Canadian National Railway Co (CNI) 2010 Q3 法說會逐字稿

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 third quarter 2010 financial results press release and analysts' presentation documents that can be found on CN's website. As such, actual results can differ materially. Reconciliations for any non-GAAP measures are also posted on CN's website at www.CN.CA.

Welcome to the CN third quarter 2010 financial results conference call. I will now like to turn the meeting over to Mr. Robert Noorigian, Vice President, Investor Relations. Ladies and gentlemen, Mr. Noorigian.

Thank you for joining us for CN's Q3 2010 financial results. I'd like to like to remind you again about the comments that have already been made regarding forward-looking statements. With us to today are Claude Mongeau, our President and Chief Executive Officer; Luc Jobin, our Executive Vice President and Chief Financial Officer; Mr. Keith Creel, Executive Vice President and Chief Operating Officer; and JJ Ruest, Executive Vice President and Chief Marketing Officer.

After the presentation, we'll take questions from those of you who are listening on the call. Would you please identify yourself when you're asking the questions. In order to be fair to everybody that's there, can you please limit yourself with one question with one follow up. It is now my pleasure to introduce Mr. Claude Mongeau, our President and Chief Executive Officer.

Thank you, Bob, and thank you to all of you for joining us on this call. We're very, very pleased to announce our third quarter results. They are good results. We are pleased that we were able to drive significant volume growth and significant top-line growth, if I measure on constant currency basis, our revenues are up 18%. JJ will get you the contour of that growth later, but pretty much the whole book of business, we've been making in rows and taking advantage of the economic recovery.

We're also making in rows in terms of our ability to serve our customers and grow faster in what the economy would give us by getting more of their discretionary business. That's solid growth that has been accommodated at the low incremental cost. Keith and his team are doing wonderful job to handle the business creating flexibility to improve service, but also maintaining our high level of efficiency and continuing to make progress in terms of productivity. This is what helps us drive very good operating ratio, our third quarter operating ratio was 60.7%, which is two-point improvement over last year.

In terms of earnings, solid earnings up 25-- 27% on an adjusted basis. Luc will give you some of the details of how we were able to drive this performance, but this is the third quarter in a row where we're able to show leverage and show solid performance on an earnings standpoint and free cash flow standpoint. Year to date, we are at CAD938 million of free cash flow, and that despite the fact that we have made a contribution to our -- a voluntary contribution to our pension plan, which Luc will explain to you in a minute. Clearly, from a financial standpoint, very solid results, and I'd like to say just a few words to give you an update on what we're trying to move forward in terms of our strategic agenda, with a particular emphasis on service excellence.

It was a lot of mild stone achieved during the quarter. In terms of supply chain collaboration, you may have followed us. We've been able to finalize the basically across Canada tour. All of the major Canadian ports now have a supply chain agreement. I'm also pleased to support that we have service-level agreements with all of the key container terminal operator in all of those major ports across Canada. We're leveraging the value that comes with those service-level agreement in terms of visibility and end to end, focus one box at a time. We're fixing issues and addressing bottleneck on an ongoing basis, really daily, with the benefit of these scorecards that we've put together with our partners. And it's really helping us improve our performance in terms of the overseas business. You've seen the result of that over the last several months. But again, the third quarter, and JJ will give you the details, we have very good growth in terms of our overseas business.

Our end-to-end approach is also showing significant benefit in the bulk side. We've had good performance in terms of our new scheduled grain performance, but also very, very good performance in moving Canadian coal to the west coast in record levels. We call it our mind-to-ship supply chain approach, and it's clearly paying dividends.

In the merchandise side, similar story, a couple milestones. We've introduced our new car order process which gives flexibility to our customers. We're using that flexibility to gain opportunity, one carload at a time, whether it's in steel or forest product. We are able to respond quickly and have higher fulfillment rate, which is helping service to our customers, but importantly is helping CN capture more business. And given that every carload counts, it is helping us having the top line grow a little faster in what the general economy would have given us.

So all of these service initiatives are core to our strategic agenda. We have said we would be working on those when we met with you in -- at our analysts meeting in May or early June. And we are delivering on them one step at a time, and it's a positive story overall. With that, I will turn it over, and Keith will give us a rundown on our operations.

Thank you, Claude. Let me start by recognizing and thanking the best operating team in the industry that I'm honored to lead, again for delivering a strong operating performance this quarter. Since Claude laid out our CN 2010 vision three quarters ago, this team continues to leverage our operating model, focusing on delivering meaningful results, which we're basing on service innovation, employee engagement, growth absorption and the constant pursuit of safety excellence. The financials you're looking at provide a strong case, this approach continues to deliver. Let me take a couple of minutes to share a few of the details that we've been up to.

Speaking to the productivity metrics that we report on each quarter, we began to achieve gains in virtually every aspect of our operation. To put it in perspective since the year end 2008 during '09 and' 10 we've driven an 20% improvement at CN from a 25 mile an hour railroad to consistently knocking on the door at 35 miles an hour railroad. We've driven over 15% in car velocity from 185 miles to 214 miles per day on every car we handle. The most critical validation point I want to leave with each of you is to our operating performance this year. Year to date, we've done all this while maintaining or improving, our metrics, absorbing a growth rate of 12% over 2009 volumes, moved on our eco-friendly trains that are safer, longer and heavier.

This team produces it relentlessly blocking and tackling day in and day out, while they're executing our operating model. I'm happy to share with JJ and with the audience that in 2010 we've involved that same tenacity and focus on improving our customer service and earning additional market share one carload at a time. To ensure the success that story continues, we have to continue to innovate at CN. We do it by making small target investments to support our growth and service performance, like the 132 locomotive DP equipped, high horse power, fuel-efficient with the latest technology in 2010. We've retrofitted others. We currently had 35% of our locomotives equipped with DP, and we're pushing to 50% by the end of 2011. So you can combine that by looking at marketing forecast six to 12 months out with our attrition, and we'll be in solid shape to handle the business.

As I mentioned, let me make a couple points on the DP side. These locomotives continue to allow us to run safer, longer trains, especially as we look forward to the cold winner months that lie ahead and the years ahead. They also allow us to further leverage our investments and loan sidings, running longer and heavier trains, that currently we are not possible without these concepts.

On the car side, we purchased just under 2000 new rail cars this year to support growth in the iron, ore, steel, coal and forest products markets. In certain cases where we've had periods of excess fleet, we're strategically storing cars to provide recoverability and our ability to respond to spot opportunities like those we converted in the volatile steel market during 2010.

Another key resource we're carefully managing is our train crew base. We have roughly 6,000 (inaudible) employees at CN over the next five years, and just under half of those will retire. Keep in mind that it takes six months to recruit and train a new conductor, so it's critical that we get this right. We're relying on the volume forecast, and we do so by the resource tool that we deployed earlier this year, precision planning process. We effectively take the forecast, we combine it with attrition on the marketing side, and it puts us where we need to be from a resource standpoint. These steps combined with our tentative labor agreement will ensure that we're prepared to protect the service.

By the way, I'll comment that I'm excited about that tentative agreement we recently reached with the conductors in Canada. It's largely a status quo agreement in nature, but it does provide a mechanism for us to work together on scheduling issues, which we hope ultimately will be good for CN and for running trades employees on a go-forward basis.

On the customer front, our daily operating metrics are being rounded out with a suite of customer-centric metrics designed to assess performance from our customers' perspective. These measures include switching performance, car supply, traffic left behind, our car return times at our Intermodal Terminals and aging of our containers at port. And finally as an excellent example of pursuing a more collaborative approach with our employees in partnership with our dispatch offices, and our employees that run our dispatch centers were implementing -- dispatching excellent initiative. Their mandate is simple. It's to identify ways to drive up train seats, service performance, doing it through process improvement, collaboration and some targeted investments. I trust that gives you a good flavor some of the key areas of innovation at CN that we're pursuing that will allow us to continue our operating story, the success story that we produced. And with that, I'll turn it over to JJ to review the top line.

Thank you, Keith. That's operation excellence. I'd like for you to join me in looking at over all revenue results on slide 10 looking first at the year-over-year results Q3 2010 versus Q3 2009. The quarterly results of this year are more than just economic recovery story. It is time to see the dividend of our new supply chain initiative, which are designed to help customers grow their business and position CN to handle a greater amount of their traffic. Revenue growth of third quarter was 18% on and FX adjusted basis. To peel that off on each element, 9% of that was rail revenue, RTM were up 9%, carloads were up 18%. 3% came from same-store price from our same-store sales. Another 2% came from fuel surcharge and the remaining 4% came from a nonrail business and some positive mix.

On the sequential basis, third quarter was the second quarter of this year, the volume declined by 1% in terms of RTM will increase 3% in terms of carload. If you want to join me on the next page looking at the business by business again, emphasizing the revenue of the FX adjusted basis. Petroleum and chemical up 14%. The Canadian recovery and chemical production was initially behind that of the US, but seems to have caught up. Metals and minerals was up a strong 29%, a reflection of our ability to work with our customers, we have strong iron ore volume, and we have truck market-share gain in the steel industries. Automotive was also strong at 26% growth, FX adjusted. Strong production from the CN serve plant, as well as new supply chain focus, for example, ground and entry dwell time where we track dwell time performance from both the ship discharge in the case in Halifax, and from the assembly plant release from the plant in Michigan. That to come feet against truck like service make sure business is no leak.

Forest product was up 8%. There was no real movement in US housing start we do not expect that dial to move very much. However, we have strong partnership with our forest product customers as well as overseas shipping line, to capitalize on China export boom in carload and containers of lumber and pulp. Coal revenue was up 31%, another strong performance. We had strong demand for coking coal, [ex] Rupert and Vancouver. And we had strong demand for export (inaudible) coal, ex US Gulf and we had some replenishment of (inaudible) in the US. Grain was up 10%. Canadian grain was up 13% on strong export mainly of canola and peas. And US grain was up 5%, mainly on strong export of soybean and corn. Fertilizer was up 9% mostly on potash. The dealers and ventures are very low out there and the best has yet to come in the fourth quarter in the fertilizing stories. Overseas intermodal was up a strong 28% due to a strong west coast import and export trade evolving very strong export story overseas. Domestic intermodal was up 10% and improvement that came mostly from our direct retail door-to-door product, and again on that, the best has yet to come.

Other revenues came -- was up 28% probably due to our Great Lakes fleet and dock operation, which are an integral part of in-house iron ore supply chain position, which has done extremely well in 2010. Now, let's go to the brief outlook on Page 12.

So far this quarter, our carload volume has grown 11% And we need to keep in mind our comparable from last year to be improving and then last year recovery was to come in the fourth quarter. If you we're looking at three broad segment, first looking at manufacturing, we have additional fleet acquisition that will come in line during the fourth quarter that will support our ongoing truck market share initiative in steel. We have a continued focus on serving the shale gas drilling activities which in our case is mostly in Western Canada, and that will support our shipment of frac sand and drilling pipe throughout the coming quarter. The automotive production level in our line expected to increase by about 10% versus 2009, in keeping with the momentum that we have acquired so far this year, and I think many of you have heard the good foreign motors result earlier today, and that bodes well.

On the bulk side all the Canadian grain harvest is smaller and late. We see very strong overseas pricing for those crop, which is actually increasing sequentially, our order to the west coast above the third quarter of this year. Market for export coal remained very positive. We view our strategic position at the Port of Prince Rupert as being something that will be very useful for us in the midterm. A slow start to this (inaudible) September is actually push forward the demand for the fourth quarter of this year. On intermodal, the import faulty came in early this year. It came in May and started to turn down around the month of the September. As imports are slowing down, there is still a very strong port to BC export to look for vessel capacity back mostly to China. Claude already mentioned our port supply chain agreement with the ports, and that bodes well also for future.

On my side I've been mostly focused on what I call the "glowing box report," which is the daily report that we produce with our partners. Customers experience is not port average well town. Customer experience is related to their own box that outside-in view of how They view our service is actually helps us to create value for those who actually pay to freight.

In conclusion, we expect usual fourth quarter sequential slow down, however, we also expect our bulk business and internal business to be very strong in fourth quarter versus 2009 ending off a great year on a strong row. So turn this over to my friend, Luc, who will comment on the financial side.

Thank you, JJ Let me briefly review the financial results for the third quarter. As was mentioned earlier by JJ, the revenues were at CAD2.1 billion up 15%, and on an constant currency basis that was actually improvement of 18% versus last year, same quarter. Our operating income and net income were both up 21%, and our adjusted EPS came in at CAD1.19, which is up 27% versus last year, and on a constant currency, that's a full 30% improvement versus 2009. Our third quarter operating ratio was 60.7%, a two-point improvement versus last year, and our year-to-date operating ratio now stands at 63.6% which is a 3.5 point improvement versus last year.

Turning to page 15, our operating expenses came in at CAD1.3 billion, and that's up 15% on constant currency. We continue to have effective cost managing throughout the quarter as our carloads were up 18% and our RTMs were up 9%. Fuel was a significant category where the cost came in at CAD249 million. That was up 27%. This was mostly due to higher prices where the WTI was actually CAD76 during the quarter versus CAD68 looking back at the same quarter a year ago. We also obviously had higher volumes.

On the labor and fringe costs, the expenses came in at CAD437 million, that was up 7%, and this is a result of an increased work force by approximately 2.5%, as we continue to adjust our manpower in line with volume and ahead of attrition. In fact our T&E resources were actually up 5%. We also had some higher wages and benefit costs during the quarter.

On the depreciation front, our expenses were CAD204 million, that was up 8% versus last year. This was mostly due to net asset additions, but we also had an increase in depreciation from the completion of our first phase of Canadian asset depreciation study. Now this study is done every three years, and it's a comprehensive review of every asset category. This year we're having the benefit of much better asset-specific information, and this first phase covered a portion of our assets and resulted in an annual increase of approximately CAD20 million going forward in depreciation. Phase II will be completed by the end of the first quarter of 2011, and while it's a bit premature, I will say we do expect the results to have a similar impact as the first phase. So all in all, we could see a potential increase in our depreciation from these asset studies to be in the tune of about 50 basis points of operating ratio.

On the casualty and other costs, the expenses were CAD91 million, and this was an increase of CAD40 million versus last year. Now, this increase was the result of two factors. The first one is, some of you may recall last year we booked a CAD20 plus million adjustment, favorable adjustment, which resulted from improved experience relating to our US legal claims. In addition, this year we've accrued about CAD15 million of environmental expenses as a result of our ongoing review of these issues.

Turning over to cash flow, as Claude mentioned earlier, our free cash flow was CAD938 million, and that was CAD280 million plus improvement versus last year. This was the result of a very strong operating performance in addition to the sale of our concourse of division in Toronto in the first quarter to the tune of about CAD170 million and also some lower cash tax installments on the Canadian front, probably for somewhere in the neighborhood of CAD250 million. This was also partly offset by a voluntary additional pension contribution, which we made in the third quarter in the amount of CAD300 million. This was intended to improve our plans-funded position.

Now asset returns remain volatile and quite modest in 2010; however, the discount rate is actually continued to come down. So if you actually just took the discount rate at the end of the year, which is what's going to determine the pension benefit obligation in our future cost, we will ultimately know what will be the liability and the future cost. But just looking at the end of September, using the rates that were in place, we can actually see the potential for an increase in our pension expense to the tune of about 50 basis points of operating ratio.

From the CapEx standpoint, we invested about CAD824 million in the year-to-date results, and we expect to invest approximately CAD800 million in the fourth quarter as we continue to prepare our winter program. In fact, we're looking at accelerating the delivery of some of our new high horsepower, DP-equipped locomotives to help in this respect. Our stock buyback is 75% completed. We're up to 11.5 million shares, which have been acquired at this point in the year.

Turning to the 2010 financial outlook, we continue to leverage the recovering economy, and as our certainly our third quarter and our year-to-date results indicate. We continue to see a gradual economic recovery unfolding, albeit at a slower pace in the fourth quarter versus, obviously, the year-to-date performance. Nevertheless, we reaffirm our 2010 guidance as we believe we have the scope to achieve an increase of approximately 25% in our 2010 adjusted diluted EPS over 2009, which was really CAD324 million. We also continue to see free cash flow in the range of CAD1.1 billion. So we're going in to the fourth quarter with good momentum and good position to finish the year. Also will be positioning the Company for solid winter program and a good performance in 2011. All of this should translate into some solid shareholder value creation. And with that I'll turn it back over to you, Claude

Well, thank you. Just to wrap it up. I think we have a solid year in the making, as Luc just explained to you. We are taking every bit of advantage of the economic recovery, but this is more than just economic recovery. We are also very much delivering on our strategic agenda, working with our customers. Our supply chain focus is helping us gain market share, one carload at a time. And if we continue to do this, I believe that the rail industry has a great future ahead of us. With more and more people see the value of railroading in terms of service, see the value of railroading in terms of environmental friendliness, and see the value of railroading in terms of cost for their transportation needs.

So our challenge is to keep the service improving, keep the operational excellence and drive that combination to reward our shareholders over time. With that, we'll be happy to take questions from the audience. Operator, over to you.

Thank you. We will now take questions from the telephone lines. (Operator Instructions) Thank you for your patience. We do have a question from Scott Group with Wolfe Trahan. Please go ahead.

Hi, good afternoon.

Good afternoon.

So, Luc question for you on the casualties side. I see that it's up a good amount year-over-year up against some tough comps. If I look at it sequentially it's down pretty materially from where we were in first and second quarter. Is there anything on the reserve adjustment side or actuarial side that's keeping the number so low? And if not, is this CAD90 million a good run rate going forward?

I'd say the CAD90 million is not a bad run rate going forward, and so I don't necessarily expect anything significant on that front in the fourth quarter. So that's kind of where we are. Yes.

Okay. Great. And then a question for JJ, you talked about some -- at least feeling near term -- feeling very good about the bulk side with grain and coal. I was wondering if you think that can continue in 2011? Do you think you might lose some volume back to CP given their new contact with [Tech]? And then on the grain side, do you think grain can be positive next year given the Canadian crop that's going to be down 10% or so?

I think we feel very positive in some of the bulk business for the fourth quarter. Canadian grain is a high price. The crop is smaller and the positive crop will be very well-known only come late November, December. But right now the product is moving very well and much higher than the third quarter. At some point when it's first quarter, second quarter, eventually the quality will start to show an impact. Also, we feel very positive about the fertilizer side, then potash inventory in North America the wholesaler, (inaudible) people are buying when they need it.

I think we'll have a good push in October, November. We'll see on the coal side. We have a good start. I think Claude mentioned a supply chain store that we have and activities in both Rupert and in Vancouver is very busy with the mine that we serve. I think it's natural that Tech and the other railroad long term partnership because of physical location of those mines in southern BC, which obviously we don't serve. From what happens there, maybe something that's very logical.

Are there volumes that you expect to lose to -- lose with Tech as a result of that contract?

I think time will tell. The thing that maybe we're getting into to narrow of a discussion, but time will tell where that will lead us.

Okay. Thanks for the time.

Thank you.

Next question is from Bill Greene with Morgan Stanley. Please go ahead.

Yes. Hi there. Good afternoon. I'm wondering if we can get a little bit of clarification on the guidance. You beat this quarter but you didn't raise the full year. So the obvious question is sort of what are you seeing in the fourth quarter that gives you pause that you don't want to raise the full year number?

Let me handle this one. I think we're very well in position to finish the year on a solid note. At this point in time, we didn't feel that changing our guidance was necessary, but we -- as long as the economy holds up and we continue to deliver, we should finish on a strong note and as Luc said approximately 25%. You have a little wiggle room around that .

Okay. If I look at some of the metrics that we showed here on the operating side, there are -- it's obvious that you are the most consistent and strongest operator out there and you've had a lot of success since '08 but recently we have topped out. Does this suggest we are hitting a wall? Is this a way to get to a new level? How do we think about the evolution level from here?

I wouldn't say we're hitting a wall. There's still plenty of capacity left in the railroad. I'd just say you're getting to a point where last year was less -- less challenged railroad with much fewer boxcars and locomotives running around. We had some outstanding metrics. We're lapping against those metrics. There's still more to go and yes there is more we can do down the line as we continue to strategically invest in locomotive and make in-roads with our unions that we operate and a more collaborative approach that we're pursuing.

So Claude that's just -- circling back then. What that says, really the only way you're going to have a big beat is really got to be revenue. There's -- it's -- we've got tougher comps on the operating metrics and so revenue is really the game. Is that fair?

I don't think it's fair. To be honest, we are leading the industry in terms of volume recovery by a wide margin. So we've been operating in the third quarter and operating in the fourth quarter has leveled approaching 2008. So the fact that we are able to keep the operating metrics that we have despite the volume growth on a cumulative basis over those two years, it's pretty stellar productivity and efficiency improvement. We've got to regroup from here and as we I accommodate the volume going forward with views to having right trade off between investing in service and flexibility and pushing on the efficiency front. You can see CM driving the top line and being able to accommodate that business at no cost.

Okay, thank you that's very helpful. Appreciate it.

Thank you. The next question is from Jason Seidl with Dahlman Rose. Please go ahead.

Just getting back to guidance, what are you using for your continuing ops for nine months in this guidance number?

I'm not sure that -- you mean in terms of EPS?

Yes.

Whatever -- I mean, this is perhaps a better question to have off line. Whatever we reported in the first two quarters plus the CAD1.19 that we reported this quarter is what you should use as the first nine months. As I said, Luc gave you guidance for the full year at approximately 25%, which is basically reaffirming what we have said here.

Okay. I'll go back and take that offline then. Claude, you have done a lot with the ports and everything else. How should we look at that going forward as revenue opportunity for CN, and how should we think about modeling that for 2011?

The way you should think about is that we'll underscore our able to grow slightly faster in what the economy will give us as we discussed when we met in Chicago. The evidence to me, you have to see it on a daily basis. I see the collaboration, for instance on the West Coast between the terminal operators and Vancouver and our operating team is nothing short of new approach. We're monitoring data and what it takes to come together terminal and railroad on a daily basis. So we are seeing issues. We have much quicker recovery.

We are able to bring dwell times in terms of the time it takes for containers to stay on the dock, they're down significantly. More importantly, because we monitor one box at a time as JJ mentioned, it's not just averages. It's making sure we don't leave boxes behind that become [rig] station killer. So if you improve consistency and you bring down the averages in terms of supply chain efficiency, eventually you get more traffic. And if you only need a few boxes more than what the economy will give you, you do that consistently over time it adds up.

Okay. Thank you. Luc, real quick, the reported number in your -- for the nine months in your press release is diluted CAD3.39, but I doubt you are going to be guiding the CAD0.66 for 4Q. Could you help us out and clarify that a little bit?

This is probably best handled off line. You have to take out the special gains that you have during the year you get to adjust the number. I think you'll need to call Bob.

Just call me afterwards.

Will do, thanks.

Okay.

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

Thanks very much and good afternoon. I wondered if you could speak a little bit about your customers and what they're telling you in terms of their inventory levels as we look forward to 2011? What kind of shape do you think they're in?

I think we get that at an inventory level obviously it's not a peak that has been depending on the segment. There has been some rebuilding, partial rebuilding, but still a ways to go. In terms of -- then you get down to commodity by commodity. And so fertilizer inventories is low. Automotive, I was looking at a dealers inventory by model type and by automotive maker, it's slightly up from where it was some automakers above the average. Some are still fairly low. So I think we -- there's still room for this run rate of rebuilding inventories slowly, plus obviously meeting the demand -- market demand.

Okay. And my second question, I just wondered if you could comment on the collaboration agreements that you've negotiated and who is leading that process internally? Have you developed standard template now? As you negotiate those agreements, how do you make sure that you protect the operating model?

Let me answer that one. I think the way we're leading this is in rugby style, using a scrum. This is truly operations, marketing, getting on the ground. Not just at CN but when we meet with a terminal operator, for instance, it's down on the dock level. The people who are operating the cranes, and operating the terminals that we have to come together and agree on what metrics make sense. So the answer to your question is, it's a scrum approach, and by now we've done it enough that we actually do have a template and every terminal is a little different, but effectively we're following the template out of the core 10 measures. Nine or eight would be the same and then we have one or two that would reflect the specificity or some of the special issues that might creep in for one terminal at a time.

And finally, we have a similar engagement with the (inaudible) terminal, a container terminal or break bulk terminal.

Okay. Thank you. That's all my questions. Talk to you next quarter.

The next question comes from Tom Wadewitz with JPMorgan. Please go ahead.

Hi, good afternoon. It's Michael Weinstein in for Tom. Just wanted to touch base really quickly on other income. I was kind of surprised that it was so high in the quarter. Was there anything specific driving that?

No, it was interest switching revenue. Are you talking other income?

Other income, yes.

No, we didn't have anything exceptional versus the last quarter versus last year.

But it was significantly higher than first and second quarter. How should we think about that going forward?

This actually can be it's not a straight projection so it can be a bit lumpy. By and large, we do expect the number that you had in the first and second quarter to on average be about the right level.

The best way to think about it you probably want to average out the volatility and then take the average and that's probably a good indication of future other income.

Okay. Makes sense. Wondering, on the head count side, how should we think about -- on volume head count, how should we think about seasonality going into fourth quarter? It looks like from a volume perspective, volumes are typically flattish fourth quarter versus third. Do you think you can get that this year, and what would that mean for head count as well?

We're hiring mostly in line with attrition and then volume comes into play. But on a sequential basis, the volume between Q3 and Q4 is not going to be a significant movement. We are more what Keith was explaining to you earlier, we are trying to stay ahead of the curve so we look out to our attrition six months into next year. Because we have to train these people, you have to start getting them on board and you'll have some of that in Q4. I think that the Q3 shape of our work force adjustment is probably a good indication more increase in T&E employees and where we are hiring basically replacing one to one. In the other sectors we are able to give productivity so the increase is less pronounced.

That makes sense. Just on the train starts and train length side, I was wondering if you can provide the year-over-year change. I don't think that was brought up in the highlights this quarter.

Train starts side year-over-year effectively absorbed a 12% increase in business and only increased train starts by about 4%. What was the second part of the question?

Train length?

Train length is up in excess, it's about 6%, 5% to 6%.

Great. I appreciate. Thanks for the time.

Thank you.

The next question is from David Newman with Cormark Securities. Please go ahead.

Good day, gentlemen.

Hi.

Just in terms of the pricing, how did the grain reversal factor into your same store pricing?

Grain, regular grain represented about 6% of our revenue.

Okay.

For the full year and that has changed to affect every year on August 1st, you go -- went from negative to positive for this year.

Yes, so a bit of positive swing factor, so that would have been played into the number for two to three months, correct?

Yes, in relation to the regular grain that we move into for the third quarter.

Okay. Just overall, are you -- obviously in the truck competitive sector that you're in, we're seeing price increases even in things like LTL, et cetera. And you have this CSA 2010, which is coming, in fact, for the trucking industry. Do you anticipate that you'll be able to take some price increases on the back of -- price increases are seen -- that are being taken by the truckers and evolving driver shortages?

Most certainly, but in the trucking industry or the state of the trucking industry or regulation pricing and regulation talked about is different between Canada and the US.

Yes, it will have some effect for sure.

It will have an effect to the extent we have exporter to US truck market, which is different behavior than the Canadian truck market.

In terms of your negotiations, you're not seeing any more inflation being built into your pricing so you're sticking with the same store or sticking with the inflation plus kind of pricing?

We're not going into specific guidance of what we're going to do next year in terms of price. The current run rate that we have right now is in line what we talked about, inflation plus pricing. So you're look at inflation. You look at the service that we provide. The better we are in terms of the first mile, last mile in some market where we are in terms of these initiative with poor stakeholder in other markets. We will leverage that to the extent we can either price of volume or better mix.

Very good. Thanks.

Thank you.

The next question from Chris Ceraso with Credit Suisse. Please go ahead.

Thanks, good evening, actually had a follow up in a similar vein on pricing and inflation. It does seem like in the quarter that pricing at plus three was not able to keep up with inflation. If I look at your labor in fringe and purchase services and materials, they're rising at a faster rate year-over-year on an FX adjusted basis. How do you -- is that something you expect to continue?

Let me challenge you a little bit on the inflation and actual fact that the broad inflation is lower than that. If you exclude factors like stock base compensation, et cetera, our wage increase is in line with about 3%, 3% to 3.5% wage increase when you include benefits. And so our pricing has been generally in that range for this quarter and in the past.

Increase above and beyond is incentive comp?

It's a larger number for work force by 2.5 then you've got some of the incentive comp on top of that.

If we think about it that way, that happens quarter after quarter, don't you feel like you're losing ground with your cost going up faster than your price?

Maybe we can take it apples-to-apples, when we measure price -- we measure in a fairly pure way. Our same store price increase is pure price. That is that 90% of the business really has a fuel surcharge. In our price, we don't have RCF order indices, which have the fuel component. Pure price is pure price. Fuel is fuel. And when you look our price it's really just price, it's not -- We don't do much index pricing, we don't do very much index business that's why 90% of the book of business is based on fuel surcharge.

Okay. Just one clarification, I didn't quite catch the comment from Keith about 6,000 employees. Over what time frame of that were you expected to hire those people? Is that equal to number you thought would lead from attrition?

6,000 base, so effectively -- of T&E employees -- training and engine employees. So right now we're up 5% year over year, so that run rate on a go forward basis -- we're going to be trending out, for the next four to five years, the demographic models constant across the Company. So we have to hire them ahead of time. Keep in mind, not just to hire the conductor that takes six months to train, it's also your engineers that are [tripped] at the same time and those conductors are replacing engineers as you pull those -- promote and pull them out to do their training for engineer certification. So it's to a degree you've got to manage both sides of it. So 5% is a pretty conservative number. Pretty good job of doing it but making sure we keep the work force correct.

So that 's roughly your attrition rate and you're going to hire to replace on a one-for-one basis.

That's correct. Plus that little advance to make sure we have it ahead of time. And we've got the training done and done a quality job of on-boarding the employees.

Understood. Thank you.

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

Thanks very much. Good afternoon everyone. Just on the service review panel, the interim report that came out. It seem that they are gong to be keeping an eye on the railroad industry, at least on the Canadian side up until 2013. And Claude, you've been doing a lot of things as you've highlighted in the service initiatives front. Just trying to gauge and understand exactly what the initiatives are that you're going to provide and what -- how they might impact -- this is a follow-on via the other question. But is there a risk to the increased levels of service that you're providing your customer. An increased risk to your operating ratio. And if there's not, can you explain to me why wasn't this something that you would have done earlier, or what is happening now that allows to provide better service without it impacting your bottom line?

I think as we explained it before in the context of the natural journey that CN has been on. You improve your basic service, schedule your train operations. You give the hub to hub velocity to a leading position, that's what we have done over the last several years . Once you've achieved that and you continue to have improvement potential in this regard, what's your next opportunity. Well your next opportunity is to focus on first mile, last mile, to get the switching window compliance, improve on order fulfillments. You also bring to this the more end to end supply chain management approach.

You reorganize marketing forces and you give it slightly different mandates to your operating team to add to their operational focus. A few more customer centric measure. That's the journey we've been on. A journey of constant innovation pushing the envelope in terms of service and operational excellence. That's the journey we're on and we think we have a great opportunity going forward to not only maintain our operational efficiency, but to improve the product and grow the business that win our customers a little bit faster in what the economy will give

That's great color, Claude. Thank you . Just moving to an administrative question here. Your guidance was around 27% to 29% tax rate. You've been getting the benefit from a lower tax rate, so it's been helping your bottom line a little bit again this quarter in the 27 -- 27.5% to 28% range. What do we look at going forward? Is this a 27% -- 28% tax rate going forward or should we model something

I think it still continues to be 28% to 30% range. We've been at the lower end of that. We came in on the quarter at 27.6%. So going forward I'd say 28%, 29% is probably a good place to be.

All right, that's my two questions. Thanks very much.

Thank you.

The next question from [Tim Hexter] with Bank of America. Please go ahead.

Hi, good afternoon. If I can just clarify the -- on the outlook just for a second. You said it was based off of 24% or 25% growth gets you at about CAD4.05 in earnings. And you've done CAD3.12 through the first three quarters. So that gives you CAD0.93 fourth quarter with consensus up CAD1.07. I know you keep kind of just saying you want to talk about this later. I want to understand why the CAD0.14 below consensus, is there something going on in the fourth quarter when you compared to last year's fourth quarter so that it would be a flat quarter relative to the pretty sizable upside we've seen on the first three quarters on a year-over-year basis?

Let me put it to you this way, as I said earlier, we've decided not to change our guidance. What we have said that we will achieve a solid end to year and that we are guiding to approximately 25% that has wiggle room. You do the straight math it gives the number that you give. But I think our fourth quarter, our third quarter results good and we expect our fourth quarter to be good and if the economy stays with us, we should finish the year end strong note.

Okay. I just wanted to clarify that there was nothing you were looking in fourth quarter that would cause it to be flat like any unknown expenses. That's not what you're saying or indicating?

We said quite the reverse. We see good bulk movement and continued opportunity to lower incremental cost and finished the year on a strong note.

Appreciate that clarification. Keith, can you talk about the cars or locomotives still in storage so we can get a concept of incremental margin potential still on the docket there.

Yes, we still have just 200 locomotives in storage. We're still in the process of acquiring orders that we placed with the locomotive producers. We've got locomotives coming online fourth quarter of this year and again first quarter of next year. There's still a lot of runway left as we make decisions and business warrants (inaudible) locomotives putting them in service.

And cars?

On the car side? Same thing. Same story effectively lack of a better term. We're up in the 100,000 range as far as cars online. We still have fleet on the (inaudible) side. Effectively across the board. There's no fleet really that we have that's constrained right now.

And lastly if I can throw in on the export side. Are you seeing the weak dollar driving any exports or you talk about the currency shift and how that's halting your business flows?

Maybe what we see is -- I don't know if it's a weak US dollar or a strong demand from Asia. But out of BC what you're exporting is natural resource, bulk natural resource, break bulk or container. This is obviously the area of very strong focus for us as our area potential is real. If you look at a lumber industry that who has real tough time in the US partly because of the strong Canadian dollars. they're finding ways to make it up through a lot like China mostly by containers. So some of these things are maybe saying slowly some permanent shift as to where the market for each commodity is going over the long run and we'll see it how these things play out.

Right. Thanks a lot. I appreciate it.

Yes.

Thank you. The next question from Gary Chase with Barclays Capital. Please go ahead.

Good evening, everybody. Two quick ones. I wondered if JJ could maybe comment a little bit on some of the business that either you referenced on the steel side where you're taking some truck competitive business, wondered if you could give us a little flavor for what the yield dynamics were there and to what extent if it was material if it might have impacted your yields in that segment during the quarter?

I think when you look at the yield for [M&M] probably the biggest impact was iron ore. Iron ore business was way up. Iron ore short-haul and that impacts (inaudible). If you go back to our market share we're getting on steel, that business is profitable. We didn't do this on price. The reason why people weren't using us in the past was not because of the price, because of our response time. When you place an order with a trucker, you could get to your plant within two days. The lead time for a trucker to move the product to market is short versus railroad lead time.

We had to work first and have the most having fleet closer proximity to steel mill and the willingness on our side to look at order systems so people can actually try us with shorter lead time order. That's what we've done and that's why it's been paying out. We've got strategic locations of cars that Keith has near Hamilton as well as Montreal. I believe to fulfill short lead order with a shorter lead time is what's allowing us to compete with trucks.

So if you clean it up on an apples to apples basis, it's safe to say it's as good as or better than?

Yes. By the way, these don't effect the same store price, they're movements. They don't go into filter for same store evidence.

Okay. And then I was wondering if you can maybe broadly comment, maybe for Keith or Luc, but are any of these initiatives creating some cost impact in the near term that we should think might go away or dissipate over time? When you think about some of these initiatives like getting cars closer to these customers. Is there some sort of cost that we should be thinking about as impacting the results that maybe will dissipate or approve with time or you're seeing most of the benefit already?

I would not -- I can tell you now that they're quite lively discussions. JJ and I are both on the same sheet of music. He understands, the critical nature of maintaining our operating models. So in these locations we strategically sort cars, there's not any material cost at all involved. It's effectively putting the cars on track, adjacent to these facilities when the call comes for that last minute order provide the flexibility we'll stop the train, we'll pick the cars up, and we'll set them off in the industry jobs that are currently servicing those locations will spot the cars. In the past we were not that flexible.

With this model we have the ability to do that. There's not a lot of cost built into it. So therefore, there wouldn't be any one fall down the line.

Let me add, on the terminal agreement that Claude referred earlier, these agreement are a two-way agreement. There's things that we want and ask from the terminal operator. Like seven days operation, which is valuable to our railroad, and I think the terminal from us. This is really not a gift. It's a trade. When we create value for them and they help us create value for ourselves on the efficiency side. Historically the waterfront was not the most productive front.

Okay. Thank you very much.

Thank you.

The next question from Benoit Poirier with Desjardins Securities. Please go ahead.

Yes. Thank you very much. Tech released their production going forward. It seems there's a nice opportunity with you with the restart of [Quinton]. Could you maybe quantify what could be the potential contribution for you and what is the CapEx implications on this particular opportunity?

We too saw that Tech may decide later this year whether they will reopen Quinton. Quinton step is located where the port of choice would be Rupert where there is capacity. I don't believe that we will have capital investment if any. It's something we did in the past that we will be happy to do again. There's capacity at Port of Prince Rupert for more coal. So that would be an upside as Tech makes that decision.

Okay. Excellent. And maybe my second question is for Keith. You've been talking about the investment on the new locomotives. Could you maybe quantify what we should expect in terms of fuel efficiency going forward in terms of GTMs per US gallon of fuel consumed?

Our guidance and our expectation is to finish the year in the 3% area and that's what we look to on go forward basis. And we do that as we effectively get better deploying the DP locomotives, and also we're implementing some newer technologies as well as with cruise control and with systems that allow us to drive compliance with our horsepower and our (inaudible) limitation that's driving some of those fuel gains. So there's several things in the pipeline that will step through that will allow us to maintain that run rate.

Okay. Thanks for the time.

Okay.

Thank you.

The next question from Fadi Chamoun with BMO Capital Markets. Please go ahead.

Thank you. Maybe different kind of question to Claude and Luc. If I'm looking back at 2009, you have had very strong financial metrics I'm looking at EBITDA (inaudible) very strong free cash flow in one of the worst years for the industry in a very long time. So I'm thinking with 2009 in the rear -- looking back at it wondering whether you feel that maybe you have more room in the capital structure to move towards that; and particularly given the low interest rate environment to increase the buyback and create some shareholder value in the process and how would you balance this -- perhaps opportunity to get strong balance sheet for potential M&A in the future?

Basically we do have an on going stock buyback for the year as I mentioned earlier. We have -- we're in the process of completing it and so that -- that's out there. Going forward obviously we do want to make sure that the business it's fully supported in terms of reinvestment then we look to increasing dividend; and last but not least, share buy backs if there's excess cash we don't necessarily see our ratios as being out of wack. they're a little bit lower than our state targets. We're not uncomfortable with where they are now. We also have to look going forward at the pension situation to make some of these decisions. We'll be reviewing it on an on going basis and we want to continue delivering excess shareholder value to the extent we can.

Thank you . Next question from Jeff Kauffmann with Sterne, Agee. Please go

Thank you very much. Congratulations on very solid quarter. Luc, I just have one question. When I look at the cash flow reconciliation for free cash on page 16 of your slides, payments for income taxes is a reduction of cash flow of about CAD186 million. Normally when you're growing the way you are, it's a source of cash flow through deferred taxes. Is this a timing issue and does those reverse at any point in '11 and become more of a driver of cash?

It's actually going to be the opposite. CAD186 million is the amount that we've actually paid in cash taxes in 2010. Because of the way the Canadian tax structure goes, we are paying lower tax installments in 2010 because it's on the basis of our 2009 income. So this will create a headwind as we get into 2011 probably to the tune of some CAD250 million to CAD300 million additional cash taxes, which will have to be paid. So as far as we stand for this particular year 2010 we expect to be having cash taxes above CAD225 million. So there's not -- there's not -- this is not going to be a tail wind. I think this is going to be a strong headwind as we get into 2011.

Now, isn't there some offset because the net income in your cash flow statement would reflect the accrual of taxes at the 27%, 28% rate, or no?

That accrual, which is actually backed out and then you put through the actual cash that you pay, so that's why -- that's why you're seeing CAD186 million, but in your CAD806 million you actually have some 200 -- CAD344 million of deferred taxes, which are back half.

Okay. Luc, thank you.

Welcome.

Thank you.

Well, I think that's the end of the questions and I just would like to thank you again for taking the time in your busy day to listen to our third quarter results. We are pleased with them and we hope that we will have a good fourth quarter results to report in a couple months. Thank you.

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