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Canadian National Railway (NYSE:CNI)

Q1 2012 Earnings Call

April 23, 2012 4:30 pm ET

Executives

Robert E. Noorigian - Vice President of Investor Relations

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

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

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

Luc Jobin - Chief Financial Officer and Executive Vice-President

Analysts

William J. Greene - Morgan Stanley, Research Division

Cherilyn Radbourne - TD Securities Equity Research

Ken Hoexter - BofA Merrill Lynch, Research Division

Benoit Poirier - Desjardins Securities Inc., Research Division

Scott H. Group - Wolfe Trahan & Co.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

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

Fadi Chamoun - BMO Capital Markets Canada

Christian Wetherbee - Citigroup Inc, Research Division

David Tyerman - Canaccord Genuity, Research Division

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

Matthew Troy - Susquehanna Financial Group, LLLP, Research Division

Christopher J. Ceraso - Crédit Suisse AG, Research Division

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

Brandon R. Oglenski - Barclays Capital, Research Division

Konark Gupta - Cormark Securities Inc., Research Division

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

Keith Schoonmaker - Morningstar Inc., Research Division

Operator

I would now 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 first quarter 2012 financial results press release and analysts presentation documents that could 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.

Welcome to CN's First Quarter 2012 Financial Results Conference Call. I would now like to turn the meeting over to Mr. Robert Noorigian, Vice President, Investor Relations. Ladies and gentlemen, Mr. Noorigan.

Robert E. Noorigian

Good afternoon, and thank you for joining us for CN's first quarter 2012 financial results. I'd like to remind you about the comments that have already been made regarding forward-looking statements. With us today is Claude Mongeau, President and Chief Executive Officer; Luc Jobin, Executive Vice President and Chief Financial Officer; Keith Creel, Executive Vice President and Chief Operating Officer; J.J. Ruest, Executive Vice President and Chief Marketing Officer. And we consider that we had a superb quarter, and we would really appreciate it when the Q&A starts that if you would kindly focus your questions on CN and business related to CN. [Operator Instructions]

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

Claude Mongeau

Thank you, Bob, and I'm here in a foggy Halifax with the team to cover these results with you. We have our AGM, and I'm very pleased that we will be officially finishing the cycle for 2011 and starting the cycle for 2012 with very, very solid results. Our Q1 results were helped by milder winter throughout our serving territory. But make no mistake, these results are about strong execution. The CN team delivered on all key fronts, whether it's growth, whether it's efficiency, whether it's safety. Our agenda is working, and it's showing through in very solid financial results for our shareholders.

Revenues during the quarter were up double digit, about 12% to be exact, J.J. will give you the details. We're seeing good growth across all of the commodity markets we serve. Our ability to accommodate that growth at a low incremental cost and to balance service and operational excellence also show through during the quarter. Keith will give you some you key metrics around those lines, but our operating ratio at 66.2% is a record operating ratio for a first quarter and it's a full 2.8% improvement versus last year.

In terms of earnings, and I'm looking at it here on an adjusted basis, we delivered $1.18, which is up 31% over last year. I'd be remiss if I didn't focus on the weather, obviously, the fact that we had one extra day also helped. There's perhaps 1/3 of that EPS growth on a year-over-year basis, which is due to those factors. But nevertheless, solid, solid first quarter result and Luc will give you all the details, including some of our monetization and how we are able to use and then deliver very strong free cash flow.

So solid results overall, I'll ask the team to give you the details and I'll wrap up at the end. Keith, over to you.

Keith E. Creel

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

Let's start with a view of the operating metrics that we report quarterly. We always provide a good overview of our productivity and the fluidity of our operation.

As you can see on the charts, we produced improvements across the board on all operating metrics. Due to a traffic mix change, our trainload was only up 1%. However, train length was up about 3% year-over-year. So regardless of the mix change, we continue to increase efficiency of our trains.

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

Let's stay in the interest of providing a bit more relative first quarter comparison to proxy, let's compare our performance. In the first quarter of 2010, which is a winter similar to this year, we also showed improvements in all of our metrics. As you see, the only exception to this metrics are in train speed and locomotive productivity. These are 2 metrics which we have impacted consciously for their efforts to focus squarely on maximizing the throughput of our Bulk logistics supply chain. I'll give you a quick example. Of the sheer goal of pushing more coal to our supply chain, we're working with our supply-chain partners to forge to ensure that we consistently have a train ready to take advantage of our unload windows.

To make this happen, we've had to dedicate locomotives against our coal trains, which at times requires staging time and queue to unload.

In the past, we were very reluctant to do this for 2 primary reasons. One, it adversely impacted locomotive productivity, our car productivity and train speed; two, we didn't have the type of positive working relationships that are necessary with the terminal operators to secure their commitments to do all they could do to work with us to optimize their piece of the supply chain.

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

Suffice it to say, these results show a strategy to provide service excellence, so working while maintaining operational excellence, becoming a powerful business multiplier, allowing us to grow with our customers and supply-chain partners.

In fact, some of the growth we're experiencing as a result of this strategy is making our strategic past investment decisions crystal clear, which is a great segue to the second slide in your deck.

To support our operational service excellence mandate, we have to continue to invest surgically to create the capacity to handle our significant growth opportunities efficiently. More specifically, on the BC North territory, we've handled 20% more traffic this year versus last and 27% more versus 2010. We've responded to this growth by running not only more trains, but also longer trains, which while it does and has had a negative impact on our train speed due to the current longer trains that are running in a territory that does not have an optimal siding spacing. It has allowed us to respond at the growth opportunity efficiently.

So with that said, what we're focusing on is a plan that we've effectively made in 2010. We're rolling it out and by the end of the third quarter, early into the fourth quarter of this year, we will have 7 additional long sidings in service in this quarter, where in which will increase our capacity to handle longer trains by 50%.

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

Our locomotive front as we reported previously, we're making strategic investments. Purchasing locomotives in advance of the demand, this will allow us to leapfrog the need to purchase locomotives during their initial implementation of the new Tier 4 compliant locomotives, which GE and EMD will be producing 2015 and forward. Given the new technology to meet these standard is still being developed, we feel strongly this is a prudent strategy to avoid usual growing pains of adapting new technology, as well as avoiding pricing escalation driven by this technology.

But to optimize this investment in locomotives, we have pursued a strategy of purchasing part-new and part-used locomotives. We'll modernized the used locomotives with engine enhancements to drive additional fuel efficiencies, we'll equip them with DP. We'll add an onboard technology such as Trip Optimizer, Wi-Tronix as well.

Now the new front, a new twist to our strategy or a new enhancement to our strategy, we're actually purchasing AC locomotives for the 65 as opposed to DC locomotives where we'll strategically allocate those to fit parts of our network that requires those. We'll convert them with productivity standards. We're going to provide more attractive effort, more specifically in Northern BC, optimizing our coal trains and also optimizing the size of our new Canpopex potash unit trains, which will soon be running to the North Shore of Vancouver.

Finally, we're focused on maintaining solid productive relationships based on mutual respect with our labor union leaders and our employees to make this business run day-in and day-out.

Proof of this progress in our area on the Canadian side, 2 significant agreements we've reached without labor disruption or uncertainty from employees and customers that were ratified during the first quarter with our TCRC representative locomotive engineers and [indiscernible] employees. Both agreements represent a win-win for our company and for our employees. Both products had fair but firm negotiations by both union leadership and management.

They're all positive points that allow us for more progressive and a productive relationship with our craft employees, while we provide certainty for our customers. And on the U.S. side, something is pretty significant for us. We implemented a new agreement with our DM&IR, DWP, WC running trains, which provides us a much-needed operational flexibility, ensure the reliability of our supply chains, and not there are no arranges but also our network running through the superior corridor, where since our WC and DM&IR acquisitions with the absence of this agreement, we've been forced to run this connection properties as individual railroads, which, obviously, has multiple operating inefficiencies.

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

So with that, I'll turn it over to J.J. to add some color to the business levels this strategy has enabled.

Jean-Jacques Ruest

Well, thank you, Keith, and good afternoon to everyone. On the revenue side, Q1 2012 was a record first quarter for CN. Revenue was up 13% versus last year. The breakdown is as follows: About 5.5% came from volume; our car load volume was up 5.1%, but our revenue ton mile volume was up 6.3%; same store price came a bit more than 4%, slightly better than the prior quarter, consistent with our stated plans to secure sustainable, above inflation increase; 3.3% came from fuel surcharge; mix was overall flat; and finally, we gained 1% from exchange that is the Canadian dollars as $0.016 weaker this year.

Now looking at our quarter in more detail, all of my comment will be on an FX-adjusted as usual. Starting with petroleum and chemical, the revenue was up 13% on the back of a very strong petroleum growth. New crude oil business accounted for roughly 1/2 of our carload growth in that segment. All other petroleum segments were also up, led by refined products. And the chemical and plastics was a combined flat. Metals and minerals grew an impressive 29% after many other quarters of being very, very strong growth. All segments in the M&M segment performed superbly.

Drilling activities continue to drive record usage at Wisconsin's frac sand and drilling pipe. We also have additional sand mine production capacity coming online in Wisconsin. Our strong steel volume was driven by our supply-chain approach for our customers, as well as by favorable steel market, which is sustained by energy and offload demand.

Forest product, the revenue rose 9%. Lumber and panel traffic in the U.S. both increased 11% from last year. Lumber to Asia and China was up 21% and pulp and boxcar recovered from a soft Asian market in the fourth quarter.

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

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

Coal revenue. Coal revenue was sequentially improved from the fourth quarter of last year and it was up 18% in revenue from the first quarter of last year.

CN, we see a permanent shift in that business from short-haul domestic movement to long-haul export. Therefore, in the first quarter of this year, our carload were down 11%, while our total revenue ton mile volume was up 19% for the quarter since our average length of haul increased 32%.

Domestic thermal coal is in circular decline, losing share to abundant cheap long-term shale gas supply. At CN, domestic thermal coal is already less than 2% of our total company revenue.

Export, however, is the story. Export is a story for the CN coal franchise, long-haul export of thermal coal and coking coal via Vancouver, Rupert and Convent, Louisiana.

In addition, we also handle strong shipment of Canadian oil sand petroleum coke, also to export market, in that case Rupert.

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

Going to intermodal. Overseas intermodal revenue was up a very strong 21%. Our Trans-Pacific revenue increased 30%, with volume over our 2 West Coast gateway outpacing again the trans-Pacific market in overall.

Traffic via the Port of Halifax declined due to shipping line service cancellation and to a weaker Transatlantic trade. Volume in Port of Montreal was flat for the quarter.

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

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

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

Starting with intermodal, the outlook is very positive. We will continue to outpace the trans-Pacific trade for import and export. Rupert is starting some new service to Edmonton, Calgary and the Ohio Valley, in that case with the CSX.

We have also opened a new lumber export container yard in Vancouver. The U.S. consumer confidence was 70.2% in March, following a sharp rise from January where it was 61.5%. We are also taking delivery of new domestic equipment. That is container, heaters, Echo Therm, chassis, which will enable us to search for the right market opportunity, if it does arise.

On Page 11, if you look at the Bulk outlook. As discussed in our New Orleans' Investor Day, we are on track to expand our export coal franchise from both existing mine expansion, as well as from existing expansion of the 4 waterfront terminal that we serve, both are required to succeed in the export market.

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

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

Finally, our outlook for manufacturing on Page 12. We will have stable lumber volume from Asian buyer from the province of BC. We will also have sustained year-over-year increase of our lumber to the U.S. market.

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

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

In closing, Q2 has the making of a growth quarter, and same as for the remaining of the year. So far this quarter, the leader is our overseas intermodal, minerals, petroleum products, and coal exports would also be strong.

Luc, if you want to take it from here?

Luc Jobin

Yes. Thanks very much J.J. Now turning to Page 14 of the presentation. Let me walk you through the key financial highlights of our quarterly financial performance and, indeed, a good quarter it was.

Revenues were up 13% at $2.3 billion. And gradually improving economy and milder winter conditions constituted a favorable backdrop in the quarter compared to last year. J.J. and Keith teams' combined efforts to help us achieve solid volume increases in practically all commodity sectors. And once again, several categories performed better than base market conditions.

Operating income was $793 million, up 23% versus last year, driven by strong revenue growth and at low incremental cost.

Other income was $293 million, up $7 million from last year, as we sold some rail line segments to Toronto's local transit agency in both years.

So our net income for the first quarter of 2012 was $775 million, up 16%. And the reported diluted EPS, therefore, was $1.75, up 21%.

Excluding the gain on sale of the rail line segments, the adjusted diluted EPS for the quarter stood at $1.18, up 31% versus 2011.

Our operating ratio was 66.2% in the quarter versus 69% last year. This represents an improvement of 2.8 points. This is an all-time record, beating our previous best, dating back to the first quarter of 2006 when our operating ratio stood back then at 67.1%.

Now turning to operating expenses on the next page. As Keith pointed out, we came through with another solid quarter in terms of operational productivity and customer service. Yes, this performance did not come at the expense of overall cost management. Operating expenses were just over $1.5 billion, up 7% versus last year on a constant currency basis. Excluding the fuel expense, this was a 4.9% increase.

Labor and fringe benefit costs were $509 million, 7% higher than last year. This was the result of wage cost inflation of about 3% and a higher headcount in the quarter versus last year. Our average headcount was at just over 23,000 employees and it was up 3.5% versus last year. While I'll remind you that our GTMs were up 7%.

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

The fuel expense increased by 13% to $376 million. Higher prices represented 9 points of this increase in the quarter, while the balance of the change was attributable to volume increases for 7%, partly offset by improved fuel efficiency in the tune of 2%.

Equipment rents at $62 million in the quarter or $11 million higher than last year, but essentially flat versus the fourth quarter of 2011. This is the result of increasing our car fleet and intermodal equipment in 2011 to handle the growth and service requirements for the current business levels.

Casualty and other costs were $77 million, $7 million better than last year as we continue to incur lower expenses and experience lower claims.

In terms of free cash flow on the following page. For the quarter, we generated $48 million. Operating results and the proceeds received from the sale of rail line segments for $311 million were offset by higher working capital of $766 million, capital expenditures of $224 million and dividends of $165 million. The higher use of cash attributable to working capital mostly results from a total pension contribution of $553 million made in the quarter.

Lower payables were about $150 million and higher inventories of materials and supplies were about $60 million.

When we compare it to last year, we generated approximately $400 million less free cash flow in the quarter. And this was mostly due to the special voluntary pension contribution totaling $450 million that we have made in the first quarter of this year versus none that were done in the last year, in the same quarter last year.

Our balance sheet remained strong with our debt ratio well within our internal guidelines.

Finally, let me speak to our 2012 outlook. We continue to see a gradual improvement in the North American economy, which should translate into mid single-digit carload growth in 2012.

On the pricing front, we are on track with our inflation plus policy. We are clearly encouraged by our first quarter performance. However, given how difficult last year's first quarter was, we will likely have more challenging comparables ahead since we arguably handled in the first quarter this year some volume, which ended up in the second quarter last year.

With this in mind, we are nevertheless now firming up our guidance. So our 2012 annual guidance has us now aiming to deliver a full 10% of EPS growth over the 2011 adjusted diluted EPS of $4.84, this despite our additional pension expense of $100 million.

We're also calling for free cash flow to now stand in the order of $950 million, and our capital investment program is set at about $1.8 billion.

So the CN team remains focused and committed to delivering superior results as we continue to unfold those strategic agenda.

And on this note, I'll turn it back over to you Claude.

Claude Mongeau

All right. Thank you, guys. So I think it's pretty clear as I said at the outset that we do have a very solid first quarter performance. But fundamentally, this is about an agenda that is delivering results. We've discussed this agenda with you in New Orleans during the first quarter. You know about it. You're seeing the proof point coming through in terms of leading the way the industry with growth, at being able to accommodate that growth at low incremental cost and continuing on our path of improving efficiency, all the while trying to balance and improve our service offering so that we can become that trusted partner that helps its customer win in the marketplace, which is the recipe for long-term value creation in the rail industry.

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

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Bill Greene from Morgan Stanley.

William J. Greene - Morgan Stanley, Research Division

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

Claude Mongeau

Bill, I know you -- I'm gratified by your trust, but I think you should take our guidance with -- for what it is. We have always been a little bit conservative, but we are also telling you that our first quarter, given winter, given an extra day, given stock-based compensation, which was very helpful during the quarter, the 30% is outstanding result, but that's not what we would have delivered if not for those factors. If you got to tweak down a little bit your -- some of your quarters in the end to get closer to our guidance, that's what I would do, if I were you. But we're here to continue to deliver solid results. If we're a little too conservative and do better, that's a good story.

William J. Greene - Morgan Stanley, Research Division

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

Claude Mongeau

I think you should take our guidance for what it is. We are not worried about anything. We see the economy continues to unfold positively. We can deliver mid single-digit carload growth. We will deliver a full 10% EPS growth and close to $1 billion of free cash flow, which would be outstanding results.

Operator

The next question is from Cherilyn Radbourne from TD Securities.

Cherilyn Radbourne - TD Securities Equity Research

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

Claude Mongeau

The domestic terminal will be challenging. Domestic terminal in the U.S. for CN was never necessarily a big revenue driver. But typically, it's fairly a big carload driver because a lot of that business was coming to us from either BNSF or the UP up to Chicago interchange. What really drives a lot of dollars is the longer haul. So either PRB coal coming to us via the interchange at Edmonton or via Vancouver. While the PRB coal is going to Rupert, so that's fairly a long haul. And Rupert is expanding, has expanded, it has had some issues but it's still -- I mean it's cranking a whole lot more product than it used to, and the future is bright for Ridley. The terminal in Vancouver, also expanding, making an effort to expand both West Shore and Neptune. And don't forget also our terminal in Convent. When we sold that terminal, we sold it to a very good operator, Cline and Foresight Energy. They're actually running this terminal harder than we did ourselves. And because the domestic market is weakening, like it is for everybody else, they have low-cost high BTU coal. And they are making efforts to sell some of that in Asia, and we saw some of that in the first quarter. So Illinois to Convent and some vessel out. So we're serving terminals, and we're serving people who are -- have been focused to export now for a couple of years already. So it's coming together nicely.

Operator

Your next question is from Ken Hoexter from Bank of America Merrill Lynch.

Ken Hoexter - BofA Merrill Lynch, Research Division

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

Claude Mongeau

What we -- we want to grow a little bit faster than what the economy would give us. And I think we did that for the last several quarters. It really depends on the rising tide, and it doesn't need to be much more than 0.5 a point to 1 point better than what we would otherwise receive from the economy to allow us on a longer-term basis to deliver solid results for our shareholders. So we're running a little bit ahead of that at the moment. We have a lot of momentum working for us. There will be quarters where we will run a little light. But on balance, one carload at a time, one unit in intermodal at a time. And the markets that J.J. highlighted to you, we're really pursuing a broad range set of initiatives to help us grow share of wallet and help our customers win in the marketplace. And it's actually working because they're rewarding us with more business on an ongoing basis.

Ken Hoexter - BofA Merrill Lynch, Research Division

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

Claude Mongeau

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

Operator

Your next question is from Benoit Poirier from Desjardins Capital.

Benoit Poirier - Desjardins Securities Inc., Research Division

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

Claude Mongeau

Benoit, when we -- look, our -- I think when you look at our intermodal result for the last 2 years, I think every quarter, you see that the business did fairly strong, and it's not a onetime event. It's a fairly solid, steady, future business plan that we have with steady quality result improvement. And the trans-Pacific trade for all railroad is stronger than the transatlantic trade. And this is where we have put our biggest focus and also had our biggest success, both in Canadian cities and U.S. cities and expanding our reach to new destination market that we didn't have 2 years ago. I think it's solid. It's a question in the end that the shipping lines choose railroad and the many owners choose the shipping line and the one that has the better partner providing the better supply chain. So we're not -- in a way, we're competing for the heart of the shipping line, which is our customers. But ultimately, what makes us successful is to win our customers' customers so that they want to use the CN port for their delivery. For intermodal, there's no reason for it to really slow down. It might go from market to market, East to West, but we have a solid plan.

Operator

The next question is from Scott Group from Wolfe Trahan.

Scott H. Group - Wolfe Trahan & Co.

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

Luc Jobin

Yes, Scott, let me take this up. This is Luc. The stock-based compensation, the benefit in this quarter was to the tune of about $30 million, so we're roughly talking about $0.05 of EPS. And this was really the result of, if you look at last year between end of quarter, the stock price went up by $7 last year. Whereas, this year, it actually went down by $1. So that's what's producing this favorable variance this year.

Scott H. Group - Wolfe Trahan & Co.

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

Claude Mongeau

As Luc explained to you, the stock-based compensation is the difference between the beginning of quarter and end of quarter stock price. And so last year, it went up $7 during the quarter; and this year, it came down $1 during the first quarter. So the swing of $8 is what drives the $30 million of benefit on a year-over-year basis. The way it's measured is from beginning to end of quarter.

Operator

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

Walter Spracklin - RBC Capital Markets, LLC, Research Division

So you did a good job of discussing the sustainability on your volume side. I was wondering if we could switch over to Keith on the operating side, obviously, another excellent quarter there. Just curious if you could speak to training cost. I know you mentioned at the beginning, that you're going to have to train a lot of workers ahead of attrition. Can you update us on that, on what we might see the headwind and perhaps quantify that from a sustainability standpoint? And also on that sustainability, if you've quantified as well the effects of weather this quarter at all on an EPS level?

Keith E. Creel

Well, I can tell you now as far as training cost, we're pretty much at a steady state. With our attrition, we're well into it now versus last year, and this is going to be sustained while we're at training. Locomotive engineers and conductors at the same time, I would think looking at our demographics through 2015. So I don't see a lot of change. The only thing I see on headcount change relative to running trains would be associated with the level of business. Even with the level of business, a lot we can absorb in our existing train starts. The only part of which we wouldn't be able to, of course, would be Bulk train starts and some intermodal train starts. So I think we're at a pretty good run rate now.

Scott H. Group - Wolfe Trahan & Co.

Okay. And in terms of quantifying the weather, was there any...

Keith E. Creel

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

Operator

The next question is from Tom Wadewitz from JPMorgan.

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

I wanted to ask you a little bit more on the cost side. If I look at operating expenses x fuel, you were up a little less than 6% in the quarter. And you had, obviously, stock-based comp. It looks like -- I don't know if casualty is kind of lower than normal run rate, given the weather or how you would look at that. But what do you think the kind of -- if you see similar level of volume growth looking forward, what do you think the right run rate is for operating expenses? Is it a point higher than that? 2 points higher that? I guess any thoughts on that will be helpful.

Luc Jobin

Well, on the casualty and other, just to comment on that, I mean as I provided general guidance on that, it should be in the $75 million to $80 million per quarter. So I mean it's just about there for the first quarter. Those things tend to be lumpy a little bit though, however, so we could have some bouncing up and down in the other quarters. Expenses are very well managed. So I think it's really just -- you're not going to see tremendous variations. The trends are there. The fuel is difficult to anticipate. But I think as you can see on the labor side, we've got things tightly under control. Of course, the pension headwind is there. That's $100 million for the year. And stock-based compensation, again, a little bit volatile, will be up and down. But it should be, over the course of the year, fairly similar. Equipment rents, I've made some comments on, and I think $62 million, $65 million is probably not a bad run rate because the equipment is essentially there. And while we're probably going to acquire a little bit more throughout the year, there was a significant change during the course of last year. So I mean that gives you a little bit more color around these, generally these expenses.

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

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

Luc Jobin

Yes. And in the quarter also there was a little bit -- the fuel lag was actually not very significant. It was only $9 million. But if you look back to last year, that's another component, which was important. Last year, this was really a headwind of about close to $30 million. So the difference quarter last year versus the quarter this year is also contributing probably a couple of pennies favorably to the comparative.

Operator

The next question is from Fadi Chamoun from BMO Capital Markets.

Fadi Chamoun - BMO Capital Markets Canada

So question on intermodal. I want to go back to the -- you've had a few quarter of good domestic growth. I just wanted to understand a little bit. I mean your length of hauls is typically longer and your ability to convert from truck is not maybe as good as what we'd see with U.S. carrier, and yet we're seeing some good numbers. Can you give us an idea about how much runway you think you have in that specific market and where specifically you are able to be effective? And the other thing on IMX as well, intermodal, what's the capacity situation right now at Prince Rupert?

Jean-Jacques Ruest

So if I start with the first one. I think about 55%, roughly in that range is overseas business. It's coming out of our port. So in that case, you're really looking in most cases a fairly long-haul business. Port of Montreal to Toronto would be the exception. So we -- in overseas growth, what we have is we're not really competing with truckers. We're competing with other railroad and other port. On the domestic side, the U.S. market and the Canadian market are very, very different. The U.S. market is -- the capacity of trucking is tighter because of their regulation there. And our rate of growth for U.S. domestic business as well as cross-border is also faster than the Canadian growth. And I think one of the areas that we've exploited that maybe is not obvious to people. On the intermodal side is we've been selling intermodal harder and harder for our carload customers. I wouldn't call this converting a boxcar or gondola into container. But I would simply put it in a framework, customers themselves at a time when you want to use something, which is more expensive, you just call like a truck to move the pulp or steel or what not. And when we approached them on the intermodal product, we have more success than we had in the past in selling an over the road product to the manufacturing sector. So I think when you add all of this in, there's still a potential for all railroad in intermodal, whether it's domestic or overseas.

Claude Mongeau

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

Fadi Chamoun - BMO Capital Markets Canada

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

Jean-Jacques Ruest

We won't call it huge, but it's something that's steady, that's sustainable. So for example, on the overseas side when I made my comment, I did talk about the new lumber transfer facilities that we've put in Vancouver. And as you remember, we did the same thing in Prince George about 2 years ago. So when you have those things, you actually help convert a product into a container. In those 2 cases, for overseas export business, but the same thing is done also in domestic. We move some domestic freight from Vancouver, manufacturing freight to BC to Canada; in container, same thing to Mexico, in some cases during the holiday season. So moving intermodal and manufacturing segment makes a lot of sense, and that's why customers have been using dry van. And we say, we have a dry van product long haul. It's called intermodal. And the same sales force starts making a much bigger effort than the past to sell that product. Intermodal is not a business unit, it's a service. It could be used by consumer product, locomotive, pulp and paper, steel, metal, you name it.

Operator

The next question is from Chris Wetherbee from Citi.

Christian Wetherbee - Citigroup Inc, Research Division

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

Luc Jobin

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

Christian Wetherbee - Citigroup Inc, Research Division

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

Luc Jobin

It's always difficult to quantify these things. So as Claude earlier made in his statement, overall, it's not inconceivable that maybe about 1/3 of the growth that we've seen during the course of the quarter may be attributable to a combination of all of these factors. So it's weather, it's leap year, it's volume and expenses coming all together, just giving us a little bit of a better first quarter this year versus last year.

Operator

Your next question is from David Tyerman from Cannacord Genuity.

David Tyerman - Canaccord Genuity, Research Division

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

Claude Mongeau

Our volume are not showing that at this point. In fact, we're still growing, whether it's intermodal, thermal coal, coking coal, pulp lumber. It's holding steady.

Luc Jobin

I mean we do hear old same chatters. But J.J. was -- just for last 1.5 week in China. And all of the key supply chain, Canada is becoming more and more top of mind in China as the source for critical commodities. Lumber, clearly our Canadian lumber producers have broken through, and they're now a force in that market. And minerals, whether it's coal, whether it's concentrate, there's a tremendous appetite and interest. There's a developing interest in iron ore, for instance, in China. So China might slow down. But I think Canada is well positioned in world markets as a source that Chinese buyers want to favor. And I think that's going to bode well for CN for many years to come.

Jean-Jacques Ruest

When we say slowdown, we mean slower growth, not slowing down very fast.

David Tyerman - Canaccord Genuity, Research Division

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

Claude Mongeau

Well, what we see is that any commodity market goes up and down. And I think the price of met coal, for example, at some point was probably higher than what it could be sustained at. And as you would see in any market, whether it's the potash or any other world commodities, it was up and down. But the price of coal at export is lower, coking coal. So the price of coking coal is also still at a price that the mine make a decent profit, profit enough that they want to produce and sell as much as what they can. So when the business are moving volume and the price commodity goes up and down. But that does not necessarily reflect itself right away through the volumes.

Operator

Your next question is from Jason Seidl from Dahlman Rose.

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

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

Claude Mongeau

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

Luc Jobin

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

Operator

The next question is from Matt Troy from Susquehanna.

Matthew Troy - Susquehanna Financial Group, LLLP, Research Division

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

Keith E. Creel

Well, let's say from a density standpoint, it's pretty much in line with the growth in business, so no dramatic changes there. We had not -- made a couple of shifts over to J trains where we're running through the inner circles, so to speak, to Chicago. Since we've cut over Madison last year, which is helping us from velocity standpoint. We continue to invest. Kirk Yard, we're building now in that facility to effectively create a hub. That in the past, we could hub about 1,500 cars a day and bump up against capacity constraints. We're going to a yard that will handle about 2,500. So we're in the middle of converting interchange that normally would have gone to the belt or other locations with other carriers, taking our interchange there to Kirk Yard where we can realize some synergies across the network, outline points where we otherwise would have switched indoor -- payments we're making to the belt for trackage charges or to the harbor for trackage charges. So that's a continuing story that will unfold for us for this year and the next year. And then finally, the last piece to that conversion will be taking a switching operation, all the switching cost out of Markham and shifting that into that same facility at Kirk Yard, as well as our locomotive facility, so that's more to come in the 2013, early '14 time frame.

Operator

Your next question is from Chris Ceraso from Credit Suisse.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

You mentioned your strategies to bring on volume at a low incremental cost, and it looks like you did a good job at that in the quarter. On my math, it was maybe $0.56 that fell to the bottom line from incremental revenue year-over-year. That's good, but it's not that abnormal for a railroad like yourself. So I'm trying to gauge how much help did you really get from the weather. And can we expect to see incremental margins like this going forward? Or does it go back to 40%, 45%, 50%? What's your feel on that?

Claude Mongeau

You guys are very demanding and gratifying in your support. There's no question we are able to accommodate the business at low incremental cost. And I think as Luc explained to you earlier, when you take into account the moving pieces that are less related to the running of the business, pension, the stock-based compensation, fuel lags, these things can move you up or down easily by 10%, 15%. So it's tough to use one quarter and make projections. But there's no question during the first quarter, you just look at the metrics that Keith explained, we were able to improve operating metrics in terms of efficiency. We were able to grow a little faster on the rough volume side and revenue with good pricing. You do those 2 things and you deliver very solid results like we just did.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And just one clarifying point on the pension. There's 2 different numbers that you've mentioned, the $450 million that you said, in the press release, there's $550 million on the cash flow. Is the difference just that the $450 million is voluntary on top of $100 million that's required?

Luc Jobin

That's exactly. $450 million is the voluntary special contributions that we've made in the quarter. We did 2. One, $150 million early in the quarter and then we made another one of $301 million at back end of the quarter. On top of that, we contributed for current service cost, $103 million. So that's the total of $553 million that you've seen.

Operator

The next question is from Peter Nesvold from Jefferies.

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

On the labor line, ordinarily, you're down roughly $40 million to $60 million sequentially when you go from 1Q to 2Q. And I guess this year, we had fewer weather-related costs in that line, you had pension going up and you have incentive comp. Is it potentially flattish from 1Q to 2Q? And then just a clarification, maybe that counts as 1/2 question. On the free cash flow, so you took it out, there was nothing in there that talked about gains on sale. Last quarter, when you gave the original guidance, $875 million, it did exclude gains on sales. So I just wanted to understand if the property gain is included in that upper division to the free cash flow?

Luc Jobin

The gain on the sale of the rail line subdivision was proceeds of $311 million. Now as I mentioned, those proceeds came in and then they quickly left and were reinvested, if you wish, in terms of the pension contribution. So that really didn't matter into the $875 million. So it wasn't in the $875 million. So it came in on top of it and then, as I said, it ended up leaving the free cash flow because of the special voluntary contributions.

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

Okay. And then on the labor cost, it's typically down $40 million to $60 million from 1Q to 2Q. Is it sort of flattish this year? Is that a reasonable number to think about in the near term?

Luc Jobin

Well, I mean you've got -- the trend is the following. I mean you've got about 3% wage inflation. You will have headcount somewhere at -- this particular quarter, we were up about 3.5 over the longer term. We're going to be trending a little bit closer to attrition, plus 1 or 2 percentage points, depending on where volume is going. And we are continuing to hire ahead of attrition. And then it's down to the pension pressure, which we've quantified at $100 million of additional expense for the year. So those are the factors that are going to drive it. If stock-based compensation doesn't bounce around too much, that's what you got in store.

Operator

The next question is from Brandon Oglenski from Barclays.

Brandon R. Oglenski - Barclays Capital, Research Division

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

Keith E. Creel

That's pretty much that's it. I mean we're losing a little bit in the West part of the territory. We're a little bit more heavier than other locations. We're gaining with our strategies and our opportunities to cross the railway. I mean we consistently review noise. It's what I call noise in the system, so to speak, and we strategically invest, eliminate noise, and then increase capacity and to maintain our velocity on our train. So what we've lost in BC North, which does have a material impact on the number because the percentage of growth we've had there that gained back with investments over the NOD. We're running trains much faster over the NOD than we did last year with those strategic investments, do a much better job of controlling velocity and cost in Chicago with the operating strategy and the strategic investment we made with EJ&E. I can go territory to territory, there's no one silver bullet. It's a gain here, it's a gain there. We got a very competitive operating group internally. We compete with each other, so to speak. Our success breeds success, and we just don't like to effectively giving thing back unless we absolutely have to. And I think you'll find in the case where we do, which is BC North, we sort of anticipated this 2 years ago and started this path, and we're 2 years into a 5-year plan that will eliminate that. Now the next challenge is I want J.J. to give us some more business and a more challenging opportunity, and we'll figure out a solution to that as well with his team.

Operator

The next question is from Konark Gupta from Cormark Securities.

Konark Gupta - Cormark Securities Inc., Research Division

I'm here for David Newman today. One question would be on the coal side. Your carloads are down 11% in Q1, and so far in Q2, 2 weeks, it's down 17%. So just talking about domestic terminal, it's weak. PRB stockpiles are above normal. Canadian met coal and thermal coal exports are very strong. Can you please comment on your coal RTMs and pricing going forward? And perhaps any impact on PRB coal shipments via Prince Rupert.

Jean-Jacques Ruest

When you look at the CN coal business, looking at the carload is somewhat misleading because our real story is in RTM. So you look at the RTM, you really get a sense of where our revenue are heading. While at looking at carload, you won't get that. The PRB coal, your number 2 question, on PRB, PRB coal is still moving via Rupert for export, mostly into Asia and obviously, China. And the pricing on coal, I know there's been some questions asked, in general, about whether or not railroad are supporting with better priced, meaning lower priced export program, and I know these requests had been made, but we are not on that page. And mostly what CN is moving in terms of coal is actually coking coal, coal which was already market was offshore and not domestically.

Konark Gupta - Cormark Securities Inc., Research Division

Okay. And on PRB, you said it's moving via Prince Rupert, obviously, right? But are you seeing any impact on the stockpile, which are -- like the other U.S. class 1 railroads that it's above normal right now, way above normal, is there an impact on that?

Jean-Jacques Ruest

I think we're about normal. Meaning, we had a run rate, and we're keeping that run rate. No, there's about a kind of a steady flow that was already in the making, if I understand your question correctly.

Claude Mongeau

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

Operator

The next question is from Jeff Kauffman from Sterne Agee.

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

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

Keith E. Creel

I think it's too many moving parts to be able to do that. I can say that DP certainly has been a significant piece of our success in this area. Effectively, we've invested a lot of money over the past 8, 10 years, over $500 million in creating a network, our core network, with long sidings that are spaced. Without DP we were not able to optimize that. With DP over the past 2 years, I mean for instance, first quarter 2010, we had about 260 or 270 DP locomotives. We ran 20 train starts per day with DP versus this year where we've got about 440, we ran 60. So I mean there's still more room to go, more improvements to be made. This is sort of -- there's not a perfect science to it. The time it really benefits your DP effectively other than controlling train starts is winter operations, maintain an air pressure to a train. So this past winter, given that the temperatures were not as extreme as they were last year, we really didn't see the benefit that I think we'll see when winter does come back. So I think there's more to play out in this thing. I can't put a number on it, but I can tell you it's substantial and it will continue to allow us to accept incremental growth especially on our manifest trains at a lower incremental cost. So it's a good story for us and more to come.

Operator

The final question is from Keith Schoonmaker from Morningstar.

Keith Schoonmaker - Morningstar Inc., Research Division

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

Keith E. Creel

Yes. No, big levers. That has Smart yard, what you're talking about. We have to pull in that over the proponents of our system. The major yards are equipped with Smart Yard, the more satellite yards, which -- we've got a modified version. It's not quite as robust. But it still gives the people that operate those terminals with good planning tools to optimize train connections in our yard rail, which you see in our metrics. I mean even with an increased level of business, we continue to push down our terminal dwell, which is controlling our cost. But again, no silver bullets or big investments. That BC North piece is going to be something we continue to focus on. We'll finish up Chicago, and then we'll see where the business is where the opportunity is from that point.

Claude Mongeau

.

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

Operator

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

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