Canadian National Railway Co (CNI) 2013 Q2 法說會逐字稿

All participants, thank you for standing by. CN's second-quarter 2013 financial results conference call will begin momentarily.

I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's second-quarter 2013 financial results press release and analyst presentation documents that can be found on CN's website. As such, actual results could differ materially.

Reconciliations for any non-GAAP measures are also posted on CN's website at www.CN.ca. Please stand by. Your call will begin shortly.

Welcome to CN's second-quarter 2013 financial results conference call. I would now like to turn the meeting over to Ms. Janet Drysdale, VP, Investor Relations. Ladies and gentlemen, Ms. Drysdale.

Thank you, Patrick. Good afternoon, everyone, and thank you for joining us. I would like to remind you of the comments that have already been made regarding forward-looking statements.

With me today is Claude Mongeau, our President and Chief Executive Officer; Luc Jobin, our Executive Vice President and Chief Financial Officer; Jim Vena, our Executive Vice President and Chief Operating Officer; and JJ Ruest, our Executive Vice President and Chief Marketing Officer.

In order to be fair to all participants, I would ask you to please limit yourself to one question. It's now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Claude Mongeau.

Thank you, Janet. The team and I are in Montreal. We are pleased to take you through our solid Q2 results.

But before I do so, I would like to take a moment to make a few comments about the tragic Lac-Megantic accident that occurred right here in Québec. I would first like to say that our thoughts and prayers are with the families and loved ones of the 47 victims, and our expression of support goes to all the citizens of Lac-Megantic who have been severely impacted.

Now, CN was not involved in any way with the train movement. But we had our safety, dangerous goods, and environmental leaders on site from day one to lend a hand to MMA and to all the first responders involved. They were there to help, but also to learn firsthand about the accident and the safety implications for CN.

And learning is what we are doing as we speak. Jim and his team are reenacting every aspect of what could have gone wrong on this highly unusual accident and are reviewing our policies accordingly.

I think it's fair to assume that it will take a few months for the TSB to complete its investigation, but we are not waiting and I have initiated a fact-based and rigorous risk assessment with a view to further improve our solid safety record.

Okay, onward to the highlights of our Q2 results on slide 4. Our second-quarter results were strong.

I think we had solid team execution. You can see it on the solid top-line growth that we delivered. Our revenues overall were up 4% at constant currency.

We saw growth in all of our business units except for coal and automotive, as JJ will further explain a little bit later. We accommodated that growth at low incremental cost.

Basically all of our key productivity metrics are up. Trainload is up, car velocity, locomotive utilization, labor productivity just to mention those. They are all up.

Jim will give you a sense of what we focused on and the steady improvement. That was not just operating metrics, but also our service performance.

We delivered solid free cash flow generation, solid earnings per share. Our adjusted EPS is up 11% and our free cash flow for the first six months is standing at CAD437 million. Luc will give you more detail on all of the numbers.

So clearly a solid second quarter, solid team execution, and steady improvement. With that, I will let the team give you more color. Jim, over to you.

Thank you, Claude. Great second quarter, proving the value of our agenda of operational and service excellence.

Looking at our productivity, you can see our volumes are up and we delivered steady productivity results year-over-year, even with an expanded capital plan. Before digging into the productivity metrics, I would like to spend a few moments to talk about safety.

The events of July 6 in Lac-Megantic are a horrific reminder that safety is the foundation of everything we do. My thoughts go out to the families, community, and everyone affected by this tragedy.

Personally, as an experienced railroader, and with all the employees at CN, we work together as a group to improve safety. Our commitment is reflected in our safety metrics, which demonstrate an improvement year-over-year and a 29% improvement in main track incidents.

Having said this, we must not dwell on this improvement. Rather, we must continue to work hard to ensure we have the safest work environment for ourselves, our customers, and the public.

As I mentioned earlier and Claude mentioned, the metrics are strong across the board. The regions are delivering on speed, put-through, and volume absorption.

Specifically looking on page 6, train productivity improved by 1%, allowing more traffic to be moved on the same number of trains. Yard productivity or cars handled per yard switching hour improved by 10%.

Terminal dwell, which indicates how much time a railcar spends in a yard, also improved by 1%. A key metric to see if you are missing those cars that come in and make the tightest connections, the 32-hour cars which we measure on a daily basis improved by 26%.

The result was an improvement in car throughput with a decrease in yard switching hours. The focus was strong across our system.

Looking at locomotive utilization -- and you have got to beg my pardon; with my math background I decided to add one more significant digit on here. But if you look at locomotive utilization or GTMs per total horsepower, we went from 209.6 to 210.12. Janet otherwise was going to show me as flat.

The Western and Eastern regions were substantially better in the quarter. The Southern region held us back slightly, or else the overall results would have been even better.

Train velocity is a very important guide to network fluidity, and we again delivered an improvement from 27.26 to 27.31.

The key metric is car velocity. It's the one that I look at every morning when I get up. And car velocity probably is the most important metric in showing a broader picture of how a railroad is performing.

Has improved. We have been able to deliver a 4% improvement in car velocity. I am proud that the improvements are reflected in all three regions across system cars, private cars, as well as any foreign cars we had on the railroad. A great job by Mike Cory, Jeff Liepelt, John Orr, and Mack Barker in driving this across the whole Company.

If you turn to page 7, proof is displayed for our capability to balance operational and service excellence. Switch window compliance or placement in promised window is at 91%. And our grain spotting performance, which is placement on day promised, is up 86%, which in turn drives better operational balance, asset utilization, as well as improved service.

If you truly understand the value of on-day in railroading in the supply chain, you are able to drive better asset utilization with better dwell, faster trains, and increased car utilization. In turn, you drive better train and yard productivity with a keen operations and cost control view.

I am very proud to work with this group of professional railroaders and dedicated people. The operating team delivered a strong quarter in both service and operations. With that, JJ, I would like to turn it over to our Chief Marketing Officer to put more color to our quarter.

Thank you, Jim; and thank you to all of you for joining us here on this beautiful July afternoon. I will start with the highlights of our quarter.

Our rail freight revenue was up 6% in the quarter breaking down the following. Same-store price on same-store sales including coal was up 3.4%. The volume and mix produced 3.5% of the rail freight revenue growth.

The carload grew 2.3%. The revenue ton mile grew 4.7%.

The weaker Canadian dollar added almost 1% to our revenue. And the fuel surcharge, especially from WTI, reduced the revenue by almost 1%.

Now a quick rundown of each segment. I will do that as usual on the FX adjusted basis.

Petroleum and chemical, the revenue was up 17% on 2% carload growth. Crude by rail revenue increased 150% in the quarter to reach nearly CAD100 million.

This was driven largely by new loading station on our network. We actually had 10 more loading station than last year the same time.

In term of carload, our second-quarter run rate was about 70,000 annualized.

The metals and minerals revenue was up 3% on 2% carload growth. The frac sand volume drove that segment with new plants and rising production on our Wisconsin franchise. Sand revenue was up 50% in the second quarter.

The remainder of metals and minerals was flat to soft except steel for pipeline projects.

Forest product revenue was up 3% on flat carload. On the very positive side, lumber and panel revenue were up 10% and 8%, respectively.

Our export to US housing start and to Asia were up in both cases, while the shipment to Canadian destination was down. On the negative side, the remainder of forest product was weak; namely pulp export to Asia was down double-digit because of demand.

Coal revenue was down 1% on a 2% decrease in revenue ton mile. Revenue for pet coke export and for coking coal export were up in both cases. Thermal coal for domestic and export was down from last year.

Now looking at grain and fertilizer, the carload was down 4% but the revenue was up 4%. The great story in that segment was potash, which revenue was up 40%, and fertilizer, which revenue was up 12%.

However, grain was another tale. Canadian carloads were down 12% on lack of grain for export activities. US grain was also lackluster, with lack of soybean and corn in inventory to be able to sell.

Automotive revenue was down 4% on negative revenue ton mile of 7%. Carload volume was flat, RTM was down, and we had less overseas import for the Canadian consumers.

Intermodal revenue was up 3% on 6% carload growth. Please remember the charge in comparable we had with last year, when one of our competitor experienced a work stoppage. Overall, CN intermodal second-quarter revenue were up actually 20% from [2011].

The position overseas was up 5%. The Port of Vancouver posted a strong 19% revenue growth and is constantly growing. Rupert was soft as the port customer lost share.

On the domestic side, revenue increased 2% with strong gain from the industrial sector. Our overall intermodal revenue per unit was impacted by the weaker WTI fuel surcharge and by the year-over-year mix change from the work stoppage comparable.

So all in all, a solid quarter in the second quarter.

Now moving to the outlook, broadly speaking, when you look at the third quarter the carloads will probably be positive but will be muted because of the weak coal and grain, fertilizer market. Both coal, grain, and fertilizer will be weak in the third quarter.

We think the total carload will tick up at a better pace in the fourth quarter, all that subject to the new crop in Canada and the US Midwest.

Looking at intermodal specifically, the comparable would be more favorable and the market demand looks somewhat mixed, so therefore our business initiative will drive these results. For example, our excellent service like our [trawler] to Calgary by the third morning, our new product like our focus on reefer service, new market like our Joliet Terminal which just opened a few weeks back, new customers like MOL, as well as filling underserved markets like in Saskatoon.

On bulk, we remain guarded as it relates to the coking coal market in Asia, especially China, and also remaining also guarded when it comes to thermal coal in general.

The outlook for manufacturing, we see sustained demand for crude by rail from an increased number of loading stations and increased overall activities on the network. We also see ongoing growth demand in energy consumables for drilling; for example, frac sand. There will also be ongoing growth for lumber and panel to the US and the Asian market.

In conclusion, all in, we will be able to outperform the economy and maintain the objective to achieve inflation-plus pricing. So Luc?

Thanks, JJ. Starting on page 14 of the presentation, let me walk you through the key financial highlights of our second-quarter's performance.

Revenues were up CAD123 million or 5% at nearly CAD2.7 billion. This was a record quarter for rail freight revenues, gross ton miles, revenue ton miles, and carloads. All in all, volume was up 2.4% in terms of carloads and 5% in terms of RTM.

Operating income was CAD1.042 billion, up 6% versus last year, as solid productivity and service levels were coupled with expense management in the quarter to complement revenue growth. Here again, this is also a quarterly record.

Our operating ratio was 60.9% in the quarter, which represents an improvement of 40 basis points versus last year. Other income stood at CAD28 million compared with CAD9 million in 2012.

We concluded in this quarter an agreement with another Class I railway to swap operating easements including track and roadway assets on specific rail lines. While this did not involve any monetary considerations, we accounted for the transaction at fair value, resulting in a gain of CAD29 million, or CAD18 million after-tax.

In the second quarter, we had a CAD5 million increase in deferred income tax expense resulting from the enactment of a higher provincial corporate income tax rate. This was offset, however, by a CAD15 million tax recovery from the recognition of US state taxes relating to nonoperating losses. Excluding the impact of these items come our effective tax rate is 28%.

So our reported net income for the second quarter is CAD717 million, up 14%. And the reported diluted EPS stands at CAD1.69, up 17% versus last year.

Excluding the impact in the quarter of the deferred income tax expense and the gain on the exchange of easements, the adjusted diluted EPS stands at CAD1.66 in 2013, which represents an 11% increase over last year's second quarter.

Turning to page 15, operating expenses were CAD1.624 billion, up 4% versus last year or 3% on a constant currency basis. At this point, I will refer to the changes in constant currency.

Labor and fringe benefit costs were CAD498 million, a decrease of CAD9 million, or 2% lower than last year. This was the result of an increase in overall wage costs of 4.4%, mostly the product of wage inflation, and a 1.4% increase in average headcount versus last year's.

GTMs were up 5%, so we did enjoy 3% gain in labor productivity in the quarter.

Second element is a higher pension expense accounting for 3 percentage points of the variance.

Offsetting these cost increases were two factors. The first was a lower stock-based compensation expense in this quarter versus last year, accounting for 4 percentage points. The other factor relates to more capital work being performed in the second quarter of this year versus last year.

Purchased services and material expenses were CAD341 million, up 11%. This was the result of higher volume and costs incurred in repairs and maintenance.

6 percentage points of the variance is due to increase in or higher locomotive and freight car repair costs, as well as higher facility and maintenance expenses. The balance of the increase or 5 percentage point relates to the contracted services with third-party carriers due to volume increases in non-rail transportation including intermodal trucking and transloading.

The fuel expense stood at CAD402 million, an increase of 5%. Higher volume represented 4 percentage points of the increase in the quarter, while higher consumption rate accounted for the balance. Although actually, when you exclude the one-time inventory adjustment relating to previous periods, the average consumption would actually be flat versus last year.

Depreciation is CAD19 million higher than last year or 8%. This is due to a combination of asset additions, depreciation studies, and other adjustments to the remaining useful life of specific assets.

Equipment rents at CAD68 million were CAD8 million higher than last year or 14%. This is attributable to increased car hire costs and higher rental charges for intermodal and rail car leased equipment.

Casualty and other costs were CAD65 million, CAD17 million favorable to last year as we incurred lower environmental, legal, and other claims, partly offset by higher general costs.

Turning to free cash flow on page 16, we generated CAD437 million of free cash flow in the first half of the year. CAD1.384 billion was generated from operating activities. This was higher than 2012 by CAD48 million, mostly as the result of CAD350 million of lower pension contributions and better working capital.

This was partly offset by higher tax payments for CAD427 million.

In 2013, CAD572 million of cash was used in investing activities versus CAD277 million in 2012. The difference is mostly a function of CAD260 million lower proceeds from non-core asset sales and higher capital expenditures in 2013.

Meanwhile, our balance sheet remains strong with debt and leverage ratios within our guidelines. We also continue to advance our stock buyback program of CAD1.4 billion announced last October, consistent with our strong shareholder returns agenda.

In the second quarter, we bought back 3.6 million shares for a consideration of CAD365 million.

Finally, on page 17, our 2013 financial outlook. We continue to see a gradual although modest improvement in the North American economy, combined with opportunities in domestic energy-related commodities. However, as JJ pointed out, we are witnessing some softness, specifically in bulk markets including grain as well as domestic and export coal.

And so, with a strong second-quarter performance to our back, cautious optimism is warranted as we look ahead to what may be a challenging second half of 2013. Nevertheless, we are maintaining our annual guidance, which aims for high single-digit EPS growth in 2013 over the 2012 adjusted diluted EPS of CAD5.61. We also continue to target free cash flow in the CAD800 million to CAD900 million range.

On that note, I will turn it back over to you, Claude.

Okay. Thank you, Luc, and team. As you can see this team of railroaders has solid momentum. The second quarter saw us achieve a number of performance records.

We are pursuing growth opportunities on all fronts, and we are also tightly managing our costs. Clearly, there is a soft patch in terms of demand here, particularly in the third quarter; and we hope the economy will continue to help us in the fourth quarter. But we are gearing up to meet our full-year outlook and deliver solid performance for our shareholders.

And with that, Patrick, I will turn it over to you.

(Operator Instructions) Ken Hoexter, Merrill Lynch.

Great, good afternoon. Maybe if we could just talk about your outlook, are you using -- just initially are you using the CAD1.69 or CAD1.66? And on that, what are your thoughts on the cost per employee going forward in terms of the volatile labor line, given what you talked about on the incentive comp and the like?

Yes, we always use the adjusted diluted EPS, so CAD1.66. And secondly, looking forward in terms of headcount, we are looking probably somewhere between flat to up slightly, somewhere around 1%.

We continue to enjoy pretty good productivity, obviously, as we tried to contain the headcount increase, but we are still seeing some favorable GTM growth. So I think that's kind of where we are heading. Otherwise the wage inflation is about 3%.

Thank you.

Benoit Poirier, Des Jardins Capital Markets.

Thanks. Claude, we have seen your comments with respect to CN's robust train securement policy. Could you please share with us your thoughts on the broader safety implication for CN and the rail industry following the runaway train accident on the MMA at Lac-Megantic?

Thank you, Benoit. It's a fair question.

As I said earlier, we are analyzing every aspect of what could have gone wrong on the MMA to cause a runaway train situation. And we are also assessing all of our train securement policies.

When it is for a train that is attached to a locomotive, our policies require our crew members to put on a full application of air brakes on the entire train. And that's in addition to adding the independent and the handbrake applied on the lead locomotive.

We also require our locomotives to be locked when they are unattended and have a reset safety control device in place to act as backup to prevent uncontrolled movements even if the locomotive is shut down. So the bottom line is we feel that our train securement policies are robust, but we are nevertheless reviewing them in light of the accident.

But before we conclude our assessment, we first need to understand what actually happened here. We don't know at this point exactly what happened. And suffice it to say that it's much more complicated than just finding out how many handbrakes were set.

The TSB will have to answer several questions to understand how many issues combined to breach multiple safety defenses and cause this tragic accident. Were the handbrakes properly secured? And was a push-pull test done? What caused the fire on the controlling locomotive?

Why was the locomotive shut down without compensating action? Why did the air pressure on the independent brake leak out in minutes as opposed to in hours? And even then, why did the required reset safety control device not play its role as an ultimate backup safety defense to stop the train when it detected movement?

As you can appreciate, Benoit, a lot of things had to go wrong and it really is premature to conclude or render judgment on safety policies without all the proper facts. This accident is a sobering reminder to industry that safety is of the utmost importance. And I hope that stakeholders as well as regulators will allow careful analysis to shape decisions and properly target actions to further improve safety in the future.

Okay, thanks for the time.

Tom Wadewitz, JPMorgan.

Yes, good afternoon. I think this is a question for you, JJ. You mentioned that you are up to a run rate of about 70,000 annual loads I think in the crude by rail. How do you think that -- how do you expect that to trend in the second half of the year? Would you expect a further step up?

I guess one of the questions that's come up for other railroads is any kind of impact from spreads. I know you wouldn't be tied as directly to WTI-Brent. But is there any change in the customer I guess discussion that you have related to the broader changes in spreads? Thanks.

Thank you, Tom. Starting with our expectation for the next six, 12, 18 months, we still believe there will be an increase in the volume. The percent may not be the same because the base is getting bigger, but there's still a likelihood that crude by rail will continue to rise in volume.

The question of the spread, we are more tied to the Western Canada Select than we are to the spread with the Brent. I think that's more relevant to our marketplace.

Those spreads have been narrowed, but they are not as narrowed as the spread between WTI and Brent. I think short-term the change in the spread has no impact because people have already made a decision; they have bought their product. Product that has been bought, that will be delivered.

So the question is maybe more a couple of months from now whether or not there will be some change in the run rate. I think all-in the value of using the two-mode is real. It has generated much better pricing for the Western Canadian than Saskatchewan producers.

I think based on those success, those improvement year to date on spread, people would be likely to maintain the use of the two modes because that has really worked out for them. Time will tell after that; but what we see today in the change of spread has been the result of using the two modes.

Okay, great. Thank you.

Cherilyn Radbourne, TD Securities.

Thanks very much. Good afternoon. I also wanted to ask you one on crude by rail because on last quarter's call you alluded to some discussions that you were having with larger producers and refiners with respect to crude by rail investment.

So I just wondered if there was any update you could give us on those dialogs, and when we might hit an inflection point and see a shift to more unit train traffic on your network versus manifests.

Okay. Thank you, Cherilyn. Yes, most of these projects are based in Western Canada; they are mostly Alberta, mostly around Edmonton. Those investments are proceeding -- meaning terminal around Edmonton or North of Edmonton will be able to -- either a new one or what is more likely is unit train that could load unit train and ship that out.

So sometime late next year this year and next year you will see a trade that will move into movement of a block based on a terminal which are built by large companies, well put together, something with a lot of efficiencies. Something that eventually also will mean that more and more refineries will probably get the product directly as opposed to by transport terminal.

Okay, thanks. That's my one.

(multiple speakers) investment is still there today.

Thanks, that's my one.

Chris Wetherbee, Citi.

Thanks, good afternoon. Maybe just a question when you think about the guidance for the second half of the year, what's implied by the guidance in the second half of the year. I think, JJ, you mentioned that the volume outlook is positive but a little bit softer in the third quarter. That implies a bit of a pickup on the volume side for the fourth quarter.

Maybe you could help us run through some of the dynamics that may change as you go from the third quarter into the fourth quarter with a pickup in that volume. I think it's mostly around the bulk side, but just curious to get a little extra color there.

Yes, thank you, Chris. Definitely when you look at the summer months, summer being all the way through the end of September, the grain will be soft. Because both in Canada and the US there's basically barely any grain for us to move. We have to wait for the next crop.

So that's one of the difference between third and fourth quarter. Another difference is in the summer months right now we are moving barely any kind of significant amount of fertilizer, whether it's potash or nitrogen-based fertilizer. Again, we hope that in the fall there will be a good application season.

And what's already in the marketplace, inventories are very high. But if there is an application in the fall, that we will see some of that.

And then you have intermodal, which there will be a pick -- nothing to have a nosebleed, but there will be some kind of a pickup in intermodal. Some of our customers are saying maybe like a 3% increase in the run rate, if you wish, from quarter to quarter. Some are saying it could start as early as sometime in August, some are saying it may be as late as September. Time will tell.

But these are some of the difference between third and fourth quarter.

Big difference on the bulk side. Bulk is soft, grain is soft. And coal has been -- coal is sort of changing a bit of direction here, whether it's coking coal or thermal call. We have had more success in the past.

Great, thank you.

Walter Spracklin, RBC Capital Markets.

Thanks very much. Good afternoon, everyone. Just wanted to follow up on the volume expectations, JJ. It seemed to me, going through the quarter, following your weekly carloads, that you had been running still at a very strong rate right up until the very end of the quarter. It seemed to have taken a little bit of a hit toward the end of that. I would assume that that is the backing behind your caution going into the third quarter.

My question I guess is around the nature of that decline. It does seem broad-based. But I'm curious as to whether you are seeing any significant reduction in demand.

Or are we seeing some market share shift to truck or over to your competitor? Just if you could give us a little bit of color around the dynamic around the declines you are seeing.

Thank you Walter. The month of June was significantly different than what we had in May and April. The month of June is where we start to see this major slowdown in the grain export.

In June, we start to run out of grain export, both Canada and the US. There was not a whole lot in the US to start with.

We also saw also the decline of the fertilizer, namely potash. Potash was still fairly strong in the month of May, namely to the US and overseas; and then eventually we have hit the wall with our customers.

So what I was talking about in terms of the third quarter, some of that we've already started to experience in a significant way in the month of June.

No market share shift there?

No, there's no market share shift in any of our markets of any significance. There's always some puts and takes back and forth, but these are not the reason for the change in run rate between May, April, June, July.

It's the fundamental amount of product out there for us to move, especially on the bulk side.

Great. Thank you very much.

Yes, I would just add to JJ's point, in fact if it was not for our market share gain, there is a soft patch in demand, particularly in bulk, but we are holding our own and continuing to make gains. And that frankly is the strategy for the balance of the year. We need to outperform base market in order to drive our agenda forward, and that's what we have been doing in the first half and will be doing in the second half.

That's right.

Thank you.

Keith Schoonmaker, Morningstar.

Yes, thanks. I would like to ask a particular question on coal, and maybe you could elaborate a little bit on shifting demand trends. A competitor indicated strength in the Illinois Basin. Has this portion of your franchise grown?

Thank you, Keith. On the US coal both our domestic and export were weaker. On the domestic side, because our franchise geographically is quite limited, we don't serve as many utilities as any other railroad in the US.

The exposure we have for the franchise on thermal call in the US domestically, we will probably see some pickup in 2014, but probably not so much this year.

On the export, it is all about the pricing overseas. In anybody's crystal ball it is the price of thermal coal in the open market, the price of coking coal in the open market. Slightly better price would help us. The price is weak. Our producers are going to have a bit of a challenge.

So reading the crystal ball of the world market of these two commodities, what will eventually turn the tide for thermal coal and coking coal in the export market.

We do find some comfort Keith that the producers on our line for export met coal are low-cost producers. So it's difficult for all producers in a tough market, but they are working hard to maintain their advantage from a cost standpoint and we hope the business will recover into 2014.

And in the meantime, we keep building the infrastructure both the service to Rupert and service to the US, the Central Gulf, such that as market comes back we don't have logistical bottleneck at the port. So those efforts logistically as well as investment in this terminal is still going on, getting ready for the next up-cycle.

Thank you.

David Tyerman, Canaccord Genuity.

Yes, hello. I was interested in interested in your comment, Claude, that you would be making market share gains in the first half and you intend to in the second half too. I was wondering what areas you are seeing particularly that you are making gains.

And related to that, obviously your major Canadian competitor is lowering its cost base significantly. I'm wondering if you are seeing any more aggressive market share things going on from them at this point.

We focus to outperform base market. That means we have to gain market share against other railroads -- not just our principal competitor in Canada but all railroads that we compete with. We also have to make market share gains against other modes of transportation, truck first and foremost, but also pipeline, and to a lesser degree shipping, barge, and other shipping opportunities.

And that's basically what we are doing. We are trying.

We are innovating, for instance, in our intermodal service both overseas and domestic, and we are gaining market share against trucks, against other railroads. And it's a range of initiatives that are helping us outperform base market in that particular segment.

Similar story in merchandise. It's about leveraging our franchise in frac sand and energy consumables. It's about improving our service so that we can help our customers win in their own markets and allow them to give us a higher share of their wallet.

We are doing it in bulk. The market share there is more against other sources around the world. Especially in tough times we have to have the best possible service so that our coal producers don't miss a beat and move as much coal as the market will allow, especially in a down market.

So at the end of the day, for the last three years we have been outpacing markets because we are gaining market share in all of those segments, against all modes. And that's what we plan to continue in the future.

Great. Thank you very much.

Bill Greene, Morgan Stanley.

Hi, there; good evening. Luc, maybe I could ask you to comment a little bit on your cost inflation. What -- where do you peg it and what do you target in terms of productivity each year?

Well, that's a tough question from the standpoint of -- it depends, again, what the business volumes are and what we are seeing in terms of train starts and those kinds of things. I mean, ideally we'd like to see a continuous push on productivity. The business is not linear, so there are moments where we are adding on more business and it just goes up in terms of step function.

Clearly, we are seeing a little bit of slowdown and I think we are going to be mindful of just pacing ourselves in terms of headcount and ensuring that we are getting the most out of the productivity of the existing workforce. So typically we have been more on the hiring a little bit ahead of schedule, given that we were seeing some -- a little bit steeper growth. So now we are recalibrating that a little bit. And maybe Jim has a few comments he would like to add on that.

We are always looking to make sure that we have got the best-trained productivity, the most amount we can add on the train service we have. And you hit it right on the nail. There's times when you have to -- you have new service on. When you open up the frac sand and the Barron sub that we opened up last year, it's a brand-new service and you have to have add people on there, because you can't add anything from scratch.

But on the other hand, I think with where -- everything I'm being told from JJ and what the marketing expertise I am getting, we are looking at we are going to tighten up how we hire. We are not going to be looking out so far forward and make sure we have got a lot of ways in the Company to be able to help ourselves with the use of the way we use people.

So I think we are going to tighten up forward our hiring and not be looking out quite as far, just to make sure we are not long.

Thank you.

Brandon Oglenski, Barclays.

Hey, good afternoon, everyone. Maybe if I can just follow up on that question from Bill, specifically on D&A. That had a big up-step this quarter. And Luc, should we be modeling that new level of run rate of D&A?

Then secondly I do think you called out an item in casualty and other, but how do we look at casualty expense going forward? There's obviously some volatility there.

In D&A I think overall as you look through the year I'd probably peg it somewhere around 10% of revenues, I mean ballpark. What we did indicate is we are seeing some headwind in terms of the depreciation studies that we are in the course of completing. They are not all done, but we have more to do there.

All in all, I am expecting probably somewhere in the order of about CAD75 million increase in depreciation as we look to complete the year. So we will see; that's still a little bit up in the air because we haven't completed all the depreciation studies.

On the C&O, again, it can be a bit bumpy so these things are not linear and they don't go in every quarter like clockwork. We did have a very good quarter.

Again, we are very mindful of expenses. So somewhere between CAD75 million, CAD80 million a quarter is usually something that I would think is doable.

So I'd look around CAD80 million as a safe number to use. All in all, that's about 3%, again, of revenues year, year out.

Thank you.

Steve Hansen, Raymond James.

Thanks, good afternoon. As it relates to the crude by rail phenomenon, several of Canada's largest heavy producers seem to have suggested here that they are intent on strategically committing a certain portion of their output to crude by rail. And that would seem to suggest a growth commitment irrespective of the spread environment.

I'm just wondering whether or not you guys are seeing in your discussions any sort of tight term commitments out there, or take-or-pay type commitments on some of the terminalling side and/or in the rail business itself.

Yes, Steve, definitely when you talk about the heavy crude, the one that you would move before you actually add the diluent, you are into a different ballgame. The spread is important, the fact you'd be sending a product which is undiluted is also very important for both the seller and the buyer.

The buyer is looking for heavy crude. He is looking for heavy crude, not diluent. And the seller would rather not put the diluent into it if he can sell it as is.

So there is quite a number of these terminals which are being built around Edmonton, which are targeting a more heavier type product, if you can capture it before it gets diluted to pipeline spec. And that's one of the attractions of moving it by rail is moving a product which is more heavy and more attractive to those who can refine it.

So it is one of the positive story of rail, and it's one where some of the investments are coming in as we speak in Alberta. Both on the fleet side because you need a different tank cars and also on the loading side because you obviously load and unload these products differently than if it was Bakken crude.

And it requires a little bit more investment in terms of steaming capability.

Those supply chains are being built as we speak and they require large refiners or oil producers to back up those investments; and we are there in the middle to connect those markets to destinations with the flexibility that comes with rail.

Well, you are right. That is, the producer would back up those capital investments either terminal or fleet with volume commitment or commitment to use them. And these are obviously part of their ways to hedge the commercial risk -- commercial risk of one mode versus another.

Okay, helpful, thank you.

Scott Group, Wolf Research.

Thanks, good afternoon, guys. So first real quick and hopefully this doesn't count as my one. But, Luc, can you just clarify what you said, one earlier question on D&A? When you talk about a CAD75 million increase, are you saying full-year 2013 versus 2012 or the second half versus the first half is the CAD75 million?

No, full-year 2013 versus 2012.

Okay, perfect. Okay, great, thanks. So my question is on the yield side. We saw three of the segments reported yields down slightly year-over-year. We haven't seen that in a while.

Just wondering if you think that's intra-commodity mix or if there's any underlying slowdown in pricing. And just maybe at a higher level, why aren't yields better if you are getting 3%, 4 pricing and RTMs are growing faster than carloads? I would think that would be positive for mix, and yields would be even better.

Scott, you are referring yield as in cent per RTM?

Revenue per carload I guess is how we have it in our model.

Okay. Revenue per carload, again your revenue per carload -- the biggest factor in revenue per carload is length of haul. So you are going back to mix; and same thing percent for RTM.

I mean that's I guess fortunately or unfortunately -- I mean the public data does not really give a good reading when it comes to yield. The real yield comes from same-store price, exact same sales year-over-year, same payor, same origin, same destination, same car. After you strip out the fuel surcharge impact and you strip out the exchange, that's how you get to a yield.

Based on those more precise figures -- and that's how we manage yield -- the price, the same-store price as I had said was up 3.4%. By the time you get that into a revenue per carload or cent per RTM, now you get a whole impact of fuel surcharge, a whole impact especially of mix and exchange.

And last year we had -- one of my competitors had a work stoppage for a mix of business. Obviously, year-over-year was a little different from a run rate point of view.

So if same-store price was 3.4%, the rest, it's all in the basket of mix and these other things that we are talking about.

Thank you, Scott. You squeezed in one and a half, but everybody has been well behaved so far.

Thanks, guys.

David Vernon, Bernstein.

Thanks, guys. I wanted to see if you could maybe comment a little bit on the length of haul for the crude oil business by rail, and then also how that is impacting the employee productivity which -- congratulations -- hit another all-time high in the quarter of 4.25, based on our quick math anyway.

Clearly we hit a number of records on productivity metrics and also in terms of our overall volume and profitability. The crude business is very long haul. Our franchise from Western Canada all the way down to the Gulf, or our franchise from Western Canada all the way to Eastern Canada are very long-haul moves. So it's business obviously that allows us to have efficient train service.

And it's volume that's helping our productivity and helping also our volume and revenue mix.

Do you have a specific number on the length of haul? Just to help us model out what the RTM would be looking like.

I don't have a specific number and we don't -- Janet would be happy to give you a sense of things. But it's about the longest haul we have when you get all the way down to the Gulf Coast; it's more than 2,000 miles. And depending on where you're going in Eastern Canada, it's clearly above 1,400 miles to get from Alberta, say, to an Eastern Canada refinery.

Great, thank you.

Allison Landry, Credit Suisse.

Good afternoon. Thanks for taking my question. I was wondering if you could give us your thoughts on the Canadian rail service legislation that was passed recently and how you think that might affect the competitive landscape further for the rail industry going forward.

Well, we have been on this file for the last four or five years, Allison, as you know. And our strategy is to improve service and become a true supply chain enabler, so we will continue with that strategy. As long as we offer good service we hope the customers will recognize that and give us more business and be willing to pay a fair price for our services.

The changes in the law are in. We will see how it goes. But as long as we provide good service hopefully we don't need to go to the government for arbitration.

Okay. Thank you.

Steven Paget, FirstEnergy.

Good afternoon and thank you. On intermodal, do you believe you might gain some pricing power in the second half of the year after per-unit prices declined in the first half?

On intermodal, again, it's a question of same-store price versus revenue per unit or revenue percent per RTM. So we will have this issue of mix behind us eventually in terms of the relation with the work stoppage.

In intermodal, our fuel surcharge is based on WTI and you saw what's happening to WTI. It's a little weak and then it's eventually going to come back up.

On the same-store pricing, I think the intermodal segment is not our biggest segment in terms of price power. But we are working very hard to make sure that we trend in the right direction step by step, step by step. And that's what the effort is all about.

Thank you, JJ. That's my one question.

David Newman, Cormark Securities.

Yes, one for Jim here. It looks like you guys pulled out all the stops, pardon the pun, in Q2 versus Q1 on a tough weather comp. I guess my question is -- how much is systematic based on some of the initiatives you've put in, in the past, a smart yard, versus tactical to recover from Q1?

And I guess how sustainable is it? And are these the new levels we can expect going forward?

I appreciate the question, David. First of all, I didn't even look back at Q1. You never heard me mention it.

It was a tough weather comp. I'm just looking at the Q and it was tough. So obviously you made a concerted effort in terms of improving the operations in Q2, which I believe customers appreciated. But where are you at and is this sustainable?

Well, we are lapping previous years' numbers. In fact in June we had a spectacular June in our operating metrics, and we are doing it by being out on the ground. I spent a lot of time out in the field with the whole team.

I know John Orr; he's willing to give up his holidays or vacation to get out there and see what we can do better. But I told him to go, because it's important to go.

So, can we maintain this? I think we can maintain.

There's always in operations things you can't control, and weather can be one of it. So I'm always cautious in saying this is maintainable forever, but I don't see anything else stopping.

We were able to take the extra volume that came in this past quarter and be able to keep the metrics running at where I'd like them. Maybe there is a little bit room left yet to make them even a little bit better. So I am looking forward to the challenge with the rest of the team.

Very good. Thanks, gentlemen.

David, Jim is very humble. I have been watching him here for the last couple of months and I have to say that it's a range of initiatives. Blocking and tackling, leveraging on the fundamental structural initiative that we have out there to improve service and improve productivity at the same time. And we are hitting new heights.

I mean, every one of our metrics is at or near our best performance ever, and I see momentum. I think it's a floor. You will see continued progress as long as we can focus with discipline, we can accommodate that business at low incremental cost.

We can do it with good operating metrics and continue to improve service. That's the game plan. It's working, and Jim is doing a bang-up job.

Congrats, guys.

Well, thanks for the pressure, David. He just told me I better get out in the field. I've got my bag packed.

Turan Quettawala, Scotiabank.

Yes, hello, good afternoon. I had a quick question on intermodal. JJ, you talked about some weakness here at Rupert; and I know you said it was related to shipping companies changing market share there. I'm just wondering.

Are you gaining some of that back, I guess, in Vancouver? Or is that being lost to your competitors based on the changing in the shipping companies or maybe even leaking to the US? Thank you.

Thank you, Turan. We are, I'd have to believe in large part, we are gaining it back. When you look at total market share without getting into specific numbers, we are the dominant carrier in Canada for overseas.

So business from time to time shifts from one shipping line to another. In that case, it probably shifted from the Port of Rupert to the Port of Vancouver. Our Vancouver results are very strong.

Some of that might be product that used to be coming over Rupert. One of the line in Rupert has tried to be very aggressive on pricing, and they have lost some business during that May contract season. They're trying to get some of this business back.

But they lost it to somebody else, and that somebody else is probably more likely coming out of one of the three terminals in Vancouver. So I would call that market share shifting more in the shipping line more so than shifting between one railroad to another.

The Canadian market is maybe not quite as strong as one would think. And the US economy is a little better than the Canadian market right now. So we have seen better days in terms of the trans-Pacific trade all-in, the Canada and the US. But I think what's happening at Rupert is specific of one shipping line strategy for this year's contract season.

And we applaud their effort because the shipping line has to improve pricing over time, and it's quite constructive. I would just add to JJ's comment that with housing starts on the mend here, with good recovery, this should bode well not just for lumber movement between Canada and the US but also for container traffic out of the West Coast ports.

When people buy a new house, they tend to buy furniture, TVs, and a whole lot of appliances. And typically for every housing start there is lumber but there's also a lot of container goods that comes from Asia. So we are hopeful that the trend in Vancouver, which is very positive, will continue. And we are hopeful that Rupert will gain momentum here in the next little while.

Maher has ordered and is about to install another crane at their terminal. And Luc was giving me a report today that our siding at -- on the Kaien siding is going to be complete between now and year end. So we will have capacity to accommodate growth at Rupert when the business comes back.

Great, that's very helpful. I guess really quickly, is there a change in the US to Canada on volume for your intermodal?

Our business to the US is still growing. It's growing as a result of what Claude was just saying here, in economy and housing starts. But also growing because we added these smaller terminal which are just about to start up.

Great, thank you very much.

Thank you. This concludes today's question-and-answer session. I would like to turn the meeting back over to Mr. Mongeau.

Well, thank you, Patrick and thank you to all of us. You were very disciplined. I think we had two one-and-a-half questions and a number of very good questions.

We are pleased. Again, as I said, we are pleased with our results in the second quarter. We do have momentum in place, and we are gearing up to finish the year strong and deliver on our commitments to you and our shareholders in terms of overall financial performance for 2013.

So all of you, have a safe day and wish to talk to you soon on our Q3 results.

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