Canadian National Railway Co (CNI) 2012 Q3 法說會逐字稿

Welcome to the CN third-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. Thank you for joining us for CN's third-quarter 2012 financial results. I would like to remind you again about the comments that have already been made regarding forward-looking statements.

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

In order to be fair to all participants, could you please limit your questions to one each? With that, it is now my pleasure to introduce Mr. Claude Mongeau, our President and Chief Executive Officer.

Thank you, Bob, and thank you for all of you to be on this call at the end of the day. Let me just go over quickly the highlights, and then I will turn it to the team to give you the key details.

But fair to say we are very pleased with our third-quarter performance. It's pretty solid overall.

We've had a number of areas where we hit record in terms of our performance. Revenues is one of them in terms of overall throughput and volume. This is one of our best third quarter ever. Our revenues were up 7% if you take out the impact of exchange, and a pretty broad-based growth across all our business sectors; JJ will give you the key elements in a minute.

We were able to accommodate that business at a low incremental cost. I am very pleased with all of our operating metrics continuing to show improvement at the same time as we are continuing to focus and making progress in our core service metrics.

So Keith will give you the highlights, but it comes down to how we were able to accommodate that business at low incremental cost. And we are very pleased with the 60.6% operating ratio for the third quarter.

In terms of earnings -- and here this is on an adjusted basis -- we delivered CAD1.52 per share. That is up 10% on an adjusted basis, very solid performance overall.

And our free cash flow follows. Year-to-date we are slightly in excess of CAD1 billion of free cash flow. And it is the strength of that free cash flow generation and also the solidity of our balance sheet that gave our Board the confidence to allow us to start a new share buyback program, which Luc will give you some more details around in a minute.

So overall, when you look at it, pretty much all aspects of our agenda are working. And operational and service excellence is helping us deliver very strong results. Keith?

Thanks, Claude. This is indeed a great quarter both from an operation perspective as well as the service perspective, as we moved our service and operational excellence agenda forward, growing our business in concert with our customers and our supply chain partners. To that point, in a few moments I'm going to provide a bit more color and detail to what we mean when we say operational service excellence, as how well is how we are tracking with the progress in this area.

But let's start on the operational excellence side of the business model first, looking at our performance in the key productivity metrics that we report on each quarter. Trainload or GTMs per train-mile continue to increase as we take advantage of our ability to safely run longer, more environmentally- and energy-efficient trains. We are handling 2% more tonnage versus same time last year and 4% over third quarter of 2010.

To that point, let me share an exciting development quickly, as we continue to innovate on this front with the recent third-quarter introduction of what we call a super-coal train, our 224-car long coal train in the BC North corridor, which were essentially double the size of the trains we were running just three years ago. This train [cost] innovation has been made possible through our continued investments in the long sidings of the BC North; the acquisition of distributed-power engines; and by bringing together the appropriate parties in the supply chain to drive end-to-end efficiency.

On this point, initial reviews from the port operator in Ridley and our customers have been very positive. More to come on this as we evolve this opportunity, but certainly a success story in the making when it comes to supply chain collaboration in concert with operational efficiency improvement.

Efficiency gains continue in our terminals as well, with a 5% increase in the number of cars processed per switching hour. This, combined with the gains in train productivity between our terminals, is allowing us to absorb the growth you mentioned at lower incremental labor cost.

On the asset side, we are moving cars 8% faster than last year. These gains are being driven by reducing the time the cars spend in terminals, which we see with terminal dwell down 7% year-over-year.

In fact, in September, we set a record for car velocity, reaching an average of 217 miles per day. These velocity gains are being achieved while handling record volumes. This quarter was our busiest of any third quarter in CN's history, averaging over 1.50 billion GTMs per day, up 8% from last year.

So overall, very solid performance on the operational excellence side of the equation, where rest assured we have not lost any of our passion for driving efficiency. But at the same time we are making a meaningful difference for our customers and our supply chain partners, pushing forward on our service excellence agenda.

So let's now spending a few moments providing some color to service highlights. Service excellence. It starts with an understanding, first, of what is important to our customers and our supply chain partners.

My team and I have been spending a lot of our time with our marketing team, customers, and partners to build relationships within the supply chain based on driving mutually beneficial improvements. What you are looking at are a couple of key service metrics that provide a quantitative assessment of how our supply chain approach is working.

In the third quarter, we met 96% of unconstrained orders placed by our customers, and provided the cars on the day requested 89% of the time. This performance is being pushed by our car management excellence team that we have talked about in the past, who now have weekly calls with a large cross-section of our customer base, covering over 60% of our weekly call orders.

As opposed to being car distributors, this team has taken ownership of driving car order fulfillment, while at the same time being held accountable for achieving improvements in our car velocity. And as you can see, they are delivering on both fronts.

Another key touch point with our customers is our switch window compliance. When we started this service evolution almost three years ago, we heard from our customers in spades that our hub-to-hub internal terminal service was excellent. In fact, the data developed and documented during the service review that we went through here in Canada validated that point.

But the reliability of our local switching, pulling or delivering the cars -- what we call our first-mile/last-mile, was painful for our customers. Understandably, the customers want some level of reasonable predictability on when we are going to show up at their facility to deliver and pull cars.

Some would argue even more crucial, they want to hear from us when we can't deliver so that they can plan accordingly. This feedback drove the establishment of new metrics and procedures.

We now measure our performance at meeting the committed switch window, which is a window we developed through the overall design of our operating plan end-to-end. In the third quarter, we were in that window 90% of the time, up from 87% last year.

More recently, a new process we call iAdvise was launched, which we feel is an industry-leading initiative to advise customers of those failures proactively during the daily planning phase of our operations. So that they have a chance to react, calling an [audible] with the material or manpower when or if a critical car is not pulled, to deliver it when it's appropriate.

Finally, a very powerful game-changer for CN and our car supply-chain customers is the scheduled grain service. As opposed to our previous weekly view, measuring spotting performance to the week, we now measure our performance by the empty cars for the day. This approach has allowed CN to schedule our grain shipments from the fields to the ports in ways never possible before, by coordinating the empty loading to the online shipments to the port deliveries and eventual export, with the goal of maintaining a fluid end-to-end pipeline.

The trust and dependability we developed establishing this robust pipeline has allowed CN to sustain a record of spotting in excess of 5,000 cars per week for the last six weeks, which is a record for CN. Previously, we had only supplied 5,000 cars two times in a given grain season; and these were not back-to-back weeks.

So needless to say this supply-chain collaborative approach that we embarked on and continue to leverage with our partners is working in spades.

So in summary, our collective supply chain approach is working. It's allowed us to build momentum in our push for operational and service excellence, for the mutual benefit of our customers, our partners, and our shareholders, all of which is built on a foundation of trust and partnership, shaped in large part by commercially driven Service Level Agreements.

Contrary to what some may currently be saying, we do have a winning recipe to handle the business that JJ and his team are bringing onstream, to the benefit of all our supply chain customers and partners that are willing to engage with us. So with that said, I'll turn it over to JJ to provide some color on the businesses' collaborative approach is bringing to the CN one carload at a time.

Thank you, Keith, and a warm welcome to all of you who are joining us tonight. I will start first of all giving you over the next few minutes the review of our team, the top-line performance in the third quarter, and give you after that a sense of our business ahead.

The third quarter was solid -- solid in terms of volume and solid in terms of price. In summary, the revenue was up 8% as reported; net of exchange it was up 7%.

The making of that is the following. Volume and mix added together was 5%. Volume was 5.5%; mix was negative 0.5% Same-store price on same-store sales was up about 3.5%, midway in our 3% to 4% range. This is in line with our inflation-plus pricing and slightly lower than our near 4% of recent quarter.

I would like to add a note also that we do not do quality pricing on export coal at CN. The fuel lag -- the lag on fuel surcharge eroded our revenue by about 0.5%.

Now let's go into more detail of the top line. And as usual I will do this only on an FX-adjusted basis for the revenue.

Starting with petroleum and chemical, which revenue was up 14% in the quarter, the story here is quite simple. Crude and condensate added an incremental CAD45 million of revenue in the quarter. Refined petroleum was up CAD10 million. Sulfur, which is related to fertilizer, was down CAD6 million; and the remaining economically sensitive chemicals would tend to be steady and flat.

Metals and minerals revenues were up 5%. The commodities which were overperforming was energy-related product, steel product and shale drilling activities. That is for example steel that goes in the making of pipeline or making of tank cars or drilling pipe, as well as frac for the fraccing of the drilling activities.

Those which were showing negative carloads were mostly steel product and the raw material for the other segment. In particular, iron ore was down; scrap steel was down; so was steel slab. Also underperforming was the nonferrous ore and nonferrous metals sector. By that I mean copper, nickel, and aluminum.

Forest product revenue was up a slight 2%, kind of two story here. One side is housing starts which drove the lumber and the panel business up for CN. Our domestic lumber panel was up 9% for the quarter, and the lumber was up 9% as well. However, our Asian lumber export was down 20%, and that is mostly related to China. Other notable variance in forest product is paper, and paper was down 11% in revenue.

Automotive revenue was up 9% in the quarter, and that was mostly driven by the offshore import on the two coasts, which in our case is what drove most of our top line. The revenue coming from our domestic served plant in Michigan and Ontario was fairly neutral.

Very unique to CN, our coal revenue was up 11% in the third quarter. CN is bucking the industry trend as it comes to coal revenue, and here is why we are different.

The revenue of our overall met coal business all-in was up 12%. The revenue of our thermal coal business all-in was up 6%. And the revenue for our pet coke business all-in was up 40%.

To give you a perspective from another angle, our total export -- that is, the combined export of met coal, thermal coal, and pet coke -- was up 38%. This is a proof that the supply-chain initiative that Keith talked about earlier and the effort that we put our partners in the last two years is really paying off in terms of our export capabilities at CN.

Now, looking at grain and fertilizer which was up 9%, the fertilizer did very well. It was up 18%. First and foremost, the export potash was up very strong as a result of CN onboarding the Canpotex new contract, which is working very well for us. But also domestically both potash and fertilizer were also up on the quarter, but only single-digit.

US grain was slightly negative because of the drought in the Midwest. We ran out of grain. The Canadian grain was up 11%, and Keith has already talked about our record level of spotting in the last seven weeks, exceeding 5,000 cars per week.

Going to intermodal, intermodal revenue was up 6%. My container units were up 7%, but the RTM was up only 2%. That's in part because our mix of length of haul is slightly lower this quarter, but also because we improve our intermodal train balance back to the port.

In the third quarter, we moved a higher amount of overseas empty container on revenue waybill. The lading tonnage of these empty container has been zero. They produce revenue, they produce carload, but they don't produce RTM. But these makes for better round-trip yield margins on these trains.

On the West Coast, the business was up 10% in revenue. In our domestic business we had strong results in both moving retail goods and manufacturing goods. Intermodal is turning out to be an excellent service for our carload customers.

Now looking at the outlook, and if you want to follow me I will start on page 10 with the Intermodal one. But before making comment on Intermodal I just want to make two statements on the two commodities at CN which are in secular decline. One is US domestic thermal coal, and the other one is North American paper carloads.

(inaudible) are cutting into that line, iPad are not going away, and we will find more cheap gas will become more readily available in the years to come. However, these end products only represent 1.5% and less than 2% of our book of business, respectively. In other words, they are both already quite small.

So, looking at intermodal, intermodal will do very well for us this fourth quarter and next year on the strength of our unique service definition, which more and more players in the marketplace are deciding to understand what we are offering and what we are producing, as well as on an expanding selection of destinations sometime in 2013.

On the international side, we welcome a new transpacific customers in October. And on the domestic side, we successfully secured a large portion of a large US retailer who was entering the Canadian marketplace sometime next year. We view both events as proof-point of our strong service offering and service definition.

On the bulk side, page 11, the following page, the Canadian grain crop is excellent and the carloads are very strong. On the US side, the crop hasn't been as good. However, regardless, we are working hard to turn a negative into a positive and with nimble initiative, and will see how we finish the quarter with US grain. We haven't given up.

Coal will remain an export story. In the third quarter we ran at an annualized rate of 8 million tonnes of export at Convent. And at Ridley we ran an annualized export of 13 million tonnes.

Export potash carload would be a bright spot for CN. The market might be a little weak, but for us it is new business on the export side, business that we did not have in the fourth quarter of last year.

On manufacturing, which is a very broad segment, US housing starts will drive our long-haul lumber and panel to the US, as it did in the third quarter. But BC carload to China will be lower or muted.

Crude will be a very bright star in the fourth quarter. And it has been ramping up for CN, like in many other railroads, quarter after quarter. It is conceivable that we may double our crude revenue in 2013 versus 2012.

On the steel side, anything which is energy-related will be strong. Anything which is not energy-related will probably be weak. We predict the carload for iron ore will be down from last year, same thing as steel product, and the same for nonferrous metal. And the weak story for steel and nonferrous might actually impact us in the first part of 2013.

The number of frac sand plants on our plan on our line is expanding. That is a Wisconsin story, and we are building quite a powerful originating franchise for sand in Wisconsin.

Now, to round this up, talking about price. On same=store price we will continue to do our inflation-plus pricing program that is in the midrange of 3% to 4%. I would like to maybe note that we apply the Canadian grain cap increase only on October 1 of this year.

On fuel surcharge, our October/November tariff already in place and well-known, and we will have a revenue tailwind that we estimate to be about 1% of revenue in the fourth quarter. On the flip side, though, in currency we will have a revenue headwind given the Canadian dollar was CAD0.98 fourth quarter of last year, and so far this year it seems to the heading about on par. That may be a 1% to 2% drag on revenue.

So wrapping this up, in conclusion, third quarter was a great quarter. We are very have proud of our people. We have more initiative in the pipeline, and we have a team to compete and we have a team to already deal with the current economic environment. On that, Luc, I'll pass it on to you.

Okay. Thanks, JJ. Now, let's turn to page 14 of the presentation and I will walk you through the key financial highlights of our quarterly performance. Revenues were up 8% at CAD2.5 million. As well, volume was up in terms of RTMs 7%.

In the quarter however, we did experience a deceleration in RTM growth versus last year, as July was up 11%, August was up 8%, while September came in only at 3% above last year. This was really the result of a couple of factors, first one being that in September the growth in RTMs was very strong last year, where we had 9%.

Secondly, we witnessed weaker growth in the North American and global economy economic activity affecting some commodity sectors such as iron ore, nonferrous ore, steel, met coal as well. We also saw some lower demand for potash and below-average US grain crop. At this point we expect this weaker economic context to continue through the fourth quarter.

In the third quarter, JJ, Keith, and their teams combined efforts to help us achieve solid volume increases in all commodity sectors. And once again, several categories performed better than base market conditions.

Operating income was CAD985 million, up 5% versus last year, driven by strong revenue growth and low incremental cost. Our operating ratio was 60.6% in the quarter, an increase of 1.3 percentage points versus last year. Last year's operating ratio was more favorable as a result of the substantially lower stock-based compensation expense in that quarter.

Other income was $18 million in the third quarter this year, which is about $8 million higher than last year, when we exclude the $60 million profit on the sale of the IC RailMarine Terminal in Convent, Louisiana, concluded last year. Other income relates mostly to small parcel sales and projects relating to passenger rail service. Timing wise, this category is always difficult to forecast. My sense is that we got a little bit of help this quarter which last year ended up in the fourth quarter.

So our net income for the third quarter of 2012 was CAD664 million, up 1%. The reported diluted EPS was CAD1.52, up 4%. Removing the impact of the sale of the IC RailMarine Terminal in 2011, the adjusted diluted EPS of CAD1.52 in 2012 represents a 10% increase over last year's third quarter.

The impact of exchange was CAD8 million favorable on net income and CAD0.02 of EPS in the quarter as the average Canadian dollar weakened against the US. So on a constant currency, excluding fuel lag and without the help of the additional other income in the quarter, our EPS growth would have been just under 10%. These are very strong results given the pension headwind we are facing and given the modest economic backdrop.

Now let's turn 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 came in at CAD1.5 billion, up 10% versus last year on a constant currency basis. At this point I will refer to the changes in constant currency.

Labor and fringe benefit costs were CAD476 million, an increase of CAD78 million or 20% versus last year. Overall, wage costs were up 5%. This was the product of wage inflation up 3%; overtime was up 1%; and we had a 1% increase in headcount in the quarter versus last year. So in the third quarter our average headcount of 23,573 employees was up 1%, while the GTMs were up 8%.

So, clearly, some very solid operations and a 7% labor productivity gain. The headcount dynamics continue to be driven by advance hiring ahead of attrition to allow for training, along with our assessment of future volume growth.

Fringe benefit cost accounted for about 4 percentage points of the increase, mostly due to higher pension expense, as expected, and partly offset by some benefit cost adjustments in the quarter. However, the biggest change -- over half of the increase in the labor category was due to a higher stock-based compensation expense resulting in 11 percentage points of the unfavorable variance or CAD44 million. As our stock price was up modestly through the quarter, versus last year, actually it was down significantly in the third quarter of last year.

Purchased services and material expenses were CAD304 million, up 11%. This was mostly a factor of higher activity levels leading to more repairs and maintenance for cars and locomotives. We had as well higher expenses for contracted services, both in third-party non-rail transportation and for various other project work.

The fuel expense stood at CAD369 million, an increase of 4%. Higher volume represented 6 percentage points of the increase, but was partly offset by improved fuel efficiency of roughly 2 percentage points. Meanwhile, prices were essentially flat.

Now turning to free cash flow for the nine months the date, as Claude indicated, we generated just over CAD1 billion of free cash in the first nine months of the year. This compares to CAD1.328 billion last year.

The difference versus last year comes from higher net income of about CAD205 million and lower tax payments, at CAD139 million to date, which is CAD184 million less than last year. This was offset by higher working capital mostly resulting from the pension contribution of CAD450 million made in the first quarter of this year, while last year this contribution was made in the fourth quarter. Also our capital expenditures were higher this year by about CAD100 million for the nine months to date.

While I'm on the subject of income taxes I should mention that our 2012 full-year cash taxes will settle around CAD300 million. But our income tax installments will more than triple next year as we expect lower advance voluntary pension contribution; and so our cash taxes in 2013 will be within 1 point or so of our effective tax rate, which we estimate will be around 29%.

Our balance sheet remains strong with debt ratios and leverage within our internal guidelines. In the third quarter, we completed our 2011/2012 share buyback program with 16.7 million shares bought at the average price of CAD81, for a total consideration of CAD1.350 billion.

Finally, let me turn to page 17 and speak to our financial outlook. First, I am pleased to report that the CN Board of Directors has approved a new stock buyback program consistent with our strong shareholder returns agenda. This new program provides for up to CAD1.4 billion to be deployed over the next 12 months for the purpose of buying back our common stock through a customary Normal Course Issuer Bid.

As it relates to 2012's outlook, we see a challenging end to the year, but we are reaffirming our 2012 annual guidance which has us aiming to deliver up to 15% growth in adjusted diluted EPS over 2011. We also reaffirm our target of generating approximately $1 billion in free cash flow; and that is after taking into consideration a potential additional voluntary pension contribution of CAD250 million to be made between now and the end of the year.

Given the weak economic context, however, we certainly have our work cut out, and the expectation of reaching the upper end of our guidance is not a foregone conclusion. You'll recall as well that we will be lapping in the fourth quarter revenue growth of 12% in 2011, which was an all-time record; and we also had adjusted EPS growth of 20%.

More specifically for the fourth quarter you should keep in mind that the timing of the other income category is such that we got last year's fourth-quarter upside, which was about CAD15 million, already in the third quarter this year. Also, the favorable income tax adjustments we had in the fourth quarter of last year of about CAD0.05 of EPS will turn into a headwind, as we expect the fourth quarter of this year to be above our year-to-date effective tax rate.

Now with respect to 2013, still too early to provide a financial outlook. This is especially true given that we maintain a cautious view with regards to the real strength underpinning economic growth prospects.

What we do know, however, is that we will unfortunately face a few headwinds, namely pension and other accounting headwinds. These combined will probably have an effect that could be in the range of about 1.5 point of operating ratio. We expect nevertheless to provide you with annual guidance for 2013 at our fourth-quarter earnings call.

In closing let me say that we are very pleased with our third-quarter results and that 2012 is lining up to be another year of strong performance for CN. We maintain our focus on operational and service excellence to effectively deliver superior returns no matter what economic conditions we have.

On this note, back to you, Claude.

Okay. Well, thank you, guys, and just let me wrap it up. This team of CN railroaders is obviously very proud of its strong third-quarter results. We hit a number of performance records as you heard; but more importantly, we are seeing our agenda gaining momentum.

We are growing faster than the economy or base markets. We are accommodating that business at low incremental cost. And we are generating solid earnings and free cash flow. And that's what it takes to continue to deliver solid shareholder value for 2012 or for many years to come after that.

Before I turn it over to Q&A, I have one important announcement to make, and it's with some trepidation. After more than 15 years, Bob Noorigian has decided that he has made enough money -- and I am guessing that Shirley wants him on the golf course and his mansion in Florida. So he came to me a few months ago and told me that he would retire at year-end. So I asked Bob to give me an indication of who he thought should succeed him, and it was not a very long discussion.

We have decided we would go with Janet Drysdale, which many of you know. Janet was with Bob for almost four years a few years ago and has been continuing to drive value with Luc as of recently in financial planning.

So Bob, this is your last third quarter, this is your last analyst call, and it's very fitting that we are hitting all sorts of record performance. I know you will be doing a roadshow with Janet over the next couple months here. She starts only on December 1, so you keep holding the fort for a couple weeks here.

But we will miss you, and I know I speak on behalf of many shareholders and analysts in wishing you the most fulfilling retirement -- in a couple months from now, not just yet.

It's always good when it's a couple of months. Thank you, Claude. And with that we will open it up for any questions we have from the audience.

Thank you. It's a great management team, great Company, and I think there is plenty of growth that we are going to see in the future. Thank you, Claude.

(Operator Instructions) Chris Wetherbee, Citi.

Thanks, good afternoon and congratulations, Bob. Looking forward to seeing you on the golf course down in Naples.

Maybe if I could just ask a quick question on the guidance and the outlook as you think about 2013. I know there is some caution about the strength of the economy. You mentioned a couple of headwinds that you see, whether it be from -- on the expense side.

But I just wanted to get a sense about the revenue opportunities that you see specifically at CN. Obviously, the crude is one that you have highlighted in the release. But just maybe give us a sense there, outside of the economy, the things that are working in your favor.

It seems like there are a decent amount of opportunities set up for you. So how should we be thinking about that roughly as we look at 2013 preliminarily?

JJ?

The market will give us leg next year, definitely crude will give us leg. Grain is a good crop on the Canadian side; that will carry us to the following, next spring.

Housing start is a good news. We have been driving the positive US housing starts for a while.

The whole thing around energies, and not just crude but also frac sand. And intermodal, whether the economy is a little weak or the economy is a little strong, our intermodal performance the last two years is we overperformed the economy. So intermodal both domestic and overseas should be plus.

And again, steel, nonferrous. Though I can't tell you exactly when this will turn around, these are very cyclical commodities. They will turn around, but they may take their time before they turn around.

I was in Japan talking to some steelmakers a few weeks back, and they are not necessarily very optimistic right now. They have kind of written off the fourth quarter and maybe the beginning of 2013.

How does that all add up? I think we haven't yet decided what kind of guidance we are ready to provide in terms of (inaudible) volume. Again our objective is to overperform the economy, the Canadian economy, US economy, and our participation in Asia.

And as JJ said, I think we like the portfolio of growth opportunities that we have. Some of them are structural, like frac sand and metallurgical coal on the West Coast. Others are really driven by our strategy to improve service and make inroads in the most service-sensitive segments in the market.

Our flexibility, keep supply chain focused, is helping us also gain market share against trucks. So I guess the best way to think about it, Chris, is we don't know where the economy will be and we'll update you in January; but we are looking to make our own lunch and grow faster than base markets.

Okay, that's helpful. That's what I was looking for. I will keep it at one. Thanks very much.

Turan Quettawala, Scotiabank.

Yes, good afternoon and congratulations, Bob, from our end as well. Just a quick question.

I was wondering about your potash business over the next two to three quarters. I understand obviously that you will benefit from the Canpotex contract here. But just it does seem to be weakening a little bit even domestically.

I am wondering, JJ, can you provide a little bit of color there on the domestic potash market? Thank you.

Thank you. Of course, Turan. On the export side, whether it's a fourth quarter of this year or first quarter of next year this is all a plus for CN. The potash market in the world may not be as strong as the producer would wish, but it is strong for CN because our base was zero. We had zero export last year, zero potash export first quarter. We did benefit during the second -- the strike at CP the second quarter, so that will be the comparable.

On the domestic side, we did have gain on the potash side in the third quarter. Again here we could just be as good as our customers; our customers need us to be as good as we can be to help them, for them.

So we still basically assume here that the fourth-quarter potash domestically for to the two big companies that we work with, that we will be up year-over-year. And the next winter? Then we will see next winter what happens.

I mean, the price of grain is high. There is reason to fertilize, because there is a good product out there. And time will tell.

I think the potash industry is also hopeful. They've got a lot of investment and a lot of capacity coming onstream.

Thank you. As a quick follow-up, is there any change to the Ridley? I guess there was supposed to be some announce -- some decision, I guess, by the end of the year on the terminal there.

Turan, you are referring to the Canpotex potash terminal?

Yes.

That's right. So as far as we know, it is definitely a major item on their Board meeting in December, and at December they will look at that very closely again and might make a decision. Positive or negative, I don't know.

Okay. Thank you very much.

Cherilyn Radbourne, TD Securities.

Thanks very much. Good afternoon, and let me start by just wishing Bob the very best.

Keith presented some very impressive service improvements. And yet, as we all know, we are facing some service legislation here in Canada that seems to be taking a little bit longer than expected to emerge.

So I wonder if you could just tell us what you are hearing in terms of when it may appear and what you think the risk is that we get something that is noncommercial, if I can express it that way.

Thank you for that question, Cherilyn. Frankly, Keith was getting miffed here about the reputation for our service being tarnished here in some circles, so he felt pretty strongly about giving you the real stats so that we can have a good discussion.

And I think it is important for our shareholders. It is also important to some of the customers and stakeholders and media that might be listening on this call. I mean the reality is the following.

The rail service review was called basically six or seven years ago. That is when the people were asking for a rail service review.

I have said it in many a circle. CN and its agenda to drive the change and improve its performance, in a way that at times was a bit too fast, is a big reason why there was a rail service review in the first place. But we are talking about six or seven years ago; and since then we have clearly stepped up.

There is no question at CN, and I know it is the same at CP. We are focused on having more customer engagement. We are listening better, and we are trying to put ourselves in the shoes of our customers.

We have an agenda that is customer-centric. We have made a dramatic change to our first-mile/last-mile focus in terms of measurement. We have always been very good hub-to-hub; but now we are focusing, as you heard Keith, on things like order fulfillment. And 96% order fulfillment after car rejection is nothing short of world-class performance, and the same goes with some of the other metrics.

But it is more than just these things. It is also supply chain collaboration, a new mindset that we are bringing to the table. So from my perspective -- and I wrote to our customers to discuss this same issue, asking them to step back about what is important and where we should go from here.

The railroads heard the message. We are stepping up to the plate. And I think it is fair to have advocacy. We don't need to agree on everything, but it would be important for the -- if we want good public policy -- for the advocacy to be fact-based.

Let me be frank, and I don't want to single out anybody, but we have an industry association -- the Mining Association, for instance, which is using grain statistics, of all commodities, to try to make the case that we are failing our customers 50% of the time.

Well, let me tell you we're not. We are actually doing a great job for our mining customers.

And I know one thing. Our shareholders wouldn't know if we were not moving coal for Teck at 50% of the time. I think you would hear about that in the marketplace.

The same is true of any other of our customers, whether it is Walter Energy or others. You have other associations that are out there saying that in actual fact they agree that the service has improved, but what we need is a backstop. We need a backstop because somehow the railroads have market power.

Well, the reality is we compete every day. We compete against other railroads; we compete against truck; and we also compete against the opportunity to have their business for our own benefit.

So we want their business. We want to grow. And we don't take any of our customers for granted. We want to get better, and we want to help them win in the marketplace.

So I think it's important and I think the government has to make a very wise policy decision here. I think it is important to step back.

The reality is there is good service. Can it improve? Absolutely. But we have good service. It is world-class.

We have a commercial system that has driven this outcome. We are focused on getting better.

And if we want this momentum to continue and the drive for more supply chain collaboration to thrive, I think it is very, very important that the government stays with a commercial agenda. Now, I may not succeed; and in the end maybe the government does decide to legislate; and if they do it is probably going to be in the next month or so, Cherilyn.

But all I stay here is let's step back. We have a good thing going. And if the government is going to legislate, then at least they should do so in a balanced way.

We are asking for only a number of key elements to prevail if there will be regulation. We want mediation before arbitration; that is a fair request. If we don't want arbitration, if we want only a backstop, we should give it a chance by first starting with mediation.

Because service legislation goes at the heart of our ability to serve all customers, not just the one that complained, we want the agency, the Canadian Transportation, CTA itself to be the arbitrator of last resort, not some roster of arbitrators that have very little knowledge of how railroads operate.

And that is the argument that some of the associations are saying. If it's about dealing with a few instances where customers are abusing their market power, if that's the case, then surely these new service regulations and these new arbitration mechanisms should apply only to customers who actually are dependent on one railway or can show some commercial harm.

So we don't think regulation is the right way to go. But if we do have regulation we hope the government will not fall for the advocacy and the anecdotes, that they will follow the advice that I am providing. And if they do so we will be able to live with their decision.

And I hope they make those decisions rather sooner as opposed to later, because we have a business to run and there is a good thing going out there at the moment.

Okay. Thanks for that very fulsome answer. That's all for me.

Scott Group, Wolfe Trahan.

Hey, thanks. Good afternoon, guys. So, JJ, I had a question for you about housing. Relative to the last cycle the Canadian dollar is a lot stronger. Do you think there is as much demand this time around for Canadian lumber?

Yes, last time the Canadian dollar was weaker. Today, we are about at par. But the price of lumber is actually pretty good. That's one of the things where you see some diversion of lumber going to Asia, to United States, and the netback is attractive.

So higher price -- it's a question of higher price and freight. Freight is about the same ballpark, plus inflation plus. The price of lumber started to go up before the housing starts started to kick in.

So no, I think for a producer in BC and Alberta, US housing start is attractive. The producer in Eastern Canada -- that is, Quebec and New Brunswick -- this cycle may not be as strong for them. But the CN business when it comes to panel and lumber very much rely on Western Canada.

That's helpful. So when we think about your capacity, how much of your center beam or other capacity to handle a rebounding housing do you still have relative to last cycle?

And then, should we be thinking that you have been maintaining those cars and there is a lot of leverage to those volumes coming back? Or do you have to spend some money maintaining and upgrading those cars relative to five or six years ago when you were using them last?

We've still got about 2,000 in storage. Certainly the ones that have been in deep storage we'd have to take a look at and make sure they are in proper order, but don't expect there would be any major significant expense there. We continue to invest in our physical plant through strategic investments, loans, sidings, improving and expanding the capacity in Prince George which is a major facility that would handle these cars, as well as in Winnipeg.

So certainly there is enough latent capacity that we have invested in over the past four or five years that I would not see any issue for a housing start rebound.

Yes, I mean the leverage -- we kept those car for that very reason, for a rebound of a housing starts.

All right, thank you, and thanks --- best of luck to you, Bob. Congratulations.

William Greene, Morgan Stanley.

Good afternoon. Bob, congrats; best of luck. And Janet, welcome back.

Hey, the -- I wanted to ask a question a little bit off the beaten path here, but something that has come up a little bit is just the notion of density in Eastern Canada. We have long heard that that is a challenge to margins.

Is that true? Is that something that we could see a creative solution that could happen to address margins in Eastern Canada? Or is that just off the table, nothing that we should have in mind?

Let me ask Keith to respond to that, but we have pretty good returns across our entire network. And while it is lower density in the East, all the business that we handle is handled at good margins. Keith, you want to comment on the challenge to keep our costs down in the East, given the lower density?

Yes. Effectively, it's summarized by doing more with less. The Eastern region, if you look at all three of our regions, as well as they all do, in this downturn over the past couple years the East has continued to raise the bar. They have done it through our strategic initiative to run long, long trains over the [NLD]. We've made some very pinpointing investments to be able to meet long trains at strategic locations to allow us to absorb the growth that we have had, although it has been marginal, by cutting trains starts so to speak.

So we have controlled our labor costs. We have increased car velocity, train velocity, terminal expense across-the-board. Jeff and his team are doing a phenomenal job controlling our cost and maintaining -- better yet, actually improving our margin when it comes to the operating side of things and given the level of business we have.

And a little crude to the East wouldn't hurt, Bill. So we are focused on all levers to make sure our business returns everywhere.

One more point. I can tell you this, these guys are getting so creative and gals in the East, we were just meeting last week in Chicago talking about our pipelines of initiatives next year. We are taking some of that latent capacity and actually doing switching downstream to take additional cost out and increase asset turns.

More specifically, in our automotive fleet which has given us direct savings of being able to turn more loads; frees up capacity for the industry with the automotive growth; and it reduces our car hire cost.

Okay, thank you.

Tom Wadewitz, JPMorgan.

Yes, first, congratulations, Bob. You've really been a true professional over the years, and it's really been a pleasure working with you. So best wishes to you in retirement.

Let's see, I think this is for Claude. When you look at the maybe near term -- I don't know if you want to call it cyclical weakness in some of the commodities, export coal comes to mind. I think that you've talked about significant growth opportunity longer-term in BC and Northern BC.

Do you see customers in their investment plans responding to some of this near-term weakness? Do you think some of the growth you would expect is at risk? Or is this a near-term blip and you would still feel quite good about the Northern BC opportunity?

You know, what? I feel quite good about the Northern BC opportunity. The markets are impacting everybody, but the export coal that we have out of British Columbia and Alberta is high-quality metallurgical coal. It has nothing with the thermal export coal that you see elsewhere across North America.

So I do think that at the margin the mines in British Columbia are very competitive even with Australia, at the margin. And we have a good sailing distance, a very efficient port capacity. And our end-to-end supply chain is helping us or is allowing us to help our customers maintain their position in the marketplace.

So there might be a little bit of a soft patch here, and it might delay things that a little bit. But I think the metallurgical coal franchise and the opportunity to grow it over the next several years remains intact.

Okay. So you think that you would say those investment plans are still on track with what you would have seen before?

That's correct, yes.

Okay, thank you.

Thank you, Tom, and you're right. Bob is the best. We will all miss him dearly.

Benoit Poirier, Desjardins Securities.

Yes, thank you very much. Best wishes, Bob, for your retirement; and welcome back, Janet.

Would it be possible to give an update on the level of activity at the Port of Halifax, especially in light of the strike issues at the US ports and the low water levels in Montreal?

I could do that. You are right, Benoit -- it's JJ here. Water level in the St. Lawrence Seaway end of the summer here were low. So the containership coming to Montreal the last two months or so, if you wish, were light loaded. So there was less container per ship.

And some of those -- some of that business ended up being handled by Halifax either as export back, as Canadian export out of Montreal tend be heavier. So the issue is a little more on the return than the import side.

So Montreal has been sort of a steady flat negative partly because of that, and Halifax has seen some benefit. But the way we are selling Halifax -- and Keith talked earlier about the density of the network in the East -- we are very focused on Halifax, very focused on Montreal. Especially Halifax; it has deepwater, it has two great terminals. Both of them have -- especially one of them have great grain (inaudible) could deal with large vessel.

And there is a big push right now from CN, the two Port Authorities and the terminals in both Montreal and Halifax to sell our services in India and Vietnam and other countries. And over time, this will pay off, and not just to serve Canadian cities but also to serve US Midwest cities. (technical difficulty) East Coast versus East Coast.

Okay. Thanks for the time, JJ.

Chris Ceraso, Credit Suisse.

Thanks, good evening, and thanks for everything, Bob. So, a question about productivity. Can you give us a rough idea, ballpark, maybe in terms of percentage points on the operating ratio, how much productivity you strive to achieve each year and what your success rate has been? Has it been 100, 200 basis points of productivity?

I am just thinking about that in light of the 150 basis points that you outlined as a headwind for fiscal '13 from pension and other employee-related costs.

Yes, certainly, I will comment and maybe Keith can pick it up from there as well. If you look at this year I think the team has done an outstanding job because we have effectively been able to offset a good chunk of the pension headwind that we were facing. So it's not something that is easy to achieve every year; obviously next year will be more challenging because we keep looking for opportunities.

But I would say that we strive to try to offset at least half if we can, and more, of these types of headwinds. So that is just to give you a sense of direction.

Yes, and as far as the challenge of doing it, day in and day out you reinvent your selves. And as you fix one issue across-the-board you are going to identify other opportunities, so the pinch point sort of moves.

So it is like I said last week. We spent two days going through this and I walked away feeling even more energized and encouraged by the innovativeness and the ownership that this team is taking, refilling that pipeline of opportunities.

So it certainly is no easy task. It is hard work. You've got to roll your sleeves up and get at it and operate in a disciplined way and execute. But it is certainly doable. We will continue to redo it and reinvent ourselves year after year.

Okay, thank you.

Walter Spracklin, RBC Capital Markets.

Thanks very much and again, as everyone is saying, Bob, congrats on the retirement; and look forward to dealing with you, Janet. I am sure you are on the line.

So, my question here is for Claude, I guess. Canadian Pacific has talked a lot about what -- been aggressive in terms of what they are going to do, what changes they are going to make. We're going to hear a lot more about it in December.

But clearly you being the main competitor and not one to I guess sit back and be reactive on this, I am sure you are looking at the potential impacts to CN from some of these changes. My question is, have you seen any changes so far in terms of any changes from your competitor?

And when you think about what might happen in the next 12 months, one year, two year, three years out, do you see this as a positive for CN if they get a little bit more, moving a little bit more on pricing or so on? Or you see it as neutral or negative?

And can you talk to me a bit about again what changes you have seen to date and what you might see in the future as it impacts CN?

Yes, I think as I said before, Walter, I think it is constructive for the rail industry in Canada. You've got a pretty competitive bunch here, and we are not going to make it easy to catch us. So if CP gets better, we're going to have to get even better -- better faster. And that is exactly what we are doing.

We are focusing on our agenda. It is working. We are, I believe, making huge strides in regaining our customers' heart in terms of what we do for them. If you forget some of the advocacy in Ottawa, it is paying in additional growth, and we are accommodating that business at low incremental cost.

So our agenda of operational excellence and service excellence is carrying the day. And we hope that CP gets better; we hope they are able to price that into the market in a disciplined way with the value of the services they create. And if we all do this, the industry will be better. Canada will be better for it. And it's a good story.

Any changes to date so far that you've noticed?

They are working hard to get better, and we are seeing evidence that it is working.

Okay, all right. Well, thanks very much.

Matt Troy, Susquehanna Bank.

Yes, just a quick question. In terms of just competitive access or potential access to your management and middle-management ranks, it's a question that often comes up with investors -- that now that your former CEO is settled at your competitor and the work begins in earnest going forward, is there a risk? I know one man is not the entire CN management team.

But could you just walk us through why you are not concerned, or the layers of defense or strategy you've got about retaining the management team? Thanks.

You know what? The best way you retain a team is to have a good agenda that is working and to have fun and to have the right chemistry as a team. And I think we have all of those conditions lined up.

There is no question we are having a lot of fun driving our agenda and we are getting good feedback from our customers and from our shareholders. I think Hunter has a good strategy undergoing. He and I go way back.

I am not certain at all he will want to come after CN employees. I think he is a man of his word, and I would expect him to focus on driving change at CP without having to poach CN. And if he does poach CN, we have a lot of retention tools and a lot of bench strength.

Got it. Thank you. And just I will close out, Bob, thanks for all the help over the years. Best of luck.

Thank you, Matt.

Jason Seidl, Dahlman Rose.

Yes, thanks. I guess I will echo everyone's comments and well wishes to Bob. Bob, you have been a true professional over the years. And the only thing that matched that was your wit; definitely going to miss you at our conferences.

You guys mentioned I think on the intermodal side that there was going to be a large retailer coming on. Could you talk to us a little bit about the level that you might see from that? Is that going to impact the length of haul?

Without getting into -- I mean the retailer will start next year, sometime in first quarter. And then we wish them the best of luck in their investment, opening of their franchise on the Canadian side. They will tend to be a combination of long-haul coming from both coasts, mostly the West Coast, as well as some product coming from United States.

So it is -- because of number of stores they are talking about opening, it should be a nice sizable account on the domestic side. And domestic accounts sell a combination of a product produced here within North America and product coming from offshore, typically Asia.

Okay. It if I can get a clarification question here. JJ, I think you mentioned that there is going to be a revenue tailwind in 4Q due to fuel of about 1 percentage points; but you said currency could hold you down between 1 and 2. Did I hear that correctly?

That's right. Last year, the Canadian dollar in the fourth quarter, if I recall, was about CAD0.98. About that, Luc?

Yes. And it's running on average -- it is early in the quarter, but it's been running about CAD1.01, CAD1.02, so it could be a penny to two pennies, as JJ pointed out, 1% or 2%.

Okay. Thanks a lot, guys. I appreciate the time as always.

Ken Hoexter, BOA.

Hi, guys this is actually [Veronica Nyageni] in for Ken.

Are you having a problem with your phone?

Is this better? Okay, sorry about that.

So regarding your recently won intermodal contract from a competitor, can you talk about your underlying process? As in, was it service, price, them not wanting to live through the management turnover and service renewal? Or was it just your work during the strike?

And on that point are there more cases you see following this path, be it in intermodal or other?

I would only focus on the one at hand, the one that came to us basically this month. It is very rare that you see a major shipping line switch from one railroad to another, so you don't see that too often. So we are extremely pleased that they decided to come and join us after a decade-plus of -- not working with CN, but working with other railroad.

And when you look at those companies, typically not all of them but most of them, they really -- they have to go and sell their service in the marketplace. They need a service that fits their own service, as they sell not only in Canada but also in other continent.

That name tend to be a service-minded name. They are -- they need service winter time, summer time, labor disruption or not. And they really like the supply-chain service that we have.

That is, what most shipping line need and what most shipping line are selling is a good consistent transit time from the time the container gets discharged at the dock to the time it [arrives] to major cities.

We all have really fast train service. But fast train service doesn't mean fast container velocity -- the container velocities from ship discharge to available at the port.

And this is where, what Keith was talking about, the whole supply chain mindset, the level of service agreement that we have at Port of Vancouver, level of service agreement we have with TSI and other and Delta port, DP World in Vancouver. These are really element that matters a whole lot to a shipping line.

And I think in the end that was a compelling offering to them, because they think it will help them sell their product, their service into the Canadian marketplace. So by and large, that was the reason why they may have made the choices that they did.

Okay, that's very helpful.

And also just a general follow-up for Keith. You guys are at 60% operating ratio already. This is very broad; but are there any other costs you want to see at this level that you target to reduce? And in particular, where?

That's a pretty broad question.

It is a good follow-up.

I would say more specifically there is always operating cost and opportunities. Again I like to get out on the property and just do a couple of visits this summer. It doesn't take long to go to any of the major terminals or road operations, and different set of eyes and ears. You get a couple of guys and gals together that understand operations and blitz the terminal, and take a look for opportunities, and you see opportunities that you want to reduce cost, time in, time out.

So certainly I am not too concerned about being able to go out and find those opportunities.

We need them, because now Luc already signed them up to a deal with close to half of our headwind into next year so we will need some of Keith's magic to deal with the pension and other accounting headwinds.

David Newman, Cormark Securities.

Good afternoon, gentlemen. First of all, congrats, Bob, and thanks for all your help over the years. Hopefully now you can throw away your shovels and boots.

Yes, I will do that. Thank you for the best wishes, and you are going to be the last question today, so we appreciate it.

Very good. So my question is -- certainly I think the buyback should help in 2013; and you guys have really stepped it up, and certainly using your balance sheet. The other previous question on density etc. I think, Claude, you mentioned on I think an earlier conference that you haven't engaged in M&A for a little while. I Ontario Northland is one that you mentioned.

Is there something that you guys might step back into, the M&A front once again, to reacquire some short lines? Like I think there has been more interest on that side.

You know what? There is not many opportunities like that out there. The O&R is one that appears to be moving towards a potential sale by the Ontario government. But we are always looking for ways to extend our network, if we can find one, whether it is short lines or regional lines like the O&R.

But while we are ready to act on them as they become available as opportunities, there are not many out there. Let's put it this way, it is not Plan A and it is certainly not part of what we have in our toolkit to continue to deliver good results between now and year-end and into 2013.

Excellent. Thanks, gentlemen.

All right. Well, thank you, David. You just got under the wire.

If I am listening to all of you wishing -- having good wishes for Bob and missing him a little bit, I get a feeling here that you are going to be looking for help to build your model and answer your questions. But fortunately, we have Janet with Paul Butcher, that will be ready to stand by as of December 1 to help with the transition as Bob moves on to a very, very well-deserved retirement.

I want to say, Bob, you have heard it about 20 times on this call, on a personal note you have been a trusted advisor of me for basically all my career at CN, and throughout I always looked forward to get your wise counsel, and never worried too much about making sure that our message was well delivered to shareholders.

So for all of that, I thank you. And I just only -- I can hope that we are going to have a fourth quarter that is another solid quarter with record performance so that we keep the tradition going while you are on the golf course.

Thank you, Claude, I really appreciate it. Like I said, I think this is a great management team. It's a great Company. It's been a good run.

And because many of you already know Janet, we are going to be visiting a lot of our investors and some of the sell-side in the next few weeks here, I appreciate it.

And no pressure, Janet. It is just when I came to work here the stock on an adjusted basis was CAD4.50, so I expect the same from you.

Bonne chance, Janet. Thank you, Claude. Come see me in Naples sometimes, gentlemen and ladies.

Thank you very much and we will be looking forward to a strong finish of the year, and seeing you all or talking to you all at the year-end in January.

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