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Executives

Jean-Jacques Ruest - Chief Marketing Officer and Executive Vice President

Keith E. Creel - Chief Operating Officer and Executive Vice President

Claude Mongeau - Chief Executive Officer, President, Director, Chairman of Donations & Sponsorships Committee and Member of Strategic Planning Committee

Luc Jobin - Chief Financial Officer and Executive Vice-president

Robert Noorigian - Vice President of Investor Relations

Analysts

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Turan Quettawala - Scotia Capital Inc., Research Division

Cherilyn Radbourne - TD Newcrest Capital Inc., Research Division

Keith Schoonmaker - Morningstar Inc., Research Division

Matthew Troy - Susquehanna Financial Group, LLLP, Research Division

Steven C. Sherowski - BofA Merrill Lynch, Research Division

John D. Godyn - Morgan Stanley, Research Division

David Vernon - Sanford C. Bernstein & Co., LLC., Research Division

Benoit Poirier - Desjardins Securities Inc., Research Division

Christian Wetherbee - Citigroup Inc, Research Division

David Tyerman - Canaccord Genuity, Research Division

David F. Newman - Cormark Securities Inc., Research Division

Jason H. Seidl - Dahlman Rose & Company, LLC, Research Division

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division

Canadian National Railway (CNI) Q3 2011 Earnings Call October 25, 2011 4:30 PM ET

Operator

I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's third quarter 2011 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 the CN Third Quarter 2011 Financial Results Conference Call. I would like to turn the meeting over to Mr. Robert Noorigian, Vice President, Investor Relations. Ladies and gentlemen, Mr. Noorigian.

Robert Noorigian

Good afternoon. Thank you for joining us for CN's third quarter conference call. I'd like to remind you about the comments that have already been made regarding CN's forward-looking statements.

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

After the presentation, we'd like to take questions from those of you who are listening on our call today. Could you please identify yourself when asking the question? In order to be fair to everybody, could you limit the number of questions that you're asking to one?

Thank you very much. And now it's my pleasure to introduce Mr. Claude Mongeau, our President and Chief Executive Officer. Claude?

Claude Mongeau

Thank you, Bob, and thank you all for joining us on this call. We're announcing our third quarter results, and I'm very, very proud of the results. We have had strong performance pretty much across the board, and we're delivering on our agenda in all aspects that matter at the moment. We have record revenue performance, a good balance between solid volume increase, good pricing, and overall, if you adjust for currency, our revenues are up 12% over last quarter. And that's reflective of our ability throughout the quarter and since the beginning of the year to outpace the general rate of economic growth.

This top line momentum was translated into solid bottom line results. We were able to turn in an operating ratio of 59.3% for the quarter. Our earnings on an adjusted basis are up 16%, and our year-to-date free cash flow is in excess of $1.3 billion.

So all in all, solid results driven by our delivering our strategic agenda.

And with that, I will turn it over to the team to give you more details, and I'll get back to you at the end with a wrap-up. Keith?

Keith E. Creel

Okay, thanks, Claude. Let me say for certain your comments are greatly appreciated by the men and the women of this operating team that execute day in and day out in enabling this performance of CN. If you combine that with the first strategic agenda, which is centered around our customer innovation and supply-chain automation. Secondly, J.J. and his team's strong book of business and finally, our precision railroading operating model. They were able to deliver an outstanding result in the third quarter.

So with that said, let's go straight to the third quarter operating performance, and I'll touch on some of our key measures.

I'll comment again on the key metrics we report quarterly. They always provide us a useful summary of our performance and the high cost in service impact areas.

As you can see the GTMs per train mile, the train load continues to grow with CN, which drives reduced clear locomotive and fuel [ph] expense. Now this performance, specifically, is made possible in significant part from our continued execution of what I call capacity enhancement investments and exciting -- extended citings in distributive power, which has allowed us to absorb a lot of this growth, incremental growth at a very low cost.

Cars per yard switching hour terminal grow roughly flat year-over-year. This is against higher volumes and some switch crews as we go through our transition with our demographics. Fewer speak [ph] and part of the learning curve, particularly in the west where we have experienced the most amount of growth.

Trailing GTM as a percent of horsepower, this is an all-in measure for our locomotive productivity. What may appear to some to be slippage year-over-year is more reflective of our decision to err on the side of being a bit low in locomotive -- locomotive left in service in order to finish cleaning up some of the traffic we impacted during the very tough winter we had and the spring, as well as prepare ourself to ramp for grain and potash, which is in full steam now. I'm very pleased to report where things are going extremely well in that regard. We're operating a very robust pipeline to the West Coast and the bulk side, as well as a very fluid and robust pipeline dealing with the Potash business to U.S. destinations.

We see a similar story in car metrics per day where we've consciously took a bit of a hit on the metric side, deploying available assets to enable improving our first mile-last mile initiatives. With that said, I'll point out, and J.J. will expand on this, we've gained 4 points of car order fulfillment overall and about 20 points on the short-term lead orders, which are more akin to truck competitive-type markets.

Finally, train speed, quarter-to-quarter, it's off slightly in part due to some lingering weather challenges from the spring carried into July and some marginal impact in the west from the larger trains, longer trains that we're handling dealing with this volume growth and low incremental cost. But I am happy to see that so far in the fourth quarter, effectively really in August and September, we really started to gain straw with our operating metrics, and we're seeing a performance fourth quarter now that exceeds same time fourth quarter last year. So it's all moving in the right direction.

And we'll continue to gain some traction as we cut over some of the key infrastructure programs that we've completed -- that will be completed late November, early December, which is a nice segue into the last slide.

I can tell you this engineering team now continues to put final touches on a number of our capacity enhancement projects, including a total of about 10 siding extensions, 4 sections, the second, third main track in different parts of our network, a number of yard improvements and speed increases. And I'd be remiss to not report to the group that we just finished our most critical connection, which was part of the EJ&E transition, linking the EJ&E to our existing network at Matteson. This specific connection allows us to make head-end [ph] moves in any direction, be it north, south, east or west, onto or off of, the EJ&E and the CN, just south of embarking yard in our Chicago intermodal facility.

This is a move that previously required running around the train in some cases which was about a 2 hour ordeal. We do it now in about 10 minutes. It's a very significant piece of asset improvement for us with that investment.

So as the slide said it’s operationally so far, this fourth quarter, we're firing on all cylinders. Our operating metrics are very strong against the record volumes we're handling, especially in the west. With that said, as we go into fourth quarter winter, of course, is something that we've planned for, we've been aware of and we're certainly ready for this year. It's around the corner. We effectively taken approach that prior planning is going to prevent poor performance. We started planning for this winter, actually, when last winter ended. In the spring, we had a group of people sit down and brainstorm. We identified the things that we did well. We identified the things that we didn't do so well, and we created an action list -- an action item list that we've been executing on since that time. And I'm happy to say that certainly we're prepared to not miss an opportunity meeting or exceeding the performance we produced last year in what was extremely tough operating conditions.

We're going into this winter with about 100 more DP locomotives than we had same time last year. We got the infrastructure upgrades I talked about. We've made huge strides in joint elimination out on the main line. We've purchased and deployed more snow fighting[ph] and road-repair equipment among -- along laundry list of other items. Suffice it to say, this has been a very active file for this operating team. We fully expect to perform this winter.

Finally, the stable base of operations that we enjoy. My senior team and I continue to spend quality time with J.J.'s folks, our customers and our supply-chain partners. With the help of Luc's IT team, we’ve built some outstanding rail-based systems together and shared information about our coal, grain, iron ore and potash supply chains. And we're seeing the results. The success of our focus has enabled us to exceed what we previously felt was coal export capacity at RTI. And on the grain side today, we're busting through what was historically a 4,500 car per week cap, a capacity cap of loading and shipping western grain. Now due to the supply-chain integration, better communication with our supply-chain partners, we're approaching the 5,000 mark on a weekly basis. We've had a 8-week that exceeded 5,000. We've had consistent weeks that are running between 4,800 and 4,900, and we fully expect to continue that.

So in closing, a very exciting quarter to report on [indiscernible], but even more exciting on the success that’s yet to come and what I know to be the best in class operating team in this industry, as we continue to execute our business strategy in line with your strategic agenda.

So now over to J.J. to speak about the growth these efforts have supported.

Jean-Jacques Ruest

Well, thank you, Keith. And let's get right away to the revenue. As Claude said, the third quarter revenue increased 12% on the adjusted -- currency adjusted basis. And simply broken down, 4.5% of that came from volume, our carloads increased 3.7% and our RTM increased 6.3%, same-store price increased 3.8% last quarter, which is in line with prior trend. As a reminder, same-store price apply only 3/4 of our book of business after the removal of fuel surcharge revenue. 4.5% came from fuel surcharge. Mix was basically flat. And finally exchange, which is revenue about 3.5%, the Canadian dollars was $0.06 above last year.

Now looking at the quarter in detail, I'm on Page 9, and as usual all my comments will be FX-adjusted basis.

Starting with petroleum and chemicals, which revenue was up 10%. During the quarter, we capitalized on market shortage of heavy fuel by moving long-haul volume. We also had more crude shipment as we continued to deploy our crude business model. And in chemical, the significant increase in sulfuric acid as all the plants in our line ran at full capacity during the quarter. Metals and minerals was a very strong story, the revenue was up 26%. Oil and gas related business, namely pipe, frac sand and the likes were roughly up 30%. Shipments of semi-finished steel also increased, driven by good demand, but also as Keith mentioned, by our more responsive service to that demand, including the short view orders.

Scrap iron and domestic iron ore volume were up in the quarter. Non-ferrous mineral was also up. We grew market share, but also our customers made a concerted effort to reduce their on-site inventory at their mine.

Forest product revenue was up 12% in the quarter on an FX adjusted basis. We've seen an uptick in lumber and panel volume to the U.S. during the quarter. Lumber volume for China increased almost 70% versus last year. For many quarters in a row now, there is little correlation between U.S. housing start in our very strong lumber business.

Wheat power export kept on increasing, as a result of new production in Northern BC where we basically serve all the wheat power plant in Northern BC.

Wood pulp was down in the quarter, and this was related to extended shut down at 2 of our major customers in Western Canada.

Automotive revenue was up 15%. Finished vehicle traffic increased for the Big 4 in Detroit, as production at CN's serve [ph] plant increased during the quarter.

However, although productions for the Japanese manufacturers have returned back to normal after the tsunami, our West Coast import traffic remained impacted this time by a labor dispute of a major waterfront water terminal in Vancouver. Ships were diverted to Tacoma, came to us via the Chicago gateway producing lower RTM on the same carloads.

The coal revenue for the quarter was up only 4%. As discussed in our last quarter Q2 results, the Q3 carloads were actually negatively impacted by production issues in Canadian mine in Northern BC. As you remember there was a lot of flooding and wet condition last spring, and these, as we predicted, impacted last summer's production.

Thermal coal in U.S. utility is continuing to be negatively impacted by long-term cheap national gas, which we do benefit in fraction in the pipe with this impact to coal business, and also because this slow economy growth in the overall electricity consumption is not as robust as it was years ago.

Despite overall carload being down 9% for our coal segment, our total RTM was flat for the quarter. And that's because we generated more long-haul PRB coal to the port of Prince Rupert, which was enough to offset the weakness in other segment of our Coal portfolio.

Grain and fertilizers revenue was up 9%. Carload of Canadian wheat and barley were off this summer as our CN cash scenario was already emptied of its stock in the season before. However, in September, the crop came in early, and we have had very strong carload ever since, as Keith described earlier.

Our U.S. grain, we have very strong demand for ethanol, as well as increased corn for domestic processing plant. However, the grain export is weaker in the third quarter, and it will be weaker in the fourth quarter.

On domestic potash, 33% carload growth from strong demand and also from an early fall application by the farmers.

Overseas intermodal was up 10%. CN import volume on the West Coast outperformed the overall West Coast port average. During the third quarter, CN grew 12%, and the North American West Coast port declined by 6%, which means that the CN coordinated supply-chain model is definitely gaining market recognition in the marketplace.

Domestic intermodal revenue was up a strong 20%. Overall, all of our domestic segment continues to grow across the board with its groceries, consumer goods and its pricing sectors mostly in the U.S. but also in Canada.

Finally, our Nonrail business was up 9%. Similar to last quarter, the growth was driven by the Great Lakes vessels that we run for iron ore and the likes, as well as our CN local trucking services, which complement our ethanol service. This was partly offset by the sale of our common coal terminal, which took place on August 1.

Now to the outlook. If you can join me on Page 10, starting with intermodal. And intermodal will definitely remain a core engine of our growth for the fourth quarter and for 2012. This year's fall peak will remain subdued, and as predicted back in July by all of our ocean shipping line, the line have already started to withdraw the transpacific service in order to deal with excess capacities.

Retailers are inventory cautious and consumers are purchase fickle. Regardless of the market condition that's ahead of us, we believe our import/export supply-chain model is designed to continue on a sustainable one-box-at-a-time market share progress.

Recent trend in inventory to sales ratio is holding steady. There's been no change since May 2011. So far in the fourth quarter, it's only been 3 weeks -- but so far in the fourth quarter, CN overall intermodal volume is up 10%.

In the case of the Bulk, if you could join me on Page 11, Bulk segment for CN in the fourth quarter will be driven first and foremost by the Canadian grain. We were prepared for an early crop in Canada, and our western operation, led by Mike Cory, really deployed all the asset back in early -- in August to be ready for it. In the last 5 weeks, we've experienced record order book, which we have been blitzing with records unit -- scheduled unit service at levels unsurpassed before.

Our U.S. Grain business, however, is another story. The crop in the U.S. this year, even though we will be flat on corn and up -- flat on corn, and soya bean will be down 8%, the crop is expected to be down as much as 13%, and that will impact negatively our Gulf Coast export.

Canadian coal mine operation are returning to normal after the difficult summer, and we're already seeing that in our cargo in the month of October.

Coal export in the U.S. via the Gulf Coast will be -- see a progressive ramp-up in our Convent terminal. In fact, since the August 1 transaction we’re climbing [ph], we've seen a definite run rate increase in the amount of coal in Wichita terminal. On the terminal side, the demand remained weak and that segment will remain anemic.

On Manufacturing, if you want join me on Page 12, U.S. Housing start expected to remain flat versus last year for the quarter. However, regardless, up to this point, the CN lumber volumes, we believe, should see an uptick in the fourth quarter. We have some sawmill that will restart, and we are also further expanding our lumber container export infrastructure on the Canadian West Coast.

Overseas market pulp price have weakened last month because of the pullback of the Chinese buyer, however, CN's shipments should ramp up because we have these 2 pulp mill coming back from that maintenance shut down.

The ISM purchasing manager index is at 51.6, which is slightly in expansion territory, so there is some hope in the Manufacturing sector for things to be steady and slightly improving.

Overall, North American finished vehicle inventory is at a less risky 49 days supply, which is 9 days down from last year, which actually bodes well.

Dealer inventories for Japanese manufacturing remain very low at 37 days. Our iron ore mine expected to run at capacity throughout the year end in advance of the vessel's season closing. And the chemical commodities price outlook is only slightly down, and our customers are mindful of keeping inventory low.

In closing, so far in the fourth quarter, after -- from week 40 to 42, we have a 5% carload growth and a 4.5 RTM growth. Our leaders in that volume is Canadian grain, both intermodal segment, metals, minerals and lumbers, and our loggers this year will be U.S. grain. And in fact, U.S. grain will probably be negative in the fourth quarter.

We stay cautious and optimistic, and we build supply-chain solution, which are aimed at helping our customers run their marketplace regardless of the economy. And on that note, I would like to thank my sales and marketing team for the innovation and tenacity. CN people is what powers CN.

On that note, I'll turn it over to another CN person who powers CN, Luc Jobin, our CFO.

Luc Jobin

All right, thanks very much, JJ. Now turning to Page 14 of the presentation, let me walk you through the key financial highlights for the third quarter of 2011.

Revenues were up 9% at $2.3 billion. All sectors were positive and federal categories actually delivered a performance that outpaced base-market conditions.

Operating income was $938 million, up 12% versus last year. In the other income category, we recorded a $60 million gain in this quarter from the sale to the Cline group of the IC RailMarine terminal located on the Mississippi River.

As part of the sale, we've also entered into a 10-year rail transportation agreement with Cline that will see us haul their coal from Illinois' base and mines.

So our net income for the third quarter was $659 million, up 19%. And the reported diluted EPS was up 23% at $1.46.

Excluding the IC RailMarine terminal gain of $0.08 per share, the adjusted diluted EPS stood at $1.38, up 16% versus 2010.

Note that we continue to face an unfavorable foreign exchange headwind, amounting to $0.05 of EPS at an average Canadian to U.S. dollar exchange in the quarter average $1.2 versus $0.96 last year.

Our operating ratio was 59.3% in the quarter versus 60.7% last year. So an improvement of 1.4 points.

Now let's turn to the operating expenses on Page 15. Here, we came through with another solid quarter, both in terms of operational execution and overall expense management. Keith and his team continued to make progress with a 2% improvement in trainload, a 2% improvement in fuel efficiency, and we also achieved a 1% gain in overall labor productivity.

Operating expenses were $1.369 billion, up 10% versus last year on a constant currency basis.

By far, the biggest increase in operating expenses was $121 million on fuel, as prices in the quarter were up over 40%, while the balance of the change was attributable to volume increase, partly offset by efficiency gains.

Labor costs were $400 million, 7% lower than last year. So let me break that down for you. Wage and fringe costs were actually up 5%. This was the result of a wage and benefit cost inflation of about 3% and also higher headcount of about 5%, which was partly offset by about 3% of increased capital work in the quarter.

On headcount, let me give a little bit more color. We were actually up 5%, as I indicated, versus the same quarter last year. And this is in line with our GTM growth, which was 6%.

The headcount increase was driven by a 3% higher base workforce and a 2% increase related to advanced hiring ahead of attrition to allow for training. The wage and headcount increases, however, were more than offset by the impact of a lower stock-based compensation expense as our stock price declined in this year's third quarter for a favorable impact of $20 million, while the stock price increased in the same period last year leading to an unfavorable variance of $30 million at that time. Now keep in mind that our stock price has largely recovered since then, and this will now become a headwind in the fourth quarter.

So total operating expenses were actually up 6%, FX adjusted, when you isolate the net impact of the fuel price increase and this stock-based compensation variance. This translates into a 60.1 operating ratio, an improvement of 0.6 points over last year's 60.7.

Looking at 2002 (sic) [2012], we do expect headcount to stabilize, but we continue to monitor our business levels and economic indicators to adapt as needed.

I should remind you, as well, that in 2012, we expect our labor and fringe cost to be under more pressure as our pension expense will likely increase in the range of 1 point of operating ratio, assuming the current trend and discount rates and investment returns continues.

Turning to purchase services and material. It was up 13%, mainly from increased repairs and maintenance, higher crew transportation and incident costs.

Last, casualty and others -- and other costs rather, was $74 million, a 16% improvement from last year, as we continue to incur lower G&A and experience lower claims. This follows the trend that we have seen all year.

Now turning to free cash flow. Year-to-date, as Claude mentioned, we generated $1.3 billion. This is $390 million higher than last year. This is the product of better operating results, higher proceeds from asset sales and lower working capital due to the timing of last year's $300 million special pension contribution, which was made in the third quarter. Whereas we now expect to make a special pension contribution in the fourth quarter of this year, and it will be in the order of $350 million.

So these free cash flow improvements were partly offset also by higher cash taxes to the tune of about $137 million and the higher capital expenditures just shy of $200 million.

Okay so finally, let me speak to our year-end outlook. While it is obvious that we have an uncertain economic environment as a backdrop, we continue to experience steady volume growth. Obviously, we monitor any and all emerging trends carefully. At this juncture, we're not seeing the signs of another recession, but a continued although somewhat bumpy road of modest to moderate growth ahead.

So having said this, we are now reaffirming our 2011 annual guidance. And that is that we expect up to 15% growth in our 2011 adjusted diluted EPS, above last year's $4.20. We also continue to call for free cash flow in the order of $1.2 billion in 2011 and after making the special contributions, pension contributions that I referred to earlier. We continue to leverage a very solid pipeline of productivity and growth initiatives well into next year. And while we expect some headwinds on the pension front and substantially higher cash taxes next year, the CN team is committed to delivering superior results and, of course, creating value for our shareholders.

On that note and on the strength of our performance, our balance sheet and a positive outlook, our board has approved a new share buyback program for 17 million shares to be achieved over the next 12 months through a normal course issuer bid.

So on that note, Claude, back to you.

Claude Mongeau

Thank you, Luc, Keith and J.J.. As I said earlier, our agenda is unfolding. And clearly, whether it's our DNA of innovation or the benefit of our supply-chain collaboration, you can see that it's driving very strong and solid results. We are helping our customers grow in their own markets. We are growing at low incremental costs, and it's allowing us to deliver very solid value for our shareholders.

Clearly, the third quarter is showing a lot of momentum, and we feel cautiously optimistic about the current environment and leading us into 2012.

We are positioned to finish 2011 on a very positive note. We're watching the economy, but we're sticking to our game plan. We know we can deliver results in good times as we can deliver results also in bad times. And the key for that is to leverage our strength.

Our precision railroading and our focus on productivity, accountability and driving results day in and day out is absolutely life. And our growth initiatives are just building momentum. And it's what we need to do to take our gain to the next level and to continue to deliver solid results.

So with that, Patrick, we will turn it over to questions from the audience.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Cherilyn Radbourne from TD Newcrest.

Cherilyn Radbourne - TD Newcrest Capital Inc., Research Division

I guess I'll lead off with a question on the outlook. You sound reasonably optimistic notwithstanding the headlines. Can you just comment on to what extent you think customers generally have erred to the low side on their inventories, such that if we get any kind of unexpected lift in demand, it has to pull through in terms of freight demand?

Claude Mongeau

Let me give you my top line and then J.J. can comment on his channel [indiscernible]. Of course, when you listen to the headlines, there's a lot of risks out there and people are concerned about Europe, people are concerned about China slowing down, and I think those are valid concerns. But when we look at our traffic patterns and the growth that we are seeing at the moment, and J.J. gave you some of the most recent statistics over the last 3 or 4 weeks entering into Q4, we're seeing good growth in every one of our commodity sectors except U.S. grain, which is not economically related. So we're continuing to see growth. The key metrics and the inventory levels are on balance. There's height, so they're driven by end demand. And we're all, like everybody else, concerned about potential shock, about confidence. But honestly, when we look at our traffic patterns, we can't see a recession in the making at the moment. J.J., you want to add to this?

Jean-Jacques Ruest

Yes, I think most of our customers, whether they're on the retail side or the manufacturing side, already making conscious effort to keep their inventory low, meaning that they want to produce to the order, they don't want to produce to inventory. So they want produce to the order. At the same time -- to avoid what happened in 2008. At the same time though, all of them -- most of them, I think, they really want to be ready at the starting block. So when the demand start to pick up, they want to be able to capitalize on that because the price is still good. So low inventory means reducing the price pressure that they have. The only industry hasn't been able to do that very well is the overseas company. They brought in too much capacity on their shipping line. Most industries are mindful of this inventories with their capacity to mitigate pressure on price, and yet you're already on the starting block if and when the economy starts to pick up by whatever amount.

Operator

The next question is from Chris Wetherbee from Citi.

Christian Wetherbee - Citigroup Inc, Research Division

Maybe just a bit on the intensive comp, and I apologize if I missed it a little bit. Just want to get a sense of how we should think about fourth quarter and maybe some rules of thumb to use when we're calculating the fourth quarter run rate relative to the headcount.

Luc Jobin

Yes, I mean, typically, if you look at this quarter, what happened was the stock price was down by about $7 in the quarter. Whereas last year, it was up about $5, so that totals to about a Delta about $12. Roughly speaking, we use about $4 million -- $3 million to $4 million impact for every dollar change in the stock price. So you can -- we finished the quarter at $70, so you can just figure out where you think the stock will end up by year end, and you can back into it.

Christian Wetherbee - Citigroup Inc, Research Division

And just to make sure, there's no other puts and takes when you think about, I think you mentioned, where headcount was kind of rolling out, but that's kind of the key driver as we think about the potential change into the fourth quarter.

Claude Mongeau

Yes, I think stock-based compensation is the adjusted volatility that Luc described. As for the other element of our labor expenses, they're actually very well behaved. We are hiring a little bit ahead of the curve, as we discussed in prior calls, to make sure that we are able to get ahead of the game in terms of attrition, but we've done that. So on a go-forward basis, we expect to hire more in line with attrition, and we'll be monitoring demand levels just to make sure that we're not caught too long if demand was to reduce in the case of a recession.

Operator

The next question is from Turan Quettawala from Scotia Capital.

Turan Quettawala - Scotia Capital Inc., Research Division

I guess my question on the coal side, there's obviously a pretty solid long-term opportunity here out of Rupert. I know there's been some temporary issues here in the quarter, but I'm just wondering if you can share a little bit on how things are progressing on that front? And is it so far tracking better than your expectations or worse? And maybe sort of how long of a growth curve is this?

Claude Mongeau

If we talk about Rupert only, the facility is actually going to have a shut down coming up mid-November to replace the dumper, and they will be down roughly, let's say, 20 days.

So what that will do is that will give them an extra 2.5 million ton in capacity entering Christmas. So that bodes well for us in 2012. That's on that front.

What we've done on the sales side, we've been generating business from the U.S., namely PRB business. Our objective is to try to make sure that this terminal is running near capacity, combining first and foremost, serving Canadian line, which are coming back to production. And we also have some expansion plan, and then complementing that capacity with PRB coal.

So I think right now we're on track. We don't want to get ourself -- we don't want to get ahead of the terminal capacity, but the terminal is expanding in November. It will also expand in the fourth quarter next year when they add the other stack of reclaimer, and that's the game plan is to keep in pace with the capacity that they have at the water front.

Turan Quettawala - Scotia Capital Inc., Research Division

And how about the mines, J.J., how is the mine development going there? I guess there's a lot of growth still to come, right?

Jean-Jacques Ruest

Some of the existing mines really didn't produce that well last summer because of production issues or corporate issues. It's mostly related to the heavy rain and flood of last spring. But they're coming back. And typically they run very long winter times. The road gets very solid and mining in winter time for whatever reason, seems to be easier than it is in the springtime.

Most of them have expansion capacities differently [ph] on the cash, even though the price of coal in Asia went down 10% October 1, but now they have quarterly pricing. All of these mines are way above reinvestment level, and it is good money to be made by investing. So we feel confident that Canadian mine are expanding, and we also feel confident that we are bringing in -- will be able to bring more PRB coal. And we feel confident that the Ridley Terminals has a good plan in term of replacing the dumper this fall. The stock of reclaimer is already in order of being put together, will come in fourth quarter next year. So all these things are lining up pretty well.

Claude Mongeau

And don't forget our little franchise for export coal down in the South through Louisiana. That's another area where we're growing it pretty strong.

Operator

The next question is from Chris Ceraso from Credit Suisse.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Just a quick question on the International Intermodal business. It's clear that you've picked up some share. Can you talk about strategies or efforts that you're making to make sure you hold on to that business?

Jean-Jacques Ruest

Yes, through all of the business, you have to provide service, service better than anybody else. And if you're a shipping line and you're doing a transpacific trade, you have a choice of a number of ports and at least 4 railroads that I know, and maybe a fifth one down to Mexico. So the name of the game is you’ve got to provide service on the import, you have to provide service on the export, and you have to find a way to help them win in the marketplace.

So it's way beyond -- that's maybe how the game was played many, many years ago. Where would they compete with everybody trans-Pacific, ports terminal operator and railroad, import, export, and it gets really to the supply chain. If we do a good product from the time the container get on the dock of the terminal operator to the time it gets delivered to an assembly plant in Ontario or an assembly plant in Michigan, then obviously we make the shipping line look good, and you can hold off the business and vice versa. Same thing on the return trip. We're going to help these guys finding money to pay for the return trip. That is in export or domestic free fall. [ph]

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Is there any investments that have made or need to make that give you an advantage and let you provide better service?

Jean-Jacques Ruest

We have made investments. For example, we have in Prince George, we put in a small intermodal ramp. We've also put in the lumber reload. We're loading a lumbering container in Rupert. We have an investment that we're doing this fourth quarter to load the container in Thornton Yard in Vancouver. We are opening a ramp in Chippewa Falls, which is not too far from Minneapolis. We are making investment to either generate export or making some investment to generate more destinations that we can offer to the line of the business for us.

Claude Mongeau

Of course, we also made the investment of the EJ&E, which is not only for intermodal, but it's for all of our traffic to be able to get across Chicago and serve the Detroit market or serve the Memphis market with a more seamless service.

Operator

The next question is from Tom Wadewitz from JP Morgan.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

So I think it's a follow-on on top of what you were just talking about. But as CP had indicated on their call earlier today, they have some conviction of some of the intermodal volume that had been lost to you would come back, and they're starting to see that take place. Are you seeing evidence of that? And I mean I guess it's -- how much conviction do you have that your current favorable trend continues looking at the next couple of months?

Claude Mongeau

Tom, we have as much conviction at the strength of our supply chain collaboration approach. I think we have been growing one box at a time, ahead of the west coast port levels in general for many years now. And we intend to continue to provide outstanding service, to do it inbound and to it outbound, and to innovate every day, so that our customers, the shipping lines that we serve and their customers, the ultimate box owners, continue to believe that CN has a good service. In an environment with higher fuel price, our ability to go across the Rockies and to do so with fuel surcharge component that is much more competitive than the rest of the industry, our ability to provide DRP service, domestic repositioning, to help load the boxes on the return move, all of these things coming together is what is helping us grow the business one box at a time, and we intend to continue for many years to come.

Operator

The next question is from Bill Greene from Morgan Stanley.

John D. Godyn - Morgan Stanley, Research Division

This is actually John Godyn filling in for Bill. I know you have a 65 long-term OR target, but you've been exceeding that target for a bit and even getting better. If we look out the next few years, is there a scenario where you continue to see year-over-year OR improvement for the next couple of years from here? And how do I think about that? What are the triggers that drive that scenario? Is it just better-than-expected macro, or could that scenario happen? I'm just trying to think about that.

Claude Mongeau

Well, just to start off, I'll let Luc answer that tough question, which keeps coming back. But our OR target is mid to low sustainable operating ratio. So it was never a bright line at 65, and we intend to continue to grow faster in the economy, to get good pricing, and to bring in the business at low incremental costs. We haven't set a bar and we haven't set the floor in terms of our operating ratio. Luc, you want to have another angle on that one?

Luc Jobin

No, I mean again, obviously we keep pushing the envelope and we make the important trade-offs between operational efficiency and customer service, the level of customer service that Claude and J.J. have referred to. So it's -- that's where we make the trade-offs. We always said sustainable mid to low 60s. And frankly, I told the team, prove me wrong. But at the same time, we're very focused on growing the franchise and continuing on our path of operational excellence. So there will be elements that will come and put a little more pressure. I mentioned one is the pension expense. So clearly, that's going to be a little bit of a pull on the OR. But meanwhile, we're looking and we do have a good pipeline of productivity initiatives, which will help us keep it in line.

Operator

The next question is from Jason Seidl from Dahlman Rose.

Jason H. Seidl - Dahlman Rose & Company, LLC, Research Division

I hate to beat a dead horse on the intermodal side. But you mentioned that you're going to retain your business base upon the service levels that you've provided. Am I to read in that, that you're not seeing any pressure from any of the business that you might have picked from your competitors? Any pressure to reduce pricing to keep that business?

Jean-Jacques Ruest

There's always -- in any dynamic marketplace, there's always pressure. There was pressure, there is pressure, there will be pressure. And in the end, you got to compete, first and foremost, on service. When you look at intermodal, especially if you look at the overseas company, business move from one shipping line to another based on overall service. So sometime, a shipping line decision to retain the business for the railroad may not be sufficient for them to retain the business for their own customers. And that's most of what happened here in the last 18 months. Some business have shifted back and forth not so much from one railroad to another, but from one shipping line to another, because the different shipping lines have assembled different supply chains, which have won in the marketplace. So is there enough pressure? There's always pressure. So I think it's different. And the pressure come, as I say, from all ports, all terminal, all channel to market, West Coast, U.S., West Coast.

Jason H. Seidl - Dahlman Rose & Company, LLC, Research Division

And real quickly, you mentioned that you're going to be picking up some of that new coal business from the Illinois basin. Is this going to be in connection with the mid-American quarter initiative that you have been going on or is this something different?

Jean-Jacques Ruest

We were referring -- referencing to the Convent terminal. We sold the Convent terminal August 1 to Cline in Illinois. And the reason why they bought that terminal is to use that [indiscernible] going forward.

Operator

The next question is from Walter Spracklin from RBC Capital Markets.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Just a quick one here, first of all, to ask you about -- perhaps, Luc, if you could comment on any potential dispositions of further assets that you see over the next 12 months. Is there any assets that you consider noncore that we could look at in terms of freeing up more cash?

Luc Jobin

No, at this point, we don't really have anything on the slate. So I mean obviously we continue to look and explore opportunities, but at this point, we don't have anything of substance to talk about.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Okay. Just back on the coal side, up at Ridley, we've been chatting with some of the West Coast ports, and ports have been sort of indicating that the flow going up to Ridley has been -- is a costly haul, and there was some question as to the long-term sustainability of that coal going up north. I know this is a key line for you guys, and you've talked about keeping up with capacity, but is there any scenario where you might question the long-term sustainability of a thermal coal haul with that kind of length to it for export markets given some of the historical volatility and demand for PRB coal on the West Coast?

Claude Mongeau

Well, let me put it to you this way, Walter, it takes an awful long time, and that may happen, but it takes an awful long time to get a permitting and to build a waterfront, coal terminal infrastructure. So if that business is good for the next 5 or 6 years and we increase it in the meantime, that's a pretty sustainable pace of growth for us, and we will write it out as hard as we can for all those years to come. If eventually there is a bigger market, if there are terminals that get built that are closer to the Powder River Basin and mines, of course, they will have a better shot, and by then hopefully, we have more met coal from Canada to fill in the slots in Ridley. So I think of it as a very sustainable piece of business that we are going after aggressively within the construct that J.J. described. We want to make sure we serve our Canadian mines, and we want to make sure we manage end-to-end supply chains and we don't flood the terminal over and above its capacity.

Operator

The next question is from Ken Hoexter from Merrill Lynch.

Steven C. Sherowski - BofA Merrill Lynch, Research Division

This is Steve Sherowski in for Ken Hoexter. Just a quick question regarding that Canpotex contract that's due to expire mid next year. I was just wondering, of that volume, how much of it do you see as natural to the CN network?

Jean-Jacques Ruest

Well, the negotiation has been underway here for a little while, and I think it would not be proper to really expand on what's happening to -- the negotiations, obviously, are confidential, so I think at this point, we're in the quiet time.

Steven C. Sherowski - BofA Merrill Lynch, Research Division

I mean you can't just comment on, like, in terms of current volumes, how much you see, like, how much of it currently touches your network?

Jean-Jacques Ruest

We serve all the potash mines whether it's for domestic, traffic or exports traffic effectively. And so we have an ability to grow with those potash suppliers, whether it's in their domestic market or through Canpotex in the export market.

Operator

The next question is from Matt Troy from Susquehanna.

Matthew Troy - Susquehanna Financial Group, LLLP, Research Division

I have just one simple question, if I could. If I'm looking at basically the last mile initiatives, it's something we've heard from CN about, for about couple of years now.

Could you talk about the decision to build versus buy? I know it's looking at the rail network and going deeper into that last mile-first mile. But might there be an opportunity to deploy capital given, kind of, softer international trends to actually go out and buy something small with a tuck-in nature of potentially something bigger?

Claude Mongeau

In terms of our first mile-last mile, Matt, it's really how we come about interfacing with our customers from better forecasting to understanding their requirements from a switch window compliance standpoint, and how we get our car management distribution activity to the next level, so that we have not only higher order fulfillment, but also more responsive order fulfillment. And I think Keith gave you a few statistics that are very important. Our basic order fulfillment performance, if I just look at the last 4, 5 weeks, is in the range of 95%. And I think during the quarter, it was up 4% versus last year. Our short lead time order performance is in the 80% range, and that's up 15%, 20% versus last year. And that is why we are able to grow our business against truck competition and outpace the economy in general. That's really what we mean about the first mile-last mile. As it relates to tuck-in extension, obviously, if we find a network that allows us to get closer to end markets and serve them on a single-line basis, we've done a few acquisitions over the past several years, and we would continue to be ready to move on such an acquisition if they became available.

Operator

The next question is from David Newman from Cormark Securities.

David F. Newman - Cormark Securities Inc., Research Division

Just in the freight markets overall, we're seeing on the trucking side, pricing appears to be doing very well, obviously, supply constraints on the trucking side. Are you seeing any acceleration on repricing, especially on your truck competitive products? And is that, sort of, leading to some share gains there as well?

Jean-Jacques Ruest

The pricing situation in the truck industry from a price point of view is better in the U.S. than Canada. And the capacity also is more constrained in U.S. than Canada because of -- driver shortage is more severe, and this new regulation came into U.S. and not in Canada. So our volume in the U.S. for domestic intermodal is growing faster than our volume for domestic intermodal for Canada for that point, and the pricing is more robust in U.S. than it is in Canada. It's really kind of, fairly different market right now in terms of the pricing and capacity.

David F. Newman - Cormark Securities Inc., Research Division

And are you seeing a pace of change, J.J., that it's actually picking up a little bit?

Jean-Jacques Ruest

As in...

David F. Newman - Cormark Securities Inc., Research Division

Just the overall pricing, are you seeing it on the truck competitive side, just the U.S.? Is it accelerating, I guess?

Jean-Jacques Ruest

I wouldn't say so much in Canada. But in the U.S. -- I'm not sure if we can call it accelerating. It was already -- when the regulation came into effect, that had a major impact on the market. And intermodal is definitely an attractive product. Either you deal with a retail product, like CNTL, or you deal with a wholesaler. No, I wouldn't say it's accelerating, but it's definitely a good market in the U.S. to do -- to compete with truck because truck capacity in pricing is better than it was.

David F. Newman - Cormark Securities Inc., Research Division

Right. And a quick one for Luc. The $350 million that you're making in Q4 in your pension, will that be enough to keep you out of debt? I know the year’s not closed, but obviously a long bond rate and operation twist is affected a lot of companies with defined benefit plans. So is it going to be enough, do you think?

Luc Jobin

No, I don't think it will be enough. I mean certainly if the discount rates -- the interest rates stay where they are today, that wouldn't be sufficient. But we’ll look at the situation as the rates will ultimately get fixed at the very end of the year. And we'll also look at where the investment returns will go for the balance of the year. If you recall last year, certainly we had a very good strong finish in terms of investment return, just towards -- I guess it was all mostly in December. And the discount rate picked up a little bit. Having said that, I mean currently, if I was looking at where things are today, we would not be -- this would not be sufficient to offset deficits.

David F. Newman - Cormark Securities Inc., Research Division

Okay. And are you sort of corralling some money aside perhaps next year on the cash flow from the cash flow for next year and maybe perhaps another true-up of some sort, is that the case?

Luc Jobin

Well, we're constantly monitoring it. And so we'll revisit the situation when we see -- when we have a better fix on the year end.

Operator

The next question is from Benoit Poirier from Desjardins Securities.

Benoit Poirier - Desjardins Securities Inc., Research Division

Claude, there's a lot of talks about the big mining opportunities in northern Québec called the [indiscernible]. It seems that you're the best railroad to benefit from that. So could you comment, provide some color about the opportunity, maybe quantify the size of the opportunity and how you intend to approach this potential opportunity?

Claude Mongeau

There's certainly a lot of talk about the potential opening of mines. But it's a difficult market to read. You're talking about mine developments that are 4, 5, 6, 7 years out, and it's always difficult to judge. You have a lot of junior players that are talking about opportunities, and they line up big volumes. Ultimately, how much of that comes downstream and what time line is difficult to judge. We are assessing this opportunity because if it was -- if it turned out to be large volumes, there might be a need for additional railroad infrastructure, and we will give you an update as it unfolds. At this time, I couldn't tell you just how big and how real it is, and I can certainly not tell you what we would do about it because it's too early to make such judgment.

Operator

The next question is from Keith Schoonmaker from MorningStar.

Keith Schoonmaker - Morningstar Inc., Research Division

Based here in Chicago, naturally I'm interested in the EJ&E. I'm wondering where is the EJ&E in its plan to divert from St. Charles Air Way and in general the traffic that inefficiently moves through the congested city?

Keith E. Creel

We probably -- we've moved a significant amount of the business. We’re close to what we filed with the STB, but there's still quite a bit left opportunity I guess, first with the business growths. We've got -- with the transition of Matteson with about 4 more trains starts out there on a consistent basis. We're being very careful to make sure that we continue keeping our commitments to the communities that we've negotiated, volunteer agreements with. So we're sort of walking before we run, being very cautious and being pragmatic about it. So there's still a lot of capacity out there. There's still some business down the line once we finish all of the work we're going to do on interchanges that we'll be able to ship. But for now, we've shifted what we're going to ship, and we're going to continue to convert it.

Operator

The next question is from David Tyerman from Cannacord Genuity.

David Tyerman - Canaccord Genuity, Research Division

The question is on casualty. It's been bouncing around quite a bit this year, and it's certainly down, as you pointed out, a lot from last year. I was wondering if you could give us some thoughts on where you see this settling out?

Luc Jobin

I think -- I tend to think that the run rate will be the low end of the range. I provided that range when it was probably about $80 million, $85 million on a quarterly basis for this year. So I think we'll end up clearly at the low end of that range. But again, as you said, sometimes this can be a bit bumpy so, so far we have been able to manage the costs in that category quite well.

David Tyerman - Canaccord Genuity, Research Division

And do you think that that's kind of a good way to think obviously with inflation over time in terms of the long-term?

Luc Jobin

It's probably -- I would say, if you look at the longer term, we've been averaging a little more than this. So I mean, I've used as a rule of thumb something closer to about $90 million a quarter.

Operator

The next question is from David Vernon from Bernstein Research.

David Vernon - Sanford C. Bernstein & Co., LLC., Research Division

Just a quick question on the Metal and Minerals business unit. The yields were up pretty substantially. Is there something specific, some overall traffic in that, that’s been going on? Is there a little bit of cohesive share on that yield increase?

Claude Mongeau

The yield as you are looking at the revenue per car or the...

David Vernon - Sanford C. Bernstein & Co., LLC., Research Division

Yes. The revenue per car -- the revenue per total miles is relatively flat, but the revenue per car is up pretty high.

Claude Mongeau

So it's a function of the length of the haul. I think this is one of the segments when our length of haul on average was up. So it's the business mix. So price is going up like in other segments, fuel is in, but also an average, we had a longer length of haul.

David Vernon - Sanford C. Bernstein & Co., LLC., Research Division

Was there something specific that was driving the length of haul increase? Or is that going to be -- it that like a one-time thing or is that ongoing?

Jean-Jacques Ruest

Well, one of the thing that's -- one of the driver of the length of haul in M&M, one of my longest haul is for Accent [ph] from Wisconsin to Western Canada. And that business, that's growing. Hopefully, it's going to be a steady business. There's no sign out there that drilling activity is going to reduce. That's one of the long haul that's increasing in volume at faster pace than the other M&M commodities.

Operator

The last question will be from Jeff Kauffman from Sterne Agee.

Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division

Actually, all our questions have been answered.

Claude Mongeau

Okay, thank you very much. There was a lot of good questions. We're very pleased with our third quarter results. And as you heard, we have good momentum into Q4. J.J. is drumming up the business, Keith is railroading hard, and Luc is collecting the dough. So we will try to keep it that way, and see you on the call for January. Thank you very much. Have a good day.

Operator

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

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