Canadian National Railway Company

Welcome to the CN First Quarter 2021 Financial and Operating Results Conference Call. I would now like to turn the meeting over to Paul Butcher, the Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

Well, thank you, Christina. Good afternoon, everyone, and thank you for joining us for CN's First Quarter 2021 Financial Results Conference Call. I would like to remind you about the comments already made regarding forward-looking statements. With me today is JJ Rouet, our President and Chief Executive Officer, Ghislaine Houlle, our Executive Vice President and Chief Financial Officer, Rob Riley, our Executive Vice President and Chief Operating Officer, and Sean Finn, our Executive Vice President, Corporate Services, and Chief Legal Officer. I do want to remind you to please limit yourselves to one question so that everyone has the opportunity to participate in the Q&A. The IR team will be available after the call for any follow-up questions. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. J.J. Rouet.

Well, thank you, Paul, and good afternoon to everyone. I hope you all had a safe, healthy, and constructive start to 2021. Here at CN, we're off to a good, strong running start. The underlying performance of CN has been strong, and this is thanks to our dedicated colleagues. Our railroad is delivered despite severe winter operating conditions, unprecedented demand in a number of markets like pork and grain, and ongoing challenges in the pandemic. As you can see from slide five, CN is on track to become the premier railway of the 21st century. We are focused on our role as an engine of the North American economic growth and prosperity, as well as a supply chain and environmental leader. We pioneered and were the first to implement precision schedule railroading across our network, and we are a clear industry leader in ESG. Our strong balance sheet is a testament to our operational excellence, and we continue to prudently invest in the business and our strategy as we grow and expand our reach. CN has a longstanding successful track record of strategic and accredited acquisition throughout North America, which has resulted in successful integration of our current rail network. In line with our existing strategy, CN made a superior proposal to acquire the KCS. This is the right next step for both CN and KCS toward becoming the premier railway of the 21st century. Turning to slide six, we are confident that together with KCS experience and very talented team, we will be able to continue that success in a combination of CN and KCS to the benefit of both companies. Specifically, This offer will deliver superior value to KCS shareholders. CN's proposal represents a 21% premium to the CP proposal and more than double the amount of cash per share, resulting in not just greater value, but also greater certainty of the value for KCS shareholders. The combination will also significantly enhance customers' choice and competition. In particular, it would create a new express route that connects the U.S., Mexico, and Canada with end-to-end seamless single-owner, single-operator service. It would connect vibrant ports from all three coasts to more interland market in cities. It would connect CN and KCS buyers and sellers to more destinations. It will also preserve access to all existing interchange options to enhance route choice and ensure robust competition. We are also firmly committed to maintaining open gateway to competitors' network. We believe this combination will enable better solution to our customers, speed of movement of goods from country to country, coast to coast, enhance competition, create jobs up and down the railroad, and prevent millions of tons of greenhouse gas from entering the atmosphere by converting truck traffic to rail supply chain. As an update on where our proposal currently stands, On April 21st, we submitted a pre-filing notification to the STB of our intent to file an application seeking authority to combine with KCS should the KCS Board of Directors accept our superior proposal. We are proposing to use an identical voting trust structure that CP has proposed, and we are confident that the STB will not subject our proposal to any different standard in approving the voting trust than those that would be applicable to CP. We believe that both voting trusts are equally likely to be approved. If our voting trust is approved and a combination with KCS is consummated, KCS shareholders will receive the value of their consideration being offered when the transaction closes in trust, which we anticipate could be as soon as the second half of 2021. We are fully committed to this transaction and confident in our ability to achieve all necessary regulatory approval to close into our voting trust and then ultimately receive approval to combine with KCS. On page 7, I would like to provide a brief update on our strong progress as we have made in only one week since announcing our proposed combination. We were very pleased to learn on Saturday that the Board of KCS determined that CN's offer is reasonably expected to lead to a company-superior proposal and we were granted permission to conduct our confirmatory due diligence. We look forward to working toward finalizing a definitive agreement merger to combine our two great railroads. I connected with Pat, the CEO of KCS, over the weekend and reiterated CN's strong enthusiasm, readiness, and most importantly, our deep commitment to begin collaboration with the KCS team toward a successful combination. Secondly, we filed earlier today an application with the STB for the approval of our voting trust and named Dave Starling as the trustee. Finally, a great importance of note, in less than a week of making a proposal to combine with KCS, we have received an overwhelming amount of support from more than 500 freight customers, port ecosystem partners, supplier, government officials, and other stakeholders. They have voiced their support for a combined CN-KCS, which will help them compete in their market and better serve their needs by offering greater choice and greater efficiencies. We have also spoken to our shareholders and many of you as well and appreciate your strong support in this combination. I myself, on behalf of the entire CN team, we are fully committed to this transaction and we're very confident in our ability to achieve all the necessary regular approval to close into a voting trust and then ultimately receive approval to combine with KCS. Together, we will create the premier North American railway for the 21st century. Moving on page 8. I am very proud of the CN underlying performance in Q1. This quarter, we realized solid results, and we continue to work on our yield of our new business mix. During the quarter, we continue to deliver industry-leading volume growth, with RTM up 5%, while revenue were flat versus last year, mainly due to adverse fuel lag and exchange rate. Our yield strategy is working. Our same-store pricing was 4.2% in Q1. Our network is fluid, and we recovered very well from the polar vortex of February. Our efforts are reflected in our ability to capitalize on consumer-driven trends and growth of our internal business, which was up 19% for the quarter, with CN significantly outpacing the rest of the industry, as well as our strong financial performance and gain in safety, train length, car velocity, labor productivity, fuel efficiencies, and other key measure of operational performance. We are confident in our business and committed to our long-term strategy. With that, I will turn it to Rob.

Rob? All right. Thank you, J.J., and thank you to the talented employees of CN who helped deliver a very solid quarter. As you'll see on slide 10, our team moved an all-time Q1 record for volume, with GTMs up 6% year over year, despite the impact of the polar vortex that J.J. just spoke about in February. While volume was up, crew starts were up only 1%, our active online inventory of rail cars was down 3%, and train length improved 5%. The railroad continues to run very well and is fluid, with car velocity also improved 5%. In addition, our labor productivity improved 9%. All in all, just a solid quarter of winter operation. As detailed on slide 11, we are the North American rail leader in fuel efficiency. We improved our fuel efficiency 4% versus the same time last year to an all-time Q1 record. These efforts allowed us to save 12 million from our initiatives alone and save the planet over 60,000 tons of CO2 emissions during the quarter. From a safety perspective, our personal injury rate and accident rate were improved an impressive 27% and 36%, respectively, living up to our core values. From a technology standpoint, our FRA-approved autonomous track inspection cars provide safety and cost improvements to our railroad. As we prepare to enter into Phase 3 of our program, we will be able to enhance overall safety while reducing manual inspections by 75%. In Q1 alone, our accident costs decreased over $30 million versus Q1 last year due to this technology and the dense ecosystem of portal and wayside detectors on our network. These cars are now covering 100% of our core mainline and 95% of where our gross ton miles move. As I previously mentioned, we experienced a couple weeks of February and extreme cold temperatures with temperatures dipping below minus 40 degrees on large parts of our network. During this time, we were able to deploy our air car fleet, which allowed us to use multiple air sources during this challenging time. With this technology, we moved an additional 232,000 feet of traffic in February that would have otherwise been delayed or lost due to the cold. This helped us move 5% more volume during the quarter while holding crew starts flat. Along with that, we were able to continue to deliver for our customers. CN has now set 13 consecutive all-time monthly records for Canadian grain, keeping the streak intact throughout the winter months. We continued deploying technology to make our railroad safer, more efficient, and more reliable, and we're starting to see additional benefits from key projects, including track and train inspections. Moving to slide 12. We are optimistic on the volumes as we look out over the remainder of the year. To that end, our board approved an additional 75 locomotives over the next 12 to 24 months to support the projected growth and economic improvement. Our business is doing very well as evidenced by our strong performance this quarter. Our capital investments over the last three years continue to provide safe and sustainable transportation options for our customers as the global and North American economies remain on a steady path to recovery. As you can see on slide 13, our strong operational performance coupled with strong demand led to record Q1 Canadian grain shipments. We beat last year's revenue record by over 20%, setting a new all-time high water mark for sustainable grain supply chain volume. In total, as I said, but I'll say it again, we have now set records for grain tonnage now for 13 consecutive months, delivering for the Canadian farmers. And as JJ highlighted a moment ago, our intermodal performance has also been very strong, increasing by 19%, which far outpaced industry growth. Turning to page 14, we are confident in our ability to continue delivering strong results as the economy rebounds. Our network is fluid and we've recovered well from the extreme temps in February. We look forward to realizing the pipeline of growth opportunities in front of us. This includes continuing to grow our position as a clear industry leader and intermodal. We continue to maintain a very disciplined approach to yield management and the strategies working. including same-store pricing of 4.2% in Q1. We are also focused on diligently managing our CapEx to drive productivity and best-in-class capacity and resiliency. As we look towards the future, we expect to maintain our leadership in digital scheduled railroading, building on our history as a PSR pioneer. This will continue to be a competitive advantage as we execute on our strategy. And as JJ already mentioned, ESG will continue to be a priority. We've recently undertaken major new ESG initiatives focused on environmental protection, active social responsibility, stakeholder engagement, and best-in-class governance. On that point, CN's Board of Directors announced in Q1 that at least 50% of independent directors come from diverse groups, including gender parity, the establishment of an Indigenous Advisory Council, and an annual advisory vote on CN's Climate Change Action Plan. We expect to continue to grow our ESG leadership and serve as an example in the industry. As I mentioned earlier, our best-in-class employees have done an exceptional job in helping to carry out our strategy, and we know that we have the right talent in place to continue to drive sustainable long-term growth. With that, I will turn the call over to Gislan to go over our financial results in detail.

Yeah, thank you, Rob. My comments will start on page 16 of the presentation, which will give a bit more color on some of the highlights of our first quarter performance that JJ discussed earlier. During the quarter, we booked a non-cash benefit of $137 million to recover part of the charge we recognized on the non-core branch lines we put up for sale in Q2 last year. Recall that in Q1 of 2020, earnings also included an income tax recovery of $141 million resulting from the CARES Act. Excluding these non-recurring items, adjusted net income was around $870 million, essentially flat, with adjusted diluted EPS of $1.23 up 1% versus last year. If we adjust for the impact of fuel lag and stronger Canadian dollar, our adjusted EPS would have been up 11%, so quite a solid underlying performance. Now moving on to slide 17, we generated strong free cash flow of nearly $540 million in Q1, down about $35 million from last year, mainly from lower net cash from operating activities, partly offset by lower capex. We have paused buying back shares in light of our proposal to combine with the KCS. Moving on to page 18, we are encouraged about the economic recovery and the vaccine rollout, which is giving us strong confidence for the balance of the year. The underlying performance in Q1 is a testament to the dedication of the CN Railroaders who perform day in and day out. We are building off a strong volume performance in Q1 and looking to see the rail-centric part of our business recover. The increase in industrial production will drive growth in our carload segment moving forward, such as chemicals, forest products, metals, fuels, and plastic. With that said, we are pleased to update our financial outlook and are now targeting double-digit adjusted diluted EPS growth for 2021 versus high single-digit EPS growth previously. This is backed by the assumptions of high single-digit volume growth in terms of revenue tonne miles. We still expect to deliver free cash flow in the range of $3 to $3.3 billion, which will drive further improvement in free cash flow conversion. I will now turn the call back to JJ to give some closing remarks ahead of the Q&A.

Thank you, Rob, and thank you, Ghislaine. Thank you for all of you joining us today. It's a proactive pro-trade, pro-economic growth merger that we're proposing, connecting more sellers and buyers. and I would like to take a moment to reiterate some of the highly compelling aspects of our proposal. By combining with KCS, we would compete head-to-head on all three coasts at lower costs, safer service, better fuel efficiencies for Mexico to the heartland of America. This will result in a safer, faster, cleaner, stronger railway. In addition, we will bring our leading ESG and operating expertise to KCS business to the benefit of both company stakeholders. As mentioned during our April 20th announcement, based on our conservative and preliminary analysis of publicly available information, the combined company is expected to achieve EBITDA synergies approaching $1 billion, with the vast majority coming from additional revenue opportunity. The strong cash flow generation of the combined company would allow the company to rapidly deliver following the close of the transaction. We anticipate the transaction will be accredited to see an adjusted diluted earning per shares in the first full year following termination of the voting trust and see an assuming control of KCS and double-digit accretion of the full realization thereafter. We are confident in the strength of our business and strategies as we progress toward becoming the premier railway of the 21st century. We look forward to engaging constructively with the KCS board and all relevant stakeholders to deliver the superior transaction with KCS, to deliver greater choice and efficiencies for customers, and deliver enhanced opportunities for employees and local communities. Overall, we have a better bid, we are a better partner, better railway, and the best solution for KCS and the North American economy. On that note, we will start to take some questions. Operator? Operator?

At this time, if you'd like to ask a question, please press star then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. And your first question comes from the line of David Brennan with Bernstein.

Good afternoon, David.

Good afternoon, guys. So, JJ, I want to kind of ask this question again a little bit. I know we talked about this when you made the bid. But, you know, looking at this transaction, why is now the right time to come in with a competing offer here? Like what's changed in the market that makes this such a better deal than it may have been two or three or five years ago at a lower price point?

So there's many reasons why now, and I covered those earlier last week, but the main reason why now is that the Board of PCS, obviously, after very thorough thinking, have decided it's time for them to crystallize the value for their shareholders. Therefore, they're willing at this point to entertain doing a merger with a strategic partner, a merger with basically another railroad. So the timing of that is also very much dependent on whether or not you have a partner with who you could dance. And then from an economic point of view, we're at the beginning of a post-economic recovery. The GDP forecast for North America looks, you know, as good as can be. We have the USMCA, which was renewed, which is also something that has specific value to, you know, top combination. And then depending, you know, who you believe, you know, the time of Mexico, this might be the decade of Mexico in terms of nearshoring. Now that... There is some challenge between relationship North America and China, but also the fact that, you know, the cost of labor in China has been rising to the point where Mexico might have a better decade. And all that, you put that together, the fact that long-term money is affordable, when you put all that together, it says to CN, yeah, it's time for you to make a good offer to the KCS board and for them to consider very seriously.

That's very clear. Maybe if I could just kind of squeeze one little follow-up in here. As you think about the unique driver's value, is it more about getting CN's rail connections further west or further south?

So the driver value here, really, definitely for us to be successful, we need to create a superior product, a product that can really compete with a long-haul truck. And on that point, I could ask Rob to comment on that. But Right now, the rail network in North America is not really designed to really be as successful as can be for long-haul distance from, say, Mexico City all the way to Detroit and Toronto on the east, or Mexico City to Wisconsin and Calgary on the west. In order to do that, you know, putting two railroads together really makes it appealing. You want to make some comment, Rob, about the product that we have in mind?

Yeah, sure, JJ. You know, David, when you look at it, as JJ just talked about with the UMCA contract just finalized here last year, it really needs a strong transportation option. We don't get to Mexico, and certainly the KCS does. And it allows us to really become the true North American railroad, really connecting the continent. But we bring a lot of things to the table when we look at it. You know, when we look at the different industries, you know, the auto industry would get a second line of service between Detroit and Kansas City that would help increase and enhance options. You know, intermodal service from Mexico to the upper Midwest and southern Ontario that's actually being trucked today. It's on I-35. It's really about taking it off the highway, saving the fuel and emissions, really increasing choices for shippers. You know, for farmers in the Midwest, Iowa, Illinois, Wisconsin, Indiana, and others, it's the opportunities to better access the Mexican market. You know, our reach and port access would open the Midwest in KCS shippers to the world, quite frankly, from the Atlantic to the Pacific and the Gulf. For Canadian aluminum producers, the ability to directly reach markets in southern U.S. and Mexico. For lumber and panel buyers in Texas, CN's force products franchise gets fully unlocked and allows for further optimization and utilization of our fleet. of over 10,000 center beams and boxcars. I could keep going on, but there's a lot of things this combination would bring, enhancing choices for shippers and customers and really being the backbone of USMCA.

Yeah, pro-charge, pro-competition, and very much focused on growth. Thank you, David.

And as a reminder, please limit yourself to one question. And your next question comes to the line of Scott Group with Wolf Research.

Good afternoon, Scott.

Hey, thanks. Afternoon, guys. So I want to ask about the operating ratio, just because it does look like it'll be worst among the rails this quarter. And I know you talked about maybe a sub-60 OR earlier in the quarter. Is that now... in in this higher guidance and then longer term uh cp talked about you know maybe a low 50s or pro forma with kcs how do you think about your or longer term on a pro forma basis and and maybe do you see opportunities to leverage some of the success that kcs has had with psr to get your margins back on track so maybe i can start and then there's just like an ad but when we look long term

We looked at a North American network focusing on the economic triad I was talking about earlier and significant growth coming from, you know, antemodal. So, you know, in a world of growth, growth from antemodal, the focus at CN will be very much more APS than the try to get the lowest OR that one could get, for example, if you move a lot of crude or a lot of coal.

Ghislaine? Yeah, and on that front, JJ, thanks. On EPS, we're quite proud of our results for this quarter. I mean, when you look, our earnings are up 1%. All the other rails are down, including our Canadian competitor. They stated that their earnings was up, but if you take out the $50 million of one-time land sales, they're actually down 5%. So we're up 1%, and when you look at the underlying earnings, fundamentals of the business, as we mentioned, we would be up 11% when we consider the fuel lag and we consider effects. So quite a lot of EPS, and this is what we're focused on. Can you just... Go ahead.

No, no, sorry to interrupt. Go ahead, JJ.

As I said, we're focused on EPS. The focus is on EPS. That's what we want to optimize.

Can you clarify where the guidance is on OR though?

No, I mean, our guidance, and we're quite proud, I mean, we upped our guidance. I think that we're quite bullish on the economy coming forward, on the markets, and we've upped our guidance, as you know, to targeting double-digit EPS growth. And that's what our guidance is, backed up by a high single-digit RTM growth. That's our guidance. Thanks, Scott. Thanks for the question. Thank you.

Your next question comes from the line of Sherilyn Radborn with TD Securities.

Good afternoon, Sherilyn.

Thanks very much. Good afternoon. I wanted to ask in relation to the increasing guidance for the year and particularly the increasing your volume outlook, obviously intermodal has been very strong, so maybe that's the upside. But we'd love to know if you're starting to see some signs of life on the carload side of the business, which I think would be helpful from a mixed standpoint. Thanks.

So, Rob, you want to talk about what you expect to move between now and the end of the year?

Yeah, so, Sherilyn, we actually see some positive movement here, particularly in the second half of the year is really where we see the upside as the economy really starts to kick in. You know, we are moving quite a bit of gas, moving out to export markets. through the Port of Prince Rupert. Actually, the second gas terminal just opened up. You know, the forest products group has continued to stay strong here. We talked about grain. I think the car load franchise really starts to move in the second half of the year, quite frankly, is what we see the big side in terms of the upside, Sherilyn.

Yeah, it's a pretty broad base, pretty broad base. Thank you.

Thank you. Your next question comes from the line of Tom Wadewitz with UBS.

Yes.

JJ, thank you for the question here. I wanted to try to get your sense of the kind of negotiation with KSU and how you address maybe some of the concerns that they potentially would have regarding the regulatory process. So I guess in particular, CP now has visibility with the waiver that they would be able to go to a voting trust. you know, you don't yet have that visibility. And so is that a significant barrier to an agreement with KSU? Are there things that you can do in terms of the negotiation that would address concern that they might have, that they reached an agreement with you, but then STB comes back and says, no, we're not going to allow you to do a voting trust?

Thank you for the question, Tom. So we've only put our offer to KCS Tuesday of last week and only this morning did we file for the Boarding Trust and we fully intend to address every regulatory issue concern that KCS has So maybe, Sean, maybe you could give a brief and an update kind of where we're at in the process of doing these different things.

Sure. Thanks, JJ. Sure, Tom. Happy to do so. So obviously we now have signed a non-disclosure agreement with KCS, and we have access to the data room. But we're going to start a dialogue in the coming days with them. I think you saw today we filed at the STB. a letter sending out our views on the process by which the STB will rule on the voting trust. First of all, secondly, we also filed a petition with our voting trust, which is identical to the other voting trust before the STB, that was put forward by CP. And our application is very simple. We're just asking the STB, as they enunciate their process to approve the voting trust, that they do both at the same time. So the same track, the same standards, and ultimately come to the decision at the same time with respect to both CP's voting trust and our voting trust. And we're very confident, even working with KCS, you know, who will obviously be interested in both parties seeing their voting trust getting approved, that, you know, be adopted a process that is fair, transparent, and even-handed. And we're confident that... The STB will do that. We've asked them to rule by May 31st, which puts us in line to be in a position where both voting trusts have been approved by the STB prior to the vote by the KCS holders sometime in June. So obviously that dialogue is ongoing. We will be able to show, no doubt, with the KCS That when it comes to the voting trust, our position is identical to CP's. And hopefully we're very confident that the STB will rule on both at the same time. We think that's the best approach to have an even level playing field for everybody. And ultimately at this stage, as you know, the standards for the voting trust is public interest. It does not go to the competitive issues, but again, our transaction is pro-competitive. We have new choices, additional choices for customers in the U.S. and across the network, and we're very confident that we'll get to a voting trust to be approved at STB in early June, late May.

Do you need an agreement first for them to review it or not an agreement with KSU or not necessarily?

No, we opened our proceeding last week, and we filed the voting trust, and it's not required that you have a final agreement signed before they approve the voting trust.

Great. Thank you.

Thank you, Tom.

Your next question comes from the line of Allison Laundrie with Credit Suisse.

Good afternoon, Allison.

Good afternoon. Maybe just following up on Tom's question, I mean, there seems to be some disparity between CN's view about what the public interest standard actually means, specifically for the voting trust, compared with how CP is outlining their view of the public interest standard. So maybe if you could just sort of walk us through how you understand the FCB language, what you think it means. I mean, basically, CP is trying to or is arguing that You know, competition is something that will be considered. I think what Sienna is saying, it's more about, you know, financial fitness and the divestiture of the asset. So I'm hoping that you could provide some clarity on your view on what the public interest standard means specifically for the voting trust. Thank you.

So, Sean, you want to talk to these technical points?

Sure, Alice. I'm very happy to. Well, first of all, again, Alice, our position is that our bid is pro-competitive. We'll create choices for customers, and therefore it doesn't have competition. I also want to comment our view is there are no insolvable regulatory problems. I mean, there's a history of competition. These issues that are raised in the context of an STB application is being mitigated and worked out with, obviously, the customers through the STB process. The standard with respect to the voting trust is very clear. And our trust is exactly the same as CP's. And it's a public interest standard, but it focuses on the risk of financial harm of the applicant carriers. And that goes to if, for some reason, a transaction were not to be approved, that both carriers, in our case, KCS and CN, would remain financially viable post the transaction if you had to unwind the voting trust. And we're very confident both companies are extremely viable, would not have an issue post the voting trust if it were not to be approved. ensuring that there's no improper control of kcs and it is clear both in our uh and our uh voting trust that there is no control by cn uh the trustee being dave starling is an independent trustee uh with the great experience when it comes to both the railway industry but also kcs specifically and we were able to welcome his independence as trustee and therefore we are very confident that the public standard test that must be met at this stage will be analyzed by the STB and again the issue will be and what we're asking the STB to do is apply the same standards and the same criteria and the same time frame to both voting trusts so we're confident that when the STB receives both applicants detailed submission on the public interest that they will come to the view that In our case, we made the public interest trust, and our voting trust would be approved by the STB. Thank you, Allison.

Just if I can – okay. Thank you.

Your next question comes from the line of Ken Hoekstra with Bank of America.

Hey, Greg. Good afternoon, JJ, Rob, and Ghislaine and team. Looking at the cost side of the 660R again, thoughts on near term on employees relatively to your – the flat performance in the quarter, how do you think you ramp as volumes ramp through the year and your thoughts on costs? And I guess, you know, maybe long-term, your thoughts on synergies. You mentioned kind of top line versus the cost side as well. Thanks.

Thank you, Ken. So maybe I can start and then Rob can add in. So the month of February was a bit of an expensive month for all the railroads in the polar vortex. We talked about yield, same store price at 4.2%, so that's a good trend. We like that numbers. And the volume ahead of us is obviously positive and constructive, just like the economy. And when you look at all the series of KPI that Rob was going through during the presentation on the operations side, we've made progress just about on all front, if not all front. So, I mean, we are – with that in light, you know, things looks – it looks positive for the rest of the year.

Rob, you know, if you want to add to – Yeah, Ken, if you just look at our operations team, so what it takes to move the freight out there in the first quarter, our operations headcount, even though I said volume was up 6%, our headcount was down – 6% in operations, roughly about 800 people less to move that freight. As I mentioned, our labor productivity was up 9%. And when we look at it, as we came out of the COVID depth of second quarter last year into the third quarter, we didn't bring all of our resources back on a one-to-one basis. And we've been able to maintain that here through the second half of last year and then certainly in the first quarter this year. As you look at the second quarter this year versus last year, of course, we're going in a different direction. We're seeing growth versus the big downturn we saw really at the end of April and May is where it started to trough on us. So we weren't doing any hiring last year in the second quarter at all. That all stopped as soon as COVID set in. And we made, as you'll recall, we had a lot of people furloughed. To the contrary, we're actually hiring. We're actually hiring conductors right now, getting ready for the second half of this year. So we're preparing. We're optimistic about the second half of this year in terms of the volume, and that's really where our focus is, is preparing to move that.

And maybe, JJ, I can add, if you're looking, Ken, at the labor costs of Q1 being higher, that's all major variance is incentive compensation because, to Rob's point, our average number of employees in the quarter were down 3%. Great. Thanks, guys. Thank you. Thank you, Ken.

Your next question comes from the line of Brian Ostenbeck with J.P. Morgan.

Hey, good afternoon. Thanks for taking the question. Just a quick one on the end markets. Can you just remind us what impact you think you'll see from the ELD mandate when it becomes effective in Canada mid-this year? We've heard some concerns about availability of devices being certified. Is that really something that you're focused on having an impact on some of your end markets that overlap with trucking?

So maybe I can pick this one up. Most trucking firms in Canada who cross borders have to have the equipment already because that's what is a legal requirement in the United States. So then you're left with only the fleet that's only running in Canada that has to meet that mandate by mid-year. So the impact is, I would say, I would qualify as slightly positive. because already a good portion of the fleet had to be converted because, you know, a number of equipment moved across borders. So the impact is a slight positive, but I think it's coming up at a time when the economy is going to be strong. So really the economy is going to be a bigger factor than the ELD implementation. Thank you.

All right. Got it. Thanks, JJ.

And your next question comes from the line of Jason Seidel with Cohen.

Thank you very much, Trevor, AJJ, and team. Thanks for taking my question. I want to talk on any of the customer overlap that may exist, and maybe you could walk us through some of your options on how to sort of, you know, placate the STB and the customers going forward in the deal.

So the overlap that is well known is between Baton Rouge and New Orleans, where both CN and KCS have a parallel line. And, you know, we know the detail of that, and we think we can definitely solve that. As Sean said earlier, you know, two-to-one problem, you know, none of them are unsolvable, and we'll resolve them. I don't know, Robby, you want to add to other so-called overlap?

Yeah, I think you hit it. You know, the overlap, just like we said on Tuesday, is really between Baton Rouge and New Orleans, where we do have a few customers that their options will go from two-to-one. We knew that going in, and we said that in – Again, that represents less than 1% of the combined railroads network, so we will remedy it. There's a number of things you can do with that, including divestiture of the line, but we'll cross that bridge when the time comes, but we will handle it. Other places that are out there that have been mentioned, I'll just go through them real quick. Jackson, Mississippi, there's no 2-to-1. East St. Louis, no 2-to-1. Springfield, Illinois, no 2-to-1. Council Bluffs, no 2-to-1. Mobile, Alabama, no two-to-one. In fact, the Port of Mobile, Alabama, has sent in their support for our proposed merger, so they get it. You know, if for some reason there is another issue out there, we'll work with our customers to remedy that, as we always have. And, you know, as JJ said, it's important to note that in a little over three business days, over 500 letters of support. That's significant in terms of what we're seeing out there. Thanks for the question.

Appreciate the conversation. Hopefully this helped clarify everything that's been said on this in the last week. So thank you for the question, Jason. Next question.

Your next question comes from the line of Justin Long with Stevens.

Thanks, and good afternoon. I wanted to ask about the 75 locomotive orders that you mentioned. I think you got approval for that from the board. Any color you can give on the expected timing of those units and when they should be delivered? And is this an order that's contingent on the merger being approved, or is this predicated on just the standalone business and the growth you're expecting?

So maybe I'll pass it on to Rob. But just to clarify, the approval of the board for the grain fleet expansion and the locomotive fleet expansion took place before we made the offer to KCS. Rob?

Yeah, that's exactly right. It had nothing to do with the merger and does not have anything to do with the merger. It's really based on growth and growth prospects we see over the next 12 to 24 months. In terms of timing, We expect to get roughly 25 of those here in the second half of this year, the other 50 first half of next year. There could be some variability if volume's bigger than that. We could pull some of those forward, but that's about what we look like in terms of the timing.

Yeah, so we're not losing our focus at all on Canadian grain and Canadian farmers. You know, we're making a major capital investment over three years, adding, renewing 3,500 new low-cube, high-capacity hopper cars. And the 75 locomotives, you know, we got some flexibility when we take them. And it's basically our commitment that as we see growth coming, we want to be prepared for it. We want to be able to move the economy and do our part to enable the recovery post-COVID. Thank you, Justin. Great. Thank you.

Your next question comes from the line of Chris Weatherby with Citi.

Hi, Chris. Hey, guys. Thanks for taking the question. I guess maybe a couple of things here. First, just on the... On the voting trust, when you think about sort of the similar approaches that you'd like the STB to take to review both of them, I guess I'm trying to make sure I understand that relative to the desire to have your deal reviewed by the new merger rules as opposed to sort of seeking the waiver. Is there a reason why maybe the same rules make sense for the trust as opposed to potentially the deal? And then, you know, in terms of what ultimately kind of becomes how the industry ultimately shapes up, how would you expect something to, you know, the downstream effects to look if you were to be able to acquire KSU? Do you think this triggers something else in the future, or do you think this is sort of one and done and this is it?

So thank you, Chris. It's a question often asked, so we'll revert to our expert here, Sean, to cover that.

Thanks, Chris. On the question of the waiver maybe, which we're asking about, but to be specific, you We believe we can close the transaction on new rules or old rules. So for some reason, the STB were to rule, but we've taken the position from the outset that we think that this transaction should be reviewed under new rules, first of all. Secondly, it does provide, and obviously our 500 or more support letters recognize the fact that CN has taken the position that we are confident that under new rules, we can get this transaction approved and closed. and when it comes to uh evaluating the voting trust again we're of the view that uh clearly in our submission what we said is that we want the same standards applied and the same timeline and the public interest test for the approval of the voting trust our submission is that it is the same for both voting trusts and leading that to asking the stb to rule both at the same time and hopefully adopting a process which will allow us to even even a level playing field, excuse me, which is fair, transparent, and even-handed. So obviously, you know, our position is that when it comes to the voting trust, our regulatory assessment is identical to a CP when it comes to getting it approved as a vehicle to use to move on to the next level of this transaction. So I hope this helps.

Go ahead. Is that downstream effects? What do you think about that?

Well, I think that's something that will be obviously assessed by the board based on the new rules on the overall transaction, and we'll address those as they come through. But, again, our capability of demonstrating is pro-competitive. That has Rob clearly explained that there is half competition and there are areas where we'll have to address with mitigation, but we remain confident that on the new rules we can get this transaction approved and closed.

Okay. Thank you. Thank you. Next question. Operator.

And your next question comes from the line of John Chappell with Evercore ISI.

Hi, John. Good afternoon. Hi, JJ. I wanted to ask about the impact of what's going on in the Port of Montreal right now. Obviously, this one was a little bit more expected, and it sounded like there was business already shifting to Halifax. How was your network positioned for the proactive shift in freight? And if you can just remind us, what was the impact both from a volume and a cost perspective on the prior strike, and how do you expect it to be similar or different this time around?

So this is the second time in about six months that they have a labor disruption. And the last time it was maybe you caught shippers or importers by surprise. This time, because it was the second time, and this was also they had a specific deadline. So customers saw it coming. Diversion of freight started to take place many weeks ago. That's another important aspect. When the disruption took place last year, it was disruptive to our own operations. So I would say there was some new business, but it was also unplanned costs as a result of. So this time, we were organized differently. I'm sure the importers also organized differently. There's been diversion of freight already to St. John and Halifax both. And currently, the federal government is actually looking at potentially having some some regulation that may bring either the work stoppage to a close or maybe bring the two parties closer together. But all in, it's not a big to-do in terms of our second quarter result.

Great. Thank you, JJ. Thank you.

Your next question comes from Brandon with Barclays.

Hello, Brandon. Good afternoon, and thanks for taking my question. I guess JJ or Rob, you know, there was a lot of public discussion last week about how your potential combination would be, you know, somewhat anti-competitive from a rail perspective. And I think it went beyond, you know, just the shared line in Louisiana. So can you give us maybe some more extensive response to those comments, especially in relation to interline agreements, which supposedly could be more challenged going forward?

Well, maybe I'll start. I mean, frankly, our focus from the beginning has been on KCS and creating value for their shareholders and their customers, as well as the CN shareholders. The combination that we're proposing is really pro-competitive. It's really about creating new products, new services to compete harder. There's nothing wrong with competition. Competition is good. It brings innovation. It brings new services. It helps connect more buyers with more sellers. CN has a bigger network. We can actually connect more destinations. All these gateways will remain open. You know, CN is – There's no railroad, including CN. We make good money interchanging traffic with other railroads, so there's definitely no incentive financially otherwise not to continue to grow the interchange business with other railroads, including the CP at Kansas City. So a merger that's based on growth is a merger that really is, you know, looking for a bigger pie of the overall freight in North America. We're not looking for a bigger pie, a bigger side of a small pie. We're looking for a bigger pie and therefore, you know, interchanging one other railroad as well as competing much harder with truck. with obviously what we created now as a premier railroad for the 21st century, focus on the economy ahead. The economy ahead of us is going to be much more related to consumers and to antimodal, a whole lot less reliant on thermal coal. And crude has been, you know, good and bad at the time, but crude is too volatile to actually do a merger of this size. And so, I mean, there's... Our view is always from the beginning. This is pro-competition. It's to create new product. It's about growth, and it's about creating reason for freight shipper to use a rail network.

Rob, you want to add? You nailed it. I think you hit on all the key points. I'd just reemphasize, as JJ said, you know, we plan on keeping the gateways open. There's no plans to shut those. So, you know, as far as your question on the interline, that's our plan.

Yeah. And just to add, when you look at the ports, you know, Mobile, New Orleans, Montreal, Quebec City, Halifax, Vancouver, Rupert, you know, Lageros, Capdenas, Veracruz, all these ports with this combination can really connect to even more interland market. You could connect St. Louis, Memphis, Kansas City to all three coasts, you know, transatlantic trade to Kansas City, you know, South American control to Kansas City, coming from the west as well. You could potentially give an opportunity again for the Lazero Cardenas to potentially be an option for those who import product in Houston and or export product from Houston back to Asia. When you look at the map, you got to look at what it could do to actually enhance the economy and enable something that was put together with a lot of effort, USMCA, and enable the continent also to do more trade within itself. You have now the content of a Finnish vehicle, North America, requires a higher content made from North America. So that means more product, more parts moving within the continent, very long haul. And that's what this combination is all about, is to support and enable the economy ahead, with no intention of reducing competition, or closing gateway. Thank you, JJ. Thank you.

And your next question comes from the line of Amit Rotorotra with Deutsche Bank.

Thank you for letting me ask a question. JJ, you know, I want to ask a previous question slightly a different way if I could, so bear with me for a second. I mean, you and the team have, you know, obviously done a lot of work, offered a compelling proposal. I think that's undeniable. But at the end of the day, the outcome is quite binary. And what I was hoping you could help us with is, you know, how CNI is impacted by a potential CP KTS merger, both, you know, I guess with respect to the competitive implications for CNI, and then also does an outcome like that necessitate the need for your company to and the CNI board to pursue other acquisition opportunities to counterbalance that competitive implication.

So thank you for the question, Amy. So that's really a question for later. It's something we've been talking about, obviously, for the last many, many years as to, you know, the so-called endgame. Our focus really is the opportunity at hand. The board of KCS had decided that they're willing to partner with another railroad, a strategic partner. And CN, you know, from the very beginning of when we got privatized, you know, the first thing that we did was made an acquisition early on of the Illinois Central. We had a marketing alliance with KCS. And then early days, we've been focused on what was at the time known as NAFTA. uh nafta has now been renewed uh with somewhat differently but a lot of the what the nafta attraction was is still there today so that's really the focus that we have uh i think if this doesn't happen then uh you know we'll we'll see at that point at that time but uh There's a lot of value, and we believe, as Sean was saying earlier, that we can resolve these different issues as they come, and that's what we're focused on right now. But just look at the CN network the way it is today with TreeCoast. Huge amount of potential, just stand alone. Just remember, when we started 25 years ago, the company was nowhere what it was today. We build it up over 17, 18 different acquisitions, big and small. We build it up with organic growth. And that will always be the case. We are very innovative, very nimble, and we're going to keep doing that. Right now, we're focusing on the one that's specific. the KCS and being the NAFTA railroad, the USCMC railroad, it doesn't mean that our future is any different long term. We have a bright future no matter what, but we think that this is the time to do this one transaction. First time since I joined CN that actually KCS is actually willing to merge with another railroad, so we'll jump on that.

Okay, very good. Thank you.

Best of luck. Thank you. JJ, if I may, just I want to be clear that I talked about the voting trust before. Clearly, our application, there's no date yet for the KCS shareholder vote, but our application today, we're looking to have our voting trust approved on the same timeline as CP's voting trust, the same standards and the same criteria, and that be done prior to the voting trust of KCS. When I said a voting trust by the end of May or June, I know I'm presumptuous. I'm assuming that's what it could take. But clearly, I want to be clear that we want to ensure that the STB rules on both voting trusts prior to the KCS shoulder vote later this year.

Very important point. Thank you, Sean.

Your next question comes line of Benoit Poirier with Desjardins Capital Markets.

Yeah, good afternoon. Good afternoon, everyone. Obviously, very good color about the voting trust. But now when we look at the data room, could you provide maybe more color about the timing to perform data room analysis. I know it's not your first time, and I would assume it's more virtual these days. And if you could also provide some color about the timing to make a binding proposal and finalize a definitive merger agreement. Thank you.

Sean, you want to cover that?

Thank you. As I said, we will be starting tomorrow hopefully getting access to the data room, looking at the material that is in there. It is a virtual data room to your question. That could take us two and a half weeks to get get our confirmatory due diligence completed and therefore allow us to then move to finalizing. We've already tabled a draft merger agreement. We have one ready to go so we'll just update it in line with the due diligence and hopefully we'll be engaging very proactively and very respectfully in the days to come with the KCS team and we're looking forward to being in a position to have hopefully a merger agreement in the next 30 to 40 days. Perfect. That's great, caller.

Best of luck. Okay. Thank you.

Thank you. I would like to turn the meeting back over to Mr. JJ Rouet.

Well, thank you. Thank you for joining us today. Obviously, it's an important time in the CN history. As we mentioned earlier, you know, we're proud of our first quarter result. Economy ahead of us looks good. The operating matrix is solid. Fuel efficiency is good. Very important to us also is our safety performance, much improved on the personal injuries and train accidents. So a lot of good things that look good for the quarters to come. On the long-term view, obviously the desire of CN to, you know, give reason to the Board of KCS to consider a combination with us is very much top of mind. And, you know, we're going to be putting a lot of focus and effort onto that in the coming weeks. So Thank you for joining us today and more to come in the weeks and months to come. Thank you.

You're welcome. The conference has now ended. Please disconnect your lines at this time and thank you for your participation.