Canadian National Railway Co (CNI) 2012 Q1 法說會逐字稿

Welcome to CN's first-quarter 2012 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.

Good afternoon and thank you for joining us for CN's first-quarter 2012 financial results. I'd like to remind you out about the comments that have already been made regarding forward-looking statements.

With us today is Claude Mongeau, President and Chief Executive Officer; Luc Jobin, Executive Vice President and Chief Financial Officer; Keith Creel, Executive Vice President and Chief Operating Officer; J.J. Ruest, Executive Vice President and Chief Marketing Officer.

And we consider that we had a superb quarter and we would really appreciate it when the Q&A starts that if you would kind of focus your questions on CN and business related to CN. In order to be fair to all the participants, we'd like to limit your questions to one each. With that it's now my pleasure to introduce Mr. Claude Mongeau, CN's President and Chief Executive Officer.

Thank you, Bob, and I'm here in foggy Halifax with the team to cover these results with you. We have our AGM and are very pleased that we will be officially finishing the cycle for 2011 and starting the cycle for 2012 with the very, very solid results.

Our Q1 results were helped by milder winter throughout our serving territories, but, make no mistake, these results are about strong execution; the CN team delivered on all key fronts. Whether it's growth, whether it's efficiency, whether it's safety, our agenda is working and it's showing through in very solid financial results for our shareholders.

Revenues during the quarter were up double-digit, about 12% to be exact. J.J. will give you the details, but we're saying good growth across all of the commodity markets that we serve.

Our ability to accommodate that growth at low incremental cost and to balance service and operational excellence also showed through during the quarter. Keith will give you some key metrics around those lines. But our operating ratio at 66.2% is a record operating ratio for a first quarter and it's a full 2.8%(Sic-see presentation slides) improvement versus last year.

In terms of earnings, and I'm looking at it here on an adjusted basis, we delivered CAD1.18, which is up 31% over last year. I'd be remiss if I didn't focus on the weather; obviously the fact that we had one extra day also helped. There's perhaps a third of that EPS growth on a year-over-year basis which is due to those factors.

But nevertheless solid, solid first-quarter results and Luc will give you all the details including some of our monetization and how we were able to use and deliver very strong free cash flow. So solid results overall; I'll ask the team to give you the details and I'll wrap up at the end. Keith, over to you.

Okay, thanks for the comments, Claude. Let me say that while definitely a milder winter in 2011, 2012 first-quarter was not without its operational challenges. Regardless of the tenacity, the execution of this operating team produced pretty solid results.

So let's start with a review of the operating metrics that we report quarterly; they always provide a good overview of our productivity and the fluidity of our operation. As you can see on the charts, we produced improvements across the board on all operating metrics. Due to a traffic mix change our train load was only up 1%. However, train length was up about 3% year over year. So regardless of the mix change we continue to increase the efficiency of our trains.

All the other metrics, as you see, are up at least 3% relative to last year which has allowed us to absorb our growth at a lower incremental cost. All the very solid performance by the talented and dedicated railroaders we have on this team.

Let's say in the interest of providing a bit more relative first-quarter comparison [to] proxy, let's compare our performance in the first quarter of 2010 which was a winter similar to this year. We also showed improvements in all of our metrics.

As you see, the only exceptions in these metrics are in train speed and locomotive productivity. These are two metrics which we have impacted consciously with our efforts to focus squarely on maximizing the throughput of our bulk logistic supply chain. I'll give you a quick example.

With the shared goal of pushing more coal through our supply-chain we're working with our supply-chain partners at the ports to ensure that we consistently have a train ready to take advantage of our own load windows. To make this happen we've had to dedicate locomotives against our coal trains which at times require staging timing cue to unload.

In the past we were very reluctant to do this for two primary reasons -- one, it adversely impacted locomotive productivity, our car productivity and train speed; two, we didn't have the type of positive working relationships that are necessary with the terminal operators to secure their commitment to do all they can do to work with us to optimize their piece of the supply chain.

But today, with our supply-chain end-to-end focus and the partnerships we forged, even though we do have to give a little bit back in terms of these metrics, overall it's been excellent for our service and for the bottom line, which is obviously what the true end game is for CN and our supply-chain partners.

Suffice it to say these results show a strategy to provide service excellence; it's working while maintaining operational excellence, becoming a powerful business multiplier allowing us to grow with our customers and supply-chain partners. In fact, some of the growth we're experiencing as a result of the strategy is making our strategic capacity investment decisions Crystal clear which is a great segue to the second slide in your deck.

To support our operational and service excellence mandate we have to continue to invest surgically to create the capacity to handle our significant growth opportunities efficiently. More specifically on the BC North territory we've handled 20% more traffic this year versus last and 27% more versus 2010.

We've responded to this growth by running not only more trains but also longer trains, which, while it does and has had a negative impact on our train speed due to the current longer trains, they're running in a territory that does not have an optimal siding spacing. It has allowed us to respond to the growth opportunity efficiently.

So with that said, what we're focusing on is a plan that we've effectively made in 2010, we're rolling it out and by the end of third quarter early into the fourth quarter of this year we will have seven additional long sidings in servicing this corridor which will increase our capacity to handle longer trains by 50%.

This in turn will allow us to enjoy our renewed levels of train speed performance with the associated benefits of locomotive and car productivity. And at the same time we continue to invest in our EJ&E property, adding capacity to run more trains efficiently and switch traffic in this critical hub for our system.

On the locomotive front, as we've reported previously, we're making strategic investments, purchasing locomotives in advance of demand. This will allow us to leapfrog the need to purchase locomotives during the initial implementation of the new Tier 4 compliant locomotives which GE and E&D will be producing 2015 and forward.

Given the new technology to meet these standards is still being developed, we feel strongly this is a prudent strategy to avoid usual growing pains of adapting new technology, as well as avoiding pricing escalation driven by this technology.

To optimize this investment in locomotives we pursued a strategy of purchasing part new and part used locomotives. We'll modernize the used locomotives with engine enhancements which will drive additional fuel efficiencies, we'll equip them with DP, we'll add onboard technology such as trip optimizer and [mitronics] as well.

And on the new front a new twist to our strategy or new enhancement to our strategy, we're actually purchasing AC locomotives for these 65 as opposed to DC locomotives where we'll strategically allocate those to fit parts of our network that requires those; we'll convert them with productivity synergies.

They're going to provide more attractive effort, more specifically Northern B.C., optimizing our coal trains and also optimizing the size of our new Canpotex potash unit trains which will soon be running to the North Shore in Vancouver.

Finally, we're focused on maintaining solid productive relationships based on mutual respect with our labor union leaders and our employees which make this business run day in and day out. Proof of this progress in our area on the Canadian side, two significant agreements we've reached without labor disruption or uncertainty for our employees and customers that were ratified during the first quarter with both our TCRC represented locomotive engineers and USW (inaudible) employees.

Both agreements represent a win-win for our Company and for our employees; both products at fair bit firm negotiations by both the union leadership and management. They're all positive points that allow us a more aggressive and productive relationship with our craft employees while we provide certainty for our customers.

And on the US side, something that's pretty significant for us, we implemented a new agreement with our DMIR/DWP/WC running trades which provides us much data operational flexibility to enter the reliability of our supply chains in not only the iron ore ranges but also our network running through the superior corridor where since our WC and DMIR acquisitions with the absence of this agreement we've been forced to run these connection properties as individual railroads which obviously had multiple operating inefficiencies.

So in the interest of time, let me wrap up my comments by emphasizing the fact that our strategy to create and provide the needed flexibility and elements to enable service excellence while protecting our legacy of operational excellence is working. We're consistently demonstrating we can provide strategic flexibility to our supply-chain partners working together to enable organic growth that we continue to handle at a low incremental cost. So with that I'll turn it over to J.J. to add some color to the business levels this strategy is enabling.

Well, thank you, Keith, and good afternoon to everyone. On the revenue side Q1 2012 was a record first quarter for CN. Revenue was up 13% versus last year. The breakdown is as follows -- about 5.5% came from volume, our carload volume was up 5.1%, but our revenue ton mile volume was up 6.3%.

Same store price came a bit more than 4%, slightly better than the prior quarter, consistent with our stated plans to secure sustainable above of inflation increase. 3.3% came from fuel surcharge, mix was overall flat and, finally, we gained 1% from exchange that is the Canadian dollars was [CAD1.6] weaker this year.

Now looking at the quarter in more detail, all of my comments will be on the FX adjusted as usual. Starting with petroleum and chemical the revenue was up 13% on the back of very strong petroleum growth. New crude oil business accounted for roughly half of our carload growth in that segment, all other petroleum segments were also up led by refined product, and the chemical and plastics was a combined flat.

Metals and minerals grew an impressive 29% after many other quarters of being very, very strong growth. All segments in the M&M segment performed superbly. Drilling activities continue to drive record users at Wisconsin, (inaudible) and drilling pipe. We also have additional sand mine and production capacity coming online in Wisconsin.

Our strong steel volume was driven by our supply-chain approach to our customers as well as by a favorable steel market which is sustained by energy and automotive demand. Forest product, the revenue rose 9%. Lumber and panel traffic to the US both increased 11% from last year. Lumber to Asia and China was up 21% and pulp and boxcar recovered from a soft Asian market in the fourth quarter.

The strong export of both lumber and pulp also helped our intermodal overseas business. Paper and boxcar is in secluded line and those shipments were down 16%.

Automotive revenue was up 11%. North American vehicle sales remained robust driving gains in our vehicle carload, as well also as our transpacific container import business for parts. This was offset partly by the year-over-year permanent closure of the Ford St. Thomas plant in Ontario and the Ford St. Paul, Minnesota plant.

Coal revenue -- coal revenue was sequentially improved from the fourth quarter of last year and it was up 18% in revenue from the first quarter of last year. CN -- at CN we see a permanent shift in that business from short haul domestic movement to long-haul export. Therefore in the first quarter of this year our carloads were down 11% but our total revenue ton mile volume was up 19% for the quarter since our average length of haul increased 32%.

Domestic thermal coal is in secular decline losing share to abundant cheap long-term shale gas supply. At CN the thermal -- domestic thermal coal is already less than 2% of our total Company revenue. Export, however, is the story -- export is the story for the CN coal franchise. Long-haul export of thermal coal and coking coal via Vancouver, Rupert and (inaudible). In addition, we also a handle strong shipment of Canadian oil sand petroleum coke also to export market, in that case Rupert.

Now looking at grain and fertilizer, Canadian grain revenue was up 17% in the quarter on very strong Canadian exports of bulk wheat and canola. Our US grain revenue, however, was down 17% on very anemic Gulf export of corn and soybean. Fertilizer revenue was down 29% in a basically very poor North American fertilizer market. And you will also remember that this winter we did not have any Canpotex spot sales as we did the winter before.

Going to intermodal -- overseas intermodal revenue was up a very strong 21%. Our transpacific revenue increased 30% with volume over our two West Coast Gateway outpacing again the transpacific market in overall. Traffic via the port of Halifax declined due to shipping line service cancellation and to a weaker Transatlantic trade. Volume in the Port of Montreal was flat for the quarter.

On the domestic side, domestic intermodal revenue was up 12%. And where we had the most success is with our wholesale partner where we continue to capitalize on the challenging conditions facing the US trucking industry. Our intra-US volume grew 12% and our cross-border traffic grew 22% in units.

Finally, our non-rail revenue was up 10% in dollar. It was driven by our iron ore vessel and iron ore terminal as well as by our CNTL intermodal local trucking unit. This was partly offset by some lost revenue related to last year's sales of our Convent coal terminal.

Now turning to the outlook, if you can join me on page 10 -- on page 10, I'm sorry -- we will continue to grow, grow in volume, grow in price, grow in service innovation and grow by helping our customers and supply-chain partners to win in their own market.

(Inaudible) with intermodal the outlook is very positive. We will continue to outpace the transpacific trade for import and export. Rupert is starting some new service to Edmonton, Calgary and the Ohio Valley, in that case with the CSX. We have also opened a new lumber export container yard in Vancouver.

The US consumer confidence was 70.2 in March following a sharp rise from January where it was 61.5. We are also taking delivery of new domestic equipment that is container heaters, (inaudible) chassis which will enable us to search for the right market opportunity if it does arise.

On page 11 to look at the bulk outlook, as is custom, our New Orleans Investor Day, we are on track to expand our export coal franchise on both existing mine expansion as well as from existing expansion of the four waterfront terminals that we serve. Both are required to succeed in the export market.

Cyclical demand for fertilizer will slowly improve from Q1 but will not reach historical peak. Our potash business with Canpotex will start this July 1. There is a huge interest in level of activities toward investment by Chinese backed consumers of natural resource into new mine that could be on the CN.

US domestic grain business will be steady, but the US export business for grain will remain slow. Canadian grain is coming off a series of back-to-back record quarters and it should stay strong during the second quarter of this year as well.

Finally the outlook for manufacturing on page 12, we will have stable lumber volume from Asian buyers from the province of B.C., we will also have sustained year-over-year increase of our lumber to the US market.

Our petroleum, metals and minerals segment will continue to capitalize on the booming shale oil activities. Crude via rail is expected to exceed 20,000 carload in CN this year versus the 5,000 carloads of last year. We also expect a very strong market in our steel products for the remaining of the year.

Chemical -- chemical right now looks to be more on the flat side, but we expect positive initial demand as well as low cost for gas to eventually provide fundamental support to this sector.

In closing, Q2 has the making of a growth quarter and same is for the remaining of the year. So far this quarter the leaders are overseas intermodal, minerals, petroleum products and coal exports would also be strong. Luc, if you want to take it from here.

Yes, thanks very much, J.J. Now turning to page 14 of the presentation, let me walk you through the key financial highlights of our quarterly financial performance and indeed a good quarter it was. Revenues were up 13% at CAD2.3 billion. A gradually improving economy and milder winter conditions constituted a favorable backdrop in the quarter compared to last year.

J.J.'s and Keith's teams combined efforts to help us achieve solid volume increases in practically all commodity sectors and, once again, several categories performed better than base market conditions.

Operating income was CAD793 million, up 23% versus last year, driven by strong revenue growth (inaudible) at low incremental cost. Other income was CAD293 million, up CAD7 million from last year, as we sold some rail line segments to Toronto's local transit agency in both years. So our net income for the first quarter of 2012 was CAD775 million, up 16%, and the reported diluted EPS therefore was CAD1.75, up 21%.

Excluding the gain on sale of the rail line segments, the adjusted diluted EPS for the quarter stood at CAD1.18, that's up 31% versus 2011. Our operating ratio was 66.2% in the quarter versus 69% last year. This represents an improvement of 2.8 points. This is an all-time record, beating our previous best dating back to the first quarter of 2006 when our operating ratio stood back then at 67.1%.

Now turning to operating expenses on the next page. As Keith pointed out, we came through with another solid quarter in terms of operational productivity and customer service. Yet this performance did not come at the expense of overall cost management. Operating expenses were just over CAD1.5 billion, up 7% versus last year on a constant currency basis. Excluding the fuel expense this was a 4.9% increase.

Labor and fringe benefit costs were CAD509 million, 7% higher than last year. This was the result of wage cost inflation of about 3% and a higher headcount in the quarter versus last year. Our average headcount was at just over 23,000 employees and it was up 3.5% versus last year while I'll remind you that our GTM's were up 7%.

Sequentially, however, the average headcount was slightly down versus the fourth quarter of 2011. Our manpower dynamics continue to be driven by advanced hiring ahead of attrition to allow for training along with our assessment of future volume growth.

The fuel expense increased by 13% to CAD376 million. Higher prices represented 9 points of this increase in the quarter while the balance of the change was attributable to volume increases for 7% partly offset by improved fuel efficiency in the tune of 2%.

Equipment rents at CAD62 million in the quarter were CAD11 million higher than last year, but essentially flat versus the fourth quarter of 2011. This is the result of increasing our car fleet and intermodal equipment in 2011 to handle the growth and service requirements for the current business levels.

Casualty and other costs were CAD77 million, CAD7 million better than last year as we continue to incur lower expenses and experience lower claims.

In terms of free cash flow, on the following page, for the quarter we generated CAD48 million. Operating results and the proceeds received from the sale of rail line segments were CAD311 million, were offset by higher working capital of CAD766 million, capital expenditures of CAD224 million and dividends of CAD165 million.

The higher use of cash attributable to working capital mostly results from a total pension contribution of CAD553 million made in the quarter. Lower payables were about CAD150 million and higher inventories of materials and supplies were about CAD60 million.

When we compared to last year we generated approximately CAD400 million less free cash flow in the quarter and this was mostly due to the special voluntary pension contribution totaling CAD450 million that we have made in the first quarter of this year versus none that were done in last year -- in the same quarter last year. Our balance sheet remains strong with our debt ratio well within our internal guidelines.

Finally, let me state speak to our 2012 outlook. We continue to see a gradual improvement in the North American economy which should translate into mid-single-digit carload growth in 2012. On the pricing front we are on track with our inflation plus policy.

We are clearly encouraged by our first-quarter performance. However, given how difficult last year's first quarter was, we will likely have more challenging comparables ahead since we arguably handled in the first quarter this year some volume which ended up in the second quarter last year. With this in mind we are nevertheless now firming up our guidance.

So our 2012 annual guidance is now aiming to deliver a full 10% of EPS growth over the 2011 adjusted diluted EPS of CAD4.84. This despite our additional pension expense of CAD100 million. We're also calling for free cash flow to now stand in the order of CAD950 million and our capital investment program is set at about CAD1.8 billion.

So, the CN team remains focused and committed to delivering superior results as we continue to unfold our strategic agenda. And on this note I'll turn it back over to you, Claude.

All right, thank you, guys. I think it's pretty clear, as I said at the outset, that we do have a very solid first-quarter performance, but fundamentally this is about an agenda that is delivering results.

We've discussed this agenda with you in New Orleans during the first quarter, you know about it, you're seeing the proof points coming through in terms of leading the way the industry would grow, being able to accommodate that growth at low incremental cost and continuing on our path of improving efficiency, all the while trying to balance and improve our service offering so that we can become the trusted partner that helps its customer win in the marketplace, which is the recipe for long-term value creation in the rail industry.

The first quarter was solid; the second quarter is starting off on a very solid footing. Our results are lining up to help us deliver a very strong year. As the economy stays with us 2012 should be a banner year and we're looking forward to deliver those results and take your questions at this point in time.

(Operator Instructions). Bill Greene, Morgan Stanley.

Claude or Luc, can I ask you to just maybe offer a little bit of color around this guidance? I realize you want to give conservative guidance that you're confidence you can do. On the other hand, 30% growth and a beat of this magnitude, it kind of suggests that we've got to have a downward negative revision for the second half, which is not consistent with what you put in the press release or sort of the comments. So what are you worried about? Because I've got to believe that this is very conservative and you'll do much better than this given the first-quarter performance.

I'm gratified by your trust, but I think you should take our guidance with -- for what it is. We have always been a little bit conservative, but we are also telling you that our first quarter, given winter, given an extra day, given stock-based compensation which was very helpful during the quarter, the 30% is outstanding results but that's not what we would have delivered if not for those factors.

If you've got to tweak down a little bit some of your quarters in the end to get closer to our guidance that's what I would do if I were you. But we're here to continue to deliver solid results. If we're a little too conservative and do better that's a good story.

Well, can I just ask you at a macro level what would you be worried about? What's the conservatism based on? Because based on everything that's in the assumptions here it's hard to get to your number. Do you see what I mean? I don't know what we're trying to lower, what the reason is?

Well, I think you should take our guidance for what it is, Bill. We are not worried about anything. We see the economy continuing to unfold positively; if we can deliver mid-single-digit carload growth we will deliver a full 10% EPS growth and close to CAD1 billion free cash flow which would be outstanding results.

All right, fair enough. Thanks. Appreciate the time.

Cherilyn Radbourne, TD Securities.

So with a strong performance out of your coal franchise this quarter, and I think that was perhaps despite Ridley not operating at full capacity. So maybe you can give us some color there and just talk about how you feel the export terminals on your network are positioned in the context of a domestic thermal environment that's challenging?

The domestic thermal will be challenging, domestic thermal in the US for CN was never necessarily a big revenue driver, but typically it is a fairly a big carload driver because a lot of that business was coming to us (inaudible) or the UP at the Chicago interchange.

What really drives a lot of dollars is the longer haul, so either PRB coal coming to us via the interchange in Edmonton or via Vancouver. All the PRB coal is going to Rupert so that's fairly long haul. And Rupert is expanding, has expanded, it had some issues but it's still -- I mean it's cranking a lot more product than it used to and the future is bright for Ridley.

The terminal in Vancouver also expanding, making an effort to expand both Westshore and Neptune. And don't forget also our terminal in Convent, when we sold the terminal we sold it to a very good operator, Cline and Foresight Energy, they actually are running this terminal harder than we did ourself.

And because the domestic market is weakening like it is for everybody else, they have low cost, high Btu coal and they are making effort to sell some of that in Asia and we saw some of that in the first quarter. So Illinois to Convent and some [vessel] out. So we're serving terminals and we're serving people who are -- have been focused to an export now for a couple of years already. So it's coming together nicely.

Okay, thank you, that's my one.

Thank you, Cherilyn, you're always very disciplined.

Ken Hoexter, Bank of Montreal (sic) Merrill Lynch.

As you look forward to those targets then maybe we could dig a little into your volume expectations and your growth. I know you target to continue to take share. Can you tell us what's in those expectations as far as the go forward?

You know what, we want to grow a little bit faster than what the economy would give us. And I think we did that for the last several quarters. It really depends on the rising tide and it doesn't need to be much more than half a point to a point better than what we would otherwise receive from the economy to allow us on a longer-term basis to deliver solid results for our shareholders.

So we're running a little bit ahead of that at the moment. We have a lot of momentum working for us. There will be quarters where we will run a little light, but on balance one carload at a time, one unit in intermodal at a time and the markets that J.J. highlighted to you, we're really pursuing a broad range set of initiatives to help us grow share of wallet and help our customers win in the marketplace. And it's actually working because they're rewarding us with more business on an ongoing basis.

Understood. If you're kind of trending ahead of that do you expect to see that slowing dramatically or are you seeing the pace that you're -- I just want to understand -- the pace that you're at in terms of taking share now, do you see that decelerating or even going a little slower or do you maintain the current pace? Because like you noted, you're far above that right now.

Yes, I think as I said a second ago, we are -- we have a lot of momentum as we speak. So is it going to continue every quarter like this? That would be difficult. But we are certainly of the view that we can continue that for many years to come at the right pace.

All right, I appreciate that. Thank you, Claude.

Benoit Poirier, Desjardins Capital.

When we look at your intermodal growth in the quarter, obviously pretty solid, but is there any specific explanation behind the strong performance? Is it sustainable and is it related to the winter issues we had last year?

When we look at our -- I think when you look at our intermodal results for the last two years, I think every quarter you see that this has been fairly strong and it's not a one-time event, it's a fairly solid, steady business plan that we have with steady quality result improvement.

And the Transpacific trade for all railroad is stronger than the Transatlantic trade and this is where we have put our biggest focus, and also had our biggest success, both in Canadian cities and US cities and expanding our reach into new destination market that we didn't have two years ago.

I think it's solid. It's a question in the end that a shipping line choose railroad and the (inaudible) owners choose the shipping line and the one that has the better partner providing the better supply-chain.

So we're not -- in a way we're competing for the heart of the shipping line which are our customers, but ultimately what makes us successful is to win our customers' customers so they want to use the CN port for their delivery. Intermodal is -- there's no reason for it to really slow down. It might go from market to market east to west, but we have a solid plan.

Okay, thanks for your time -- the time.

Scott Group, Wolfe Trahan.

Claude, I just want to clarify one thing. I think you mentioned to one of the earlier questions that incentive comp or stock based comp was a benefit in the quarter. Did you quantify that and was that a benefit because it was low in this quarter or because it was so high a year ago?

Yes, Scott, let me pick this up, this is Luc. The stock-based compensation benefit in this quarter was to the tune of about CAD30 million, so we're roughly talking about CAD0.05 of EPS. And this was really the result of; if you look at last year between the end of quarter the stock price went up by CAD7 last year whereas this year it actually went down by CAD1. So that's what's producing this favorable variance this year.

Okay, but most of that, it sounds like, is in the year ago period. I'm just trying to get a sense of the real run rate we're on just because even if I take out the weather benefit it feels like, just based on what first quarter normally is as a percent of the year, we're running closer to the CAD5.75 range for the year relative to the guidance. I'm just trying to understand what is -- what's this year and what's last year in terms of the stock-based comp?

As Luc explained to you, the stock-based compensation is the difference between the beginning of quarter and end of quarter is stock price. And so last year it went up CAD7 during the quarter and this year it came down CAD1 during the first quarter. So the swing of CAD8 is what drives the CAD30 million of benefit on a year-over-year basis. But the way it's measured is from beginning to end of quarter.

Okay, that makes a lot of sense. Thanks, guys.

Walter Spracklin, RBC Capital Markets.

So you did a good job of discussing the sustainability on your volume side. I was wondering if we could switch over to Keith on the operating side, obviously another excellent quarter there. Just curious if you could speak to training costs.

I know you mentioned at the beginning that you're going to have to train a lot of workers ahead of attrition. Can you update us on what we might see as a headwind and perhaps quantify that from a sustainability standpoint? And also on that sustainability, if you've quantified as well the effects of weather this quarter at all on an EPS level?

I can tell you now as far as training costs we're pretty much at a steady state with our attrition. We're well into it now versus last year and this is going to be sustained where we're at in training locomotive engineers and conductors at the same time I would think looking at our demographics through 2015. So I don't see a lot of change.

The only thing I see on headcount change relative to running trains would be associated with the level of business. And even with the level of business a lot we can absorb in our existing train starts the only part of which we wouldn't be able to of course would be bulk train starts and some intermodal train starts. So I think we're at a pretty good run rate now.

Okay, and in terms of quantifying the weather, was there any --?

I wouldn't put an exact number on it. I mean I'd be taking a hard stab at it so to speak. So let me avoid doing that, but let me just say that weather of course helped us, it helped us on the revenue side, it helped us on the operating cost side and on a reliability side. But to put a number on it I think would be -- I'd be a little bit reckless.

Okay. Thanks, congratulations on a great quarter.

Tom Wadewitz, JPMorgan.

I wanted to ask you a little bit more on the cost side. If I look at operating expenses ex fuel you were up a little less than 6% in the quarter and you had obviously stock-based comp. It looks like -- I don't know if casualty is kind of lower than normal run rate given the weather or how you would look at that.

But what do you think the -- if you say similar level of volume growth looking forward, what do you think the right run rate is for operating expenses, is it a point higher than that, 2 points higher than that? I guess any thoughts on that would be helpful. Thank you.

Well, on the casualty and other, just to comment on that -- I mean as I provided general guidance on that, it should be in the CAD75 million to CAD80 million per quarter. So I mean it's just about there for the first quarter. Those things tend to be lumpy a little bit though however, so we could have some bouncing up and down in the other quarters.

Expenses are very well managed, so I think it's really just you're not going to see tremendous variations. The trend is there, the fuel is difficult to anticipate, but I think as you can see on the labor side we've got things tightly under control. Of course the pension headwind is there, that's $100 million for the year. And stock-based compensation, again, a little bit volatile, it will be up and down, but it should be over the course of the year fairly similar.

Equipment rents I made some comments on and I think CAD62 million to CAD65 million is probably not a bad run rate because the equipment is essentially there. And while we're probably going to acquire a little bit more throughout the year, there was a significant change during the course of last year. So that gives you a little bit more color around these -- generally these expenses.

So it was really the stock-based comp that was probably the biggest thing that we might want to consider looking forward?

Yes, and in the quarter also there was a little bit -- the fuel lag was actually not very significant, it was only CAD9 million. But if you look back to last year that's another component which was important. Last year this was really a headwind of about close to CAD30 million. So the difference quarter to quarter last year versus quarter this year is also contributing probably a couple pennies favorably to the comparative.

Okay, great. Thank you for the time.

You never cease to amaze me; you have these good one questions.

Fadi Chamoun, BMO Capital Markets.

A question on intermodal. I want to go back to the -- you've had a few quarters of good domestic growth. I just wanted to understand a little bit, I mean your length of haul is typically longer and your ability to convert from truck is not maybe as good as what we'd see with a US carrier and yet we're seeing some good numbers.

Can you give us an idea about how much runway you think you have in that specific market and where specifically you are -- you are able to be effective? And the other thing on IMX as well intermodal, what's the capacity situation now at Prince Rupert?

So if I start with the first one, I think about 55%, roughly in that range, is overseas business, it's coming via our ports. So in that case you're really looking in most cases at fairly long-haul business, Port of Montreal to Toronto would be the exception. So we -- in overseas growth what we have is we're not really competing with truckers, we're competing with other railroads and other ports.

On the domestic side, the US market and Canadian market are very, very different. The US market is -- the capacity of trucking is tighter because of the regulations there. And our rate of growth for US domestic business as was cross-border is also faster than the Canadian growth.

And I think one of the areas that we've exploited, and maybe it's not obvious to people on the intermodal side, is we've been selling intermodal harder and harder to our carload customers. I wouldn't call this converting a boxcar or gondola into container, but I would simply put it in a framework -- customers themselves at a time want to use something which is more expensive, called like a truck, to move pulp or steel or whatnot.

And when we approach them with the intermodal product we have more success than we had in the past in selling an over-the-road product to the manufacturing sector. So I think when you add all this in there's still a potential for all railroads in intermodal, whether domestic or overseas.

This last example, Fadi, that J.J. was referring to is a very good expression of our supply chain approach. If you are there for the customer on that extra load and you are offering both solid carload product and also the intermodal product to flex when we have issues in terms of service or when there's a little spike in the math, you can get to that incremental piece of business, that share of wallet that we were not going after before. We are now more focused on it and it's paying off in terms of customer sentiment, but also paying off in terms of a little bit more intermodal growth on the domestic side.

That's right.

Okay, that's helpful. How much of the growth of the domestic would be explained by this carload conversion? I mean, is this a big piece of the growth that you are seeing on the domestic side?

I wouldn't call it huge, but it's something that's steady that's sustainable. So for example, on the overseas sides when I made my comment I did talk about the new lumber transfer facilities that we've put in Vancouver and, as you remember, we did the same thing in Prince George about two years ago.

So when you have those things you actually help convert product into container in those two cases for overseas export business. But the same thing is done also in domestic; we move some domestic freight from Vancouver manufacturing freight to (inaudible) in container, same thing to Mexico in some cases during the holiday season.

So moving intermodal in the manufacturing segment makes a lot of sense and that's why customers have been using dry van. And we say we have a dry van product long haul, it's called Intermodal and the same sales force now is making a much bigger effort in the past to sell the product. Intermodal is not a business unit, it's a service. It could be used by consumer product, automotive, pulp and paper, steel, metal, you name it.

Okay, thank you.

Chris Wetherbee, Citi.

Just a question, Luc, you mentioned in your wrap-up slide there that maybe you saw a bit of a pull forward of volumes I think was the comment you had made from the first quarter. Maybe it was due to weather, the favorable operating conditions. Just curious if there were specifically any commodities that we should see some of that impact on. Was that kind of a thought 2Q into 1Q, I think that's the way you phrased it, I just wanted to dig into that a little bit if I could.

Yes, I mean there's probably a little bit in the area of grain and a little bit in terms of how quickly we could get some of our vessel sailings on the Great Lakes. I mean those are some areas where there's been a little bit of that. Intermodal is also something that was helped by a lot of the favorable weather conditions. So those are some of the areas where you are likely to see a little bit of a pull because of the good weather.

And just order of magnitude, is it something material we should be thinking about or maybe just a little bit on the margin?

It's always difficult to quantify these things. So as Claude earlier made in his statement, overall it's not inconceivable that maybe about a third of the growth that we've seen during the course of the quarter may be attributable to a combination of all these factors. So it's weather, it's leap year, it's volume and expenses coming altogether, just giving us a little bit of a better first quarter this year versus last year.

Okay, that's great. Thank you very much.

David Tyerman, Canaccord Genuity.

I guess one concern that's out there in the market is on Asia and the potential for a slowdown in China. I was wondering -- obviously your volumes aren't showing it yet, but I was wondering if you're seeing any kind of leading indicator that the kind of situation could be developing from your conversations with customers, etc.?

Our volumes are not showing none at this point, in fact we're still growing. Whether it's intermodal, thermal coal, coking coal, pulp, lumber, it's holding steady.

We do hear those same chatters, but J.J. was just the last week and a half in China and all the key supply chains. Canada is becoming more and more top of mind in China as a source for critical commodities, lumber -- clearly our Canadian lumber producers have broken through and they're now a force in that market.

And minerals, whether it's coal, whether it's a concentrate, there's a tremendous appetite and interest, there's a developing interest in iron ore, for instance, in China. So, China might slow down, but I think Canada is well-positioned in world markets as a source that the Chinese buyers want to favor. And I think that's going to bode well for CN for many years to come.

When we say slowdown we mean slower growth, not slowing down (inaudible).

So you're not actually seeing anything right now where met coal or things like that are coming under pressure?

Well, what we see is that in a commodity market goes up and down and I think the price of met coal, for example, at some point was probably higher than what it could be sustained at. And as you would see in any market, whether it's potash or any other world commodities, it goes up and down.

But the price of coal at export is lower for coking coal, so the price of coking coal is also still at a price that the mines make a decent profit, profit enough that it wants to produce and sell as much as they can. So we're in the business of moving volume and the price commodity goes up and down, that does not necessarily reflect itself right away through the volume.

Okay, thank you, David.

Jason Seidl, Dahlman Rose.

On the pricing front, a little bit better than we expected here. Could you guys talk about the strengths that you're seeing on the pricing side, which commodity groups that they're favoring? And also what gives you confidence that you guys are going to be able to maintain that sort of 4% plus pricing going forward?

The pricing is coming from the same area that it was coming last year, it's fairly broad-based, some segments pay a little more than some others. And we don't necessarily see much change in where the pricing comes from. And yes, we did have slightly more this year than last year, so we view that as a positive encouragement that it is sustainable.

And I think it's a reflection of the quality of our service and the situation in end markets that we have always said we will deliver price ahead of inflation in that 3% to 4% range. It's a good thing when it's firming up as we speak and we'll try to keep it sustainable at that level.

Gentlemen, thank you for your time.

Matt Troy, Susquehanna.

I was wondering in the broader context of your investment in EJ&E. Could you just give us an update with respect to traffic density flowing through that piece of track and as well as just the strategic fit? You talked about it being more of a chess piece than a checker jump and was wondering if you could offer some examples of how that property continues to pay dividends?

Well, I'd say from a density standpoint it's pretty much in line with the growth in business, so no dramatic changes there. We have not -- made a couple of shifts over the [J] trains we were running through the inner circle, so to speak, of Chicago, since we've cut over Matson last year which is helping us from velocity standpoints.

We continue to invest -- Kirk Yard we're building now in that facility to effectively create a hump that in the past we could hump about 1,500 cars a day, and bump up against capacity constraints, we're going to a yard that will handle about 2,500.

So we're in the middle of converting the interchange that normally would have gone to the belt or other locations with other carriers, taking our interchange there to Kirk Yard where we can realize some synergies across the network and outline points where we otherwise would have (inaudible) payments we were making to the belt for trackage charges or to the harbor for trackage charges.

So that's a continuing story that will unfold for us this year into next year. And then finally, the last piece to that, conversion, we'll be taking the switching operation, all the switching costs out of Markham and shifting that into that same facility at Kirk Yard as well as our locomotive facility. So that's more to come in the 2013 early '14 timeframe.

Excellent, that's my one. Thank you.

Chris Ceraso, Credit Suisse.

You mentioned your strategy is to bring on volume at a low incremental cost and it looks like you did a good job at that in the quarter. On my math it was maybe CAD0.56 that fell to the bottom line from incremental revenue year over year.

That's good, but it's not that abnormal for a railroad like yourself. So I'm trying to gauge how much help did you really get from the weather and can we expect to see incremental margins like this going forward or does it go back to 40%, 45%, 50%? What's your feel on that?

You guys are very demanding and gratifying in your support. There's no question we are able to accommodate the business at low incremental cost. And I think as Luc explained to you earlier, when you take into account the moving pieces that are less related to the running of the business, pension, the stock-based compensation, fuel lag, these things can move you up or down easily by 10% to 15%.

So it's tough to use one quarter and make projections, but there's no question during the first quarter you just look at the metric that Keith explained. We were able to improve the operating metrics in terms of efficiency, we were able to grow a little faster on the (inaudible) volume side in revenue with good pricing. You do those two things and you deliver very solid results like we just did.

Okay. And just one clarifying point on the pension. There's two different numbers that you mentioned, the CAD450 million that you said in the press release, there's CAD550 million on the cash flow, is the difference just that the CAD450 million is voluntary on top of CAD100 million that's required?

That's exactly it. CAD450 million is the voluntary special contributions that we made in the quarter. We did two, CAD150 million early in the quarter and then we made another one of CAD300 million at the back end of the quarter. On top of that we contributed for current service cost CAD103 million. So that's the total of CAD553 million that you've seen.

Okay, thank you very much.

Peter Nesvold, Jefferies.

On the labor line, ordinarily you're down roughly CAD40 million to CAD60 million sequentially when you go from 1Q to 2Q. Now I guess this year we had fewer weather-related costs in that line. You have pension going up and you have incentive comp. Is it potentially flattish from 1Q to 2Q?

And then just a clarification -- maybe that counts as a half question -- on the free cash flow, so you took it up, there was nothing in there that talked about gains on sale. Last quarter when you gave the original guidance of CAD875 million it did exclude gains on sale. So I just wanted to understand if the property gain is included in that upper division to the free cash flow?

The gain on the sale of the rail line subdivision was proceeds of CAD311 million. Now as I mentioned, those proceeds came in and then they quickly left and were reinvested, if you wish, in terms of the pension contribution. So that really didn't matter into the CAD875 million. So it wasn't in the CAD875 million so it came in on top of it and then it, as I said, it ended up leaving the free cash flow because of the special voluntary contributions.

And then on the labor cost, it's typically down [CAD40 million] to [CAD60 million] from 1Q to 2Q. Is it sort of flattish this year? Is that a reasonable number to think about in the near-term?

Well, I mean you've got -- the trend is the following, I mean you've got about 3% of wage inflation, you will have headcount somewhere at -- this particular quarter we were up about 3.5%, over the longer term we're going to be trending a little bit closer to attrition plus 1 or 2 percentage points depending on where volume is going and we are continuing to hire ahead of attrition.

And then it's down to the pension pressure which we've quantified at CAD100 million of additional expense for the year. So those are the factors that are going to drive it. If stock-based compensation doesn't bounce around too much that's what you've got in store.

Okay, all right, thank you.

Brandon Oglenski, Barclays.

Just quickly, Keith, looking at the unit cost performance in the quarter, it looks pretty solid to us even with, as you mentioned, locomotive utilization down and train velocity slightly down. So can you maybe just expand on how these new service patterns are impacting those metrics but you're able to more than offset it at a network level?

No, it's pretty much that's it. I mean, we're losing a little bit in the west part of the territory, we're a little bit more heavier than other locations. We're gaining with our strategies and our opportunities across the railway. I mean we consistently review noise -- it's what I call noise in the system so to speak and we strategically invest to eliminate noise and increase capacity and maintain our velocity on our trains.

So what we've lost in BC North, which does have a material impact on the number because the percentage of growth we've had there, we've gained back with investments over the [NOD], we're running trains much faster over the NOD than we did a last year with those strategic investments. We're doing a much better job of controlling velocity and cost in Chicago with the operating strategy and the strategic investment we've made with EJ&E. And I can go territory to territory.

There's no one silver bullet, it's just a gain here, it's a gain there. We've got a very competitive operating group internally and we compete with each other so to speak. Our success breeds success and we just don't like to effectively give anything back unless we absolutely have to.

And I think you'll find in that case where we do, which is BC North, we sort of anticipated this two years ago when we started this path and we're two years into a five-year plan that will eliminate that. Now the next challenge is I want J.J. to give us some more business and a more challenging opportunity and we'll figure out a solution to that as well with this team.

All right, thanks a lot, guys.

Konark Gupta, Cormark Securities.

I'm here for David Newman today. My one question would be on the coal side. Your carloads are down 11% in Q1 and so far in Q2 two weeks it's down 17%. So just talking about domestic thermal, it's weak, PRB stockpiles are above normal, Canadian met coal and thermal coal exports are very strong. So can you please comment on your coal RTMs and pricing going forward and perhaps any impact on PRB coal shipments via Prince Rupert?

When you look at the CN coal business, looking at a carload is somewhat misleading because our real story is in RTM. So you look at the RTM you really get a sense of where our revenue are heading, looking at carload you won't get that. The PRB coal -- your number two question on PRB, PRB coal is still moving via Rupert for export mostly to Asia and obviously China.

And the pricing on coal -- I know there's been some question asked in general about whether or not railroads are supporting with better price, meaning lower price, export program. And I know these requests are being made, but we are not on that page. And most of what CN is moving in term of coal is actually coking coal, coal which was already -- market was offshore not domestically.

And on PRB you said it's moving via Prince Rupert obviously, right. But are you seeing any impact to the stockpiles which are like the other US Class 1 railroad said it's above normal right now, it's way up above normal. Is there any impact of that?

Yes, I think we're about normal meaning we had a run rate and we're keeping that run rate -- there is about kind of a steady flow that was already in the making, if I understand your question correctly.

I think what's important for you to recognize is our so-called utility coal is less than 2% of our revenues and because it's very short-haul it's a lot of carloads. So our volumes in coal in the first quarter and our volume so far in the second quarter in coal, if you measure it by RTM, is up on a year-over-year basis and it's up because our export business, which is longer haul, is doing very well. But if you follow only carloads you might get a sense that things are coming down, but it's very short-haul on this in 2% of our business.

Okay that's a very good. Thank you.

Jeff Kauffman, Sterne, Agee.

Congratulations, terrific quarter. One question for Keith, 23 parts. Keith, you were talking a bit about the longer trains that you're running and you mentioned slower in the west. I know it differs by what class of service and where you're running it, but can you give me an idea, because you're bringing on the DP locomotives now, how far can this go before gravity kicks in and what's kind of a way for me to think about it? Have you thought about it in terms of every 5% we add to train length should be worth what to bottom line operating ratio?

No, I think it's too many moving parts to be able to do that. I can say that DP certainly has been a significant piece of our success in this area. Effectively we've invested a lot of money over the past eight, 10 years, over CAD500 million in creating a network, our core network with long sidings that are spaced without DP we were not able to optimize that.

With DP over the past two years, I mean for instance first-quarter 2010 we had about 260 or 270 DP locomotives, we ran 20 train starts per day with DP versus this year where we've got about 440 and we ran 60. So there's still more room to go -- more improvements to be made. This is sort of -- there's not a perfect science to it. The time it really benefits you DP effectively other than controlling train starts is winter operations, maintaining air pressure through a train.

So this past winter, given that the temperatures were not as extreme as they were last year, we really didn't see the benefit that I think we'll see when winter does come back. So I think there's more to play out in this thing, I can't put a number on it, but I can tell you it's substantial and it will continue to allow us to accept incremental growth and especially on our manifest trains at a lower incremental cost. So it's a good story for us and more to come.

Thank you, Jeff.

Thank you.

Keith Schoonmaker, Morningstar.

Keith, I think this question is for you. In addition to the DP equipment let's say the Jay, Kirk -- those all sound quite major. At the investor meeting in Chicago a couple years ago I think you mentioned maybe even a full percentage point of margin gain from deploying more completely yard management software. Has that tool been deployed and are there other such big levers still left to pull?

Yes, no big levers, that has -- SmartYard is what you're talking about. We have deployed that over the preponderance of our system. The major yards are equipped with SmartYard. The more satellite yards we've got a modified version that's not quite as robust but still gives the people that operate those terminals very good planning tools to optimize train connections in our yard rail, which you see in our metrics.

I mean, even with an increased level of business we continue to push down our terminal dwell, which is controlling our cost. But again, no silver bullets. Our big investments -- that BC North piece is going to be something we continue to focus on, we'll finish off Chicago and then we'll see where the business is and where the opportunity is from that point.

Okay, thank you.

Thank you. Thank you, Keith. And thank you for all of you to participate on this call. Again, a very solid first quarter. I think we are constructive about the year. Trust us, you can take a little leap of faith and add a couple of percentage if you want to, but stay honest with our guidance and let us over perform again over the next few quarters and we'll be looking forward to report on those at our upcoming call. Thank you very much and have a good and safe day.

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