Canadian National Railway Co (CNI) 2011 Q1 法說會逐字稿

Welcome to CN's first-quarter 2011 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.

Hi, good afternoon. Thank you for joining us for CN's first-quarter 2011 conference call. I would like to remind you about the comments that have already been made regarding the forward-looking statements and the information that you can find on the web.

With me today is Claude Mongeau, CN's President and Chief Executive Officer; Luc Jobin, Executive Vice President and Chief Financial Officer; Mr. Keith Creel, Executive Vice President and Chief Operating Officer; JJ Ruest, Executive Vice President and Chief Marketing Officer. And after the presentation, as we have mentioned a number of times, we will be taking questions from all of the participants or a number of the participants that are listening. Would you please limit your questions to one to be fair to us and also to be fair to your colleagues?

With that, it is now my pleasure to introduce Claude Mongeau, CN's President and Chief Executive Officer.

Thank you, Bob, and thank you all for joining us for our first-quarter call. I think it is a very good set of results that we want to discuss with you. We have obviously had a challenging environment to deal with during the winter, but our level of preparation and our focus on execution really put us in good stead. I think, as you will see when you hear some of the details from Keith, we were able to maintain very good service overall, and continue to make progress in terms of running a solid railroad for our customers, and actually did well from an efficiency standpoint. If you step back and look at it with enough perspective, most of our metrics are better than where we were in 2009.

So solid operating performance, continued focus on engaging our customers. JJ will report on some of that in more details. But really, I am very pleased with the growth that we have been able to achieve across all of the commodity groups.

So overall, 9% revenue growth. If I look at it on a constant currency basis, the solid efficiency, allowing us to deliver a 69% operating ratio in a tough winter. Good EPS growth, CAD0.90 on an adjusted basis. CAD0.55 more if you add the gain that we made on the sale of a corridor here in Toronto. And solid performance in terms of free cash flow.

Luc will give you some more detail. But to be able to deliver solid earnings, but also monetization of a corridor for just under CAD300 million once again this year, is testament to our focus on all levers of value creation.

So overall, I am very, very pleased with the first quarter. It is a solid start to the year, and we believe that we have a solid potential to continue to deliver solid shareholder value throughout the year.

With that, I will let Keith give you some details on our operation.

Okay, thanks, Claude. As you said, first quarter was certainly solid start to 2011. Granted, there is always room for improvement, but overall, I am very pleased with the way our operating team delivered on service and productivity fronts during what was, by most objective measures, clearly a tough winter.

As you are aware, well before the snow fell or the cold weather set in, we identified many unique challenges that winter presents. And we immediately began to act on specific actions and initiatives, with an objective to mitigate those challenges during the winter operation.

In summary, investment, prior planning, execution, all key cornerstones for our success. I think the financials will give you a pretty good indication of how successful we were in our efforts, but let's turn to the next slide to drill down a bit more in detail.

As all of you know -- anyone that is associated with railroading -- railroading is an outdoor sport that winter brings a variety of challenges to, especially with extreme cold temperatures and heavy snowfall. Extreme cold temperatures historically meant we were forced to run shorter trains, which drives more train starts, consumes more assets, be they people, cars or locomotives, and equates to more train maintenance and mainline capacity consumption.

Extreme cold temperatures and heavy snowfall typically means more mechanical failures and associated congestion on the [line of road], making it extremely hard to keep your mainlines fluid. And finally, extreme cold temperatures and heavy snowfall typically makes it challenging to process cars efficiently through our terminals, where cars will build up quickly, resulting in not only congested yard operations and increased costs, but mainline operations as well.

So accordingly, our winter operating plan had three primary objectives. We are going to maintain train length, maintain train speed and keep the yards processing efficiently. As you can see from the GTMs per train mile chart, we were able to maintain train size quite well, and in fact increase it over first quarter of last year, which was, by most comparisons, a mild winter. We did this through our continued deployment of distributed power, which we have talked to you about often in previous calls.

By and large, as an example, over 50 trains per day operated DP this past winter versus about 15 same quarter last year. We did it through our ongoing rifle-shot infrastructure investments and of course our intense focus on equipment and plant quality.

You can also see from the terminal dwell charts we were successful in our efforts to keep the yards clear and processing efficiently. We did this through our focus on our operating plan, continual rightsizing of our car fleet and execution of our snow-fighting recovery plans, to name a few of the key areas.

Our results on the other velocity and productivity metrics are by and large flat to mostly down year over year against the backdrop of higher volumes and much tougher winter conditions compared to first quarter of last year.

So I would say overall, our winter planning and execution efforts delivered very respectable results. But what is most important to me -- or more important than what we have done is what we still have left to do as we prepare for 2011/2012 winter. We have got lessons we have identified that we will convert to opportunities for the next bout with winter, and rest assured, internally, we have started down that path.

Finally, as we transitioned out of winter, I am pleased to share with you, Claude, and with those of you on the call that the railroad is running extremely well so far second quarter of this year.

Now let's talk about going forward. Let's talk about the initiatives. Most of you who know this Company well know that we are always pushing to manage expenses, improve productivity and accelerate our assets, all against a foundation of safety. You can see a number of these operational initiatives listed on the chart in front of you.

We have spoken about many of them before. But let me speak for a moment on the exciting things we are doing externally on the service front with our customers and the ways we are engaging internally with our employees.

Under Claude's leadership, and working closely with JJ's team, we continue to reach out to customers and supply-chain partners to establish mutually beneficial service-level agreements. These innovative agreements allow us to jointly measure key performance indicators all along the supply chain and develop improvement plans based on communication, hard facts and mutual respect and benefit.

Now, I was recently asked how much are these agreements going to cost, and my answer is pretty simple. They don't cost us anything. In fact, they help us improve reliability and velocity while connecting with our customers in positive ways. With our precision railroading mindset, we translate these improvements into higher asset utilization, fewer surprises, both internally for CN and externally for our supply-chain partners and customers, and as a result, lower cost. So JJ, I love it. We are going to keep signing customers up.

On the employee front, we work every day to engage with our people through direct discussion, mentoring training safety summits and our RTC excellent initiatives, which is showing our employees that we are listening to them and acting on their suggestions in concrete ways. We continue to hire a significant number of new employees to deal with attrition in business, close to 1000 year-to-date, where we're investing quality time on the front-end to ensure we get the right folks. And then once we secure them, we are taking steps to ensure we bring them into the CN family in a professional, welcoming way, with an objective of making them safe and productive as quickly as possible.

And obviously, in line with the volume growth effectively that we are dealing with, we have to make sure we stay diligent and continue to stay ahead of our [T&E] demands, hiring to match the volume where it is coming to us on different parts of the region.

So this franchise has the infrastructure. We have got the plan, the assets and the people to continue to improve service while we grow in a controlled manner. And with our precision railroading mindset and about 21,000 of the best railroaders in this business, I don't see that changing anytime soon.

Now I will turn it over to JJ, who will tell you what he and his team have accomplished in the marketplace.

Why, thank you, Keith. And I would like to welcome the many customers who often join us on the webcast or webcast replay.

The first-quarter revenue increased by 6%, or 9% on an FX-adjusted basis. Our revenue ton mile volume, the RTM, increased about 5%. Bulk and Intermodal established a Company RTM record for a winter.

We ended the quarter with a backlog in some markets, namely grains and coal, pulp, finished vehicle and nonferrous concentrate. However, having said that, the first quarter RTM volume for CN was a Company record for wintertime. Hats off the Keith's team to do this in very adverse conditions. Our customers have appreciated and noticed the result.

Same-store price increased 4%, in line with our service plan. (inaudible) charter revenue increased about 2%. The mix was about neutral, and exchange reduced our revenue by about 3%.

Now let's look at the first quarter in detail. I am on page 9. And all of my revenue comments will be on the FX-adjusted basis.

Starting with petroleum and chemical, the revenue was up 10%, the RTM was up 5%. And this [year] production is what drives chemical plant operating rates. Those were in the range of 90%. We also had increased shipment of refined product, such as diesel and jet fuel.

Metals and minerals revenue, excluding of iron ore, was up 4% and RTM was up 1%. Increased drilling activities resulted in strong performance in oil and gas material. Nonferrous metals declined because of two of our smelters had permanent closures last year. However, nickel and zinc concentrate volumes are on the rise on the CN network.

Iron ore was up 2% on revenue, but down 22,000 carloads. One of the mines switched production grade and used another [dock], not on CN. However, we redeployed our fleet of railcars to an all-rail winter program, and we ended the quarter with an overall RTM up 1% from 2010 for iron ore.

Forest product revenue was up 8%, RTM down 1%. Chinese demand for lumber continued rising. Lumber shipments to export terminals -- that is to the West Coast -- were almost up 60%. Pulp mills continued to operate at very high production rates and record price, but carloads were somewhat limited by the availability of our boxcar supply. Strong European demand continued to increase our West Coast wood pellet carload export.

Automotive revenue was up 5% and RTM was up 1%. Many of the CN-served plants enjoyed larger production increases in the first quarter.

Our coal revenue was up 10%, the RTM was up 7%. Our US coal franchise had an historical high for first quarter in RTM volume, with strong offshore export via the Gulf Coast terminal that we serve. However, we did encounter difficult terminal supply chain operating conditions in Canada, which reduced Canadian coal and pet coal volume below the quarter of last year.

Grain and fertilizer revenues were up 12%; RTM in that segment was up 7%. We leveraged the winter challenge to showcase our service to Canpotex and help them set a first-quarter company record on tonnage export.

World grain markets reported very strong export of canola over the BC port, and our corn and soybean export over the Louisiana terminal also did very well.

Intermodal. Intermodal overseas revenue was up 13%; the RTM was up 6%. The Intermodal domestic revenue was also up 13% as well, but the RTM was up 8%. Both our overseas and domestic customers definitely experienced the best winter service in many years, thanks to our level of service agreement with the waterfront terminal that Keith referred to earlier and the fine tuning of our domestic services.

In overseas, CN continued to outpace the market in Vancouver. In domestic, our service focus and our capital investment in the temperature-sensitive service, like grocery and consumer goods, is yielding very strong growth in the long-haul market.

Finally, other revenue were up 4%. The primary driver of that was our stronger bulk export via the Louisiana -- [common] Louisiana bulk terminal. We also had higher finished vehicle activities in our auto port facilities, and that was partly offset by lower freight forwarding business.

Now, let's look at the review market-by-market. Let's go on page 10 and cover Intermodal. But before I get into Intermodal, I would like to make a few comments about oil price.

High oil prices are [sure to cause] headwinds for railroad, including CN. But for CN, it is also a midterm tailwind to grow our book of business. Our universally applied fuel surcharge tariff are cost revenue neutral to a fluctuating oil price after the impact of the two-month lag. Because of CN fuel efficiencies, we have the industry-leading most cost-effective fuel surcharge tariff. For example, in April, at $0.32 per mile, CN has the best mileage-based tariff of the rail industry. And it is even more compelling when you compare that with the long-haul trucking cost spot fuel surcharge program.

Our outlook for the domestic Intermodal business is we believe we will be improving our volume in the consumer and manufacturing goods segments. We are also investing in roughly 1000 containers, mostly insulated containers, to renew and expand our domestic container fleet and grow in the long-haul segment.

On the overseas market, we have an ever-growing franchise that produced a lot of container export to the Asian economies. We generate a lot of export of Western pulp, export of B.C. lumber, export of Prairie specialty crop, and a fast-growing Intermodal ramp in Prince George B.C.

We are also welcoming new shipping line services in 2011. Rupert will see the addition of two new weekly services before the next peak season. We also have one new vessel service in Vancouver.

Vancouver import and export growth also looks positive, due to the CN superior supply chain operation.

Bulk outlook, on page 11. On coal, export met coal, as well as export thermal coal, is strong and steady. We are working with the Rupert terminal to debottleneck the capacity pinch point. This will pay dividends sometime later this year and especially in 2012.

We are working a backlog of coal and grain on the Canadian side. We concluded our service demonstration with Canpotex, and now will be focusing our efforts on the North American potash in the coming quarter with our North American customers.

On page 12, manufacturing outlook. The North American steel operating rates are about 75%. The chemical plants are holding steady at 90%. And our iron ore carloadings are now flat versus a quarter of last year. The mine came back on using the CN network.

Condensate will continue to be eroded by the new pipeline, the Southern Lights. Lumber and pulp export will remain very strong; Asia is driving increased carload to the B.C. port. Nonferrous metal will stay down because of the shutdown of the two smelters, but the nonferrous concentrate will continue to grow in our line.

All in all, the volume looks positive for 2011, and we have sustainable same-store price, sustainable future (inaudible) program, and our engagement with our customers and our supply-chain partners will help us help them win in their own market. Luc?

Okay. Thanks, JJ, and good afternoon, everyone. I am pleased to report on CN's financial performance for the first quarter of 2011. Let me cover the highlights starting on page 14.

First, as JJ mentioned, our performance was strong across all business sectors. RTMs went up by 5%, while revenues for the first quarter came in just shy of CAD2.1 billion. That is up 6%, or 9% on a constant currency basis versus last year.

This was achieved in the midst of a very demanding environment. And so we are pleased with the operating income generated of CAD645 million, up 7% versus last year.

We also completed the disposal of a segment of the Kingston subdivision during the quarter, which resulted in a gain of CAD288 million. Now, this is part of our ongoing strategy to monetize non-core assets as we reposition them to their highest and best use. And in the result, we generate shareholder value and free cash flow.

Now, the strength of our operating performance and this gain translated into a net income of CAD668 million, up 31% versus last year. The reported diluted EPS, therefore, stood at CAD1.45, and that is up 34%.

Excluding the rail line subdivision sales recorded in each of 2010 and 2011, our adjusted diluted EPS in the first quarter of the year stood at CAD0.90. That is a 12.5% increase over 2010.

Now to put these results in perspective, keep in mind that we faced in the quarter several headwinds, not to mention weather. From a currency standpoint, the strength of the Canadian dollar reduced our EPS by some CAD0.02, while a significant increase in oil prices also caused an adverse fuel lag of roughly CAD0.05 on our first-quarter EPS. So excluding these two items, actually our EPS is up 21%, quite impressive for a rough winter.

The operating ratio, in turn, stood at 69%, and that is an improvement of 30 basis points versus 2010. This highlights the industry-leading performance delivered by our railroading team, as they balanced protecting service for our customers versus managing costs tightly, while keeping operational metrics in check.

Let's turn to page 15 for the expenses, the operating expenses now. Expenses came in slightly above CAD1.4 billion, and that is 6% higher than last year and 9% more on a constant currency basis. The majority of the increase was attributable to fuel, up 36%, mostly due to higher prices. The WTI averaged some $94 in the quarter versus $79 in 2010. We still managed to squeeze out a 1% improvement in fuel productivity.

Meanwhile, purchased services and material increased by 14%, as we incurred higher repairs and maintenance, utilities and snow removal costs in dealing with the harsh winter conditions. Labor costs were up 3% higher than last year as a result mostly of wage inflation and more employees on the payroll. This was partly offset by more capital projects and more benefit costs in the quarter.

Our casualty and other expenses were lower than last year by some 26%, but pretty well on target for the year. Last year, we had higher expenses, mostly due to an adjustment to our personal injury claims liability in Canada and some higher G&A costs.

Now let's turn to free cash flow on the next page. Free cash flow, we continued to generate some very solid results. In fact, we produced CAD445 million of free cash flow in the quarter. That is slightly lower than last year by some CAD48 million, as we paid CAD138 million of cash taxes in the quarter, and that is CAD113 million more than last year.

We also invested CAD220 million in CapEx from our CAD1.7 billion program, and this was CAD86 million ahead of last year. We have increased also our dividends by some 20% earlier this year, which was our 15th consecutive annual increase.

We also achieved 30% of our CAD16.5 million stock buyback program in the first quarter.

Our balance sheet is strong, and our net debt position stood just above CAD5.3 billion.

Now in closing, let me now turn and address the 2011 financial outlook. First, we continue to see a gradual economic recovery unfolding. We anticipate good fundamental demand for most of our business segments as we continue to work with our customers to help them maximize their growth opportunities. This should translate into solid single-digit carload growth for the year. And we also maintain our pricing policy at above inflation.

Meanwhile, Keith and the team continue to have a full pipeline of productivity initiatives.

Let me remind you that we do have some headwinds to contend with in 2011, a few of which are the continued strength of the Canadian dollar versus the US greenback, some higher depreciation costs resulting from our depreciation studies, rising fuel costs and higher cash taxes.

Now, it is early in the year, and while there is still some volatility around the global pace of recovery, we, however, on the basis of our solid performance in the first quarter and a positive outlook for continued improvement in economic conditions for the balance of the year, are revising upward our 2011 guidance.

From our original guidance of aiming for double-digit growth in adjusted EPS versus last year, we now expect EPS growth of up to 15% in 2011 on an adjusted basis over the CAD4.20 achieved in 2010. In addition, based on our solid results for the first quarter, including the proceeds from the sale of our Kingston subdivision and our higher earnings forecast for the balance of the year, we are raising our free cash flow guidance from CAD850 million to CAD1.2 billion.

I should mention as well that this amount is net of CAD200 million that we are setting aside for potential additional voluntary pension contributions, should we deem this desirable as we reassess the situation, based on conditions which will prevail in the fourth quarter of the year.

So as you can see, this team maintains a very strong shareholder value focus at all times. On that note, back to you, Claude.

Well, thank you. As you can see there, is a lot to be proud in those results, and I think we have a solid momentum going our way in the market place at the moment, solid focus on execution in terms of running an efficient railroad.

As Keith mentioned, we are into Q2 and all of our metrics are improving, and that is despite the significant volume growth. So in terms of 2011, I feel very good about this revised guidance and our ability to deliver on it. And more broadly in terms of our strategic agenda, I am very pleased as to how this team of railroaders is coming together. Our initiatives are sound and they are working -- they are clicking, I would say. Our customer engagement, our innovation, our supply-chain collaborations, all with an eye to maintain operational and service excellence, are delivering clear results. The proof points are in front of you. And we look forward to continuing on this momentum for the balance of the year and well into the future.

With that, we will take your questions.

(Operator Instructions). Walter Spracklin, RBC Capital Markets.

Thanks very much. Good evening, everyone.

Good evening, Walter. We are here in Toronto with you.

Well, good stuff. It sounds like you are limiting us to one question here, so I will try to make it a good one. It sounds like you had -- your volume growth did have some market share gains. You guys did a great job in the quarter on managing the winter weather. That led to some share gains.

I don't know if, JJ, you can speak to this or -- is there any sense that on a go-forward basis, this is going to help you either -- is there any stickiness to some of those volume gains? And how does it help -- when you talk to your customers about the tremendous job you did do during the winter, how does that allow you to hold on to some of those share gains?

I think if you look at some segments -- for example, if you look at Intermodal, the stickiness of what we have done has started to really appear in the third quarter of last year, so it started way before the winter. Same thing in domestic Intermodal; it started in the fourth quarter of last year. I think we had also a very good run last fall on grain.

So, yes, we are feeling positive that the model we put together as of last spring is actually generating solid results quarter-by-quarter, winter or not. And we believe that we have a good thing going; at least that is what the customers tell us.

Is that why you got some of that Rupert business up there? Is that up to 500,000 now, with the two new weekly vessels that you are adding?

I think, again, when you look at the line, they are looking at both import and export. I did make some comment how strong the export is, for example, for product coming out of northern B.C. -- pulp, lumber and some specialty crops from the prairies. And it is attractive for a line in Asia to capitalize on that market. Right now, that market is underserved. There is a shortage of containers for export of B.C. and Alberta. And it is one of the things that is very appealing, what we have been able to develop as a franchise. But also, obviously, our service to the east and how we work very close with the terminal operator to move these boxes, not only in the railroad, but as Keith mentioned, as soon as they hit the dock, we start the clock.

Great. Thank you very much.

Thank you, Walter. I would just add that we are indeed helping our customers win in the marketplace, so we are helping them succeed. And we get a lot of interest -- a lot of people are interested in trying to understand and feel out what this customer engagement of CN is all about. And they know we have a great product. They know about the velocity. They know about our resiliency and our focus on serving them day in and day out. And it is paying, as JJ said, pretty much across the board dividends that will stick with us for a long time.

Great. Congratulations on a tough quarter there that you guys did a great job.

Thank you.

Cherilyn Radbourne, TD Newcrest.

Thanks very much, good evening. I wanted to ask a question with respect to I guess what I would call employee engagement.

Claude, when you started in the role as CEO, you spent a lot of time with customers. And I guess historically, CN has had a reputation of, you know, difficult relations with both customers and employees. So I just wonder if you could talk about whether you are doing anything differently from an employee perspective and what implications that may have for the labor negotiations that you've got coming up later this year.

Well, I think it is a natural evolution. We have made an awful lot of changes in the way we manage our business. And obviously, as I said before, this impacted our customers. We have also made a lot of changes in the way we operate and that impacted our employees.

But from where we sit now, we have an opportunity to take our game to the next level. There is a tremendous amount of attrition in our workforce, which will allow us to bring in new railroaders that are stepping in to replace those who have had a great career with us. And we are doing everything to make them feel part of the success of CN, and they feel it and it is working. And we are very pleased we were able to do to two collective agreements recently with our -- in the fall with our running trades and this winter with our CAW mechanical and clerical employees. And we intend to continue on this path going forward.

Thank you. That is my one.

Bill Greene, Morgan Stanley.

Hey, good afternoon. You know, JJ, I am wondering if you can talk a little bit about the market on the Intermodal side relative to the opportunity to take off the highway. The US guys I think are a little bit behind you in this, perhaps, in that they sort of talked about an addressable market being measured in millions of trucks that can come off the highway. How do you think about the opportunity for you, or is the length of haul something that you have already captured that, and now it is just organic growth?

Well, there is still business be gained on the length of haul. When you look at a distance between, say, eastern Canada, Toronto, Montreal, then Alberta, which is a major corridor, this is really where railroad should be king, and especially with the price of oil. Same thing from the US Midwest, Ohio going west. We do that typically with our DRP program, meaning using 40-foot containers that need to go back to the West Coast anyway to eventually get back to Asia. And we do have -- the traction that we have in the domestic Intermodal is more than just organic growth; it is organic growth plus some gain with over-the-road. Sometimes we do it with our trucking partners; sometimes we do it directly with our own retail product.

How big would you say that market is?

I think time will tell. Because I think when you look across the cost of fuel, when you look at the issue of drivers, when you look at the imbalance -- the freight wants to go west and it is not really coming back east -- and we could do that without the imbalance with our DRP program of overseas box. I think we have quite a bit of good run to go and we will see how far that could be (inaudible).

But you have never talked about a number of trucks that you think you could take off the highway, et cetera?

No.

Okay. All right, thank you.

Jacob Bout, CIBC.

Good evening. Can you talk a little bit about the flooding that you have seen so far this quarter, what type of impact you are expecting there?

Well, I can tell you we have not had any significant impact to date. We have had some high water situation or conditions between Winnipeg and Superior that we have had to mitigate. Nothing that has taken us out of service for any significant amount of time. In fact, in that corridor, we are helping some of our counterparts to navigate some of their trains over corridors where they do not have access.

South of us, south of Chicago, we are experiencing, with the recent huge amount of rain that -- we have all gone through some flooding. But to this point, we have had some lines, again, impacted. But as far as our core routes, we still have access across our network. So no material impact to CN, and in fact, we are able to help some of our counterparts,. as I mentioned earlier.

Gary Chase, Barclays Capital.

Good afternoon, everybody. Wanted to see if I could just quickly follow up on a comment that you made, Luc, in your prepared remarks about the labor expense, which came in a decent bit better than we were expecting. You mentioned reduced benefit payments. I don't see anything in the pension expense that would be material from your disclosures. So could you elaborate a little bit on that? And then just, more importantly, is this -- is the traction you experienced in the quarter likely to continue as we roll through the year?

Yes, in terms of the benefit cost, there was a combination of certain -- not just the pension, but other benefit elements. But on the pension, we do have a slightly better situation than we expected. And we had a pension income in the order of CAD20 million in the quarter, which I do expect to be the run rate for the balance of the year. So that is one component of that.

And the other component, as I said, is a mixture of different things.

In terms of the overall labor and fringe benefit cost for the year, I would expect it to be higher as we do continue to have -- we recruit and increase the employee count to deal with both issues of attrition, as well as hiring and training folks ahead of time to make sure that we have them productive to meet the increased demand. So I would expect the labor and fringe to run higher than this on an ongoing basis through the year.

When you say higher, you mean in terms of year-on-year growth, right?

Yes, that's correct.

Thanks, guys.

Tom Wadewitz, JPMorgan.

Hi, it's Michael [Weins] in for Tom this afternoon. Let's see -- just following up on the headcount question there, and kind of leading into capacity, how should we think about sequential headcount from the level of 22,304 employees that you put up in the first quarter? And what is your view on capacity in the network and how much room you have to expand before you have any constraints there, aside from headcount?

Let me tackle the first part of the question. In terms of the total employee base, we were 3.8% up quarter on quarter. And on a sequential basis, we were up about 1%. More importantly, from a T&E standpoint, quarter to quarter, we were up 5%, which is roughly in line with the RTM growth. And on a sequential basis. we were actually up around 7%. So that is just the body count.

In terms of capacity, I will pass it over to Keith.

Overall, as far as capacity, our story has not changed. We are not experiencing any huge constraints or demands on our physical plant. Certainly we do have areas that are more used than they have been in the past, which is a good thing. We are sweating those assets.

But we continue to invest strategically; where we see noise in the system or we see an opportunity to improve productivity and asset turns, train speed, et cetera, we invest, and those investments are paying dividends for us. All of our major yards continue to be very fluid, even in the dead of winter, which should tell you -- be quite a proxy for what capacity is still left, especially in non-winter operating months.

I would just add to this -- we are working hard as part of our supply chain approach to create capacity from a supply-chain standpoint end-to-end. A very good example is what we are doing in coal. We have a lot of coal demand, we have an opportunity to move more coal. CN has a lot of opportunity to handle that business, but we are facing waterfront capacity bottlenecks and we are addressing them in a supply-chain manner with our partners at RTI, for instance.

We have had what we call at CN a proverbial scrum around this issue to make sure that we understood what were the bottlenecks, how we could get throughput at relay terminal to increase. And I am pleased to report the month of March was a record amount of coal tonnage for CN in our history, and April so far is starting to be about 10% higher. Because not only CN, but also, how we come together with RTI is allowing us to get to a higher level of capacity.

So we are doing this in coal; we are doing this with our terminal partners on the West Coast, for instance, for Intermodal, in preparation for what we believe will be a very strong fall peak. And we feel good about the capacity of our railroad and are working with our partners to create end-to-end supply-chain capacity.

Yes, that's great color. Just for a clarification on the headcount comment earlier, how should we think about the headcount going forward? Are you already at levels that you have the employees in the training programs, ready for further volume growth in the year? Or would you have to have a step function up with new hiring later in the year to handle more volume?

We want to continue to higher ahead of time, to be able to handle the business that is coming our way. And we have done this consistently, and it has put us in good stead. So we want to continue to do that, and as long as we see strong demand going forward, we will make sure we don't have crew shortages.

The good news is we have enough attrition that if we are wrong, it is going to be wrong for a couple of months, because we can always dial down on hiring and wait for attrition to fix and put us back into balance.

All right. Great. Thank you very much; that's great color.

David Newman, Cormark Securities.

Good afternoon, gentlemen. Just a quick question on the J. It has been some time since we have had an update. Where do you stand right now on sort of the terminal yard rationalization? I think at one point it was kind of ticketed to pay for itself, some of the consolidation that you had there. Mitigation, I see, announced another one last week. And are you seeing any metrics across the US system where you are seeing US car miles per day improve?

I will let Keith comment, because the J was actually a big asset for us this winter. We started to see the benefit in the middle of the weather issues.

But I am very, very pleased with the way the J integration is coming, and those connections -- actually, I was visiting them a week and a half ago -- are being constructed. And I can't wait to be able to run trains across those connections, to get the fluidity and get the transit time advantage. But Keith, do you want to add to terminal and how you actually used the [J] through the winter.

I can say this. I will just give you a comparison. We had one of the largest snowfalls ever in February in Chicago, which effectively crippled the Midwest. With our ability to get in and around Chicago, get through Chicago, on our own route, controlling our own destiny, effectively, we were out for about 12 or 13 hours. We were able to, using the J, using the reduced stress on our terminals, recover from that quite quickly. So short-term, a lot of capacity there. Long-term, as we rationalize, we get these connections done, we convert some of the existing traffic that still runs through the inner city to that outer arc, you will see additional step benefits.

But certainly, it is paying dividends and exceeding my expectations and what I thought we would be able to do and convert from a productivity standpoint.

Where do you stand, Keith, just in terms of the timelines in terms of full execution of the plan? And what metrics are you sort of using to track? Are you seeing the US car miles per day go up across the system? Or ultimately where are we in terms of full benefits of it?

Car miles per day is a pretty good proxy, and certainly not all cars go through Chicago that are in the US region (multiple speakers).

Right.

But a large percentage do. We have seen about a 15% improvement. There is still more to be garnered as a result of the terminals. The main terminal that we're going to build in Chicago -- or that we are retrofitting in Chicago is Kirk Yard. That is probably 18 to 24 months out before we convert. Then once we convert and we get cars out of [Marcum] into Kirk, you will see another stepped improvement.

The infrastructure improvements with the connections, we're toward the end of this year, beginning of next year, having all those done, so that we can turn out at higher rates of speed, getting onto the J so that we can go through the communities, mitigating adverse impacts of those communities and go in and through.

Joliet Yard, that track effectively is done. We are getting that signaled up now, so that speed will increase. And then finally, the large project that Claude talked about down in Matson -- the third and fourth quarter this year, we will be transversing through there.

So it is very, very, very close; you can see the light at the end of the tunnel. But more to come as we convert the yard operations.

Excellent. Thanks, gentlemen.

Matt Troy, Susquehanna.

Yes, thanks. I wanted to ask a question about export coal. It is obviously a topic du jour for the US rails. But I was interested in your comments about the export opportunity out of Rupert. We have all seen that place. We took that trip you were kind enough to bring us on a few years ago.

I would just ask what are the bottlenecks? It is a pretty rural place. What is in your control in terms of bringing the capacity up versus RTI at Ridley? And what do you see -- if you could move all the coal that you could, what kind of tonnage could you see long-term through that facility? And then as a side note, is Vancouver a growing opportunity as well? Thanks.

Thank you, Matt. Both of them are growing opportunities. But if we start with Rupert, our work with the coal terminal is really to find ways to make sure that the terminal always has coal on hand, that the train, the way we get them has actually reduced their workload inside the terminal. They when they are finished with a set that we pull the set out.

Currently, they are a better handle -- they are more efficient when they handle steel sets. We try to give them more steel sets where we can. So we do everything we can to try to make them more efficient.

However, RTI does have a plan to help themselves through capital investment. The first thing they are going to do, they are going to change -- they are going to modify their rotary dumper in December of this year. What that will do is they will then have increased unloads, especially with aluminum as of 2012.

The next step they want to do also, they want to spend some money on the stacker reclaimer, which also will increase the capacity. And eventually, you know, if they have the funding and the business is there and robust, they also will have an option on a piece of land right behind them to increase their footprint, which eventually could make them to make a major terminal. Because terminal rate today is -- what -- 11, 12,000 -- 9, 10 million ton terminal. It could become a 12, really -- should really be a 25 million ton terminal in two or three years if it is run well. And it could actually do more than that if they do exercise that option of that export footprint.

In Vancouver, (inaudible) has some project to debottleneck the terminal. And Neptune, the one that we serve in the North Shore, also is doing some work on their indexer, as well as some other work that they talked to us about that will also increase the capacity of these two terminals.

What that means for CN is at Rupert, we can serve all the Canadian coal business coming from B.C., coming from Alberta, and some of it from Kamloops, and potentially also coming from the PRB.

Okay, thank you very much for the specifics.

Scott Group, Wolfe Trahan.

Thanks. Good afternoon, guys.

Good afternoon.

First, JJ, I missed that breakout of pricing fuel and mix. Can you give that again real quick, please?

Yes, the same store price was in the range of 4%. The fuel was about a 2% increase and the mix was neutral, and the exchange took away about 3% of revenue.

Okay, great. Thanks. And then I wanted to ask about the potash. Is there any way to quantify the benefit you had in the quarter for moving export potash for Canpotex? And then thinking longer-term, is there anything you learned -- from moving that volume, is there anything you learned that you think could help you as that contract comes up for bid sometime next year?

Yes, let me tell you that we were there to step up to help an important potential customer at Canpotex, but also an important supplier in the Canadian supply chain that serves the world. And we did it through the first quarter. I think the main opportunity was our chance to showcase our service and also to showcase to them the value of diversity. When you go through tough times, it pays to have outlets, it pays to have diversity in your supply chain. And there is no surprise that they actually were able to do a record volume in their history at Canpotex. So I think the value will come in the future as Canpotex assesses its options on a go-forward basis.

That makes sense. Is there any way to quantify the volume or revenue in the quarter from that export move?

It was a nice piece of business. And we ended that at the end of March.

Fair enough. Okay, thanks for the time, guys.

Chris Wetherbee, Citigroup.

Yes, hi, good afternoon, guys. Just wanted to touch on pricing a little bit. It looked like the core number was up; sequentially, it was a solid number. Just curious kind of your thoughts on pricing as you progress through the quarter here. As you have a tail wind at your back here, does it seem like you have the potential to continue to keep that core number in that kind of 4% range going forward?

The run rate that we have right now for the first quarter is -- we are quite satisfied with it in terms of it relates to the level of service. It is reasonable. It is sustainable. It is somewhat better than what we had last year, and it is above inflation. So I think it is -- for 4% was satisfactory.

Okay, fair enough. And then one quick follow-up, just a clarification. I just wanted to make sure I heard it right -- on the casualty line there was an addback there of about CAD30 million of pension income in the quarter. I just wanted to make sure I understood that correctly.

No, on the casualty and other, really that was last year we had an adjustment which was relating to our workmen's comp. So the personal injury liability. So we put through an adjustment and we also had some higher G&A. So that is what is causing the difference in the casualty and other.

With respect to the pension, just to clarify, again, this is the change -- this is part of the -- a little bit of the favorable change which offsetted some of the inflation costs as well as the higher headcount in the quarter. We had some increased pension income versus last year, which was really in the neighborhood of about CAD4 million or CAD 5 million, so it is not huge. But we do have -- we did have a CAD20 million or so pension income in the quarter.

So that, along with some other capital projects -- we did carry out a fuel more capital projects than last year -- and so that also was a bit of an offset to the increased costs on the labor side.

Okay, that is very helpful. And just to make sure going forward the pension income -- did that just immediately go away in the second quarter, or is there any sense that a piece of that continues going (multiple speakers)?

No, no. That is a pretty good run rate.

Okay, that is very helpful. Thanks for the time, guys.

Ken Hoexter, Bank of America Merrill Lynch.

Hi, this is Steve Sherowski in for Ken Hoexter. I was just wondering -- you obviously faced a difficult winter, although maybe not as difficult as some of your competitors. I was hoping that you could quantify the impact of weather during the quarter, and maybe talk about the lessons learned that you referred to earlier in your opening remarks, and whether or not those lessons are more weighted towards infrastructure buildout or primarily process oriented?

I will let Keith comment on what we are focusing on for next year. When it is all said and done, I don't think that it is worth it to quantify the first-quarter impact. It was a difficult -- it was a very difficult winter. I mean, just to give you a few statistics, we have three times more cold days in this Q1 than the previous quarter -- and by that I mean days that are minus 25 or below. And we had four to five times more snow in much of our network across the West.

But at the end of the day, there is winter every year. And you take the good and the bad, and we are very pleased that our service stood up and that we were able to maintain operating efficiency throughout the quarter. Keith -- in terms of lessons learned for next year?

Just a couple of comments. When it comes to infrastructure, huge capital spend, that is not what we are talking about. We are talking about blocking and tackling stuff. There is no silver bullet.

But this railroad, you have got a bunch of railroaders that have a passion for operational excellence. And you've got a bunch of railroaders that use very efficient IT systems to understand and measure the key components of the way we do our business day in and day out. So we quickly see noise in the system that adversely impacts our velocity, our terminals et cetera, et cetera. I could talk about it for more time than you or I have.

But a couple of key things I will leave as opportunities for us next year. Process as well as reliability. And when I say reliability, mechanical reliability with our locomotives, with our cars and even with our track. And once again, no silver bullet. But things such as working with locomotive manufacturers to ensure that the DP, which we have deployed across our system, works properly together from a communications standpoint. We did have some issues or some learning lessons marrying up say EMD locomotives with GE locomotives. It is not our fault of either of the manufacturers, but certainly an opportunity through the year, through experience, that we have identified and we have got to correct it. And we will be correcting it even to a higher degree for next winter.

Process-wise, inspections, that is something we invest heavily in when it comes to broken rails. We do quite a bit of RFD, rail flaw defect, detection testing across our network. Our core network, we have invested quite a bit in. We effectively try to do the coordinate work about once every month.

From a process standpoint, some of our branch lines, which we feel are in pretty good shape reliability-wise, we did not inspect as much. And just as -- recently coming out of winter, we had a derailment, that I am certain with a process change, instead of us inspecting it just before winter and after winter, we will add a couple more frequencies to those type lines and we will see a reduction in those type of derailments that adversely impact the network.

So in summary, it is not any one single thing; it is a list of a multitude of things. But you have got to have the passion, you have got to have the railroaders with the knowledge and the ability to do something about it and go out and execute it. It is not sexy; it is just what is necessary to be effective in this business.

Okay, thank you.

Jeff Kauffman, Sterne, Agee.

Hi, it's actually [Concena] in for Jeff. I just had one quick question. Are there any supply-chain concerns in the automotive industry and do you serve any of the affected suppliers?

We serve all of the major automotive carriers to a degree, but in particular GM and Ford. And for sure, with the winter and the success of their business, for sure there was industry car supply issues during the first quarter -- partly winter, partly demand and network issues.

But we are -- we stepped up and I am pleased to say that it is only three weeks into April; we have made significant headway in terms of recovering the vehicles that were on the ground waiting to be loaded. And I think we at CN and we as an industry will learn of the issues and we will be much better next year.

Got you. There shouldn't be any major impact in the second half of the year?

I don't think so. No, I --

Got it. That is all I had. Thank you.

Chris Ceraso, Credit Suisse.

Good afternoon. This is Allison Landry in for Chris. I guess as a follow-up to the auto question, Toyota and Honda have announced some plant shutdowns in North America, and I believe you guys serve some of those. Are you aware of that? Are you guys expecting any impact from those shutdowns or even a timing issue?

We have limited exposure to these two producers. As it turns out, GM and Ford are the two companies with who CN does the most business in North America. Also, Nissan plant, and then we also do import by the two coasts.

So it just turned out our portfolio is more toward the North American one, who do -- have been affected up to a point because of the import parts.

All in, as Claude mentioned, we are working through a backlog already in the month of March and April, so it is not like we are short of vehicles to move right now. And there may be an impact in the second quarter. It will probably be very small from what we can see. And eventually, if somebody is not producing vehicles, it doesn't mean that the consumers will not be buying something. If they buy the product that is maybe in North America, we may end up having second half more gain than what we may have lost in the first half.

Okay, that's helpful. Thank you.

Peter Nesvold, Jefferies.

Hi, good afternoon. It's [Elliott Waller] in for Peter. How are you?

Very good. What about you?

Good, thank you. Quick question. With oil prices moving up, how much conviction do you have that the reported OR improves year over year? Or is most of the earnings growth that you are speaking of, is that going to be from the top line? Thanks.

I think we are working on all levers to help us create earnings and create the cash flow. And so it is top line, top line above the rate of economic growth. It is the quality of our service and the ability to support market share gain, and also solid pricing. And there is no question that in the short term, higher fuel prices is a small headwind as we have fuel lag between what we charge and what we have to pay on the spot market. But it is constructive for the railroad industry going forward. As long as the economy is not impacted, higher fuel prices helps us shine versus the trucking industry and it should help us accelerate top-line growth over time.

Okay, very good. Thank you.

David Tyerman, Canaccord Genuity.

Hi. I would like to take another crack at the headcount question. So when we are thinking about modeling for the rest of this year, should we be thinking in terms of flat, half of RTM growth, or full RTM growth? Any insights there, please.

You know, as we have said, we have opportunities to gain productivity in all of the areas where we can make attrition work for us. That means that for most of our trades, if we have attrition, we don't necessarily replace one for one. So you have productivity gains in the mechanical and engineering functions, for instance.

In the transportation sector, if you have more coal to move, if you are introducing new trains to handle the business out of Prince Rupert, you have to have train starts and you have to have additional crews. And you never want to be short on crews, so we are hiring ahead of the game, and we are hiring one-for-one, and we expect that the more business growth we have, the more headcount will be increased.

Overall though, the pattern that you have seen that Luc described to you in terms of the year-over-year growth in headcount for the first quarter and the sequential growth is not a bad -- it is as good a baseline for you to judge in terms of on a go-forward basis.

Okay, that's helpful. And just on the tax rate, any thoughts on the tax rate for the remainder of this year?

No, I mean it continues to be around, I would say, roughly around 29%. I mean that is a good place to peg it.

Okay. Thank you.

Benoit Poirier, Desjardins Securities.

Yes, thank you very much. You ended the quarter, obviously, with a very solid balance sheet. When we look at your guidance, free cash flow guidance is improving, CapEx is unchanged, as well as dividends, and share buyback is well advanced. So what are the opportunities you are looking at right now? And are there things you are waiting to see before making further moves on the balance sheet initiatives?

Yes, I think -- I mean just to restate the way in which we approach that -- I mean, first and foremost, we have a CAD1.7 billion capital plan that is crucial for us to maintain our network safe and fluid. And so that is the first place that we are going to be investing the free cash.

Then we will look at other opportunities if and when they come along. And we are not envisaging to raise the guidance in terms of capital spending, but if the appropriate circumstances warranted it, we could review it.

You know, after we have done that, we basically look to dividends. And we have put through, as you know, a 20% dividend increase earlier this year. So we want to maintain a good, solid growth on the dividend front. And last but not least, we typically look at stock buyback programs to round up the picture.

So I mean, we have been generating some very good cash. We should keep in mind that we do have and we keep an eye on the pension issue, which we have a very large pension liability, so it can be sensitive to discount rates, and that is something -- as I mentioned, that we've set aside a few hundred million to potentially address that. And you know, that is kind of where we are in terms of free cash.

The debt position is also -- has been helpful for us because it is all in US -- mostly in US currency. So the strength of the Canadian dollar has worked to improve that. And so we keep an eye on where the Canadian dollar is going to go, because if it was to come down a little bit, then we would see our debt position creep up a little bit. So those are some of the things that we keep in mind as we look at our balance sheet and the use of cash.

And it is a pretty good story. I think you put your finger on it. It provides a lot of support for our shareholders to know that we are generating strong cash flow and have a strong balance sheet.

Okay, thanks for the time.

Mike Baudendistel, Stifel Nicolaus.

Thank you. Just got a question on the operating metrics. It seems like you are making great progress on the lengths, kind of despite the weather. And when I think about the last few years, it seemed like it was dwell and speed where you made kind of the most progress. So I am just wondering if train length is where you see kind of the most opportunity going forward for improvements in the network or is that more a function of mix and other things?

Train length is definitely an opportunity for us. Anytime we can absorb additional business without adding additional train starts, you do it through length and tonnage, which DP is giving us an opportunity to convert.

But we have other opportunities as well that we will invest in that will add additional abilities to drive our metrics. Rifle-shot investments, maybe a siding extension here, a siding extension there.

There are several things still left on our plate, so to speak, that if I had time and resources to convert now, I know that I could drive improvements in those metrics. And once we do that down the line, in due time, other noise will pop up in the system and we will convert those opportunities as well. That is sort of the beauty of the way we approach our business; it is a constant improvement culture. Once we fix one issue, another one comes up, another opportunity and we address that one.

The beauty of the team dynamic is that JJ sees a lot of demand out there and he wants us to have more velocity so we can create capacity to handle it. So you can rest assured that whether it is train length, whether it is car velocity, whether it is recovering on our train speed, all of those levers are expected to improve as we come out of winter. And that is the way we are going to be able to grow at low incremental cost.

Thanks very much.

Okay. Well, thank you very much. It was a good call. Not that we want to cut it short, but we have some Montreal Canadien fans here that want to see the Canadiens get back on top. And Keith has a bet with our Chairman that Chicago will eliminate Vancouver.

So I hope you have a good day. As I said, we are very pleased with our results and we feel we have good momentum, and we look forward to report on strong second-quarter results in a couple months. Thank you very much.

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