competing with truck and trucks supplies getting tighter.

In conclusion, we are positive about the business prospect for the second half of the year. We're definitely gaining momentum with our strong customer engagement, as well as supply chain approach initiative with key stakeholders like port and terminal. For the total year, we're looking for volume growth in the mid-teen area. Luc?

Thanks, JJ. Well, it's a pleasure to be reporting great results for the second quarter and certainly as well for the first half of 2010. I think where we set out, we're achieving what what we set out to do which was to leverage the economic recovery and our results are showing that in spades. As Claude pointed out, we have been making progress on all key performance metrics, whether they're operating productivity, service related, in terms of providing the great service to our customers, and our financial results for our shareholders.

We're delivering adjusted EPS of C$1.13 for the second quarter and that's a 49% improvement over last year. Indeed when you adjust for foreign currency, you actually get 59% improvement over last year. As JJ pointed out, we actually made some strong progress in all parts of our business. And this was obviously comparing to last year, which was the trough of the recession.

Our revenues came in at C$2.1 billion, which is up about 18% versus last year. And that's 20% on an FX adjusted basis. We also saw growth in all of our commodity groups, and our RTMs as was previously mentioned increased 25%, our carloads 27%.

Our operating ratio was a low 61.2% in the quarter, which was a full six-point improvement and for the first half of 2010, our operating ratio stands at 65.1%, which is a full four-point improvement over last year. Turning to expenses for the second quarter. Our total expenses came in just under C$1.3 billion which was up 7% versus 2009 on an FX adjusted basis that translates to about 15% increase.

The major area, category, of increase was in the fuel. Fuel line, which was mostly due to higher prices, as the WTI went from C$60 last year to C$78 this year. As well, the volume obviously was a big contributory, and that was partly offset by continued improvements in terms of our fuel productivity, where we had about a 3% improvement in the second quarter.

Our labor costs went up about 6% on an FX adjusted basis versus 2009. The principle reason for the change was wages, which have increased, and a little bit more overtime. On the other hand, our manpower was up as well a little bit 1%, so a very small increase in terms of overall manpower, 1% overall, however, we probably had about 3% in the running trades.

In terms of other changes, casualty and others was up a little bit from last year. An increase about $30 million in second quarter. Mostly due to some higher legal and environmental costs across several small items. However, I should point out that on the first half of the year we're tracking with last year and we're about only C$4 million above last year on an FX adjusted basis.

It's important to go back and just keep in mind that these financial results are stellar. These expense levels in terms of the business that we've been able to accommodate are exceptional. The trainload actually went up 7% to about 8,000-gross tons per train. Our cars handled per yard hour has gone up 9%, and our labor productivity in terms of million GTMs was up a solid 13%, just an exceptional productivity results from Keith and his team.

Turning over to free cash flow, as Claude pointed out, C$958 million of free cash generated in the first half of 2010. And that's almost $500 million more than last year. Obviously, this is attributable to better operating results, as well as lower cash taxes in Canada it, and the sale of our Oakville subdivision to GO Transit in the first quarter of 2010.

We continue to accomplish our objective in terms of repurchasing our stock, our share buyback program we've now completed slightly over half, so we have about 7.7 million shares, which have been bought back in the first half of the year. We have a net debt position of about C$5.6 billion, and that is net of about C$900 million of cash, which we had on the balance sheet at the end of the second quarter.

Now, let's turn to our updated financial outlook for 2010. As you can see, we've had very, very strong first half results, and we expect the economy to continue on its gradual course of recovery. We are mindful of some of the concerns in terms of some parts of the economy, and we do expect the pace of growth to be lower in the second half, simply because we also were seeing some of the start of the recovery back in the second half of 2009.

We don't, however, at this point, and JJ I think covered that in quite some detail, we were not seeing any slowdown in terms of our traffic, and we do not expect a double-dip economic scenario at this point. On that basis, our revised guidance is for adjusted diluted EPS. We believe we have the scope to achieve an increase of approximately 25% in 2010 over 2009, which was at the C$3.24. As well, we see our 2010 free cash flow to stand in the range of about C$1.1 billion.

That's, as well, reflecting the very strong cash that we've generated in the first half of the year, our increased earning forecast, the proceeds that we realize on the sale of our Oakville subdivision, as I mentioned, in the first quarter and lower cash taxes in Canada. We're using this opportunity as we expect to make an additional voluntary contribution to our pension plan in the order of C$250 million.

This will come to improve the funded position of our plan as we feel that it is prudent given certainly the less than stellar equity returns that we have seen, and the prospects for a continued low interest rate environment at least for the short term. All of that, will translate into solid shareholder value creation. On that note, I'll turn it back over to you, Claude.

Well, thank you, Keith, JJ and Luc. As you can see or hear, clearly this leadership team is clicking. We are delivering on our game plan. We are trying our best to help our customers accommodate the recovery and, from our side, we are leveraging it by accommodating at low costs. There is strong team execution.

We're focused on our mid to long-term game plan with a range of initiatives, many of which are focused on engaging with our customers, and finding ways to continuously improve our business from the platform of operational excellence that has made CN what it is.

So our focus is on keeping the momentum. I think the guidance that Luc is giving you for the balance of the year, if the economy holds on its path of recovery, is something we can deliver, and if we succeed at that we should have a strong finish to what is a first year for the transition of this new leadership team. With that, I will open, Operator, to questions.

Thank you. Questions will now be taken from the telephone lines. (Operator Instructions) The first question is from Jason Seidl with Dahlman Rose. Please go ahead.

Good afternoon, gentlemen. If I can, just on the guidance on the cash flow side, it seems a little bit low concerning what you guys generated in the first half of the year.

I mean, you've already done a billion already and I get that you're going to be paying out another C$250 million. Do you have more capital spending planned for the back half of the year than you did in the front half?

Yes, I mean, we have, we have about a billion dollars or so of capital spending, which will be taking place in the second half. I mean, this is consistent with the C$1.6 billion capital program that we've you laid out, and if you look in the, in the results, we've got about C$0.5 billion or so done in the first part of the year.

Okay. That makes sense. It's the extra CapEx plus the additional C$250 million payout and that will make up the difference, right?

That's correct, Jason.

Okay. Perfect. Thank you. I appreciate that. My next question. You guys obviously have had a little bit of a slowdown or at least a work stoppage in the Port of Montreal, I wonder if you could give is an update on where we stand right now?

Well, I think the parties at the Port of Montreal are in discussions as we speak, and we are hopeful that they will find a resolution to the conflict and the labor dispute in short order. My comments would be the following, I think it just goes to show how important railroads and port infrastructure are to the economic backbone of both countries in North America. And it just puts a lot of emphasis on making sure the parties find ways to come to agreement to solve such labor dispute.

I'm hopeful that they will do so in short order. In the meantime, for us the impact is not really material. We are trying to help our customers handle the business. Some of them are moving to other ports, including Halifax, and we are working in partnership with terminal operators and other stakeholders to try minimize the impact of cargo owners of this labor dispute.

Claude, what I found interesting was that when you go on your customer site today, this took sort of second place to a little blurb that you guys had put up there about, hey, CN is ready for peak season and listing through sort of all the steps that you've take tone prepare for the additional freight coming on. Could you talk about that? Do you have a lot of shippers calling up and asking if you guys are prepared for this peak season and just talk about the expectations and the mood this year versus maybe the prior three?

Well, I think, our customers are able to see what this team is available to deliver as we speak. I mean, I just go back to what JJ was explaining to you. Our overseas business, for instance, at international containers has been, it's been a very, very strong surge for the last two months or two months and a half on both coasts, both on the West Coast and Vancouver and Prince Rupert, but also here in Montreal and Halifax, across the board.

So we are showing our ability to accommodate that business. It's not without challenges, we've had some hiccups inside our terminals, for instance, in terms of our ability to serve the trucking community in short timeframes with the so call [carter] time, and, and other small issues to that effect. But what our customers are seeing is that we are able to accommodate very strong growth while improving service levels and that bodes well for the balance of the year.

Okay, guys. Thank you for your time as always. I'll let somebody have at it

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

Yes, hey, good afternoon. I wanted to ask about the OR. So if we think about the investor day and some of your longer-term targets there, you're already better than that here in the second quarter, and I realize this can bounce around a bit. But how should we think about the fact that you're better than sort of the longer-term guidance? Does this mean that you're going to try to just grow the earnings faster here even if it means higher OR or how do we reconcile those two?

Well, Bill, let me put to you this way. Our CFO has given you a guidance from kind of sustainable mid-60 operating ratio. If you look at the first half the year that's exactly where we are at around 65%. I stand by his guidance for the long term, but we'll certainly do everything we can as a team to beat it if we can.

And for sure the second quarter results and our ability to accommodate the initial rebound of growth at the very low incremental costs bodes well. At some point, though, you do get step functions and that initial capacity available has to be lapped out and you have to add resources more in sync with volume growth.

So we'll do our best to meet or beat the guidance that we've given, and over the long term, we'll see whether we're able to do so.

Okay. So along those lines, how should we think about the head count as you're volumes grow from here? Could it stay flat on a full year basis in 2010 is it sort of, no, we've already hit that inflection point, we've got to start adding back?

Our head counts are up 1% in the second quarter, with about 3% increase in our running rate. And we are doing everything to stay ahead of the curve, and we have opportunities for products to be gained in certain areas, and we will make sure we have running trades and locomotives, engineers ready to accommodate the business going forward.

So I think the model we've discussed is something that would have us grow our workforce in line with, with the business volume over time, keeping in mind that we're trying to accommodate this business with productivity gains and the growth will not be proportional.

Okay. Thank you for the time.

Thank you. The next question is from Chris Ceraso with Credit Suisse, please go ahead.

Oh, thanks, I actually had a follow-up on the labor question. Is there a contractual increase in wages that kicks in the second half? Or what do we expect for the balance of this year and next year on the wage rates?

I mean, we have collective agreements, which have been adopted, and so we're looking at roughly, I mean, ballpark about 3% growth in terms of wages. There's no, but there's no significant change in the second half versus the first half.

So.

The only change -- . It may have, if we were to settle the [TCRC] but again that's going to be second half

So, so you had a 3% increase in the first half versus a year ago, so yet you managed to keep wage and benefit costs flat year over year despite that?

Actually, if you look on it an exchange adjusted basis, our labor expense is up about 6%, Chris, and a 3% or so, is wage, a little bit more from adding over time, and the rest is the slight increase in workforce and noise around other aspects of labor expense.

Okay. That makes sense. And actually a similar question with regard to the effect of FX. How much of the difference between RTMs and carloads was FX versus mix or other factors?

Yes. There shouldn't be any impact there, Chris, because our carload is carload, this is physical count, and we have more carload growth because we had a lot of short-haul movements, particularly the iron ore. Our RTMs, again, are physical counts of the movement of goods over a distance for the tonnage, and that's up 15%. So both measures are not really impacted by the FX conversion.

Wouldn't that have depressed the revenue ton miles relative to the amount of freight that you moved, though?

No, the revenue per revenue ton miles it would but not the RTM versus carload.

Okay. All right. Thank you.

Thank you. The next question is from Jacob Bout with CIBC, please go ahead.

Good afternoon. I had a question on pricing renewals. You talk a little bit about pricing going into the second half of the year, how much has been over your book has been repriced and just how the customers are responding? Are you seeing a little less push back with the rebounding economy?

A high percent of it is only put to bed, I wouldn't provide specific numbers. And the, obviously, the customers are still coming through the recession, they are in the early days of the recovery. They too are putting price increases into their own markets. Some of them are very significant like you've seen in the coal market, some other market may be in early days of changing their price. So it really gets down to the value we create and who we compete with, and right now with our guidance we're able to get price increases on a steady basis in the range of the 3.5% in the guidance for the end of the year as Luc has provided in the documents.

Okay. Maybe my next question then would be on the flooding that we've seen in Western Canada, maybe talk a little bit about how that impacted the second quarter and then how has that changed your outlook as far as grain volumes going into 2011?

On the grain, the flooding in Western Canada, obviously the seeding was less this year, number one. Number two, the carryover from last year's crop to the next year's crop is higher because the Wheat Board has not been able to sell as much of its product as it first thought, last winter, and last spring.

And then when you add to that, our desire with our new scheduled grain service to really start early this year with our program we think that for the next six months we should be all in, we should be able to close to what we did last year in our volume.

But when you get to the second half of next year, which is the second half of the crop then we will see the impact that the fact that there is going to be less crop coming in the bin this fall. So short-term impact this year limited, but we'll see the effect next year.

I'd just add to that, Jacob, obviously, with wheat prices going up, it's not just Canada having less production but also droughts in Russia. So with wheat prices being up, the fact that the Wheat Board has available carry to sell into the fall should help cushion the impact of the lower production for 2010, but as JJ says, the early part of 2011 is when we should see lower grain volumes

And as far as the second quarter was concerned, was there any impact with the, with your competitors main line flooding?

No. From an operation standpoint, maybe, Keith, you want to explain what we did to help CP, but for us it was not nearly an impact like, like it was for CP.

Yes. Not, not a material impact to us at all. In fact, we work closely with CP to allow them to continue service taking detour trains, probably upwards of close to ten days over our main line out in Alberta going through Edmonton to Winnipeg and a couple other routes that they run.

But certainly we worked close with them and allowed them -- and I think at the end of the day they would say this and told us, hopefully helps them recover their network which at the end of the day is good for the industry and good for our relationship and good for all the freight that we interchange together, and as we work together on a go-forward basis.

Some day that you shoe may be on the other foot, so we've always tried to approach it from that respect. We're not going to kick somebody when they're down. They're our partners we're going to help them as much as we can.

All right great. Thank you.

Thank you. The next question is from Ed Wolfe with Wolfe Trahan, please go ahead.

Good afternoon.

Hi, Ed.

Could you break out the reported yields, the revenue per carloads in terms of the impact from price fuel mix and FX?

On the price, we've got 3% price increase, that's when you, when you take into account and we still have some RCF, some grain legacy. On the fuel we've got 4% and the revenue came from from the fuel surcharge, a change in BTI and the highway diesel. And on the volume, we've got 15% as we mentioned early, all related to our RTM. And then there's the last 4% which comes from other revenue.

The revenue which is not rail, therefore does not contribute to the RTM, but, nevertheless, it's a significant revenue for us, that's all operation. Dock, autoport and the transload and that generated us of 4% of the total 26% on an FX adjusted basis that we talked about.

But if I want to look at total carloads yield down 9.5% year-over-year, and prices up 3% and fuel is up 4%, what's the impact of FX and mix to get me to negative 9.5%, what am I missing here?

I think you should better look at it from an RTM standpoint, Ed, because from a carload standpoint you have a huge mix impact from the short-hail moves of iron ore that are up on a significant basis on a year-over-year basis. So I think if you take the 26% revenue growth and you break it down on a per RTM basis that's the best place to look to.

Oh, okay. So I guess the answer is, there's a big impact from mix and we've got to think about it the other direction.

Correct.

That's the difference between a carload -- yes.

We'd be happy to help you further on an offline basis, but I think that's, RTM is the better gauge of volume and how to break down the key pieces of revenue growth.

Fair enough. Claude, when you think about the operating ratio, seasonally, there's not a reason why third quarter should be worse than second quarter, is there or anything that you can think of other than a sudden change in demand or something like that?

Well, take the good and the bad that comes to you in the quarter. It's tough to predict what the third quarter will be until it's done, but there are no major differences between Q2 and Q3.

It's the, the more important drivers that, that would have a seasonal impact are Windsor, our capital program, and those aspects are not very different from, from Q3 to Q2. But in the second quarter, we had a tremendous amount of growth and we are accommodating that early phase of growth at very low incremental costs because we have the available capacity now.

Our ability to continue to sustain this level of low incremental costs diminishes over time and that should start in Q3 and Q4 of this year.

Are there any signs yet of a slowdown in export met coal or export any of your products at this point?

Coal is holding up in the West Coast of Canada.

When you say holding up, is there, is it strengthening, kind of doing what it's been doing or is it slowing but still strong? How do you classify that?

I'm looking at the inventory of our customers at the mine and those inventories we keep them low which is our job, and, therefore, we're moving everything they can make (inaudible) as they can.

The answer's we're not really seeing any slowdown, in fact, there's good growth in this market.

Okay. And are you hearing from customers anything about inventory one way or another, whether it's above normal levels, whether there's restocking going on? Any concern about that from anybody that they don't have enough inventory or that they're going to need less inventory going forward, either way?

We've seen a lot of inventory replenishment in the first six months of the year, and, and we believe that unless there is a, a contraction in the economy, that the continued demand should be helping our customers continue to drive volume going forward.

There is obviously a lot of chatter, Ed, and it's tough to call whether, whether demand will falter or whether other issues will creep up, and if, if people will have to trim production and start to be more cautious about inventory. At this point in time, we don't see that. And we are, we are hopeful that the balance of the year will continue on that pace.

Last question, just in terms of the CP revenue that came across your track, where do we see that revenue show up and how much of that was in the quarter?

It's not a large amount. And it's an in expense recovery, Ed.

So it's a contra expense basically?

That's correct, I believe, yeah.

Okay. Thank you.

Thank you.

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

Thanks so much. Good afternoon, everyone.

Hey, Walter.

Just two questions really here for JJ. You mentioned the other revenues that had a really nice spice here, up over 30%, almost 40%. Can you talk a little bit about the sustainability of that kind of increase? I know that in the past you've been running, back in 2000 -- through the years you've been much lower than the 250 run rate you've been getting now. Is 250 the right rate to run that forward on a quarter basis now?

You're referring to (inaudible).

Other revenues.

Other revenues? Other revenues for us are really in large part related to the carload revenue. When carload goes up these other revenues tend follow it because they are linked to it like iron ore, automotive, transload activities, some freight forwarding.

So right now, maybe because of the, how low they were last year and how related, how they're related to iron ore they were significantly higher. Iron ore right now, frankly, is running very, very strong. I can't say, maybe there's another 10% iron ore that we could see, that is if the mine can actually run at those rates.

So on a more normalized basis is that closer, that's lower than the 250, I guess?

I think on a normalized basis going forward, we should see other revenues subject to iron ore continue at this space or in that range.

Okay.

But on a year-over-year increase we're not going to see a 40% increase going forward.

Right. Okay. That's great. Second question here, also for JJ, I know there's a question on pricing and how, did you, did you reference how much you booked for 2011, given your current contracts that you've already negotiated so far?

No, I did not. And we're, we're not providing that specific information to our, to publicly

Well, how about in terms of your average length of contract still around two years, two to three years, is that a fair statement?

We have the whole range. Just tariff. One-year contract, two-year contract, long-term contract when it is valuable. The length of the contract is maybe at this point slightly drifting up and that's because there would be reasons to do that if a customer's making major capital investments or the like.

Okay. All right. Thank you very much.

Thank you. The next question is from Tom Wadewitz with JPMorgan, please go ahead.

Yes, good afternoon. I wanted to ask another question on the other revenue, which I guess you indicated that's going to keep going at a pretty strong pace. Does that tend to be similar to the overall margin or is that a lot lower margin or how would you think about that?

Actually, when we look at these other revenue, we also track same-store pricing for that, we track volume, how much is volume related, how much, same way as we manage our other business, we also look a operating ratio. The operating ratio for these other revenue in total is not at the same level of the railroad. But at the same time, the capital investment in these other activities is quite different. They're different business, they're as profitable but they're not the same type on the capital investments.

You also have to recognize that, Tom, in this are passenger revenues, for instance, [via] revenues. Other revenues is all other revenues, and some are asset intensive, some are not asset intensive. I think they are on a different basis than the normal rail revenues.

Right. So it's different type of revenue, obviously, and, but it's not going to be accretive to OR, if anything, that would be a slight drag on your OR in the quarter having a big move up in the other revenue.

Yes, it would be actually, yes.

Okay. Let's see, in terms of the per worker cost, I know it gets tricky to model you've got currency and you've got stock-based comp and other things, but how would you look at that going forward in terms of the year-over-year change in per worker comp and benefits, for like the third quarter, fourth quarter?

I think you said it yourself, Tom. It depends a lot on stock-based compensation and a lot of other moving parts. I think the important point for you to remember is other than those volatile items which are very difficult to predict but for which you have good guidance, a dollar up on the stock price tends to add C$4 million or C$5 million of stock-based compensation. And the other sensitivity that we've disclosed in and informed you about, the other piece is wage increases in the range of 3%, and and whatever our workforce addition will be going forward.

Right. Okay. Great. Thank you for the time.

Thank you. The next question is from Cherilyn Radbourne with TD Newcrest, please go ahead.

Thank you very much. Good afternoon. I wonder if you could tell us how many train starts you added in the quarter and just how that compared to the 15% increase in RTMs that you accommodated in the quarter, and give us some sense of your ability to add volume through your existing intermodal and merchandise trains, recognizing that I'm asking you to make a generalization there because it's going to vary by corridor?

Train starts up about 7%, with the volume that we saw, so quarter-to-quarter, so Clark, solid job of sorting a lot of that volume was just in trains. Train linked up, train load up significantly, and the second part of the question was how much more, is that --?

Yes, how much capacity do you have to continue adding cars to your existing intermodal and merchandise train starts?

Well, just looking at the averages, and there's, this is not a perfect science, but effectively you've got a 10,000-foot railroad and if you're average train length is 7,200 feet, I mean, that tells you that in some corridors it will be more. Quite a bit more, and in some corridors, probably the most restrictive or the most constrained corridors -- and constrained is probably not the appropriate word, I would say at least 20%.

Okay. Thank you. And then for JJ, I think you made some reference to this in your prepared comments, but you referred to sort of a trial at your analyst day in the steel industry to see if you could increase your market share by being a bit more flexible in terms of your car order lead times. Could you just kind of speak to the early results there?

Yes, the early results are positive. I mean, maybe other, like other railroad, our market share has some of the inbound, outbound, what goes to the steel mill is quite limited. On your look on the outside of a steel mill it's mostly truck as opposed to rail. So it's not so much a question of whether the steel mills are running at 65% or 75% operating rates, it's more of a question can we respond in time with our product? So we've actually reduced lead time for steel mill to order a car. We'll call those short-order lead time, the guaranteed car holder process. We also mentioned a lot of it's focus on our first mile, last mile. In that case, our first mile. And, yes, we have gained points of share out of steel mill when it comes to CN versus the trucking competitors.

Still early days, but I can tell you one thing customers are trying out, and it's, it's a positive sign, so if we can respond with flexibility, hopefully over time they will trust us with more of their business.

Okay. Thank you. That's all my questions.

Thank you.

Thank you. The next question is from Ken Hoexter with Merrill Lynch, please go ahead.

Great. Good afternoon. Just coming back to the yields revenue per carload if I can for a second. Intermodal and coal were so robust including the currency relative to some of the others you noted had mix. Is that because coal is more in the U.S. and, therefore, you're just looking straight or were there some contracts that got renewed? I'm just wondering why the large differentiations there?

It's all mix related, distance of haul, more business for one account versus the other account, so it's all about mix, mix of customers, mix of length of haul. All contracts are renewed with some increase, and it's about the mix of business.

We've been at, on an effort to price to the value of our services for many years now, and so by now we tend to have our pricing guidance and there's much less variance around that 3% to 4% price. Sometimes if we have a little bit more opportunity because we create value it meet be on the upper end or slightly higher than that.

Other times when customers have difficulty or the competition with the alternative is a little tougher, we might be a little bit at the lower end or slightly below. But our pricing is in that band of 2% to 5%, with very few instances above that.

Wonderful. And if I look at the coal, though, is that, something like that may be more met coal that you've gained, can you talk a little bit about that?

Actually, this quarter, the second quarter, we've actually seen an increase in both met coal in Canada as well as thermal coal in the U.S. Both markets have generated for us increase in volume and in our Canadian coal market you also have see into that, buried into those results petroleum coke which when we publish coal is some pet coke into that. And pet coke from Canada comes from basically Fort MacMurray and close to the coast.

JJ, when you were going over your review, I thought you said something about 3% on same-store sales and then you threw out a 4%. Was that a currency adjusted for that 3%?

The difference between the 3% price increase on same-store and the 4% is if we were to normalize if you (inaudible) for the Canadian grain which right now in the second quarter we have a 7% decrease versus last year, as well as the fact that we do have some legacy contract that goes back acquisition of railroad that we did over the years which are related to RCF, which obviously now are negative and eventually these index will turn vastly positive. It's really 4% when you take out RCF and grain, but it's really because they're in the portfolio it is what it is, it is right now 3%.

Wonderful. And then in the casualty line, it was obviously an improvement from last quarter, is there anything in there other than Keith's improved operations, any actuarial gains or anything in the quarter?

Nope.

Okay. And then last question, volumes it sounded, JJ, when you were going through the numbers that you were feeling pretty good about where things are going. I just want to understand if that was just as you looked toward peak season or is this even kind the economic environment beyond that and around that you're still feeling the strength continuing?

When we look at our weekly carload, we can't quite necessarily relate to all of what we're read in newspaper because we're still moving very strongly the overseas business, the domestic business holding up and the manufacturing sector all seems to be holding up. Our customers on the overseas side, I met a couple of those recently, are feeling very good about the third quarter, because already we're in late July so we already have a month, and what's coming at us in August is already obviously on the docks somewhere in China waiting to come in, so we have visibility to that. So the question is really toward the fourth quarter and we'll see in the fourth quarter, the fourth quarter is a little off in terms of some of these things that we'll see. The proof will be in the pudding as to what will happen then.

Great, I appreciate the time, thank you.

Yes, Ken.

Thank you. The next question is from Scott Malat of Goldman Sachs, please go ahead.

Thanks. I want to ask a little question about intermodal you talked about the surge, I know Prince Rupert has its own dynamic, but really just trying to figure what's driving the kind of intermodal growth we're seeing across the industry. Could you help us think through the factors here? How long does the inventory restocking provide a tailwind, are there shifts from trucks accelerating for any reason? Are there certain categories of goods within intermodal that you think are really driving some of the outsize growth?

The import is mostly related to the economy in North America and Canada and the U.S. Vancouver has seen a record in June all in, we've seen a record. Rupert is combination mostly U.S. market and, therefore, potentially are share related as opposed to economy related. On the East Coast, of CN, Montreal and Halifax, it's not really share related it's kind of steady (inaudible) some of our customers are seeing.

The export business is actually up on the West Coast because there are more container available. We could have seen an export business of Canadian goods in the first quarter but there were not enough container coming in to create a capacity for containers going out. So now that we have this Tsunami of containers that come in May and June all the shipping lines want those containers back to China, either they're paying to move them empty or ideally they want to get some freight into it with Canadian manufacturers. You're talking pulp, lumber, grain products and the like are happy to try it get deal with the shipping line to put some goods into it going back.

Domestic freight, a different story, we'll compete with truck, truck market has capacity issues. Cost issues, and this is a place where our product may make, maybe as much of a difference on how we fair as opposed to the overall market strength itself. We've put a lot of focus on improving both our domestic and overseas product and our customers are reacting positively to that better product.

All right. That's helpful. thanks. And then just as another one, just maybe, we haven't asked a while about the export potash opportunity, I know it's not for a while in terms of when things come up, but what do you have the capacity for? What do you need to do to increase capacity and maybe just touch on the overall opportunity of export potash?

Without specifically talking potash, we have export capacity for a lot of product. I think manufacturing, anything that wants to go west, west like (inaudible), Vancouver, Rupert. Our rail line, in our view, are vastly underutilized and I think Keith can probably comment better than me on that. We do have a lot of network capacity to move a lot of stuff going west. After that it's a question of locomotive which you buy as you need them, and people, which you hire as you need them.

And last mile activity in this instance. People have to -- often it's the waterfront capacity that's the bottleneck, whether it's the terminal in Vancouver or the new terminal in Rupert. And so we will be there to accommodate growth as it comes in all those bulk commodities. We feel privileged to have access to both Vancouver and the Port of Prince Rupert in terms of long-term growth.

So there's nothing specific you need to do export potash specifically?

No. Because typically export potash moves in customer cars and we have the rail line capacity. The issue is terminal capacity and where will the customer send the business.

Okay. Thanks.

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

Good afternoon. Sal Vitale on for Jeff Kauffman. I have a question, just looking at the incremental margins, I calculate an incremental margin for the second quarter of about 74%.

Just looking at the expense line items, you talked a little bit about labor earlier. What about like purchased services, and for example, equipment rents? I see purchased services down 1%, so FX adjusted it's probably something like up 5%, 6%, 7%. Is that something that's a level that's sustainable given the carload growth of, what, 27% and RTMs up 15%? How should we look at that for the second half of the year?

Yes, well, specifically on purchased services, you're right, actually when we do an FX adjusted for the second quarter, that's actually up 5%. And as far as the balance of the year's concerned, we feel, we feel pretty good. I mean, again, some of these things move in step functions but, we feel that we've got the capacity and, and we can absorb some additional volume without necessarily seeing a proportional increase in our costs. So we'll have to see how that, how the business gets layered on, but we feel that that's actually not a bad run rate for us.

Okay. Does that also apply to, for example, equipment rents?

Equipment rents actually was was quite, quite favorable. I mean, we were, we were looking at an improving in the 6%. Now, I think that one may be more difficult to keep at that level.

Right.

We'll have to see, but I think that may be a little tougher there.

Okay. And then just following up on labor, as you spoke about earlier, what, did you mention what head count levels we should expect for the second half of the year?

Yes, we said we will continue, subject to growth, going forward, we will continue to have higher running rates in line with business volume and in the other categories replace our attrition, but try to continue to gain productivity. So I think the second quarter performance which added a 3% increase in running rates and 1% increase in the workforce overall is not a bad, bad model on a go-forward basis.

Okay. Thank you .

Thank you very much.

Thank you. I'd now like to turn the meeting back over to Mr. Mongeau.

Well, thank you. Thank you all for taking your precious time to listen in to our results. We hope you're satisfied and that we are closing the day, which was a good day, on a good note, and we look forward to see you on this call again at the end of the third quarter.

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