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FORM 6-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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REPORT OF FOREIGN PRIVATE ISSUER
PURSUANT TO RULE 13a-16 or 15d-16 OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR OCTOBER 29, 2002
Canadian National Railway Company
(Exact name of Registrant as specified in its charter)
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Canadian National Railway Company
(Translation of Registrant's name into English)
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935 de la Gauchetiere Street West
Montreal, Quebec
Canada H3B 2M9
(514) 399-7091
(Address of principal executive offices)
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[Indicate by check mark whether the registrant files or will file annual reports
under cover Form 20-F or Form 40-F:]
FORM 20-F FORM 40-F X
--- ---
[Indicate by check mark whether the registrant by furnishing the information
contained in this form is also thereby furnishing the information to the
Commission pursuant to rule 12g3-2(b) under the Securities Exchange Act of
1934.]
YES NO X
--- ---
[If "Yes " is marked, indicate below the file number assigned to the registrant
in connection with Rule 12g3-2(b):] Not applicable
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Canadian National Railway Company
TABLE OF CONTENTS
Item
----
1. Press release dated October 22, 2002
2. Third-quarter 2002 Financial Statements
3. Certificate of CEO Regarding Facts and Circumstances Relating to
Exchange Act Filings
4. Certificate of CFO Regarding Facts and Circumstances Relating to
Exchange Act Filings
ITEM 1
CANADIAN NATIONAL RAILWAY COMPANY
PRESS RELEASE
--------------------------------------------------------------------------------
[CANADIAN NATIONAL LOGO]
FOR IMMEDIATE RELEASE
Stock symbols: TSX : CNR / NYSE: CNI
www.cn.ca
CN reports third-quarter 2002 financial results
o Third-quarter 2002 net income and diluted earnings per share of $268
million and $1.32, respectively, compared with adjusted net income and
diluted EPS(1) of $240 million and $1.21 for third-quarter 2001
o Revenues of $1,503 million, up 13 per cent on WC acquisition and solid
merchandise revenue performance
o Nine-month free cash flow of $444 million
MONTREAL, Oct. 22, 2002 -- Canadian National today reported third-quarter 2002
net income of $268 million, a 12 per cent increase over adjusted net income (1)
of $240 million for the same quarter of 2001.
Diluted earnings per share for the quarter ended Sept. 30, 2002, were $1.32, up
nine per cent from adjusted diluted earnings per share (1) of $1.21 for the
comparable period of 2001. Reported net income for third-quarter 2001 was $252
million, or $1.27 per diluted share.
Third-quarter 2002 operating income increased 13 per cent to $484 million.
Revenues for the period rose 13 per cent to $1,503 million, while operating
expenses were $1,019 million.
1
CANADIAN NATIONAL RAILWAY COMPANY
PRESS RELEASE
--------------------------------------------------------------------------------
CN President and Chief Executive Officer Paul M. Tellier said: "CN met the
challenge this quarter, turning in good financial results in the face of
devastating drought conditions that continue to weigh heavily on our Western
Canadian grain franchise. Solid gains in our service-sensitive merchandise
businesses - automotive, petroleum and chemicals, intermodal and forest products
- and the consolidation of Wisconsin Central revenues more than offset depressed
bulk commodity revenues. The performance of our merchandise and intermodal units
is particularly satisfying because they will continue to drive much of CN's
growth.
"In addition, we are gratified by CN's strong free cash flow performance. We
generated $444 million in free cash flow for the first nine months of 2002 and
$88 million for the quarter - right on company target.
"For the latest quarter, increased automotive revenues reflected stronger motor
vehicle production in Canada and the United States, while petroleum and
chemicals revenues benefited from the inclusion of WC revenues and continued
strength in the petroleum segment, which experienced higher sulfur shipments and
market share gains in various sectors. Increased intermodal revenues reflected
improved domestic performance from growing markets in Canada and the U.S., and
growth in the overseas segment despite stagnant trade. Forest products revenue
gains were driven by the inclusion of WC revenues and increased lumber and
panels traffic, in line with a strong North American housing market. Improved
market conditions in the Canadian pulp and paper industry also contributed to
third-quarter forest products revenue growth.
"CN will continue to drive productivity improvements and leverage its strong
service capabilities to generate growth, but it remains cautious about near-term
business prospects. Tough conditions will continue to prevail in our grain and
coal businesses. Despite this, CN is determined to deliver improved results in
2003."
Six of CN's seven business units registered revenue gains during the most recent
quarter: forest products (30 per cent); petroleum and chemicals (22 per cent);
automotive (20 per cent); metals and minerals (17 per cent); intermodal (12 per
cent), and coal (six per cent). Grain and fertilizers revenues declined by 15
per cent.
Total carloadings for the third quarter of 2002 rose 14 per cent to 1,043
thousand.
CN's operating ratio for the most recent three-month period was 67.8 per cent,
compared with 67.5 per cent for the year-earlier quarter.
The increase in operating expenses for third-quarter 2002 was largely
attributable to the consolidation of WC expenses and higher expenses for labor
and fringe benefits and equipment rents, which were partially offset by lower
fuel costs.
2
CANADIAN NATIONAL RAILWAY COMPANY
PRESS RELEASE
--------------------------------------------------------------------------------
Results for the first nine months of 2002
Net income for the first nine months of 2002 increased 14 per cent to $778
million from adjusted net income (1) of $682 million for the comparable period
of 2001.
Diluted earnings per share for the nine-month period ended Sept. 30, 2002, were
$3.86, up 12 per cent from adjusted diluted earnings per share (1) of $3.44 for
the year-earlier period. Reported net income for the first nine months of 2001
was $744 million, or $3.75 per diluted share.
Operating income for the first nine months of 2002 was $1,380 million, compared
with $1,259 million - excluding the effect of a special charge to operations to
recognize the costs of a workforce adjustment program - for the same period of
2001. Including the charge, operating income was $1,161 million for last year's
nine-month period.
Nine-month 2002 revenues increased 11 per cent to $4,563 million, while
operating expenses were $3,183 million. Excluding the special charge, operating
expenses for the first nine months of 2001 were $2,856 million; including it,
they were $2,954 million.
Five of CN's business units reported increased revenues for the first nine
months of 2002: forest products (29 per cent); petroleum and chemicals (23 per
cent); metals and minerals (20 per cent); automotive (18 per cent), and
intermodal (six per cent). Grain and fertilizers revenues declined 13 per cent,
and coal revenues declined four per cent.
Total carloadings for the first nine months of 2002 increased 10 per cent to
3,101 thousand.
The financial results in this press release are reported in Canadian dollars and
were determined on the basis of U.S. GAAP.
----------
(1) Adjusted net income and diluted earnings per share for the third quarter of
2001 exclude a deferred income tax recovery of $12 million, or six cents per
share, resulting from the enactment of lower corporate tax rates in Canada.
For the first nine months of 2001, adjusted net income and diluted earnings per
share exclude an after-tax gain of $73 million (36 cents per share) from the
sale of CN's 50 per cent interest in the Detroit River Tunnel Company; a
$62-million after-tax charge (31 cents per share) to operations for a workforce
adjustment program; a $71 million after-tax charge (35 cents per share) to write
down CN's net investment in 360networks Inc.; and a $122 million deferred income
tax recovery (61 cents per share) resulting from the enactment of lower
corporate tax rates in Canada.
Note 10 to the accompanying financial statements provides a reconciliation of
adjusted net income to the Company's net income reported in accordance with
United States generally accepted accounting principles (U.S. GAAP).
This news release contains forward-looking statements. CN cautions that, by
their nature, forward-looking statements involve risk and uncertainties and that
its results could differ materially from those expressed or implied in such
statements. Reference should be made to CN's most recent Form 40-F filed with
the United States Securities and Exchange Commission, and the Annual Information
Form filed with the Canadian securities regulators, for a summary of major
risks.
3
CANADIAN NATIONAL RAILWAY COMPANY
PRESS RELEASE
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Canadian National Railway Company spans Canada and mid-America, from the
Atlantic and Pacific oceans to the Gulf of Mexico, serving the ports of
Vancouver, Prince Rupert, B.C., Montreal, Halifax, New Orleans, and Mobile,
Ala., and the key cities of Toronto, Buffalo, Chicago, Detroit, Duluth,
Minn./Superior, Wis., Green Bay, Wis., Minneapolis/St. Paul, Memphis, St. Louis,
and Jackson, Miss., with connections to all points in North America.
Contacts:
Media Investment Community
----- --------------------
Mark Hallman Robert Noorigian
System Director, Media Relations Vice-President, Investor Relations
(416) 217-6390 (514) 399-0052
4
ITEM 2
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF INCOME (U.S. GAAP)
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(In millions, except per share data)
Three months ended Nine months ended
September 30 September 30
--------------------- --------------------
2002 2001 2002 2001
---------------------------------------------------------------------------------------------------
(Unaudited)
Revenues $ 1,503 $ 1,325 $ 4,563 $ 4,115
---------------------------------------------------------------------------------------------------
Operating expenses excluding special charge 1,019 895 3,183 2,856
Special charge (Note 3) - - - 98
---------------------------------------------------------------------------------------------------
Total operating expenses 1,019 895 3,183 2,954
Operating income 484 430 1,380 1,161
Interest expense (89) (73) (276) (231)
Other income (Note 4) 8 12 69 34
---------------------------------------------------------------------------------------------------
Income before income taxes 403 369 1,173 964
Income tax expense (Note 5) (135) (117) (395) (220)
---------------------------------------------------------------------------------------------------
Net income (Note 10) $ 268 $ 252 $ 778 $ 744
===================================================================================================
Earnings per share (Note 10)
Basic $ 1.34 $ 1.31 $ 3.98 $ 3.88
Diluted $ 1.32 $ 1.27 $ 3.86 $ 3.75
Weighted-average number of shares
Basic 200.3 192.4 195.7 191.9
Diluted 203.0 201.4 203.1 200.7
===================================================================================================
See accompanying notes to consolidated financial statements.
5
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF OPERATING INCOME (U.S. GAAP)
--------------------------------------------------------------------------------
(In millions)
Three months ended September 30 Nine months ended September 30
---------------------------------------- ---------------------------------------
Variance Variance
2002 2001 Fav (Unfav) 2002 2001 Fav (Unfav)
----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues
Petroleum and chemicals $ 275 $ 225 22% $ 819 $ 668 23%
Metals and minerals 138 118 17% 398 332 20%
Forest products 337 260 30% 996 774 29%
Coal 85 80 6% 243 253 (4%)
Grain and fertilizers 217 254 (15%) 741 850 (13%)
Intermodal 273 243 12% 769 724 6%
Automotive 130 108 20% 440 374 18%
Other items 48 37 30% 157 140 12%
---------------------------------------------------------------------- ---------------------------------------
1,503 1,325 13% 4,563 4,115 11%
Operating expenses
Labor and fringe benefits 410 352 (16%) 1,301 1,100 (18%)
Purchased services 148 121 (22%) 428 386 (11%)
Depreciation and amortization 149 131 (14%) 434 394 (10%)
Fuel 109 111 2% 335 375 11%
Equipment rents 85 70 (21%) 264 221 (19%)
Material 48 43 (12%) 166 157 (6%)
Operating taxes 39 34 (15%) 122 115 (6%)
Casualty and other 31 33 6% 133 108 (23%)
Special charge (Note 3) - - - - 98 100%
---------------------------------------------------------------------- ---------------------------------------
1,019 895 (14%) 3,183 2,954 (8%)
---------------------------------------------------------------------- ---------------------------------------
Operating income $ 484 $ 430 13% $ 1,380 $ 1,161 19%
==================================================================================================================================
Operating ratio (excluding special charge) 67.8% 67.5% (0.3) 69.8% 69.4% (0.4)
==================================================================================================================================
See accompanying notes to consolidated financial statements.
6
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED BALANCE SHEET (U.S. GAAP)
--------------------------------------------------------------------------------
(In millions)
September 30 December 31 September 30
2002 2001 2001
----------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 24 $ 53 $ 830
Accounts receivable (Note 6) 715 645 759
Material and supplies 150 133 124
Deferred income taxes (Note 5) 120 153 142
Other 179 180 154
----------------------------------------------------------------------------------------------------
1,188 1,164 2,009
Properties 19,348 19,145 16,395
Other assets and deferred charges (Note 2) 903 914 397
----------------------------------------------------------------------------------------------------
Total assets $ 21,439 $ 21,223 $ 18,801
====================================================================================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable and accrued charges $ 1,377 $ 1,374 $ 1,297
Current portion of long-term debt (Note 6) 699 163 148
Other 71 132 93
----------------------------------------------------------------------------------------------------
2,147 1,669 1,538
Deferred income taxes (Note 5) 4,798 4,591 3,572
Other liabilities and deferred credits 1,205 1,345 1,148
Long-term debt (Note 6) 4,699 5,764 4,968
Convertible preferred securities (Note 7) - 366 363
Shareholders' equity:
Common shares (Note 7) 4,848 4,442 4,415
Accumulated other comprehensive income 102 58 68
Retained earnings 3,640 2,988 2,729
----------------------------------------------------------------------------------------------------
8,590 7,488 7,212
----------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 21,439 $ 21,223 $ 18,801
====================================================================================================
See accompanying notes to consolidated financial statements.
7
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (U.S. GAAP)
--------------------------------------------------------------------------------
(In millions)
Three months ended Nine months ended
September 30 September 30
--------------------- ---------------------
2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------------------------
(Unaudited)
Common shares (1)
Balance, beginning of period $ 4,499 $ 4,402 $ 4,442 $ 4,349
Stock options exercised 10 13 66 66
Conversion of convertible preferred securities (Note 7) 339 - 340 -
-----------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 4,848 $ 4,415 $ 4,848 $ 4,415
=======================================================================================================================
Accumulated other comprehensive income
Balance, beginning of period $ 31 $ 36 $ 58 $ 151
Other comprehensive income (loss):
Unrealized foreign exchange gain (loss) on translation of
U.S. dollar denominated long-term debt designated as a
hedge of the net investment in U.S. subsidiaries (158) (134) 50 (163)
Unrealized foreign exchange gain (loss) on translation of
the net investment in foreign operations 251 197 (52) 248
Unrealized holding loss on investment in 360networks Inc. - - - (129)
Unrealized holding gain (loss) on fuel derivative
instruments (Note 8) 14 (13) 69 (18)
-----------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) before income taxes 107 50 67 (62)
Income tax expense on other comprehensive income (loss)
(Note 5) (36) (18) (23) (21)
-----------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) 71 32 44 (83)
-----------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 102 $ 68 $ 102 $ 68
=======================================================================================================================
Retained earnings
Balance, beginning of period $ 3,415 $ 2,515 $ 2,988 $ 2,098
Net income 268 252 778 744
Dividends (43) (38) (126) (113)
-----------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 3,640 $ 2,729 $ 3,640 $ 2,729
=======================================================================================================================
See accompanying notes to consolidated financial statements.
(1) The Company issued 6.2 million and 7.6 million shares for the three and
nine months ended September 30, 2002, respectively, as a result of stock
options exercised and the conversion of convertible preferred securities.
At September 30, 2002, the Company had 200.3 million common shares
outstanding.
8
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (U.S. GAAP)
--------------------------------------------------------------------------------
(In millions)
Three months ended Nine months ended
September 30 September 30
---------------------- --------------------
2002 2001 2002 2001
-------------------------------------------------------------------------------------------------------------------
(Unaudited)
Operating activities
Net income $ 268 $ 252 $ 778 $ 744
Non-cash items in income:
Depreciation and amortization 151 132 439 398
Deferred income taxes (Note 5) 81 46 237 63
Equity in earnings of English Welsh and
Scottish Railway (4) - (19) -
Gain on sale of investment (Note 4) - - - (101)
Write-down of investment (Note 4) - - - 99
Special charge (Note 3) - - - 98
Changes in:
Accounts receivable (2) (95) (43) (44)
Material and supplies 16 13 (17) (13)
Accounts payable and accrued charges 12 6 32 (101)
Other net current assets and liabilities 8 (12) (4) (15)
Payments for workforce reductions (36) (39) (130) (128)
Other (63) 12 (85) (93)
-------------------------------------------------------------------------------------------------------------------
Cash provided from operating activities 431 315 1,188 907
-------------------------------------------------------------------------------------------------------------------
Investing activities
Net additions to properties (271) (264) (633) (662)
Other, net (29) (23) 15 66
-------------------------------------------------------------------------------------------------------------------
Cash used by investing activities (300) (287) (618) (596)
-------------------------------------------------------------------------------------------------------------------
Dividends paid (43) (38) (126) (113)
Financing activities
Issuance of long-term debt 642 2,034 2,532 2,538
Reduction of long-term debt (807) (1,231) (3,067) (1,973)
Issuance of common shares 8 7 62 52
-------------------------------------------------------------------------------------------------------------------
Cash provided from (used by) financing activities (157) 810 (473) 617
-------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (69) 800 (29) 815
Cash and cash equivalents, beginning of period 93 30 53 15
-------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 24 $ 830 $ 24 $ 830
===================================================================================================================
See accompanying notes to consolidated financial statements.
9
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP)
--------------------------------------------------------------------------------
(in millions)
Note 1 - Basis of presentation
In management's opinion, the accompanying unaudited interim consolidated
financial statements, prepared in accordance with U.S. generally accepted
accounting principles (U.S. GAAP), contain all adjustments (consisting of normal
recurring accruals) necessary to present fairly Canadian National Railway
Company's (the Company) financial position as at September 30, 2002, December 31
and September 30, 2001, its results of operations, changes in shareholders'
equity and cash flows for the three and nine months ended September 30, 2002 and
2001.
These consolidated financial statements and notes have been prepared using
accounting policies consistent with those used in preparing the Company's 2001
Annual Consolidated Financial Statements. While management believes that the
disclosures presented are adequate to make the information not misleading, these
consolidated financial statements and notes should be read in conjunction with
the Company's Annual Consolidated Financial Statements.
Note 2 - Acquisition of Wisconsin Central Transportation Corporation
Wisconsin Central Transportation Corporation (WC) was consolidated effective
October 9, 2001, the date the Company acquired control of WC. Accordingly, the
Company's results of operations for the three and nine months ended September
30, 2001 exclude the results of operations of WC. For comparative purposes only,
if the Company had acquired WC on January 1, 2001, based on the historical
amounts reported by WC, revenues, net income, basic and diluted earnings per
share would have been $1,470 million, $275 million, $1.43 per basic share and
$1.38 per diluted share, respectively, for the three months ended September 30,
2001 and $4,539 million, $793 million, $4.13 per basic share and $4.00 per
diluted share, respectively, for the nine months ended September 30, 2001. These
pro forma figures do not reflect synergies, and accordingly, do not account for
any potential increases in operating income, any estimated cost savings or
facilities consolidation.
In the first quarter of 2002, the Company sold its investment in Tranz Rail
Holdings Limited (Tranz Rail), for net proceeds of $68 million. The Company had
acquired Tranz Rail, a company which operates a 2,400-route mile freight and
passenger rail business in New Zealand, through its acquisition of WC, and had
accounted for it as "available for sale" in accordance with the Financial
Accounting Standards Board's (FASB) Emerging Issues Task Force (EITF) 87-11,
"Allocation of Purchase Price to Assets to be Sold." The difference between the
carrying amount of the investment and the proceeds from sale was not
significant.
Note 3 - Special charge
In the second quarter of 2001, the Company recorded a charge of $98 million, $62
million after tax, for the reduction of 690 positions by the end of 2002. The
charge included severance and other payments to be made to affected employees.
Note 4 - Other income
In June 2001, the Company recorded a charge of $99 million, $71 million after
tax, to write down its net investment in 360networks Inc.
In the first quarter of 2001, the Company recorded a gain of $101 million, $73
million after tax, from the sale of its 50 percent interest in the Detroit River
Tunnel Company (DRT). The DRT is a 1.6-mile rail-only tunnel crossing the
Canada-U.S. border between Detroit and Windsor, Ontario.
Note 5 - Income taxes
In the second and third quarter of 2001, the Company recorded a reduction of $78
million and $12 million, respectively, to its net deferred income tax liability,
resulting from the enactment of lower corporate tax rates in Canada. As a
result, for the three and nine months ended September 30, 2001, a deferred
income tax recovery of $12 million and $122 million, respectively, was recorded
in the Consolidated statement of income. For the nine months ended September 30,
2001, a deferred income tax expense of $32 million was recorded in Other
comprehensive income.
Note 6 - Financing activities
Share repurchase program
On October 22, 2002, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 13 million common
shares between October 25, 2002 and October 24, 2003 pursuant to a normal course
issuer bid, at prevailing market prices.
10
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP)
--------------------------------------------------------------------------------
Revolving credit facilities
The Company has U.S.$1,000 million revolving credit facilities that expire in
March 2003. The credit facility agreements contain customary financial covenants
with which the Company has been in full compliance since the inception of the
agreements. The Company's borrowings of U.S.$172 million (Cdn$273 million)
outstanding at December 31, 2001 were entirely repaid in the first quarter of
2002 and since then, the credit facilities have not been drawn upon. At
September 30, 2002, letters of credit under the revolving credit facilities
amounted to $295 million. The Company currently expects to renew the existing
facilities and to complete the refinancing before their maturity.
Commercial paper
The Company has a commercial paper program, which is backed by a portion of its
revolving credit facilities, enabling it to issue commercial paper up to a
maximum aggregate principal amount of $600 million, or the U.S. dollar
equivalent. The revolving credit facilities will mature in March 2003 and while
the Company's intent is to renew the existing revolving credit facilities, the
refinancing has not been completed and, as such, the outstanding balance of
U.S.$117 million (Cdn$184 million) of commercial paper has been included in the
current portion of long-term debt at September 30, 2002.
Accounts receivable securitization
The Company has a revolving agreement, expiring in June 2003, to sell eligible
freight trade receivables up to a maximum of $350 million of receivables
outstanding at any point in time. At September 30, 2002, pursuant to the
agreement, $168 million and U.S.$113 million (Cdn$178 million) had been sold on
a limited recourse basis reflecting no change in the level of accounts
receivable sold since December 31, 2001.
Note 7 - Termination of conversion rights of 5.25% Convertible preferred
securities ("Securities")
On May 6, 2002, the Company announced that it had met the conditions required to
terminate the Securities holders' right to convert their Securities into common
shares of the Company, and set the conversion termination date as July 3, 2002.
The conditions were met when the Company's common share price exceeded 120% of
the conversion price of U.S.$38.48 per share (as adjusted, following the
Company's two-for-one common stock split in September 1999) for a specified
period, and all accrued interest on the Securities had been paid.
On July 3, 2002, the closing price of the Company's common shares exceeded the
conversion price of U.S.$38.48 per share. As a result, Securities that had not
been previously surrendered for conversion were converted, resulting in the
issuance of approximately 6 million common shares of the Company.
11
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP)
--------------------------------------------------------------------------------
Note 8 - Derivative instruments
At September 30, 2002, a portion of the Company's fuel requirement has been
hedged using derivative instruments that are carried at market value on the
balance sheet. These fuel hedges are accounted for as cash flow hedges whereby
the effective portion of the change in the market value of the derivative
instruments has been recorded in Other comprehensive income. At September 30,
2002, Accumulated other comprehensive income included an unrealized holding gain
of $31 million, $21 million after tax, ($38 million unrealized holding loss, $25
million after tax at December 31, 2001) of which $29 million relates to
derivative instruments that will mature within the next twelve months.
Note 9 - Commitments
At September 30, 2002, the Company had commitments to acquire railroad ties,
rail, freight cars and locomotives at an aggregate cost of $223 million ($52
million at December 31, 2001).
12
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP)
--------------------------------------------------------------------------------
Note 10 - Net income and earnings per share
In addition to the consolidation of the WC results of operations for the three
and nine months ended September 30, 2002 as explained in Note 2, the
comparability of the results of operations for the three and nine months ended
September 30, 2002 and 2001 is also impacted by the following items:
Three months ended Nine months ended
September 30 September 30
--------------------------------- ---------------------------------
2002 2001 2001 2002 2001 2001
pro forma pro forma
(1) (1)
-----------------------------------------------------------------------------------------------------------------------------------
(In millions) (Unaudited)
Income before income taxes, excluding undernoted items $ 403 $ 369 $ 407 $ 1,173 $ 1,060 $ 1,136
Income tax expense (135) (129) (144) (395) (378) (405)
-----------------------------------------------------------------------------------------------------------------------------------
Adjusted net income 268 240 263 778 682 731
Undernoted items, net of tax:
Special charge for workforce reductions - - - - (62) (62)
Write-down of net investment in 360networks Inc. - - - - (71) (71)
Deferred income tax recovery - 12 12 - 122 122
Gain on sale of Detroit River Tunnel Company - - - - 73 73
-----------------------------------------------------------------------------------------------------------------------------------
- 12 12 - 62 62
Net income $ 268 $ 252 $ 275 $ 778 $ 744 $ 793
===================================================================================================================================
The following table provides a reconciliation between basic and diluted earnings
per share:
Three months ended Nine months ended
September 30 September 30
--------------------------------- ---------------------------------
2002 2001 2001 2002 2001 2001
pro forma pro forma
(1) (1)
-----------------------------------------------------------------------------------------------------------------------------------
(In millions, except per share data) (Unaudited)
Net income $ 268 $ 252 $ 275 $ 778 $ 744 $ 793
Income impact on assumed conversion of
preferred securities (Note 7) - 3 3 6 9 9
-----------------------------------------------------------------------------------------------------------------------------------
$ 268 $ 255 $ 278 $ 784 $ 753 $ 802
Weighted-average shares outstanding 200.3 192.4 192.4 195.7 191.9 191.9
Effect of dilutive securities and stock options 2.7 9.0 9.0 7.4 8.8 8.8
-----------------------------------------------------------------------------------------------------------------------------------
Weighted-average diluted shares outstanding 203.0 201.4 201.4 203.1 200.7 200.7
Basic earnings per share $ 1.34 $ 1.31 $ 1.43 $ 3.98 $ 3.88 $ 4.13
Diluted earnings per share $ 1.32 $ 1.27 $ 1.38 $ 3.86 $ 3.75 $ 4.00
===================================================================================================================================
(1) The pro forma figures reflect the Company's results of operations as if the
Company had acquired WC on January 1, 2001.
13
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP)
--------------------------------------------------------------------------------
Note 11 - Stock-based compensation expense
Compensation expense for certain performance-based stock-option awards under the
Company's various stock option plans is determined by the options' intrinsic
value in accordance with Accounting Principles Board Opinion (APB) 25,
"Accounting for Stock Issued to Employees," and related interpretations. Had
compensation expense been determined based upon fair values at the date of grant
for awards under all plans, consistent with the methods of Statement of
Financial Accounting Standards (SFAS) No.123, "Accounting for Stock-Based
Compensation," the Company's net income and earnings per share for the three and
nine months ended September 30, 2002 and 2001 would have been as follows:
Three months ended Nine months ended
September 30 September 30
------------------- --------------------
2002 2001 2002 2001
-----------------------------------------------------------------------------
Net income (in millions) $ 254 $ 247 $ 751 $ 729
Basic earnings per share $ 1.27 $ 1.28 $ 3.84 $ 3.80
Diluted earnings per share $ 1.25 $ 1.24 $ 3.73 $ 3.68
=============================================================================
These amounts include compensation cost as calculated using the Black-Scholes
option-pricing model with the following assumptions:
Three months ended Nine months ended
September 30 September 30
------------------- --------------------
2002(1) 2001 2002 2001
-----------------------------------------------------------------------------
Expected option life (years) - 7.0 7.0 7.0
Risk-free interest rate - 5.36% 5.79% 5.36%
Expected stock price volatility - 30% 30% 30%
Average dividend per share - $ 0.78 $ 0.86 $ 0.78
=============================================================================
Three months ended Nine months ended
September 30 September 30
------------------- --------------------
2002(1) 2001 2002 2001
-----------------------------------------------------------------------------
Weighted average fair value
of options granted $ - $ 23.42 $ 30.98 $ 18.76
=============================================================================
(1) In the third quarter of 2002, the Company did not grant any stock-option
awards.
14
CANADIAN NATIONAL RAILWAY COMPANY
SELECTED RAILROAD STATISTICS (U.S. GAAP)
--------------------------------------------------------------------------------
Three months ended Nine months ended
September 30 September 30
--------------------- ----------------------
2002 2001(1) 2002 2001(1)
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Rail operations
Freight revenues ($ millions) 1,455 1,288 4,406 3,975
Gross ton miles (millions) 75,687 69,408 229,677 216,863
Revenue ton miles (RTM) (millions) 39,460 35,909 119,081 113,267
Route miles (includes Canada and the U.S.) 17,843 15,476 17,843 15,476
Operating expenses per RTM (cents)(2) 2.58 2.49 2.67 2.52
Freight revenue per RTM (cents) 3.69 3.59 3.70 3.51
Carloads (thousands) 1,043 915 3,101 2,814
Freight revenue per carload ($) 1,395 1,408 1,421 1,413
Diesel fuel consumed (Liters in millions) 334 305 1,047 987
Average fuel price ($/Liter) 0.32 0.35 0.31 0.36
Revenue ton miles per liter of fuel consumed 118 118 114 115
Gross ton miles per liter of fuel consumed 227 228 219 220
Diesel fuel consumed (U.S. gallons in millions) 89 81 277 261
Average fuel price ($/U.S. gallon) 1.23 1.28 1.19 1.33
Revenue ton miles per U.S. gallon of fuel consumed 443 443 430 434
Gross ton miles per U.S. gallon of fuel consumed 850 857 829 831
Locomotive bad order ratio (%)(3) 6.9 6.6 6.9 7.2
Freight car bad order ratio (%) 5.9 5.6 6.0 5.8
------------------------------------------------------------------------------------------------------------------------------------
Productivity
Operating ratio (%)(2) 67.8 67.5 69.8 69.4
Freight revenue per route mile ($ thousands) 82 83 247 257
Revenue ton miles per route mile (thousands) 2,212 2,320 6,674 7,319
Freight revenue per average number of employees ($ thousands) 62 57 190 179
Revenue ton miles per average number of employees (thousands) 1,669 1,586 5,126 5,096
------------------------------------------------------------------------------------------------------------------------------------
Employees
Number at end of period 23,484 22,410 23,484 22,410
Average number during period 23,647 22,646 23,231 22,227
Labor and fringe benefits expense per RTM (cents) 1.04 0.98 1.09 0.97
Injury frequency rate per 200,000 person hours 3.4 4.2 3.1 4.3
Accident rate per million train miles 2.2 1.7 2.2 1.8
------------------------------------------------------------------------------------------------------------------------------------
Financial
Debt to total capitalization ratio (% at end of period) 38.6 43.2 38.6 43.2
Return on assets (% at end of period) 1.5 1.6 4.4 4.7
====================================================================================================================================
(1) 2001 data exclude WC which was acquired and consolidated effective October
9, 2001.
(2) 2001 figures exclude special charge.
(3) In 2002, the Company expanded its measure of bad order locomotives to
include all those not available for service, including on-line failures.
The 2001 figures have been restated accordingly.
15
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY INFORMATION (U.S. GAAP)
--------------------------------------------------------------------------------
Three months ended September 30 Nine months ended September 30
------------------------------------- --------------------------------------
Variance Variance
2002 2001(1) Fav (Unfav) 2002 2001(1) Fav (Unfav)
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenue ton miles (millions)
Petroleum and chemicals 7,538 6,181 22% 22,222 18,299 21%
Metals and minerals 3,574 2,618 37% 10,012 7,712 30%
Forest products 8,508 7,193 18% 25,200 21,699 16%
Coal 3,872 3,795 2% 10,786 11,789 (9%)
Grain and fertilizers 7,800 8,982 (13%) 26,913 31,933 (16%)
Intermodal 7,429 6,481 15% 21,500 19,686 9%
Automotive 739 659 12% 2,448 2,149 14%
--------------------------------------------------------------------------- ---------------------
39,460 35,909 10% 119,081 113,267 5%
Freight revenue / RTM (cents)
Total freight revenue per RTM 3.69 3.59 3% 3.70 3.51 5%
Business units:
Petroleum and chemicals 3.65 3.64 - 3.69 3.65 1%
Metals and minerals 3.86 4.51 (14%) 3.98 4.30 (7%)
Forest products 3.96 3.61 10% 3.95 3.57 11%
Coal 2.20 2.11 4% 2.25 2.15 5%
Grain and fertilizers 2.78 2.83 (2%) 2.75 2.66 3%
Intermodal 3.67 3.75 (2%) 3.58 3.68 (3%)
Automotive 17.59 16.39 7% 17.97 17.40 3%
--------------------------------------------------------------------------- ---------------------
Carloads (thousands)
Petroleum and chemicals 147 126 17% 438 383 14%
Metals and minerals 104 69 51% 294 195 51%
Forest products 151 116 30% 452 359 26%
Coal 127 125 2% 374 391 (4%)
Grain and fertilizers 123 136 (10%) 400 434 (8%)
Intermodal 319 273 17% 904 828 9%
Automotive 72 70 3% 239 224 7%
--------------------------------------------------------------------------- ---------------------
1,043 915 14% 3,101 2,814 10%
Freight revenue / carload (dollars)
Total freight revenue per carload 1,395 1,408 (1%) 1,421 1,413 1%
Business units:
Petroleum and chemicals 1,871 1,786 5% 1,870 1,744 7%
Metals and minerals 1,327 1,710 (22%) 1,354 1,703 (20%)
Forest products 2,232 2,241 - 2,204 2,156 2%
Coal 669 640 5% 650 647 -
Grain and fertilizers 1,764 1,868 (6%) 1,853 1,959 (5%)
Intermodal 856 890 (4%) 851 874 (3%)
Automotive 1,806 1,543 17% 1,841 1,670 10%
===================================================================================================================================
(1) 2001 data exclude WC which was acquired and consolidated effective October
9, 2001.
16
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY INFORMATION
PRO FORMA CONSOLIDATED STATEMENT OF INCOME (U.S. GAAP)
--------------------------------------------------------------------------------
(In millions, except per share data)
Three months ended September 30 Nine months ended September 30
------------------------------------- ------------------------------------
2002 2001 Variance 2002 2001 Variance
pro forma(1) Fav (Unfav) pro forma(1) Fav (Unfav)
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues
Petroleum and chemicals $ 275 $ 248 11% $ 819 $ 736 11%
Metals and minerals 138 149 (7%) 398 413 (4%)
Forest products 337 319 6% 996 954 4%
Coal 85 87 (2%) 243 275 (12%)
Grain and fertilizers 217 267 (19%) 741 893 (17%)
Intermodal 273 252 8% 769 747 3%
Automotive 130 108 20% 440 374 18%
Other items 48 40 20% 157 147 7%
--------------------------------------------------------------------------- ----------------------
1,503 1,470 2% 4,563 4,539 1%
Operating expenses
Labor and fringe benefits 410 395 (4%) 1,301 1,235 (5%)
Purchased services 148 129 (15%) 428 416 (3%)
Depreciation and amortization 149 143 (4%) 434 426 (2%)
Fuel 109 122 11% 335 409 18%
Equipment rents 85 77 (10%) 264 243 (9%)
Material 48 47 (2%) 166 178 7%
Operating taxes 39 36 (8%) 122 121 (1%)
Casualty and other 31 34 9% 133 120 (11%)
Special charge - - - - 98 100%
--------------------------------------------------------------------------- ----------------------
1,019 983 (4%) 3,183 3,246 2%
Operating income 484 487 (1%) 1,380 1,293 7%
Interest expense (89) (99) (276) (310)
Other income 8 19 69 57
--------------------------------------------------------------------------- ----------------------
Income before income taxes 403 407 1,173 1,040
Income tax expense (135) (132) (395) (247)
--------------------------------------------------------------------------- ----------------------
Net income $ 268 $ 275 $ 778 $ 793
==================================================================================================================================
Operating ratio (excluding special charge) 67.8% 66.9% (0.9) 69.8% 69.4% (0.4)
==================================================================================================================================
Diluted earnings per share $ 1.32 $ 1.38 $ 3.86 $ 4.00
Adjusted diluted earnings per share (2) $ 1.32 $ 1.32 $ 3.86 $ 3.69
Diluted weighted-average number of shares 203.0 201.4 203.1 200.7
==================================================================================================================================
(1) The pro forma figures reflect the Company's results of operations as if the
Company had acquired WC on January 1, 2001.
(2) 2001 excludes the gain on sale of DRT, the special charge for workforce
reductions, the charge to write down the net investment in 360networks
Inc., and the deferred income tax recovery resulting from the enactment of
lower corporate tax rates in Canada.
17
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY PRO FORMA INFORMATION (U.S. GAAP)
--------------------------------------------------------------------------------
Three months ended September 30 Nine months ended September 30
------------------------------------- ------------------------------------
2002 2001 Variance 2002 2001 Variance
pro forma(1) Fav (Unfav) pro forma(1) Fav (Unfav)
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenue ton miles (millions)
Petroleum and chemicals 7,538 6,484 16% 22,222 19,222 16%
Metals and minerals 3,574 3,448 4% 10,012 10,189 (2%)
Forest products 8,508 8,052 6% 25,200 24,331 4%
Coal 3,872 4,153 (7%) 10,786 12,797 (16%)
Grain and fertilizers 7,800 9,183 (15%) 26,913 32,627 (18%)
Intermodal 7,429 6,535 14% 21,500 19,840 8%
Automotive 739 660 12% 2,448 2,153 14%
-------------------------------------------------------------------------- ----------------------
39,460 38,515 2% 119,081 121,159 (2%)
Freight revenue / RTM (cents)
Total freight revenue per RTM 3.69 3.71 (1%) 3.70 3.62 2%
Business units:
Petroleum and chemicals 3.65 3.82 (4%) 3.69 3.83 (4%)
Metals and minerals 3.86 4.32 (11%) 3.98 4.05 (2%)
Forest products 3.96 3.96 - 3.95 3.92 1%
Coal 2.20 2.09 5% 2.25 2.15 5%
Grain and fertilizers 2.78 2.91 (4%) 2.75 2.74 -
Intermodal 3.67 3.86 (5%) 3.58 3.77 (5%)
Automotive 17.59 16.36 8% 17.97 17.37 3%
-------------------------------------------------------------------------- ----------------------
Carloads (thousands)
Petroleum and chemicals 147 135 9% 438 410 7%
Metals and minerals 104 120 (13%) 294 328 (10%)
Forest products 151 147 3% 452 456 (1%)
Coal 127 135 (6%) 374 420 (11%)
Grain and fertilizers 123 143 (14%) 400 455 (12%)
Intermodal 319 288 11% 904 871 4%
Automotive 72 70 3% 239 224 7%
-------------------------------------------------------------------------- ----------------------
1,043 1,038 - 3,101 3,164 (2%)
Freight revenue / carload (dollars)
Total freight revenue per carload 1,395 1,378 1% 1,421 1,388 2%
Business units:
Petroleum and chemicals 1,871 1,837 2% 1,870 1,795 4%
Metals and minerals 1,327 1,242 7% 1,354 1,259 8%
Forest products 2,232 2,170 3% 2,204 2,092 5%
Coal 669 644 4% 650 655 (1%)
Grain and fertilizers 1,764 1,867 (6%) 1,853 1,963 (6%)
Intermodal 856 875 (2%) 851 858 (1%)
Automotive 1,806 1,543 17% 1,841 1,670 10%
===================================================================================================================================
(1) The pro forma data has been prepared assuming the Company had acquired WC
on January 1, 2001.
18
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
Management's discussion and analysis relates to the financial condition and
results of operations of Canadian National Railway Company (CN) together with
its wholly owned subsidiaries, including Grand Trunk Corporation (GTC), Illinois
Central Corporation (IC) and Wisconsin Central Transportation Corporation (WC),
the latter from October 9, 2001. As used herein, the word "Company" means, as
the context requires, CN and its subsidiaries. CN's common shares are listed on
the Toronto and New York stock exchanges. Except where otherwise indicated, all
financial information reflected herein is expressed in Canadian dollars and
determined on the basis of United States generally accepted accounting
principles (U.S. GAAP). The Company also prepares consolidated financial
statements in accordance with Canadian GAAP, which are included in this
document. The Canadian GAAP financial statements are different in some respects
from these financial statements, principally in the treatment of track
replacement costs, expenditures relating to improvements of bridges and other
structures and freight cars, derivative instruments, stock-based compensation
and convertible preferred securities.
FINANCIAL RESULTS
Third quarter and first nine months of 2002 compared to corresponding periods in
2001
The Company consolidated WC effective October 9, 2001, the date it acquired
control of WC. Accordingly, in the following discussion, the Company's results
of operations for the three and nine months ended September 30, 2001 exclude the
results of operations of WC. Hereafter, pro forma refers to the consolidation of
the results of operations of WC, assuming the acquisition and control of WC
occurred on January 1, 2001.
The Company recorded consolidated net income of $268 million ($1.34 per basic
share or $1.32 per diluted share) for the quarter ended September 30, 2002
compared to consolidated net income of $252 million ($1.31 per basic share or
$1.27 per diluted share) in the third quarter of 2001, an increase of $16
million ($0.03 per basic share or $0.05 per diluted share). Consolidated net
income for the nine months ended September 30, 2002 was $778 million ($3.98 per
basic share or $3.86 per diluted share) compared to $744 million ($3.88 per
basic share or $3.75 per diluted share) in the same period of 2001.
Operating income was $484 million for the third quarter of 2002 compared to $430
million in the same quarter of 2001. For the first nine months of the year,
operating income was $1,380 million compared to $1,161 million in the same
period of 2001. The operating ratio increased to 67.8% in the current quarter
from 67.5% in the third quarter of 2001, a 0.3-point increase.
The three and nine-month periods ended September 30, 2001 included items
impacting the comparability of the results of operations to those in the
respective periods of 2002. Included in the third quarter and nine months ended
September 30, 2001 was a deferred income tax recovery of $12 million ($0.06 per
basic and diluted share) and $122 million ($0.64 per basic share or $0.61 per
diluted share) respectively, resulting from the enactment of lower corporate tax
rates in Canada. The nine-month period ended September 30, 2001 also included a
special charge for workforce reductions of $98 million, $62 million after tax
($0.32 per basic share or $0.31 per diluted share), a charge to write down the
Company's net investment in 360networks Inc. of $99 million, $71 million after
tax ($0.37 per basic share or $0.35 per diluted share), and a gain of $101
million, $73 million after tax ($0.38 per basic share or $0.36 per diluted
share) related to the sale of its 50 percent interest in the Detroit River
Tunnel Company (DRT).
Excluding the aforementioned items, net income in the current quarter increased
by $28 million ($0.09 per basic share or $0.11 per diluted share) from net
income of $240 million ($1.25 per basic share or $1.21 per diluted share) for
the same quarter last year. For the nine months ended September 30, 2002, net
income increased by $96 million ($0.43 per basic share or $0.42 per diluted
share), from $682 million ($3.55 per basic share or $3.44 per diluted share) for
the same period in 2001.
Excluding the 2001 special charge, operating income for the nine-month period
ended September 30, 2002,
19
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
increased by $121 million, or 10%, to $1,380 million from $1,259 million in the
same period last year. The nine-month operating ratio, excluding the 2001
special charge, increased to 69.8% in 2002 from 69.4% in 2001, a 0.4-point
increase.
Comparison to 2001 pro forma
Excluding the 2001 item previously discussed, net income in the current quarter
increased by $5 million (a decrease of $0.03 per basic share or unchanged on a
diluted share basis) from pro forma net income of $263 million ($1.37 per basic
share or $1.32 per diluted share) in the comparative 2001 quarter. For the nine
months ended September 30, 2002, net income, excluding the 2001 items previously
discussed, increased by $47 million ($0.18 per basic share or $0.17 per diluted
share) from pro forma net income of $731 million ($3.80 per basic share or $3.69
per diluted share) in the same 2001 period.
Revenues for the third quarter of 2002 increased by $33 million, or 2%, when
compared to pro forma revenues of $1,470 million in the same 2001 period. For
the nine-month period ended September 30, 2002, revenues increased by $24
million, or 1%, when compared to pro forma revenues of $4,539 million in the
same period last year.
Operating expenses in the current quarter increased by $36 million, or 4%, from
pro forma operating expenses of $983 million in the same quarter of 2001. For
the first nine months of 2002, operating expenses increased by $35 million, or
1%, from pro forma operating expenses, excluding the special charge, of $3,148
million in the same period last year.
Operating income for the third quarter of 2002 was $484 million, a decrease of
$3 million, or 1%, when compared to pro forma operating income of $487 million
in the comparable 2001 quarter. The operating ratio increased to 67.8% in the
current quarter from the pro forma operating ratio of 66.9% in the same quarter
of 2001. For the nine-month period ended September 30, 2002, operating income
was $1,380 million, a decrease of $11 million, from pro forma operating income,
excluding the special charge, of $1,391 million in the comparable 2001 period.
The nine-month operating ratio increased to 69.8% in 2002 from the pro forma
operating ratio, excluding the special charge, of 69.4% in 2001.
Revenues
Revenues in the third quarter of 2002 totaled $1,503 million compared to $1,325
million during the same period in 2001, an increase of $178 million, or 13%.
Revenues for the first nine months of 2002 were $4,563 million, an increase of
$448 million, or 11%, from the same period last year. The increase in the
quarter and first nine months was mainly attributable to the consolidation of WC
revenues and to gains in petroleum and chemicals, automotive, intermodal and
forest products. Partly offsetting these gains were continued weakness in
Canadian grain, and coal revenues. Also contributing to the nine-month increase
was the impact of the weaker Canadian dollar, particularly in the petroleum and
chemicals, forest products and automotive business units.
Revenue ton miles increased by 10% in the quarter and 5% in the nine-month
period ended September 30, 2002 when compared to the same periods in 2001.
Freight revenue per revenue ton mile for the quarter and first nine months of
the year increased by 3% and 5%, respectively, when compared to the same periods
last year.
Petroleum and chemicals: Revenues increased by $50 million, or 22%, for the
third quarter and $151 million, or 23%, for the first nine months when compared
to the same periods in 2001. Growth in the quarter and nine-month period was
mainly due to the inclusion of WC revenues and continued strength in the
petroleum segment, including strong sulfur shipments and market share gains in
various sectors. Revenue per revenue ton mile for the current quarter remained
unchanged and increased by 1% during the first nine months of 2002, as the
inclusion of shorter haul WC traffic and the effects of the weaker Canadian
dollar were offset by an increase in longer haul traffic.
Metals and minerals: Revenues increased by $20 million, or 17%, for the third
quarter and $66 million, or 20%, for the first nine months when compared to the
same periods in 2001. The increase in the quarter and first nine months was
mainly due
20
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
to the inclusion of WC revenues, market share gains in the aluminum sector and
strong construction materials traffic, partly offset by one-time gains in 2001.
Also impacting the quarter were market share gains in the steel industry that
were offset by reduced traffic in specific segments due to ongoing customer
strikes. Revenue per revenue ton mile decreased by 14% in the current quarter
and 7% for the first nine months of the year mainly due to an increase in longer
haul traffic and the inclusion of certain lower-rated WC traffic.
Forest products: Revenues increased by $77 million, or 30%, for the third
quarter and $222 million, or 29%, for the first nine months when compared to the
same periods in 2001. Growth in the quarter and first nine months of the year
was mainly due to the inclusion of WC revenues and, increased lumber and panels
traffic, in line with a strong North American housing market. Improved market
conditions in the Canadian pulp and paper industry also contributed to third
quarter growth. The increase in revenue per revenue ton mile of 10% in the
current quarter and 11% in the first nine months of 2002 was mainly due to the
inclusion of shorter haul WC traffic and the effect of the weaker Canadian
dollar.
Coal: Revenues increased by $5 million, or 6%, for the third quarter and
decreased by $10 million, or 4%, for the first nine months when compared to the
same periods in 2001. The increase in the quarter reflected the inclusion of WC
revenues, partly offset by some weakness in CN coal traffic on a year-over-year
basis. The decrease in the nine-month period was mainly due to reduced demand
from power utilities and weak Canadian coal exports to offshore markets. The
revenue per revenue ton mile increase of 4% in the current quarter and 5% during
the first nine months of 2002 was mainly due to a decrease in longer haul
traffic and the effect of the weaker Canadian dollar.
Grain and fertilizers: Revenues decreased by $37 million, or 15%, for the third
quarter and $109 million, or 13%, for the first nine months when compared to the
same periods in 2001. The decline in both the quarter and first nine months of
2002 reflected a significant deterioration in the Canadian grain crop. The third
quarter was also impacted by the loss of a potash move and a decline in United
States originating grain traffic. The 2% decrease in revenue per revenue ton
mile in the current quarter was mainly attributable to a shift in traffic mix.
For the first nine months, revenue per revenue ton mile increased by 3% mainly
as a result of an increase in regulated grain rates and a decline in longer haul
traffic.
Intermodal: Revenues increased by $30 million, or 12%, for the third quarter and
$45 million, or 6%, for the first nine months when compared to the same periods
in 2001. The increase in the quarter and first nine months of 2002 was
attributable to growth in both the overseas and domestic segments. Growth in the
overseas segment was achieved in spite of stagnant trade and the loss of an
overseas move in the second half of 2001. The domestic segment benefited from
growing markets in both Canada and the United States. The decrease in revenue
per revenue ton mile of 2% for the current quarter and 3% for the first nine
months of 2002 was mainly attributable to the fuel surcharge in 2001 and an
increase in the average length of haul.
Automotive: Revenues increased by $22 million, or 20%, for the third quarter and
$66 million, or 18%, for the first nine months when compared to the same periods
in 2001, reflecting stronger motor vehicle production in both Canada and the
United States. The 7% revenue per revenue ton mile increase for the current
quarter and 3% increase for the first nine months of 2002 was mainly
attributable to the weaker Canadian dollar.
21
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
Operating expenses
In the third quarter of 2002, operating expenses amounted to $1,019 million
compared to $895 million in the same quarter of 2001. Operating expenses for the
first nine months of 2002 were $3,183 million compared to $2,954 million in the
same period of 2001.
Excluding the 2001 special charge for workforce reductions, operating expenses
for the first nine months of the year increased by $327 million, or 11%, from
$2,856 million in the same period of 2001. The increases in the quarter and
first nine months of 2002 were mainly due to the consolidation of WC expenses,
higher expenses for labor and fringe benefits and equipment rents, partially
offset by lower fuel costs.
Labor and fringe benefits: Labor and fringe benefit expenses in 2002 increased
by $58 million, or 16%, for the third quarter and $201 million, or 18%, for the
first nine months when compared to the same 2001 periods. The increase in the
quarter and first nine months of the year was mainly attributable to the
inclusion of WC expenses ($42 million for the quarter and $127 million for the
nine-month period), wage increases, higher benefit expenses, including health
and welfare and other post-retirement benefits, and the impact of the weaker
Canadian dollar on U.S. denominated expenses. These increases were partly offset
by the effects of a reduced workforce in 2002.
Purchased services: The costs of purchased services increased by $27 million, or
22%, for the quarter and $42 million, or 11%, for the nine-month period ended
September 30, 2002, when compared to corresponding periods in 2001. The increase
in the quarter and first nine months of the year was mainly due to the inclusion
of WC expenses and higher expenses for professional services and equipment
repairs.
Depreciation and amortization: Depreciation and amortization expense for the
quarter and nine months ended September 30, 2002, increased by $18 million, or
14%, and $40 million, or 10%, respectively, from the comparable 2001 periods.
The increase in the quarter and first nine months of the year was mainly due to
the inclusion of WC expenses and the impact of capital additions in 2002.
Fuel: Fuel expense decreased by $2 million, or 2%, for the third quarter and $40
million, or 11%, for the first nine months of 2002, when compared to the
respective 2001 periods. The decrease in the quarter and first nine months of
the year was primarily due to a decrease in the average price of fuel, partially
offset by the inclusion of WC expenses.
Equipment rents: These expenses increased by $15 million, or 21%, in the quarter
and $43 million, or 19%, for the first nine months of the year, when compared to
the same 2001 periods. The increase in the quarter and first nine months of the
year was mainly due to the inclusion of WC expenses and lower car hire income.
Material: For the quarter and nine months ended September 30, 2002, material
costs increased by $5 million, or 12%, and $9 million, or 6%, respectively, from
the comparable 2001 periods. The increase in the quarter and first nine months
of the year was mainly due to the inclusion of WC expenses that were partly
offset by lower locomotive and car maintenance costs.
Operating taxes: Operating taxes increased by $5 million, or 15%, during the
third quarter and $7 million, or 6%, during the nine-month period ended
September 30, 2002 when compared to the corresponding 2001 periods. The increase
in the quarter and first nine months of the year was mainly due to the inclusion
of WC expenses and lower recoveries in 2002.
Casualty and other: These expenses decreased by $2 million, or 6%, in the
current quarter and increased by $25 million, or 23%, for the first nine months
of 2002, when compared to the corresponding 2001 periods. The decrease in the
current quarter is due to lower expenses for casualty and legal claims,
including occupational-related claims, partly offset by the inclusion of WC
expenses. The increase in the nine-month period was mainly due to higher
expenses for casualty and legal claims, including occupational-related claims,
and higher derailment-related expenses that were partly
22
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
offset by lower expenses related to environmental matters and bad debts.
Other
Interest expense: Interest expense for the third quarter increased by $16
million, or 22%, from the comparable 2001 quarter and $45 million, or 19%, in
the first nine months of 2002 versus the equivalent 2001 period. The increase in
the quarter and first nine months of the year was mainly due to the financing
related to the acquisition of WC and the inclusion of WC expenses. Partly
offsetting these increases was lower interest expense related to the conversion
of the convertible preferred securities in July 2002 and the maturity of certain
notes in the first nine months of 2001.
Other income: The Company recorded other income of $8 million for the third
quarter of 2002 compared to $12 million in the same period of 2001. The decrease
is mainly due to lower gains on disposal of surplus assets, partly offset by the
Company's equity in earnings of English Welsh and Scottish Railway (EWS) of $4
million. On September 30, 2002, the Company completed the sale of IC Terminal
Holdings Company for net sales proceeds of U.S.$18 million (Cdn$28 million),
which approximated the carrying value of the investment. Excluding the impact of
the 2001 DRT and 360networks Inc. transactions previously discussed, other
income for the first nine months of 2002 increased to $69 million from $32
million in the comparable period of 2001. The increase was mainly due to the
Company's equity in earnings of EWS of $19 million and higher gains on disposal
of surplus assets.
Income tax expense: The Company recorded an income tax expense of $135 million
for the current quarter and $117 million for the corresponding period in 2001.
Income tax expense was $395 million for the nine months ended September 30, 2002
and $220 million for the comparable 2001 period. When compared to 2001, the
increase in income tax expense for the quarter and nine-month period is mainly
due to a 2001 deferred income tax recovery of $122 million, of which $12 million
was recorded in the third quarter, resulting from the enactment of lower
corporate tax rates in Canada. The effective tax rate for the quarter and nine
months ended September 30, 2002 was 33.5% and 33.7%, respectively. The effective
tax rate for the comparative 2001 periods was 35.0% and 35.7%, respectively,
excluding the deferred income tax recovery and, the income tax effect on the
special charge, the DRT transaction and the charge for 360networks Inc.
23
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of liquidity is cash generated from operations.
The Company also has the ability to fund liquidity requirements through its
revolving credit facilities, the issuance of debt and/or equity, and the sale of
a portion of its accounts receivable through the Accounts receivable
securitization program. In addition, from time to time, the Company's liquidity
requirements can be supplemented by the disposal of surplus properties and the
monetization of assets.
Operating activities: Cash provided from operating activities was $431 million
and $1,188 million for the three and nine-month periods ended September 30,
2002, respectively, compared to $315 million and $907 million for the same 2001
periods. Net income, excluding non-cash items, generated cash of $496 million
for the current quarter and $1,435 million for the nine months ended September
30, 2002, compared to $430 million and $1,301 million in the corresponding 2001
periods. Cash generated in the first nine months of 2002 was partially consumed
by payments for workforce reductions and income taxes of $130 million and $88
million, respectively, compared to $128 million and $70 million, respectively,
for the same period last year. Payments for casualty and legal claims, including
amounts paid for workers' compensation, for the first nine months of 2002 and
2001 were $105 million and $119 million, respectively.
Investing activities: Cash used by investing activities in the quarter and nine
months ended September 30, 2002 amounted to $300 million and $618 million,
respectively, compared to $287 million and $596 million for the comparable
periods in 2001. The Company's investing activities in the first nine months of
2002 included net proceeds of $68 million from the sale of its investment in
Tranz Rail Holdings Limited, whereas the comparative period included net
proceeds of $112 million from the sale of DRT. Net capital expenditures amounted
to $271 million and $633 million in the three and nine months ended September
30, 2002, respectively, an increase of $7 million and a decrease of $29 million
from the same 2001 periods. Capital expenditures included expenditures for
roadway renewal, rolling stock, and other capacity and productivity
improvements.
The Company anticipates that capital expenditures for 2002 will remain at
approximately the same level as 2001. This will include funds required for
ongoing renewal of the basic plant and other acquisitions and investments
required to improve the Company's operating efficiency and customer service.
Dividends: The Company paid a quarterly dividend of $0.215 per share amounting
to $43 million for the third quarter and $126 million for the first nine months
of 2002 compared to $38 million and $113 million, respectively, at the rate of
$0.195 per share, for the same periods in 2001.
Free cash flow
The Company generated $88 million and $444 million of free cash flow for the
three and nine months ended September 30, 2002, respectively, compared to cash
consumed of $10 million and cash generated of $198 million for the same 2001
periods. The Company defines free cash flow as cash provided from operating
activities less capital expenditures, other investing activities and dividends
paid.
Financing activities: Cash used by financing activities totaled $157 million for
the third quarter and $473 million for the nine months ended September 30, 2002
compared to cash generated from financing activities of $810 million and $617
million in the same periods of 2001. In 2002, issuances and repayments of
long-term debt related principally to the Company's commercial paper and
revolving credit facilities. In September 2001, the Company issued debt
securities in two series, U.S.$400 million (Cdn$629 million) 6.375% Notes due
2011 and U.S.$200 million (Cdn$314 million) 7.375% Debentures due 2031, related
to the acquisition of WC.
The Company has access to various financing arrangements:
Revolving credit facilities
The Company has U.S.$1,000 million revolving credit facilities that expire in
March 2003. The
24
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
credit facility agreements contain customary financial covenants with which the
Company has been in full compliance since the inception of the agreements. The
Company's borrowings of U.S.$172 million (Cdn$273 million) outstanding at
December 31, 2001 were entirely repaid in the first quarter of 2002 and since
then, the credit facilities have not been drawn upon. At September 30, 2002,
letters of credit under the revolving credit facilities amounted to $295
million. The Company currently expects to renew the existing facilities and to
complete the refinancing before their maturity.
Commercial paper
The Company has a commercial paper program, which is backed by a portion of its
revolving credit facilities, enabling it to issue commercial paper up to a
maximum aggregate principal amount of $600 million, or the U.S. dollar
equivalent. The revolving credit facilities will mature in March 2003 and while
the Company's intent is to renew the existing revolving credit facilities, the
refinancing has not been completed and, as such, the outstanding balance of
U.S.$117 million (Cdn$184 million) of commercial paper has been included in the
current portion of long-term debt at September 30, 2002.
Shelf registration statement
At September 30, 2002, the Company had U.S.$400 million remaining for issuance
under its shelf registration statement.
Accounts receivable securitization program
The sale of a portion of the Company's accounts receivable is conducted under a
securitization program, which has a $350 million maximum limit and will expire
in June 2003. The program is subject to customary credit rating and reporting
requirements. In the event the program is terminated before its scheduled
maturity, the Company expects to have sufficient liquidity remaining in its
current and future revolving credit facilities to meet future obligations and
anticipated capital expenditures. The Company intends to renew the program upon
expiration. At September 30, 2002, pursuant to the agreement, $168 million and
U.S.$113 million (Cdn$178 million) had been sold on a limited recourse basis
reflecting no change in the level of accounts receivable sold since December 31,
2001.
The Company's access to current and alternate sources of financing at
competitive costs is dependent on its credit rating. The Company is not
currently aware of any adverse trend, event or condition that would affect the
Company's credit standing.
25
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
Contractual obligations and commercial commitments
In the normal course of business, the Company incurs contractual obligations and
commercial commitments. The following tables set forth material obligations and
commitments as of September 30, 2002:
Contractual obligations
(In millions)
Contract Type Total 2002 2003-2004 2005-2006 2007 &
thereafter
-----------------------------------------------------------------------------------------
Debentures, notes and other $ 4,517 $ 11 $ 1,104 $ 581 $ 2,821
Capital leases (a) 881 35 188 97 561
-----------------------------------------------------------------------------------------
Long-term debt $ 5,398 $ 46 $ 1,292 $ 678 $ 3,382
Operating leases (b) 1,206 56 406 302 442
-----------------------------------------------------------------------------------------
Total obligations $ 6,604 $ 102 $ 1,698 $ 980 $ 3,824
=========================================================================================
Commercial commitments
(In millions)
Committment Type Total 2002 2003-2004 2005-2006 2007 &
thereafter
-----------------------------------------------------------------------------------------
Standby letters of credit (c) $ 488 $ 194 $ 293 $ 1 $ -
Other commercial commitments (d) 223 27 196 - -
-----------------------------------------------------------------------------------------
Total commitments $ 711 $ 221 $ 489 $ 1 $ -
=========================================================================================
(a) Excludes $507 million of imputed interest on capital leases at rates
ranging from approximately 3.0% to 14.6%.
(b) The Company has guaranteed the residual values of $77 million of equipment
with lease terms expiring in the years 2004 through 2012. As at September
30, 2002, the Company does not expect to make any payments pertaining to
the guarantees of these leases.
(c) Consists mainly of letters of credit issued as a financial guarantee of the
Company's contractual obligations under various arrangements. Letters of
credit under the revolving credit facilities amounted to $295 million.
(d) Includes commitments for railroad ties, rail, freight cars and locomotives.
For 2002 and the foreseeable future, the Company expects cash from operations
and from its various sources of financing, including the expected renewal of its
revolving credit facilities, to be sufficient to meet its future obligations and
fund anticipated capital expenditures.
26
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
SHARE REPURCHASE PROGRAM
On October 22, 2002, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 13 million common
shares between October 25, 2002 and October 24, 2003 pursuant to a normal course
issuer bid, at prevailing market prices.
TERMINATION OF CONVERSION RIGHTS OF 5.25% CONVERTIBLE PREFERRED SECURITIES
("SECURITIES")
On May 6, 2002, the Company announced that it had met the conditions required to
terminate the Securities holders' right to convert their Securities into common
shares of the Company, and set the conversion termination date as July 3, 2002.
The conditions were met when the Company's common share price exceeded 120% of
the conversion price of U.S.$38.48 per share (as adjusted, following the
Company's two-for-one common stock split in September 1999) for a specified
period, and all accrued interest on the Securities had been paid.
On July 3, 2002, the closing price of the Company's common shares exceeded the
conversion price of U.S.$38.48 per share. As a result, Securities that had not
been previously surrendered for conversion were converted, resulting in the
issuance of approximately 6 million common shares of the Company.
ACQUISITION OF WISCONSIN CENTRAL TRANSPORTATION CORPORATION
On October 9, 2001, the Company completed its acquisition of WC for an
acquisition cost of $1,297 million (U.S.$831 million) and began a phased
integration of the companies' operations.
The Company accounted for the merger using the purchase method of accounting as
required by the Financial Accounting Standards Board's (FASB) Statement of
Financial Accounting Standards (SFAS) No. 141 "Business Combinations." As such,
the Company's consolidated financial statements include the assets, liabilities
and results of operations of WC as of October 9, 2001, the date of acquisition.
The results of the final valuation of WC's assets and liabilities are not
expected to have a material impact on the results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires companies to
classify certain gains and losses from debt extinguishments as extraordinary
items, eliminates the provisions of SFAS No. 44 regarding transition to the
Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require
that certain lease modifications be treated as sale leaseback transactions. This
statement is effective for transactions occurring after May 15, 2002. The
Company does not expect SFAS No. 145 to have a material impact on its financial
statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" which requires that a liability for costs
associated with an exit or disposal activity be recognized when the liability is
incurred. SFAS No. 146 also establishes that the liability should initially be
measured at fair value and subsequently adjusted for changes in estimated cash
flows. This statement is to be applied to exit or disposal activities initiated
after December 31, 2002. The Company will apply SFAS No. 146 on a prospective
basis and, as such, does not expect this statement to have an initial material
impact on its financial statements upon adoption.
CRITICAL ACCOUNTING POLICIES, BUSINESS RISKS AND OTHER MATTERS
Management's discussion and analysis of the Company's financial condition and
results of operations is based on the same accounting policies as those used in
preparing the Company's 2001 Annual Consolidated Financial Statements. As such,
this document should be read in conjunction with Note 1 "Summary of significant
accounting policies" of the Company's 2001 Annual Consolidated Financial
Statements.
27
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of revenues and expenses during the period, the
reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the financial statements. On an ongoing
basis, management reviews its estimates, including those related to litigation,
environmental liabilities, casualty claims, depreciation lives, income tax
liabilities, and pension and other post-retirement benefits, based upon
currently available information. Actual results could differ from these
estimates.
Legal actions
In the normal course of its operations, the Company becomes involved in various
legal actions, including claims relating to personal injuries, occupational
related claims, damage to property claims and environmental claims. The Company
maintains, and regularly updates on a case-by-case basis, casualty provisions
for such items when the expected loss is both probable and can be reasonably
estimated. Although the Company considers such provisions to be adequate for
these matters, the final outcome with respect to actions outstanding or pending
at September 30, 2002, or with respect to future claims, cannot be predicted
with certainty, and therefore there can be no assurance that their resolution
will not have a material adverse effect on the Company's financial position or
results of operations in a particular quarter or fiscal year.
Employee work-related injuries, including occupational related claims, are
compensated according to the provisions of the Federal Employers' Liability Act
(FELA) and represent a significant expense for the railroad industry in the
United States. Consistent with the case-by-case approach, the Company does not
accrue a provision for unasserted occupational related claims. In view of the
Company's increasing expansion in the United States, and the increase in the
number of occupational claims over the past years, the Company will consider
using an actuarial based approach to evaluate the sufficiency of its provision
for occupational and other claims. The Company has been, and continues working
with an independent actuarial firm. Any change in the estimated liability would
be accounted for as a change in accounting estimate and recorded in the results
of operations.
As at September 30, 2002, the Company had aggregate reserves for legal matters
of $258 million ($277 million at December 31, 2001), of which approximately $152
million was for work-related injuries to employees in the United States,
including occupational related claims.
Environmental matters
Regulatory compliance
The Company's operations are subject to federal, provincial, state, municipal
and local regulations under environmental laws and regulations concerning, among
other things, emissions into the air; discharges into waters; the generation,
handling, storage, transportation, treatment and disposal of waste, hazardous
substances and other materials; decommissioning of underground and aboveground
storage tanks; and soil and groundwater contamination. A risk of environmental
liability is inherent in the railroad and related transportation operations;
real estate ownership, operation or control; and other commercial activities of
the Company with respect to both current and past operations. As a result, the
Company incurs significant compliance and capital costs, on an ongoing basis,
associated with environmental regulatory compliance and clean-up requirements.
Environmental expenditures that relate to current operations are expensed unless
they relate to an improvement to the property. Expenditures that relate to an
existing condition caused by past operations and which are not expected to
contribute to current or future operations are expensed.
Known existing environmental concerns
The ultimate cost of known contaminated sites cannot be definitely established,
and the estimated environmental liability for any given site may vary
28
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
depending on the nature and extent of the contamination, the available clean-up
technique, the Company's share of the costs and evolving regulatory standards
governing environmental liability. As a result, liabilities are recorded when
environmental assessments and/or remedial efforts are likely, and when costs,
based on a specific plan of action in terms of the technology to be used and the
extent of the corrective action required, can be reasonably estimated.
Unknown existing environmental concerns
While the Company believes that it has identified the costs likely to be
incurred in the next several years, based on known information, for
environmental matters, the Company's ongoing efforts to identify potential
environmental concerns that may be associated with its properties may lead to
future environmental investigations, which may result in the identification of
additional environmental costs and liabilities. The magnitude of such additional
liabilities and costs cannot be reasonably estimated and as such, costs related
to future remediation will be accrued in the year they become known.
Future occurrences
In the operation of a railroad, it is possible that derailments, explosions or
other accidents may occur that could cause harm to human health or to the
environment. As a result, the Company may incur costs in the future, which may
be material, to address any such harm, including costs relating to the
performance of clean-ups, natural resource damages and compensatory or punitive
damages relating to harm to individuals or property.
As at September 30, 2002, the Company had aggregate accruals for environmental
costs of $101 million ($112 million at December 31, 2001). The Company has not
included any reduction in costs for anticipated recovery from insurance.
There can be no assurance that material liabilities or costs related to
environmental matters will not be incurred in the future, or will not have a
material adverse effect on the Company's financial position or results of
operations in a particular quarter or fiscal year, or that the Company's
liquidity will not be adversely impacted by such environmental liabilities or
costs.
Properties
The Company follows the group method of depreciation and, as such, depreciates
the cost of properties, net of asset impairment write-downs, on a straight-line
basis over the estimated useful life of each asset class. Assessing the
reasonableness of the estimated useful lives of properties requires judgment and
is based upon currently available information, including comprehensive
depreciation studies that incorporate assumptions of remaining useful lives. A
revision to the estimated useful lives of properties is considered a change in
accounting estimate and, as a result, depreciation rates would be changed on a
prospective basis. A significant change in depreciable lives could result in a
material change to depreciation expense.
Pension and Other post-retirement benefits
The Company accounts for pension and other post-retirement benefits as required
by SFAS No. 87, "Employers' Accounting for Pensions" and SFAS No. 106,
"Employers' Accounting for Post-retirement Benefits Other Than Pensions,"
respectively. Under these accounting standards, the 2002 assumptions regarding
the valuation of benefit obligations and performance of plan assets were
established on the plan's last measurement date of January 1, 2002. Delayed
recognition of differences between actual results and those assumed is a guiding
principle of these standards. This approach allows for recognition of changes in
benefit obligations and plan performance over the working lives of the employees
who benefit from the plans.
An actuarial valuation is conducted at least on a triennial basis, to account
for pension and other post-retirement benefits which uses management assumptions
for the discount rate, the expected return on plan assets, the rate of
compensation increase, the health care cost trend and the expected average
remaining service life of the employee group. A change in any one of these
assumptions could have a significant impact on the pension and post-retirement
29
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
benefit expense recorded under SFAS No. 87 and SFAS No. 106, respectively. The
Company regularly reviews these assumptions on an annual basis.
During the last ten years ended December 31, 2001, the CN Pension Plan earned an
average rate of return in excess of 10% annually. For that same period, the
Company used a long-term rate of return assumption not exceeding 9% to compute
pension expense. However, given the recent performance of its plan assets and
the equity markets in North America, it is anticipated that the Company will,
effective for 2003, reduce the expected long-term rate of return on plan assets
from 9% to 8% to reflect management's current view of long-term investment
returns. The effect of this change in management's assumption will be to
increase pension expense by approximately $50 million.
Financial instruments
Although the Company conducts its business and receives revenues primarily in
Canadian dollars, a growing portion of its revenues, expenses, assets and debt
are denominated in U.S. dollars. Thus, the Company's results are affected by
fluctuations in the exchange rate between these currencies. Changes in the
exchange rate between the Canadian dollar and other currencies (including the
U.S. dollar) make the goods transported by the Company more or less competitive
in the world marketplace and thereby affect the Company's revenues.
The Company has limited involvement with derivative financial instruments and
does not use them for trading purposes. Collateral or other security to support
financial instruments subject to credit risk is usually not obtained. However,
the credit standing of counterparties or their guarantors is regularly
monitored, and losses due to counterparty non-performance are not anticipated.
To mitigate the effects of fuel price changes on its operating margins and
overall profitability, the Company has a systematic hedging program which calls
for regularly entering into swap positions on crude and heating oil to cover a
target percentage of future fuel consumption up to two years in advance. At
September 30, 2002, the Company hedged approximately 46% of the estimated 2002
fuel consumption, 45% of the estimated 2003 fuel consumption and 14% of the
estimated 2004 fuel consumption. This represented approximately 391 million U.S.
gallons at an average price of U.S.$0.6064 per U.S. gallon.
For the three months ended September 30, 2002, the Company realized a gain of $4
million from its fuel hedging activities, compared to a negligible gain in the
same period last year. For the first nine months of 2002, the Company's hedging
activities resulted in a realized loss of $5 million compared to a $4 million
gain in the same period of 2001.
Other comprehensive income for the quarters ended September 30, 2002 and 2001,
included an unrealized gain of $14 million, $10 million after tax, and an
unrealized loss of $13 million, $9 million after tax, respectively, resulting
from the Company's fuel hedging activities. For the first nine months of 2002
and 2001, other comprehensive income included an unrealized gain of $69 million,
$46 million after tax, and an unrealized loss of $18 million, $12 million after
tax, respectively.
At September 30, 2002, Accumulated other comprehensive income included an
unrealized holding gain of $31 million, $21 million after tax, ($38 million
unrealized holding loss, $25 million after tax at December 31, 2001) of which
$29 million relates to derivative instruments that will mature within the next
twelve months.
Competition
The Company faces significant competition from a variety of carriers, including
Canadian Pacific Railway Company which operates the other major rail system in
Canada, serving most of the same industrial and population centers as the
Company, long distance trucking companies and, in certain markets, major U.S.
railroads and other Canadian and U.S. railroads. Competition is generally based
on the quality and reliability of services provided, price, and the condition
and suitability of carriers' equipment. Competition is particularly intense in
eastern Canada where an extensive highway network and population centers,
located relatively close to one another, have encouraged significant competition
from trucking companies. In addition, much of the freight carried
30
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
by the Company consists of commodity goods that are available from other sources
in competitive markets. Factors affecting the competitive position of suppliers
of these commodities, including exchange rates, could materially adversely
affect the demand for goods supplied by the sources served by the Company and,
therefore, the Company's volumes, revenues and profit margins.
To a greater degree than other rail carriers, the Company's subsidiary, Illinois
Central Railroad Company (ICRR), is vulnerable to barge competition because its
main routes are parallel to the Mississippi River system. The use of barges for
some commodities, particularly coal and grain, often represents a lower cost
mode of transportation. Barge competition and barge rates are affected by
navigational interruptions from ice, floods and droughts, which can cause widely
fluctuating barge rates. The ability of ICRR to maintain its market share of the
available freight has traditionally been affected by the navigational conditions
on the river.
In recent years, there has been significant consolidation of rail systems in the
United States. The resulting larger rail systems are able to offer seamless
services in larger market areas and effectively compete with the Company in
certain markets. There can be no assurance that the Company will be able to
compete effectively against current and future competitors in the railroad
industry and that further consolidation within the railroad industry will not
adversely affect the Company's competitive position. No assurance can be given
that competitive pressures will not lead to reduced revenues, profit margins or
both.
Labor negotiations
Canadian workforce
As of October 2002, the Company had achieved ratified settlements with
bargaining groups representing substantially all of its Canadian unionized
workforce. These agreements are generally for a three-year period effective
until December 31, 2003.
U.S. workforce
The general approach to labor negotiations by U.S. Class 1 railroads is to
bargain on a collective national basis. Grand Trunk Western (GTW), Duluth
Winnipeg and Pacific (DWP), ICRR, CCP Holdings, Inc. (CCP) and just recently WC,
have bargained on a local basis rather than holding national, industry wide
negotiations because the resulting settlements better address both the
employees' concerns and preferences and the railways' actual operating
environment. However, local negotiations may not generate federal intervention
in a strike or lockout situation, since a dispute may be localized. The Company
believes the potential mutual benefits of local bargaining outweigh the risks.
As of October 2002, the Company had in place agreements with bargaining units
representing the entire unionized workforce at ICRR, GTW, DWP, and CCP, and 43%
at WC. These agreements have various durations, ranging from the end of 2001 to
the end of 2005. Several of these agreements have reopened or will reopen in
2002.
Negotiations are ongoing with the bargaining units with which the Company has
not yet achieved new settlements. Until new agreements are reached or until
settlements are ratified, the terms and conditions of previous agreements
continue to apply. Although the Company does not anticipate work action related
to these negotiations while they are ongoing, there can be no assurance that
their resolution will not have a material adverse effect on the Company's
financial position or results of operations.
Regulation
The Company's rail operations in Canada are subject to regulation as to (i) rate
setting and network rationalization by the Canadian Transportation Agency (the
Agency), under the Canada Transportation Act (Canada) (the CTA), and (ii) safety
by the federal Minister of Transport under the Railway Safety Act (Canada) and
certain other statutes. The Company's U.S. rail operations are subject to
regulation by the Surface Transportation Board (STB) (the successor to the
Interstate Commerce Commission) and the Federal Railroad Administration. In
addition, the Company is subject
31
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
to a variety of health, safety, security, labor, environmental and other
regulations, all of which can affect its competitive position and profitability.
The CTA Review Panel, which was appointed by the federal government to carry out
a comprehensive review of the Canadian transportation legislation, issued its
report to the Minister of Transport at the end of June 2001. It was released to
the public on July 18, 2001 and contains numerous recommendations for
legislative changes, which, if adopted, would affect all modes of
transportation, including rail. No assurance can be given that any decision by
the federal government pursuant to the report's recommendations will not
materially adversely affect the Company's financial position or results of
operations.
Business prospects and other risks
In any given year, the Company, like other railroads, is susceptible to changes
in the economic conditions of the industries and geographic areas that produce
and consume the freight it transports or the supplies it requires to operate. In
addition, many of the goods and commodities carried by the Company experience
cyclicality in the demand for them. However, many of the bulk commodities the
Company transports move offshore and are impacted more by global economic
conditions than North American economic cycles. The Company's results of
operations can be expected to reflect this cyclicality because of the
significant fixed costs inherent in railroad operations.
The Company's revenues are affected by prevailing economic conditions. In 2001,
widespread recessionary conditions in the economy affected the Company's
revenues. While the Company expects continued North American economic growth in
the fourth quarter of 2002, much of that will depend on consumer and business
confidence, both of which show signs of being tested by uncertain domestic
markets and international events. The Company will continue to leverage its
strong service capabilities but remains cautious about business prospects for
the near term.
Should a major economic slowdown or recession occur in North America or other
key markets, or should major industrial restructuring take place, the volume of
rail shipments carried by the Company is likely to be affected.
In addition to the inherent risks of the business cycle, the Company is
occasionally susceptible to severe weather conditions. For example, in the first
quarter of 1998, a severe ice storm hit eastern Canada, which disrupted
operations and service for the railroad as well as for CN customers. More
recently, severe drought conditions in western Canada significantly reduced bulk
commodity revenues, principally grain. There continues to be widespread concerns
about the impact of crop conditions on grain supplies in the near term.
Inflation
Generally accepted accounting principles require the use of historical cost as
the basis of reporting in financial statements. As a result, the cumulative
effect of inflation, which has significantly increased asset replacement costs
for capital-intensive companies such as CN, is not reflected in operating
expenses. Depreciation charges on an inflation-adjusted basis, assuming that all
operating assets are replaced at current price levels, would be substantially
greater than historically reported amounts.
32
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
--------------------------------------------------------------------------------
Forward-looking information
Certain information included in this report may be "forward-looking statements"
within the meaning of the United States Private Securities Litigation Reform Act
of 1995. Such forward-looking statements are not guarantees of future
performance and involve known and unknown risks, uncertainties and other factors
which may cause the outlook, the actual results or performance of the Company or
the rail industry to be materially different from any future results or
performance implied by such statements. Such factors include the factors set
forth in this section as well as other risks detailed from time to time in
reports filed by the Company with securities regulators in Canada and the United
States.
Disclosure Controls and Procedures
The Company's Chief Executive Officer and its Chief Financial Officer, after
evaluating the effectiveness of the Company's "disclosure controls and
procedures" (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c)) as of
October 22, 2002 (the "Evaluation Date") within the 90 day period leading to and
ending on the filing date of this quarterly report, have concluded that the
Company's disclosure controls and procedures were adequate and effective and
designed to ensure that material information relating to the Company and its
consolidated subsidiaries would have been made known to them. Subsequent to the
Evaluation Date, there were no significant changes in the Company's internal
controls or, to their knowledge, in other factors that could significantly
affect the Company's disclosure controls and procedures.
33
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF INCOME (CANADIAN GAAP)
--------------------------------------------------------------------------------
(In millions, except per share data)
Three months ended Nine months ended
September 30 September 30
------------------------------ -----------------------------
2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues $ 1,503 $ 1,325 $ 4,563 $ 4,115
-----------------------------------------------------------------------------------------------------------------------------------
Operating expenses excluding special charge 1,141 994 3,444 3,079
Special charge (Note 4) - - - 98
-----------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 1,141 994 3,444 3,177
Operating income 362 331 1,119 938
Interest expense (89) (71) (268) (220)
Other income (Note 5) 8 14 69 34
-----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 281 274 920 752
Income tax expense (94) (96) (310) (263)
-----------------------------------------------------------------------------------------------------------------------------------
Net income (Note 10) $ 187 $ 178 $ 610 $ 489
===================================================================================================================================
Earnings per share (Note 10)
Basic $ 0.93 $ 0.91 $ 3.09 $ 2.50
Diluted $ 0.92 $ 0.88 $ 3.00 $ 2.44
Weighted-average number of shares
Basic 200.3 192.4 195.7 191.9
Diluted 203.0 201.4 203.1 200.7
===================================================================================================================================
See accompanying notes to consolidated financial statements.
34
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF OPERATING INCOME (CANADIAN GAAP)
--------------------------------------------------------------------------------
(In millions)
Three months ended September 30 Nine months ended September 30
------------------------------------- -------------------------------------
Variance Variance
2002 2001 Fav (Unfav) 2002 2001 Fav (Unfav)
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues
Petroleum and chemicals $ 275 $ 225 22% $ 819 $ 668 23%
Metals and minerals 138 118 17% 398 332 20%
Forest products 337 260 30% 996 774 29%
Coal 85 80 6% 243 253 (4%)
Grain and fertilizers 217 254 (15%) 741 850 (13%)
Intermodal 273 243 12% 769 724 6%
Automotive 130 108 20% 440 374 18%
Other items 48 37 30% 157 140 12%
---------------------------------------------------------------------------- -----------------------
1,503 1,325 13% 4,563 4,115 11%
Operating expenses
Labor and fringe benefits 480 417 (15%) 1,466 1,247 (18%)
Purchased services 166 136 (22%) 464 412 (13%)
Depreciation and amortization 128 106 (21%) 373 336 (11%)
Fuel 109 112 3% 335 376 11%
Equipment rents 87 72 (21%) 268 225 (19%)
Material 72 61 (18%) 218 208 (5%)
Operating taxes 39 34 (15%) 122 115 (6%)
Casualty and other 60 56 (7%) 198 160 (24%)
Special charge (Note 4) - - - - 98 100%
---------------------------------------------------------------------------- -----------------------
1,141 994 (15%) 3,444 3,177 (8%)
---------------------------------------------------------------------------- -----------------------
Operating income $ 362 $ 331 9% $ 1,119 $ 938 19%
==================================================================================================================================
Operating ratio (excluding special charge) 75.9% 75.0% (0.9) 75.5% 74.8% (0.7)
==================================================================================================================================
See accompanying notes to consolidated financial statements.
35
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED BALANCE SHEET (CANADIAN GAAP)
--------------------------------------------------------------------------------
(In millions)
September 30 December 31 September 30
2002 2001 2001
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 24 $ 53 $ 830
Accounts receivable (Note 6) 715 645 759
Material and supplies 150 133 124
Deferred income taxes 120 153 142
Other 150 180 154
------------------------------------------------------------------------------------------------------------------------------------
1,159 1,164 2,009
Properties 16,662 16,723 14,083
Other assets and deferred charges (Note 3) 900 901 385
------------------------------------------------------------------------------------------------------------------------------------
Total assets $ 18,721 $ 18,788 $ 16,477
====================================================================================================================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable and accrued charges $ 1,377 $ 1,374 $ 1,292
Current portion of long-term debt (Note 6) 699 163 148
Other 71 101 83
------------------------------------------------------------------------------------------------------------------------------------
2,147 1,638 1,523
Deferred income taxes 3,820 3,729 2,730
Other liabilities and deferred credits 1,160 1,296 1,134
Long-term debt (Note 6) 4,699 5,764 4,968
Shareholders' equity:
Common shares (Note 7) 3,602 3,209 3,182
Convertible preferred securities (Note 7) - 327 327
Contributed surplus 178 178 178
Currency translation 123 133 119
Retained earnings 2,992 2,514 2,316
------------------------------------------------------------------------------------------------------------------------------------
6,895 6,361 6,122
------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 18,721 $ 18,788 $ 16,477
====================================================================================================================================
See accompanying notes to consolidated financial statements.
36
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (CANADIAN GAAP)
--------------------------------------------------------------------------------
(In millions)
Three months ended Nine months ended
September 30 September 30
---------------------- ----------------------
2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Common shares (1)
Balance, beginning of period $ 3,266 $ 3,169 $ 3,209 $ 3,124
Stock options exercised 10 13 66 58
Conversion of convertible preferred securities (Note 7) 326 - 327 -
-----------------------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 3,602 $ 3,182 $ 3,602 $ 3,182
===================================================================================================================================
Convertible preferred securities
Balance, beginning of period $ 326 $ 327 $ 327 $ 327
Converted shares (Note 7) (326) - (327) -
-----------------------------------------------------------------------------------------------------------------------------------
Balance, end of period $ - $ 327 $ - $ 327
===================================================================================================================================
Contributed surplus
-----------------------------------------------------------------------------------------------------------------------------------
Balance, beginning and end of period $ 178 $ 178 $ 178 $ 178
===================================================================================================================================
Currency translation
-----------------------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 123 $ 119 $ 123 $ 119
===================================================================================================================================
Retained earnings
Balance, beginning of period $ 2,848 $ 2,179 $ 2,514 $ 1,949
Net income 187 178 610 489
Dividends (43) (41) (132) (122)
-----------------------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 2,992 $ 2,316 $ 2,992 $ 2,316
===================================================================================================================================
See accompanying notes to consolidated financial statements.
(1) The Company issued 6.2 million and 7.6 million shares for the three and
nine months ended September 30, 2002, respectively, as a result of stock
options exercised and the conversion of convertible preferred securities.
At September 30, 2002, the Company had 200.3 million common shares
outstanding.
37
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (CANADIAN GAAP)
--------------------------------------------------------------------------------
(In millions)
Three months ended Nine months ended
September 30 September 30
----------------------- -----------------------
2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Operating activities
Net income $ 187 $ 178 $ 610 $ 489
Non-cash items in income:
Depreciation and amortization 130 107 378 340
Deferred income taxes 40 25 152 106
Equity in earnings of English Welsh and
Scottish Railway (4) - (19) -
Gain on sale of investment (Note 5) - - - (101)
Write-down of investment (Note 5) - - - 99
Special charge (Note 4) - - - 98
Changes in:
Accounts receivable (2) (95) (43) (46)
Material and supplies 16 13 (17) (13)
Accounts payable and accrued charges 16 5 32 (99)
Other net current assets and liabilities 9 (11) (3) (14)
Payments for workforce reductions (36) (39) (130) (128)
Other (62) 10 (91) (101)
-----------------------------------------------------------------------------------------------------------------------------------
Cash provided from operating activities 294 193 869 630
-----------------------------------------------------------------------------------------------------------------------------------
Investing activities
Net additions to properties (157) (120) (361) (388)
Other, net (2) (41) 71 79
-----------------------------------------------------------------------------------------------------------------------------------
Cash used by investing activities (159) (161) (290) (309)
-----------------------------------------------------------------------------------------------------------------------------------
Dividends paid (47) (42) (135) (127)
Financing activities
Issuance of long-term debt 642 2,034 2,532 2,538
Reduction of long-term debt (807) (1,231) (3,067) (1,973)
Issuance of common shares 8 7 62 52
-----------------------------------------------------------------------------------------------------------------------------------
Cash provided from (used by) financing activities (157) 810 (473) 617
-----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (69) 800 (29) 811
Cash and cash equivalents, beginning of period 93 30 53 19
-----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 24 $ 830 $ 24 $ 830
===================================================================================================================================
See accompanying notes to consolidated financial statements.
38
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CANADIAN GAAP)
--------------------------------------------------------------------------------
(In millions)
Note 1 - Basis of presentation
In management's opinion, the accompanying unaudited interim consolidated
financial statements, prepared in accordance with Canadian generally accepted
accounting principles (Canadian GAAP), contain all adjustments (consisting of
normal recurring accruals) necessary to present fairly Canadian National Railway
Company's (the Company) financial position as at September 30, 2002, December 31
and September 30, 2001, its results of operations, changes in shareholders'
equity and cash flows for the three and nine months ended September 30, 2002 and
2001.
These consolidated financial statements and notes have been prepared using
accounting policies consistent with those used in preparing the Company's 2001
Annual Consolidated Financial Statements except for Stock-based compensation as
explained in Note 2. While management believes that the disclosures presented
are adequate to make the information not misleading, these consolidated
financial statements and notes should be read in conjunction with the Company's
Annual Consolidated Financial Statements.
Note 2 - Accounting changes
Stock-based compensation
Effective January 1, 2002, the Company adopted the Canadian Institute of
Chartered Accountants (CICA) Handbook Section 3870 "Stock-Based Compensation and
Other Stock-Based Payments." The new recommendations require the use of a fair
value based approach of accounting for all non-employee and certain employee
stock-based awards, such as direct awards of stock, awards that call for
settlement in cash or other assets, or stock appreciation rights that call for
settlement through the issuance of equity instruments. For all other employee
stock-based awards, such as stock option awards, the recommendations encourage
but do not require that the fair value based approach be used, though require
additional disclosure including net income and earnings per share, as if the
fair value based accounting method had been used to account for these awards.
The Company has elected to prospectively apply the intrinsic value based method
of accounting to its awards of conventional and performance-based employee stock
options granted on or after January 1, 2002. These options are granted at an
exercise price equal to the market value of the common shares at the date of
granting and, as such, compensation cost is not recognized for
conventional-based options since both the number of shares to which an
individual is entitled and the exercise price are known at the date of granting.
Compensation cost attributable to performance-based employee stock option
awards, granted on or after January 1, 2002, is measured at intrinsic value and
recognized over the vesting period. Changes in intrinsic value between the grant
date and the measurement date result in a change in the measure of compensation
cost. For the three and nine months ended September 30, 2002, no compensation
expense was recognized as no performance-based employee stock option awards were
granted. In prior periods, the Company did not record compensation cost related
to employee stock options grants and, any consideration paid by employees on the
exercise of stock options was recorded as share capital.
In accordance with the new recommendations, the Company accounts for its direct
awards of stock to employees, which are issued through the mid-term incentive
share unit plan, using the fair value based approach to awards granted on or
after January 1, 2002. The mid-term incentive share unit plan, entitles
employees to receive payout of a combination of common stock of the Company
(equity settled portion), as to 50 percent, and cash value (cash settled
portion), as to the remaining 50 percent.
The new recommendations will not be applied to the equity settled portion of
this award granted prior to January 1, 2002 since the new recommendations
require prospective application for such awards.
Compensation cost for the cash settled portion of this award is measured at fair
value, which in all respects is equivalent to intrinsic value since the
compensation cost stemming from the award must be finally measured at intrinsic
value, and is recognized over the vesting period. Changes in intrinsic value
between the grant date and the measurement date result in a change in the
measure of compensation cost. The new recommendations require retroactive
application, without restatement, of the Company's grants outstanding at January
1, 2002 that call for settlement in cash. Had the new recommendations been
retroactively applied to the cash settled portion, there would have been no
impact on prior periods' financial statements, since no compensation expense
was, or would have been recognized for prior periods, due to the nature of the
vesting conditions.
For the nine months ended September 30, 2002, the Company granted 3.2 million
conventional options. For the three and nine months ended September 30, 2002,
0.2
39
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CANADIAN GAAP)
--------------------------------------------------------------------------------
million and 1.6 million, respectively, of previously issued stock options were
exercised.
Had compensation cost been determined as if the fair value based accounting
approach had been used for all awards granted for the three and nine months
ended September 30, 2002, the Company's net income and earnings per share would
have been as follows:
Three months ended Nine months ended
September 30, 2002 September 30, 2002
--------------------------------------------------------------------------------
Net income (in millions) $ 182 $ 597
Basic earnings per share $ 0.91 $ 3.02
Diluted earnings per share $ 0.90 $ 2.94
================================================================================
As permitted by the new recommendations, these amounts exclude the effect of
awards granted prior to January 1, 2002 and include the calculation of
compensation expense using the Black-Scholes option-pricing model with the
following assumptions:
Three months ended Nine months ended
September 30, 2002(1) September 30, 2002
--------------------------------------------------------------------------------
Expected option life (years) - 7.0
Risk-free interest rate - 5.79%
Expected stock price volatility - 30%
Average dividend per share - $ 0.86
================================================================================
Three months ended Nine months ended
September 30, 2002(1) September 30, 2002
--------------------------------------------------------------------------------
Weighted average fair value
of options granted $ - $ 30.98
================================================================================
(1) In the third quarter of 2002, the Company did not grant any stock-option
awards.
Foreign currency translation
In 2001, the Company early adopted the CICA amended recommendations of Section
1650 "Foreign Currency Translation." As required by the amended section, the
Company has restated all financial data for 2001.
Note 3 - Acquisition of Wisconsin Central Transportation Corporation
Wisconsin Central Transportation Corporation (WC) was consolidated effective
October 9, 2001, the date the Company acquired control of WC. Accordingly, the
Company's results of operations for the three and nine months ended September
30, 2001 exclude the results of operations of WC. For comparative purposes only,
if the Company had acquired WC on January 1, 2001, based on the historical
amounts reported by WC, revenues, net income, basic and diluted earnings per
share would have been $1,470 million, $194 million, $0.99 per basic share and
$0.96 per diluted share, respectively, for the three months ended September 30,
2001 and $4,539 million, $523 million, $2.68 per basic share and $2.61 per
diluted share, respectively, for the nine months ended September 30, 2001. These
pro forma figures do not reflect synergies, and accordingly, do not account for
any potential increases in operating income, any estimated cost savings or
facilities consolidation.
In the first quarter of 2002, the Company sold its investment in Tranz Rail
Holdings Limited (Tranz Rail), for net proceeds of $68 million. The Company had
acquired Tranz Rail, a company which operates a 2,400-route mile freight and
passenger rail business in New Zealand, through its acquisition of WC, and had
accounted for it as "available for sale." The difference between the carrying
amount of the investment and the proceeds from sale was not significant.
Note 4 - Special charge
In the second quarter of 2001, the Company recorded a charge of $98 million, $62
million after tax, for the reduction of 690 positions by the end of 2002. The
charge included severance and other payments to be made to affected employees.
Note 5 - Other income
In June 2001, the Company recorded a charge of $99 million, $77 million after
tax, to write down its net investment in 360networks Inc.
In the first quarter of 2001, the Company recorded a gain of $101 million, $82
million after tax, from the sale of its 50 percent interest in the Detroit River
Tunnel Company (DRT). The DRT is a 1.6-mile rail-only tunnel crossing the
Canada-U.S. border between Detroit and Windsor, Ontario.
Note 6 - Financing activities
Share repurchase program
On October 22, 2002, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 13 million common
shares between October 25, 2002 and October 24, 2003 pursuant to a normal course
issuer bid, at prevailing market prices.
40
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CANADIAN GAAP)
--------------------------------------------------------------------------------
Revolving credit facilities
The Company has U.S.$1,000 million revolving credit facilities that expire in
March 2003. The credit facility agreements contain customary financial covenants
with which the Company has been in full compliance since the inception of the
agreements. The Company's borrowings of U.S.$172 million (Cdn$273 million)
outstanding at December 31, 2001 were entirely repaid in the first quarter of
2002 and since then, the credit facilities have not been drawn upon. At
September 30, 2002, letters of credit under the revolving credit facilities
amounted to $295 million. The Company currently expects to renew the existing
facilities and to complete the refinancing before their maturity.
Commercial paper
The Company has a commercial paper program, which is backed by a portion of its
revolving credit facilities, enabling it to issue commercial paper up to a
maximum aggregate principal amount of $600 million, or the U.S. dollar
equivalent. The revolving credit facilities will mature in March 2003 and while
the Company's intent is to renew the existing revolving credit facilities, the
refinancing has not been completed and, as such, the outstanding balance of
U.S.$117 million (Cdn$184 million) of commercial paper has been included in the
current portion of long-term debt at September 30, 2002.
Accounts receivable securitization
The Company has a revolving agreement, expiring in June 2003, to sell eligible
freight trade receivables up to a maximum of $350 million of receivables
outstanding at any point in time. At September 30, 2002, pursuant to the
agreement, $168 million and U.S.$113 million (Cdn$178 million) had been sold on
a limited recourse basis reflecting no change in the level of accounts
receivable sold since December 31, 2001.
Note 7 - Termination of conversion rights of 5.25% Convertible preferred
securities ("Securities")
On May 6, 2002, the Company announced that it had met the conditions required to
terminate the Securities holders' right to convert their Securities into common
shares of the Company, and set the conversion termination date as July 3, 2002.
The conditions were met when the Company's common share price exceeded 120% of
the conversion price of U.S.$38.48 per share (as adjusted, following the
Company's two-for-one common stock split in September 1999) for a specified
period, and all accrued interest on the Securities had been paid.
On July 3, 2002, the closing price of the Company's common shares exceeded the
conversion price of U.S.$38.48 per share. As a result, Securities that had not
been previously surrendered for conversion were converted, resulting in the
issuance of approximately 6 million common shares of the Company.
Note 8 - Derivative instruments
The Company uses derivative instruments to hedge a portion of its fuel
requirement. As a result of its fuel hedging activities, the Company had an
unrealized holding gain of $31 million at September 30, 2002 ($38 million
unrealized holding loss at December 31, 2001).
Note 9 - Commitments
At September 30, 2002, the Company had commitments to acquire railroad ties,
rail, freight cars and locomotives at an aggregate cost of $223 million ($52
million at December 31, 2001).
41
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CANADIAN GAAP)
--------------------------------------------------------------------------------
Note 10 - Net income and earnings per share
In addition to the consolidation of the WC results of operations for the three
and nine months ended September 30, 2002 as explained in Note 3, the
comparability of the results of operations for the nine months ended September
30, 2002 and 2001 is also impacted by the following items:
42
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CANADIAN GAAP)
--------------------------------------------------------------------------------
Three months ended Nine months ended
September 30 September 30
------------------------------- ------------------------------
2002 2001 2001 2002 2001 2001
pro forma pro forma
(1) (1)
-----------------------------------------------------------------------------------------------------------------------------------
(In millions) (Unaudited)
Income before income taxes, excluding undernoted items $ 281 $ 274 $ 300 $ 920 $ 848 $ 899
Income tax expense (94) (96) (106) (310) (302) (319)
-----------------------------------------------------------------------------------------------------------------------------------
Adjusted net income 187 178 194 610 546 580
Undernoted items, net of tax:
Special charge for workforce reductions - - - - (62) (62)
Write-down of net investment in 360networks Inc. - - - - (77) (77)
Gain on sale of Detroit River Tunnel Company - - - - 82 82
-----------------------------------------------------------------------------------------------------------------------------------
- - - - (57) (57)
Net income $ 187 $ 178 $ 194 $ 610 $ 489 $ 523
===================================================================================================================================
The following table provides a reconciliation between basic and diluted earnings
per share:
Three months ended Nine months ended
September 30 September 30
------------------------------- ------------------------------
2002 2001 2001 2002 2001 2001
pro forma pro forma
(1) (1)
-----------------------------------------------------------------------------------------------------------------------------------
(In millions, except per share data) (Unaudited)
Net income $ 187 $ 178 $ 194 $ 610 $ 489 $ 523
Dividends on convertible preferred securities (Note 7) - (3) (3) (6) (9) (9)
-----------------------------------------------------------------------------------------------------------------------------------
Income used for basic earnings per share $ 187 $ 175 $ 191 $ 604 $ 480 $ 514
Weighted-average shares outstanding 200.3 192.4 192.4 195.7 191.9 191.9
Effect of dilutive securities and stock options 2.7 9.0 9.0 7.4 8.8 8.8
-----------------------------------------------------------------------------------------------------------------------------------
Weighted-average diluted shares outstanding 203.0 201.4 201.4 203.1 200.7 200.7
Basic earnings per share $ 0.93 $ 0.91 $ 0.99 $ 3.09 $ 2.50 $ 2.68
Diluted earnings per share $ 0.92 $ 0.88 $ 0.96 $ 3.00 $ 2.44 $ 2.61
===================================================================================================================================
(1) The pro forma figures reflect the Company's results of operations as if the
Company had acquired WC on January 1, 2001.
43
CANADIAN NATIONAL RAILWAY COMPANY
SELECTED RAILROAD STATISTICS (CANADIAN GAAP)
--------------------------------------------------------------------------------
Three months ended Nine months ended
September 30 September 30
----------------------- ----------------------
2002 2001(1) 2002 2001(1)
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Rail operations
Freight revenues ($ millions) 1,455 1,288 4,406 3,975
Gross ton miles (millions) 75,687 69,408 229,677 216,863
Revenue ton miles (RTM) (millions) 39,460 35,909 119,081 113,267
Route miles (includes Canada and the U.S.) 17,843 15,476 17,843 15,476
Operating expenses per RTM (cents)(2) 2.89 2.77 2.89 2.72
Freight revenue per RTM (cents) 3.69 3.59 3.70 3.51
Carloads (thousands) 1,043 915 3,101 2,814
Freight revenue per carload ($) 1,395 1,408 1,421 1,413
Diesel fuel consumed (Liters in millions) 334 305 1,047 987
Average fuel price ($/Liter) 0.32 0.35 0.31 0.36
Revenue ton miles per liter of fuel consumed 118 118 114 115
Gross ton miles per liter of fuel consumed 227 228 219 220
Diesel fuel consumed (U.S. gallons in millions) 89 81 277 261
Average fuel price ($/U.S. gallon) 1.23 1.28 1.19 1.33
Revenue ton miles per U.S. gallon of fuel consumed 443 443 430 434
Gross ton miles per U.S. gallon of fuel consumed 850 857 829 831
Locomotive bad order ratio (%)(3) 6.9 6.6 6.9 7.2
Freight car bad order ratio (%) 5.9 5.6 6.0 5.8
------------------------------------------------------------------------------------------------------------------------------------
Productivity
Operating ratio (%)(2) 75.9 75.0 75.5 74.8
Freight revenue per route mile ($ thousands) 82 83 247 257
Revenue ton miles per route mile (thousands) 2,212 2,320 6,674 7,319
Freight revenue per average number of employees ($ thousands) 62 57 190 179
Revenue ton miles per average number of employees (thousands) 1,669 1,586 5,126 5,096
------------------------------------------------------------------------------------------------------------------------------------
Employees
Number at end of period 23,484 22,410 23,484 22,410
Average number during period 23,647 22,646 23,231 22,227
Labor and fringe benefits expense per RTM (cents) 1.22 1.16 1.23 1.10
Injury frequency rate per 200,000 person hours 3.4 4.2 3.1 4.3
Accident rate per million train miles 2.2 1.7 2.2 1.8
------------------------------------------------------------------------------------------------------------------------------------
Financial
Debt to total capitalization ratio (% at end of period) 43.9 45.5 43.9 45.5
Return on assets (% at end of period) 1.3 1.3 4.2 3.8
====================================================================================================================================
(1) 2001 data exclude WC which was acquired and consolidated effective October
9, 2001.
(2) 2001 figures exclude special charge.
(3) In 2002, the Company expanded its measure of bad order locomotives to
include all those not available for service, including on-line failures.
The 2001 figures have been restated accordingly.
44
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY INFORMATION (CANADIAN GAAP)
--------------------------------------------------------------------------------
Three months ended September 30 Nine months ended September 30
-------------------------------------- --------------------------------------
Variance Variance
2002 2001(1) Fav (Unfav) 2002 2001(1) Fav (Unfav)
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenue ton miles (millions)
Petroleum and chemicals 7,538 6,181 22% 22,222 18,299 21%
Metals and minerals 3,574 2,618 37% 10,012 7,712 30%
Forest products 8,508 7,193 18% 25,200 21,699 16%
Coal 3,872 3,795 2% 10,786 11,789 (9%)
Grain and fertilizers 7,800 8,982 (13%) 26,913 31,933 (16%)
Intermodal 7,429 6,481 15% 21,500 19,686 9%
Automotive 739 659 12% 2,448 2,149 14%
--------------------------------------------------------------------------- ---------------------
39,460 35,909 10% 119,081 113,267 5%
Freight revenue / RTM (cents)
Total freight revenue per RTM 3.69 3.59 3% 3.70 3.51 5%
Business units:
Petroleum and chemicals 3.65 3.64 - 3.69 3.65 1%
Metals and minerals 3.86 4.51 (14%) 3.98 4.30 (7%)
Forest products 3.96 3.61 10% 3.95 3.57 11%
Coal 2.20 2.11 4% 2.25 2.15 5%
Grain and fertilizers 2.78 2.83 (2%) 2.75 2.66 3%
Intermodal 3.67 3.75 (2%) 3.58 3.68 (3%)
Automotive 17.59 16.39 7% 17.97 17.40 3%
--------------------------------------------------------------------------- ---------------------
Carloads (thousands)
Petroleum and chemicals 147 126 17% 438 383 14%
Metals and minerals 104 69 51% 294 195 51%
Forest products 151 116 30% 452 359 26%
Coal 127 125 2% 374 391 (4%)
Grain and fertilizers 123 136 (10%) 400 434 (8%)
Intermodal 319 273 17% 904 828 9%
Automotive 72 70 3% 239 224 7%
--------------------------------------------------------------------------- ---------------------
1,043 915 14% 3,101 2,814 10%
Freight revenue / carload (dollars)
Total freight revenue per carload 1,395 1,408 (1%) 1,421 1,413 1%
Business units:
Petroleum and chemicals 1,871 1,786 5% 1,870 1,744 7%
Metals and minerals 1,327 1,710 (22%) 1,354 1,703 (20%)
Forest products 2,232 2,241 - 2,204 2,156 2%
Coal 669 640 5% 650 647 -
Grain and fertilizers 1,764 1,868 (6%) 1,853 1,959 (5%)
Intermodal 856 890 (4%) 851 874 (3%)
Automotive 1,806 1,543 17% 1,841 1,670 10%
====================================================================================================================================
(1) 2001 data exclude WC which was acquired and consolidated effective October
9, 2001.
45
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY INFORMATION
PRO FORMA CONSOLIDATED STATEMENT OF INCOME (CANADIAN GAAP)
--------------------------------------------------------------------------------
(In millions, except per share data)
Three months ended September 30 Nine months ended September 30
------------------------------------- ------------------------------------
2002 2001 Variance 2002 2001 Variance
pro forma(1) Fav (Unfav) pro forma(1) Fav (Unfav)
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues
Petroleum and chemicals $ 275 $ 248 11% $ 819 $ 736 11%
Metals and minerals 138 149 (7%) 398 413 (4%)
Forest products 337 319 6% 996 954 4%
Coal 85 87 (2%) 243 275 (12%)
Grain and fertilizers 217 267 (19%) 741 893 (17%)
Intermodal 273 252 8% 769 747 3%
Automotive 130 108 20% 440 374 18%
Other items 48 40 20% 157 147 7%
---------------------------------------------------------------------------- ----------------------
1,503 1,470 2% 4,563 4,539 1%
Operating expenses
Labor and fringe benefits 480 468 (3%) 1,466 1,400 (5%)
Purchased services 166 146 (14%) 464 446 (4%)
Depreciation and amortization 128 118 (8%) 373 368 (1%)
Fuel 109 123 11% 335 410 18%
Equipment rents 87 79 (10%) 268 247 (9%)
Material 72 67 (7%) 218 232 6%
Operating taxes 39 36 (8%) 122 121 (1%)
Casualty and other 60 57 (5%) 198 172 (15%)
Special charge - - - - 98 100%
---------------------------------------------------------------------------- ----------------------
1,141 1,094 (4%) 3,444 3,494 1%
Operating income 362 376 (4%) 1,119 1,045 7%
Interest expense (89) (97) (268) (299)
Other income 8 21 69 57
---------------------------------------------------------------------------- ----------------------
Income before income taxes 281 300 920 803
Income tax expense (94) (106) (310) (280)
---------------------------------------------------------------------------- ----------------------
Net income $ 187 $ 194 $ 610 $ 523
====================================================================================================================================
Operating ratio (excluding special charge) 75.9% 74.4% (1.5) 75.5% 74.8% (0.7)
====================================================================================================================================
Diluted earnings per share $ 0.92 $ 0.96 $ 3.00 $ 2.61
Adjusted diluted earnings per share (2) $ 0.92 $ 0.96 $ 3.00 $ 2.90
Diluted weighted-average number of shares 203.0 201.4 203.1 200.7
====================================================================================================================================
(1) The pro forma figures reflect the Company's results of operations as if
the Company had acquired WC on January 1, 2001.
(2) Adjusted diluted earnings per share for 2001 exclude the gain on sale of
DRT, the special charge for workforce reductions and the charge to write
down the net investment in 360networks Inc.
46
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY PRO FORMA INFORMATION (CANADIAN GAAP)
--------------------------------------------------------------------------------
Three months ended September 30 Nine months ended September 30
----------------------------------- -------------------------------------
2002 2001 Variance 2002 2001 Variance
pro forma(1) Fav (Unfav) pro forma(1) Fav (Unfav)
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenue ton miles (millions)
Petroleum and chemicals 7,538 6,484 16% 22,222 19,222 16%
Metals and minerals 3,574 3,448 4% 10,012 10,189 (2%)
Forest products 8,508 8,052 6% 25,200 24,331 4%
Coal 3,872 4,153 (7%) 10,786 12,797 (16%)
Grain and fertilizers 7,800 9,183 (15%) 26,913 32,627 (18%)
Intermodal 7,429 6,535 14% 21,500 19,840 8%
Automotive 739 660 12% 2,448 2,153 14%
------------------------------------------------------------------------- ----------------------
39,460 38,515 2% 119,081 121,159 (2%)
Freight revenue / RTM (cents)
Total freight revenue per RTM 3.69 3.71 (1%) 3.70 3.62 2%
Business units:
Petroleum and chemicals 3.65 3.82 (4%) 3.69 3.83 (4%)
Metals and minerals 3.86 4.32 (11%) 3.98 4.05 (2%)
Forest products 3.96 3.96 - 3.95 3.92 1%
Coal 2.20 2.09 5% 2.25 2.15 5%
Grain and fertilizers 2.78 2.91 (4%) 2.75 2.74 -
Intermodal 3.67 3.86 (5%) 3.58 3.77 (5%)
Automotive 17.59 16.36 8% 17.97 17.37 3%
------------------------------------------------------------------------- ----------------------
Carloads (thousands)
Petroleum and chemicals 147 135 9% 438 410 7%
Metals and minerals 104 120 (13%) 294 328 (10%)
Forest products 151 147 3% 452 456 (1%)
Coal 127 135 (6%) 374 420 (11%)
Grain and fertilizers 123 143 (14%) 400 455 (12%)
Intermodal 319 288 11% 904 871 4%
Automotive 72 70 3% 239 224 7%
------------------------------------------------------------------------- ----------------------
1,043 1,038 - 3,101 3,164 (2%)
Freight revenue / carload (dollars)
Total freight revenue per carload 1,395 1,378 1% 1,421 1,388 2%
Business units:
Petroleum and chemicals 1,871 1,837 2% 1,870 1,795 4%
Metals and minerals 1,327 1,242 7% 1,354 1,259 8%
Forest products 2,232 2,170 3% 2,204 2,092 5%
Coal 669 644 4% 650 655 (1%)
Grain and fertilizers 1,764 1,867 (6%) 1,853 1,963 (6%)
Intermodal 856 875 (2%) 851 858 (1%)
Automotive 1,806 1,543 17% 1,841 1,670 10%
====================================================================================================================================
(1) The pro forma data has been prepared assuming the Company had acquired WC
on January 1, 2001.
47
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
--------------------------------------------------------------------------------
Management's discussion and analysis relates to the financial condition and
results of operations of Canadian National Railway Company (CN) together with
its wholly owned subsidiaries, including Grand Trunk Corporation (GTC), Illinois
Central Corporation (IC) and Wisconsin Central Transportation Corporation (WC),
the latter from October 9, 2001. As used herein, the word "Company" means, as
the context requires, CN and its subsidiaries. CN's common shares are listed on
the Toronto and New York stock exchanges. Except where otherwise indicated, all
financial information reflected herein is expressed in Canadian dollars and
determined on the basis of Canadian generally accepted accounting principles
(Canadian GAAP). The Company also prepares consolidated financial statements in
accordance with U.S. GAAP, which are included in this document. The U.S. GAAP
financial statements are different in some respects from these financial
statements, principally in the treatment of track replacement costs,
expenditures relating to improvements of bridges and other structures and
freight cars, derivative instruments, stock-based compensation and convertible
preferred securities.
FINANCIAL RESULTS
Third quarter and first nine months of 2002 compared to corresponding periods in
2001
The Company consolidated WC effective October 9, 2001, the date it acquired
control of WC. Accordingly, in the following discussion, the Company's results
of operations for the three and nine months ended September 30, 2001 exclude the
results of operations of WC. Hereafter, pro forma refers to the consolidation of
the results of operations of WC, assuming the acquisition and control of WC
occurred on January 1, 2001.
The Company recorded consolidated net income of $187 million ($0.93 per basic
share or $0.92 per diluted share) for the quarter ended September 30, 2002
compared to consolidated net income of $178 million ($0.91 per basic share or
$0.88 per diluted share) in the third quarter of 2001, an increase of $9 million
($0.02 per basic share or $0.04 per diluted share). Consolidated net income for
the nine months ended September 30, 2002 was $610 million ($3.09 per basic share
or $3.00 per diluted share) compared to $489 million ($2.50 per basic share or
$2.44 per diluted share) in the same period of 2001.
Operating income was $362 million for the third quarter of 2002 compared to $331
million in the same quarter of 2001. For the first nine months of the year,
operating income was $1,119 million compared to $938 million in the same period
of 2001. The operating ratio increased to 75.9% in the current quarter from
75.0% in the third quarter of 2001, a 0.9-point increase.
The nine-month period ended September 30, 2001 included items impacting the
comparability of the results of operations to those in the respective period of
2002. For the nine months ended September 30, 2001, the Company recorded a
special charge for workforce reductions of $98 million, $62 million after tax
($0.32 per basic share or $0.31 per diluted share), a charge to write down its
net investment in 360networks Inc. of $99 million, $77 million after tax ($0.40
per basic share or $0.39 per diluted share) and a gain of $101 million, $82
million after tax ($0.43 per basic share or $0.41 per diluted share) related to
the sale of its 50 percent interest in the Detroit River Tunnel Company (DRT).
Excluding the aforementioned items, net income in the nine months ended
September 30, 2002, increased by $64 million ($0.30 per basic share or $0.27 per
diluted share), from $546 million ($2.79 per basic share or $2.73 per diluted
share) for the same period in 2001.
Excluding the 2001 special charge, operating income for the nine-month period
ended September 30, 2002, increased by $83 million, or 8%, to $1,119 million
from $1,036 million in the same period last year. The nine-month operating
ratio, excluding the 2001 special charge, increased to 75.5% in 2002 from 74.8%
in 2001, a 0.7-point increase.
Comparison to 2001 pro forma
Net income in the current quarter decreased by $7 million ($0.06 per basic share
or $0.04 per diluted share) from pro forma net income of $194 million ($0.99 per
basic share or $0.96 per diluted share) in
48
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
--------------------------------------------------------------------------------
the comparative 2001 quarter. Excluding the 2001 items previously discussed, net
income for the nine months ended September 30, 2002, increased by $30 million
($0.12 per basic share or $0.10 per diluted share) from pro forma net income of
$580 million ($2.97 per basic share or $2.90 per diluted share) in the same 2001
period.
Revenues for the third quarter of 2002 increased by $33 million, or 2%, when
compared to pro forma revenues of $1,470 million in the same 2001 period. For
the nine-month period ended September 30, 2002, revenues increased by $24
million, or 1%, when compared to pro forma revenues of $4,539 million in the
same period last year.
Operating expenses in the current quarter increased by $47 million, or 4%, from
pro forma operating expenses of $1,094 million in the same quarter of 2001. For
the first nine months of 2002, operating expenses increased by $48 million, or
1%, from pro forma operating expenses, excluding the special charge, of $3,396
million in the same period last year.
Operating income for the third quarter of 2002 was $362 million, a decrease of
$14 million, or 4%, when compared to pro forma operating income of $376 million
in the comparable 2001 quarter. The operating ratio increased to 75.9% in the
current quarter from the pro forma operating ratio of 74.4% in the same quarter
of 2001. For the nine-month period ended September 30, 2002, operating income
was $1,119 million, a decrease of $24 million, from pro forma operating income,
excluding the special charge, of $1,143 million in the comparable 2001 period.
The nine-month operating ratio increased to 75.5% in 2002 from the pro forma
operating ratio, excluding the special charge, of 74.8% in 2001.
Revenues
Revenues in the third quarter of 2002 totaled $1,503 million compared to $1,325
million during the same period in 2001, an increase of $178 million, or 13%.
Revenues for the first nine months of 2002 were $4,563 million, an increase of
$448 million, or 11%, from the same period last year. The increase in the
quarter and first nine months was mainly attributable to the consolidation of WC
revenues and to gains in petroleum and chemicals, automotive, intermodal and
forest products. Partly offsetting these gains were continued weakness in
Canadian grain, and coal revenues. Also contributing to the nine-month increase
was the impact of the weaker Canadian dollar, particularly in the petroleum and
chemicals, forest products and automotive business units.
Revenue ton miles increased by 10% in the quarter and 5% in the nine-month
period ended September 30, 2002 when compared to the same periods in 2001.
Freight revenue per revenue ton mile for the quarter and first nine months of
the year increased by 3% and 5%, respectively, when compared to the same periods
last year.
Petroleum and chemicals: Revenues increased by $50 million, or 22%, for the
third quarter and $151 million, or 23%, for the first nine months when compared
to the same periods in 2001. Growth in the quarter and nine-month period was
mainly due to the inclusion of WC revenues and continued strength in the
petroleum segment, including strong sulfur shipments and market share gains in
various sectors. Revenue per revenue ton mile for the current quarter remained
unchanged and increased by 1% during the first nine months of 2002, as the
inclusion of shorter haul WC traffic and the effects of the weaker Canadian
dollar were offset by an increase in longer haul traffic.
Metals and minerals: Revenues increased by $20 million, or 17%, for the third
quarter and $66 million, or 20%, for the first nine months when compared to the
same periods in 2001. The increase in the quarter and first nine months was
mainly due to the inclusion of WC revenues, market share gains in the aluminum
sector and strong construction materials traffic, partly offset by one-time
gains in 2001. Also impacting the quarter were market share gains in the steel
industry that were offset by reduced traffic in specific segments due to ongoing
customer strikes. Revenue per revenue ton mile decreased by 14% in the current
quarter and 7% for the first nine months of the year mainly due to an increase
in longer haul traffic and the inclusion of certain lower-rated WC traffic.
49
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
--------------------------------------------------------------------------------
Forest products: Revenues increased by $77 million, or 30%, for the third
quarter and $222 million, or 29%, for the first nine months when compared to the
same periods in 2001. Growth in the quarter and first nine months of the year
was mainly due to the inclusion of WC revenues and, increased lumber and panels
traffic, in line with a strong North American housing market. Improved market
conditions in the Canadian pulp and paper industry also contributed to third
quarter growth. The increase in revenue per revenue ton mile of 10% in the
current quarter and 11% in the first nine months of 2002 was mainly due to the
inclusion of shorter haul WC traffic and the effect of the weaker Canadian
dollar.
Coal: Revenues increased by $5 million, or 6%, for the third quarter and
decreased by $10 million, or 4%, for the first nine months when compared to the
same periods in 2001. The increase in the quarter reflected the inclusion of WC
revenues, partly offset by some weakness in CN coal traffic on a year-over-year
basis. The decrease in the nine-month period was mainly due to reduced demand
from power utilities and weak Canadian coal exports to offshore markets. The
revenue per revenue ton mile increase of 4% in the current quarter and 5% during
the first nine months of 2002 was mainly due to a decrease in longer haul
traffic and the effect of the weaker Canadian dollar.
Grain and fertilizers: Revenues decreased by $37 million, or 15%, for the third
quarter and $109 million, or 13%, for the first nine months when compared to the
same periods in 2001. The decline in both the quarter and first nine months of
2002 reflected a significant deterioration in the Canadian grain crop. The third
quarter was also impacted by the loss of a potash move and a decline in United
States originating grain traffic. The 2% decrease in revenue per revenue ton
mile in the current quarter was mainly attributable to a shift in traffic mix.
For the first nine months, revenue per revenue ton mile increased by 3% mainly
as a result of an increase in regulated grain rates and a decline in longer haul
traffic.
Intermodal: Revenues increased by $30 million, or 12%, for the third quarter and
$45 million, or 6%, for the first nine months when compared to the same periods
in 2001. The increase in the quarter and first nine months of 2002 was
attributable to growth in both the overseas and domestic segments. Growth in the
overseas segment was achieved in spite of stagnant trade and the loss of an
overseas move in the second half of 2001. The domestic segment benefited from
growing markets in both Canada and the United States. The decrease in revenue
per revenue ton mile of 2% for the current quarter and 3% for the first nine
months of 2002 was mainly attributable to the fuel surcharge in 2001 and an
increase in the average length of haul.
Automotive: Revenues increased by $22 million, or 20%, for the third quarter and
$66 million, or 18%, for the first nine months when compared to the same periods
in 2001, reflecting stronger motor vehicle production in both Canada and the
United States. The 7% revenue per revenue ton mile increase for the current
quarter and 3% increase for the first nine months of 2002 was mainly
attributable to the weaker Canadian dollar.
50
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
--------------------------------------------------------------------------------
Operating expenses
In the third quarter of 2002, operating expenses amounted to $1,141 million
compared to $994 million in the same quarter of 2001. Operating expenses for the
first nine months of 2002 were $3,444 million compared to $3,177 million in the
same period of 2001.
Excluding the 2001 special charge for workforce reductions, operating expenses
for the first nine months of the year increased by $365 million, or 12%, from
$3,079 million in the same period of 2001. The increases in the quarter and
first nine months of 2002 were mainly due to the consolidation of WC expenses,
higher expenses for labor and fringe benefits and equipment rents, partially
offset by lower fuel costs.
Labor and fringe benefits: Labor and fringe benefit expenses in 2002 increased
by $63 million, or 15%, for the third quarter and $219 million, or 18%, for the
first nine months when compared to the same 2001 periods. The increase in the
quarter and first nine months of the year was mainly attributable to the
inclusion of WC expenses ($55 million for the quarter and $158 million for the
nine-month period), wage increases, higher benefit expenses, including health
and welfare and other post-retirement benefits, and the impact of the weaker
Canadian dollar on U.S. denominated expenses. These increases were partly offset
by the effects of a reduced workforce in 2002.
Purchased services: The costs of purchased services increased by $30 million, or
22%, for the quarter and $52 million, or 13%, for the nine-month period ended
September 30, 2002, when compared to corresponding periods in 2001. The increase
in the quarter and first nine months of the year was mainly due to the inclusion
of WC expenses and higher expenses for professional services and equipment
repairs.
Depreciation and amortization: Depreciation and amortization expense for the
quarter and nine months ended September 30, 2002, increased by $22 million, or
21%, and $37 million, or 11%, respectively, from the comparable 2001 periods.
The increase in the quarter and first nine months of the year was mainly due to
the inclusion of WC expenses and the impact of capital additions in 2002.
Fuel: Fuel expense decreased by $3 million, or 3%, for the third quarter and $41
million, or 11%, for the first nine months of 2002, when compared to the
respective 2001 periods. The decrease in the quarter and first nine months of
the year was primarily due to a decrease in the average price of fuel, partially
offset by the inclusion of WC expenses.
Equipment rents: These expenses increased by $15 million, or 21%, in the quarter
and $43 million, or 19%, for the first nine months of the year, when compared to
the same 2001 periods. The increase in the quarter and first nine months of the
year was mainly due to the inclusion of WC expenses and lower car hire income.
Material: For the quarter and nine months ended September 30, 2002, material
costs increased by $11 million, or 18%, and $10 million, or 5%, respectively,
from the comparable 2001 periods. The increase in the quarter and first nine
months of the year was mainly due to the inclusion of WC expenses that were
partly offset by lower locomotive and car maintenance costs.
Operating taxes: Operating taxes increased by $5 million, or 15%, during the
third quarter and $7 million, or 6%, during the nine-month period ended
September 30, 2002 when compared to the corresponding 2001 periods. The increase
in the quarter and first nine months of the year was mainly due to the inclusion
of WC expenses and lower recoveries in 2002.
Casualty and other: These expenses increased by $4 million, or 7%, in the
current quarter and $38 million, or 24%, for the first nine months of 2002, when
compared to the corresponding 2001 periods. The increase in the current quarter
is mainly due to the inclusion of WC expenses. The increase in the nine-month
period was mainly due to higher expenses for casualty and legal claims,
including occupational-related claims, and higher derailment-related expenses
that were partly offset by lower expenses related to environmental matters and
bad debts.
51
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
--------------------------------------------------------------------------------
Other
Interest expense: Interest expense for the third quarter increased by $18
million, or 25%, from the comparable 2001 quarter and $48 million, or 22%, in
the first nine months of 2002 versus the equivalent 2001 period. The increase in
the quarter and first nine months of the year was mainly due to the financing
related to the acquisition of WC and the inclusion of WC expenses. Partly
offsetting these increases was lower interest expense related to the maturity of
certain notes in the first nine months of 2001.
Other income: The Company recorded other income of $8 million for the third
quarter of 2002 compared to $14 million in the same period of 2001. The decrease
is mainly due to lower gains on disposal of surplus assets, partly offset by the
Company's equity in earnings of English Welsh and Scottish Railway (EWS) of $4
million. On September 30, 2002, the Company completed the sale of IC Terminal
Holdings Company for net sales proceeds of U.S.$18 million (Cdn$28 million),
which approximated the carrying value of the investment. Excluding the impact of
the 2001 DRT and 360networks Inc. transactions previously discussed, other
income for the first nine months of 2002 increased to $69 million from $32
million in the comparable period of 2001. The increase was mainly due to the
Company's equity in earnings of EWS of $19 million and higher gains on disposal
of surplus assets.
Income tax expense: The Company recorded an income tax expense of $94 million
for the current quarter and $96 million for the corresponding period in 2001.
Income tax expense was $310 million for the nine months ended September 30, 2002
and $263 million for the comparable 2001 period. The effective tax rate for the
quarter and nine months ended September 30, 2002 was 33.5% and 33.7%,
respectively. The effective tax rate for the comparative 2001 periods was 35.0%
and 35.6%, respectively, excluding the income tax effect on the special charge,
the DRT transaction and the charge for 360networks Inc.
52
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
--------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of liquidity is cash generated from operations.
The Company also has the ability to fund liquidity requirements through its
revolving credit facilities, the issuance of debt and/or equity, and the sale of
a portion of its accounts receivable through the Accounts receivable
securitization program. In addition, from time to time, the Company's liquidity
requirements can be supplemented by the disposal of surplus properties and the
monetization of assets.
Operating activities: Cash provided from operating activities was $294 million
and $869 million for the three and nine-month periods ended September 30, 2002,
respectively, compared to $193 million and $630 million for the same 2001
periods. Net income, excluding non-cash items, generated cash of $353 million
for the current quarter and $1,121 million for the nine months ended September
30, 2002, compared to $310 million and $1,031 million in the corresponding 2001
periods. Cash generated in the first nine months of 2002 was partially consumed
by payments for workforce reductions and income taxes of $130 million and $88
million, respectively, compared to $128 million and $70 million, respectively,
for the same period last year. Payments for casualty and legal claims, including
amounts paid for workers' compensation, for the first nine months of 2002 and
2001 were $105 million and $119 million, respectively.
Investing activities: Cash used by investing activities in the quarter and nine
months ended September 30, 2002 amounted to $159 million and $290 million,
respectively, compared to $161 million and $309 million for the comparable
periods in 2001. The Company's investing activities in the first nine months of
2002 included net proceeds of $68 million from the sale of its investment in
Tranz Rail Holdings Limited, whereas the comparative period included net
proceeds of $112 million from the sale of DRT. Net capital expenditures amounted
to $157 million and $361 million in the three and nine months ended September
30, 2002, respectively, an increase of $37 million and a decrease of $27 million
from the same 2001 periods. Capital expenditures included expenditures for
roadway renewal, rolling stock, and other capacity and productivity
improvements.
The Company anticipates that capital expenditures for 2002 will remain at
approximately the same level as 2001. This will include funds required for
ongoing renewal of the basic plant and other acquisitions and investments
required to improve the Company's operating efficiency and customer service.
Dividends: The Company paid a quarterly dividend of $0.215 per common share
amounting to $43 million for the third quarter and $126 million for the first
nine months of 2002 compared to $38 million and $113 million, respectively, at
the rate of $0.195 per common share for the same periods in 2001. In the third
quarter and first nine months of 2002, $4 million and $9 million, respectively,
was paid on the convertible preferred securities compared to $4 million and $14
million, respectively, for the same periods in 2001, at an annual rate of 5.25%.
Free cash flow
The Company generated $88 million and $444 million of free cash flow for the
three and nine months ended September 30, 2002, respectively, compared to cash
consumed of $10 million and cash generated of $194 million for the same 2001
periods. The Company defines free cash flow as cash provided from operating
activities less capital expenditures, other investing activities and dividends
paid.
Financing activities: Cash used by financing activities totaled $157 million for
the third quarter and $473 million for the nine months ended September 30, 2002
compared to cash generated from financing activities of $810 million and $617
million in the same periods of 2001. In 2002, issuances and repayments of
long-term debt related principally to the Company's commercial paper and
revolving credit facilities. In September 2001, the Company issued debt
securities in two series, U.S.$400 million (Cdn$629 million) 6.375% Notes due
2011 and U.S.$200 million (Cdn$314 million) 7.375% Debentures due 2031, related
to the acquisition of WC.
53
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
--------------------------------------------------------------------------------
The Company has access to various financing arrangements:
Revolving credit facilities
The Company has U.S.$1,000 million revolving credit facilities that expire in
March 2003. The credit facility agreements contain customary financial covenants
with which the Company has been in full compliance since the inception of the
agreements. The Company's borrowings of U.S.$172 million (Cdn$273 million)
outstanding at December 31, 2001 were entirely repaid in the first quarter of
2002 and since then, the credit facilities have not been drawn upon. At
September 30, 2002, letters of credit under the revolving credit facilities
amounted to $295 million. The Company currently expects to renew the existing
facilities and to complete the refinancing before their maturity.
Commercial paper
The Company has a commercial paper program, which is backed by a portion of its
revolving credit facilities, enabling it to issue commercial paper up to a
maximum aggregate principal amount of $600 million, or the U.S. dollar
equivalent. The revolving credit facilities will mature in March 2003 and while
the Company's intent is to renew the existing revolving credit facilities, the
refinancing has not been completed and, as such, the outstanding balance of
U.S.$117 million (Cdn$184 million) of commercial paper has been included in the
current portion of long-term debt at September 30, 2002.
Shelf registration statement
At September 30, 2002, the Company had U.S.$400 million remaining for issuance
under its shelf registration statement.
Accounts receivable securitization program
The sale of a portion of the Company's accounts receivable is conducted under a
securitization program, which has a $350 million maximum limit and will expire
in June 2003. The program is subject to customary credit rating and reporting
requirements. In the event the program is terminated before its scheduled
maturity, the Company expects to have sufficient liquidity remaining in its
current and future revolving credit facilities to meet future obligations and
anticipated capital expenditures. The Company intends to renew the program upon
expiration. At September 30, 2002, pursuant to the agreement, $168 million and
U.S.$113 million (Cdn$178 million) had been sold on a limited recourse basis
reflecting no change in the level of accounts receivable sold since December 31,
2001.
The Company's access to current and alternate sources of financing at
competitive costs is dependent on its credit rating. The Company is not
currently aware of any adverse trend, event or condition that would affect the
Company's credit standing.
54
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
--------------------------------------------------------------------------------
Contractual obligations and commercial commitments
In the normal course of business, the Company incurs contractual obligations and
commercial commitments. The following tables set forth material obligations and
commitments as of September 30, 2002:
Contractual obligations
(In millions)
Contract Type Total 2002 2003-2004 2005-2006 2007 &
thereafter
-----------------------------------------------------------------------------------------
Debentures, notes and other $ 4,517 $ 11 $ 1,104 $ 581 $ 2,821
Capital leases (a) 881 35 188 97 561
-----------------------------------------------------------------------------------------
Long-term debt $ 5,398 $ 46 $ 1,292 $ 678 $ 3,382
Operating leases (b) 1,206 56 406 302 442
-----------------------------------------------------------------------------------------
Total obligations $ 6,604 $ 102 $ 1,698 $ 980 $ 3,824
=========================================================================================
Commercial commitments
(In millions)
Committment Type Total 2002 2003-2004 2005-2006 2007 &
thereafter
-----------------------------------------------------------------------------------------
Standby letters of credit (c) $ 488 $ 194 $ 293 $ 1 $ -
Other commercial commitments (d) 223 27 196 - -
-----------------------------------------------------------------------------------------
Total commitments $ 711 $ 221 $ 489 $ 1 $ -
=========================================================================================
(a) Excludes $507 million of imputed interest on capital leases at rates
ranging from approximately 3.0% to 14.6%.
(b) The Company has guaranteed the residual values of $77 million of equipment
with lease terms expiring in the years 2004 through 2012. As at September
30, 2002, the Company does not expect to make any payments pertaining to
the guarantees of these leases.
(c) Consists mainly of letters of credit issued as a financial guarantee of the
Company's contractual obligations under various arrangements. Letters of
credit under the revolving credit facilities amounted to $295 million.
(d) Includes commitments for railroad ties, rail, freight cars and locomotives.
For 2002 and the foreseeable future, the Company expects cash from operations
and from its various sources of financing, including the expected renewal of its
revolving credit facilities, to be sufficient to meet its future obligations and
fund anticipated capital expenditures.
55
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
--------------------------------------------------------------------------------
SHARE REPURCHASE PROGRAM
On October 22, 2002, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 13 million common
shares between October 25, 2002 and October 24, 2003 pursuant to a normal course
issuer bid, at prevailing market prices.
TERMINATION OF CONVERSION RIGHTS OF 5.25% CONVERTIBLE PREFERRED SECURITIES
("SECURITIES")
On May 6, 2002, the Company announced that it had met the conditions required to
terminate the Securities holders' right to convert their Securities into common
shares of the Company, and set the conversion termination date as July 3, 2002.
The conditions were met when the Company's common share price exceeded 120% of
the conversion price of U.S.$38.48 per share (as adjusted, following the
Company's two-for-one common stock split in September 1999) for a specified
period, and all accrued interest on the Securities had been paid.
On July 3, 2002, the closing price of the Company's common shares exceeded the
conversion price of U.S.$38.48 per share. As a result, Securities that had not
been previously surrendered for conversion were converted, resulting in the
issuance of approximately 6 million common shares of the Company.
ACQUISITION OF WISCONSIN CENTRAL TRANSPORTATION CORPORATION
On October 9, 2001, the Company completed its acquisition of WC for an
acquisition cost of $1,297 million (U.S.$831 million) and began a phased
integration of the companies' operations.
The Company accounted for the merger using the purchase method of accounting as
required by the Canadian Institute of Chartered Accountants (CICA) Handbook
Section 1581 "Business Combinations." As such, the Company's consolidated
financial statements include the assets, liabilities and results of operations
of WC as of October 9, 2001, the date of acquisition. The results of the final
valuation of WC's assets and liabilities are not expected to have a material
impact on the results of operations.
CRITICAL ACCOUNTING POLICIES, BUSINESS RISKS AND OTHER MATTERS
Management's discussion and analysis of the Company's financial condition and
results of operations is based on the same accounting policies as those used in
preparing the Company's 2001 Annual Consolidated Financial Statements. As such,
this document should be read in conjunction with Note 1 "Summary of significant
accounting policies" of the Company's 2001 Annual Consolidated Financial
Statements.
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of revenues and expenses during the period, the
reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the financial statements. On an ongoing
basis, management reviews its estimates, including those related to litigation,
environmental liabilities, casualty claims, depreciation lives, income tax
liabilities, and pension and other post-retirement benefits, based upon
currently available information. Actual results could differ from these
estimates.
Legal actions
In the normal course of its operations, the Company becomes involved in various
legal actions, including claims relating to personal injuries, occupational
related claims, damage to property claims and environmental claims. The Company
maintains, and regularly updates on a case-by-case basis, casualty provisions
for such items when the expected loss is both probable and can be reasonably
estimated. Although the Company considers such provisions to be adequate for
these matters, the final outcome with respect to actions outstanding or pending
at September 30, 2002, or with respect to future claims,
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CANADIAN NATIONAL RAILWAY COMPANY
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cannot be predicted with certainty, and therefore there can be no assurance that
their resolution will not have a material adverse effect on the Company's
financial position or results of operations in a particular quarter or fiscal
year.
Employee work-related injuries, including occupational related claims, are
compensated according to the provisions of the Federal Employers' Liability Act
(FELA) and represent a significant expense for the railroad industry in the
United States. Consistent with the case-by-case approach, the Company does not
accrue a provision for unasserted occupational related claims. In view of the
Company's increasing expansion in the United States, and the increase in the
number of occupational claims over the past years, the Company will consider
using an actuarial based approach to evaluate the sufficiency of its provision
for occupational and other claims. The Company has been, and continues working
with an independent actuarial firm. Any change in the estimated liability would
be accounted for as a change in accounting estimate and recorded in the results
of operations.
As at September 30, 2002, the Company had aggregate reserves for legal matters
of $258 million ($277 million at December 31, 2001), of which approximately $152
million was for work-related injuries to employees in the United States,
including occupational related claims.
Environmental matters
Regulatory compliance
The Company's operations are subject to federal, provincial, state, municipal
and local regulations under environmental laws and regulations concerning, among
other things, emissions into the air; discharges into waters; the generation,
handling, storage, transportation, treatment and disposal of waste, hazardous
substances and other materials; decommissioning of underground and aboveground
storage tanks; and soil and groundwater contamination. A risk of environmental
liability is inherent in the railroad and related transportation operations;
real estate ownership, operation or control; and other commercial activities of
the Company with respect to both current and past operations. As a result, the
Company incurs significant compliance and capital costs, on an ongoing basis,
associated with environmental regulatory compliance and clean-up requirements.
Environmental expenditures that relate to current operations are expensed unless
they relate to an improvement to the property. Expenditures that relate to an
existing condition caused by past operations and which are not expected to
contribute to current or future operations are expensed.
Known existing environmental concerns
The ultimate cost of known contaminated sites cannot be definitely established,
and the estimated environmental liability for any given site may vary depending
on the nature and extent of the contamination, the available clean-up technique,
the Company's share of the costs and evolving regulatory standards governing
environmental liability. As a result, liabilities are recorded when
environmental assessments and/or remedial efforts are likely, and when costs,
based on a specific plan of action in terms of the technology to be used and the
extent of the corrective action required, can be reasonably estimated.
Unknown existing environmental concerns
While the Company believes that it has identified the costs likely to be
incurred in the next several years, based on known information, for
environmental matters, the Company's ongoing efforts to identify potential
environmental concerns that may be associated with its properties may lead to
future environmental investigations, which may result in the identification of
additional environmental costs and liabilities. The magnitude of such additional
liabilities and costs cannot be reasonably estimated and as such, costs related
to future remediation will be accrued in the year they become known.
Future occurrences
In the operation of a railroad, it is possible that derailments, explosions or
other accidents may occur that could cause harm to human health or to the
environment. As a result, the Company may incur costs in the future, which may
be material, to address any such harm, including costs relating to the
performance of clean-ups, natural resource damages
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CANADIAN NATIONAL RAILWAY COMPANY
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and compensatory or punitive damages relating to harm to individuals or
property.
As at September 30, 2002, the Company had aggregate accruals for environmental
costs of $101 million ($112 million at December 31, 2001). The Company has not
included any reduction in costs for anticipated recovery from insurance.
There can be no assurance that material liabilities or costs related to
environmental matters will not be incurred in the future, or will not have a
material adverse effect on the Company's financial position or results of
operations in a particular quarter or fiscal year, or that the Company's
liquidity will not be adversely impacted by such environmental liabilities or
costs.
Properties
The Company follows the group method of depreciation and, as such, depreciates
the cost of properties, net of asset impairment write-downs, on a straight-line
basis over the estimated useful life of each asset class. Assessing the
reasonableness of the estimated useful lives of properties requires judgment and
is based upon currently available information, including comprehensive
depreciation studies that incorporate assumptions of remaining useful lives. A
revision to the estimated useful lives of properties is considered a change in
accounting estimate and, as a result, depreciation rates would be changed on a
prospective basis. A significant change in depreciable lives could result in a
material change to depreciation expense.
Pension and Other post-retirement benefits
The Company accounts for pension and other post-retirement benefits as required
by CICA Handbook Section 3461 "Employee Future Benefits." Under this accounting
standard, the 2002 assumptions regarding the valuation of benefit obligations
and performance of plan assets were established on the plan's last measurement
date of January 1, 2002. Delayed recognition of differences between actual
results and those assumed is a guiding principle of this standard. This approach
allows for recognition of changes in benefit obligations and plan performance
over the working lives of the employees who benefit from the plans.
An actuarial valuation is conducted at least on a triennial basis, to account
for pension and other post-retirement benefits which uses management assumptions
for the discount rate, the expected return on plan assets, the rate of
compensation increase, the health care cost trend and the expected average
remaining service life of the employee group. A change in any one of these
assumptions could have a significant impact on the pension and post-retirement
benefit expense recorded under CICA Section 3461. The Company regularly reviews
these assumptions on an annual basis.
During the last ten years ended December 31, 2001, the CN Pension Plan earned an
average rate of return in excess of 10% annually. For that same period, the
Company used a long-term rate of return assumption not exceeding 9% to compute
pension expense. However, given the recent performance of its plan assets and
the equity markets in North America, it is anticipated that the Company will,
effective for 2003, reduce the expected long-term rate of return on plan assets
from 9% to 8% to reflect management's current view of long-term investment
returns. The effect of this change in management's assumption will be to
increase pension expense by approximately $50 million.
Financial instruments
Although the Company conducts its business and receives revenues primarily in
Canadian dollars, a growing portion of its revenues, expenses, assets and debt
are denominated in U.S. dollars. Thus, the Company's results are affected by
fluctuations in the exchange rate between these currencies. Changes in the
exchange rate between the Canadian dollar and other currencies (including the
U.S. dollar) make the goods transported by the Company more or less competitive
in the world marketplace and thereby affect the Company's revenues.
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CANADIAN NATIONAL RAILWAY COMPANY
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The Company has limited involvement with derivative financial instruments and
does not use them for trading purposes. Collateral or other security to support
financial instruments subject to credit risk is usually not obtained. However,
the credit standing of counterparties or their guarantors is regularly
monitored, and losses due to counterparty non-performance are not anticipated.
To mitigate the effects of fuel price changes on its operating margins and
overall profitability, the Company has a systematic hedging program which calls
for regularly entering into swap positions on crude and heating oil to cover a
target percentage of future fuel consumption up to two years in advance. At
September 30, 2002, the Company hedged approximately 46% of the estimated 2002
fuel consumption, 45% of the estimated 2003 fuel consumption and 14% of the
estimated 2004 fuel consumption. This represented approximately 391 million U.S.
gallons at an average price of U.S.$0.6064 per U.S. gallon.
For the three months ended September 30, 2002, the Company realized a gain of $4
million from its fuel hedging activities, compared to a negligible gain in the
same period last year. For the first nine months of 2002, the Company's hedging
activities resulted in a realized loss of $5 million compared to a $4 million
gain in the same period of 2001.
As a result of fuel hedging activities, the Company had an unrealized holding
gain of $31 million at September 30, 2002 ($38 million unrealized holding loss
at December 31, 2001).
Competition
The Company faces significant competition from a variety of carriers, including
Canadian Pacific Railway Company which operates the other major rail system in
Canada, serving most of the same industrial and population centers as the
Company, long distance trucking companies and, in certain markets, major U.S.
railroads and other Canadian and U.S. railroads. Competition is generally based
on the quality and reliability of services provided, price, and the condition
and suitability of carriers' equipment. Competition is particularly intense in
eastern Canada where an extensive highway network and population centers,
located relatively close to one another, have encouraged significant competition
from trucking companies. In addition, much of the freight carried by the Company
consists of commodity goods that are available from other sources in competitive
markets. Factors affecting the competitive position of suppliers of these
commodities, including exchange rates, could materially adversely affect the
demand for goods supplied by the sources served by the Company and, therefore,
the Company's volumes, revenues and profit margins.
To a greater degree than other rail carriers, the Company's subsidiary, Illinois
Central Railroad Company (ICRR), is vulnerable to barge competition because its
main routes are parallel to the Mississippi River system. The use of barges for
some commodities, particularly coal and grain, often represents a lower cost
mode of transportation. Barge competition and barge rates are affected by
navigational interruptions from ice, floods and droughts, which can cause widely
fluctuating barge rates. The ability of ICRR to maintain its market share of the
available freight has traditionally been affected by the navigational conditions
on the river.
In recent years, there has been significant consolidation of rail systems in the
United States. The resulting larger rail systems are able to offer seamless
services in larger market areas and effectively compete with the Company in
certain markets. There can be no assurance that the Company will be able to
compete effectively against current and future competitors in the railroad
industry and that further consolidation within the railroad industry will not
adversely affect the Company's competitive position. No assurance can be given
that competitive pressures will not lead to reduced revenues, profit margins or
both.
Labor negotiations
Canadian workforce
As of October 2002, the Company had achieved ratified settlements with
bargaining groups representing substantially all of its Canadian
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CANADIAN NATIONAL RAILWAY COMPANY
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unionized workforce. These agreements are generally for a three-year period
effective until December 31, 2003.
U.S. workforce
The general approach to labor negotiations by U.S. Class 1 railroads is to
bargain on a collective national basis. Grand Trunk Western (GTW), Duluth
Winnipeg and Pacific (DWP), ICRR, CCP Holdings, Inc. (CCP) and just recently WC,
have bargained on a local basis rather than holding national, industry wide
negotiations because the resulting settlements better address both the
employees' concerns and preferences and the railways' actual operating
environment. However, local negotiations may not generate federal intervention
in a strike or lockout situation, since a dispute may be localized. The Company
believes the potential mutual benefits of local bargaining outweigh the risks.
As of October 2002, the Company had in place agreements with bargaining units
representing the entire unionized workforce at ICRR, GTW, DWP, and CCP, and 43%
at WC. These agreements have various durations, ranging from the end of 2001 to
the end of 2005. Several of these agreements have reopened or will reopen in
2002.
Negotiations are ongoing with the bargaining units with which the Company has
not yet achieved new settlements. Until new agreements are reached or until
settlements are ratified, the terms and conditions of previous agreements
continue to apply. Although the Company does not anticipate work action related
to these negotiations while they are ongoing, there can be no assurance that
their resolution will not have a material adverse effect on the Company's
financial position or results of operations.
Regulation
The Company's rail operations in Canada are subject to regulation as to (i) rate
setting and network rationalization by the Canadian Transportation Agency (the
Agency), under the Canada Transportation Act (Canada) (the CTA), and (ii) safety
by the federal Minister of Transport under the Railway Safety Act (Canada) and
certain other statutes. The Company's U.S. rail operations are subject to
regulation by the Surface Transportation Board (STB) (the successor to the
Interstate Commerce Commission) and the Federal Railroad Administration. In
addition, the Company is subject to a variety of health, safety, security,
labor, environmental and other regulations, all of which can affect its
competitive position and profitability.
The CTA Review Panel, which was appointed by the federal government to carry out
a comprehensive review of the Canadian transportation legislation, issued its
report to the Minister of Transport at the end of June 2001. It was released to
the public on July 18, 2001 and contains numerous recommendations for
legislative changes, which, if adopted, would affect all modes of
transportation, including rail. No assurance can be given that any decision by
the federal government pursuant to the report's recommendations will not
materially adversely affect the Company's financial position or results of
operations.
Business prospects and other risks
In any given year, the Company, like other railroads, is susceptible to changes
in the economic conditions of the industries and geographic areas that produce
and consume the freight it transports or the supplies it requires to operate. In
addition, many of the goods and commodities carried by the Company experience
cyclicality in the demand for them. However, many of the bulk commodities the
Company transports move offshore and are impacted more by global economic
conditions than North American economic cycles. The Company's results of
operations can be expected to reflect this cyclicality because of the
significant fixed costs inherent in railroad operations.
The Company's revenues are affected by prevailing economic conditions. In 2001,
widespread recessionary conditions in the economy affected the Company's
revenues. While the Company expects continued North American economic growth in
the fourth quarter of 2002, much of that will depend on
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CANADIAN NATIONAL RAILWAY COMPANY
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consumer and business confidence, both of which show signs of being tested by
uncertain domestic markets and international events. The Company will continue
to leverage its strong service capabilities but remains cautious about business
prospects for the near term.
Should a major economic slowdown or recession occur in North America or other
key markets, or should major industrial restructuring take place, the volume of
rail shipments carried by the Company is likely to be affected.
In addition to the inherent risks of the business cycle, the Company is
occasionally susceptible to severe weather conditions. For example, in the first
quarter of 1998, a severe ice storm hit eastern Canada, which disrupted
operations and service for the railroad as well as for CN customers. More
recently, severe drought conditions in western Canada significantly reduced bulk
commodity revenues, principally grain. There continues to be widespread concerns
about the impact of crop conditions on grain supplies in the near term.
Inflation
Generally accepted accounting principles require the use of historical cost as
the basis of reporting in financial statements. As a result, the cumulative
effect of inflation, which has significantly increased asset replacement costs
for capital-intensive companies such as CN, is not reflected in operating
expenses. Depreciation charges on an inflation-adjusted basis, assuming that all
operating assets are replaced at current price levels, would be substantially
greater than historically reported amounts.
Forward-looking information
Certain information included in this report may be "forward-looking statements"
within the meaning of the United States Private Securities Litigation Reform Act
of 1995. Such forward-looking statements are not guarantees of future
performance and involve known and unknown risks, uncertainties and other factors
which may cause the outlook, the actual results or performance of the Company or
the rail industry to be materially different from any future results or
performance implied by such statements. Such factors include the factors set
forth in this section as well as other risks detailed from time to time in
reports filed by the Company with securities regulators in Canada and the United
States.
Disclosure Controls and Procedures
The Company's Chief Executive Officer and its Chief Financial Officer, after
evaluating the effectiveness of the Company's "disclosure controls and
procedures" (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c)) as of
October 22, 2002 (the "Evaluation Date") within the 90 day period leading to and
ending on the filing date of this quarterly report, have concluded that the
Company's disclosure controls and procedures were adequate and effective and
designed to ensure that material information relating to the Company and its
consolidated subsidiaries would have been made known to them. Subsequent to the
Evaluation Date, there were no significant changes in the Company's internal
controls or, to their knowledge, in other factors that could significantly
affect the Company's disclosure controls and procedures.
61
ITEM 3
Statement of Principal Executive Officer Regarding Facts and
Circumstances Relating to Exchange Act Filings
I, PAUL M. TELLIER, President and Chief Executive Officer of Canadian National
Railway Company ("CN"), certify that:
(1) I have reviewed this quarterly report on Form 6-K of CN;
(2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
(4) The Executive Vice-President and Chief Financial Officer of CN and I
are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant ("CN") and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to CN, including its consolidated
subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of CN's disclosure controls and
procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
(5) CN's other certifying officers and I have disclosed, based on our
most recent evaluation, to CN's auditors and the audit committee of
CN's board of directors;
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarizes and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
(6) CN's other certifying officers and I have indicated in this quarterly
report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
The following certification is made on a voluntary basis and is not required
under the laws of Canada, the United States or any other jurisdiction. The
certification is not and shall not be deemed to be a certification made
pursuant to the Sarbanes-Oxley Act of 2002 of the United States or any other
law or regulation of the United States, Canada or any other jurisdiction. The
certification is made as of the date of issuance of this report and neither we
nor the undersigned assumes any duty to update the certification.
/s/ PAUL M. TELLIER
-------------------------------------
PAUL M. TELLIER
President and Chief Executive Officer
Canadian National Railway Company
DATE: October 24, 2002
ITEM 4
Statement of Principal Financial Officer Regarding Facts and
Circumstances Relating to Exchange Act Filings
I, CLAUDE MONGEAU, Executive Vice-President and Chief Financial Officer of
Canadian National Railway Company ("CN"), certify that:
(1) I have reviewed this quarterly report on Form 6-K of CN;
(2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
(4) The President and Chief Executive Officer of CN and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant ("CN") and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to CN, including its consolidated
subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of CN's disclosure controls and
procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
(5) CN's other certifying officers and I have disclosed, based on our
most recent evaluation, to CN's auditors and the audit committee of
CN's board of directors;
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarizes and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
(6) CN's other certifying officers and I have indicated in this quarterly
report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
The following certification is made on a voluntary basis and is not required
under the laws of Canada, the United States or any other jurisdiction. The
certification is not and shall not be deemed to be a certification made
pursuant to the Sarbanes-Oxley Act of 2002 of the United States or any other
law or regulation of the United States, Canada or any other jurisdiction. The
certification is made as of the date of issuance of this report and neither we
nor the undersigned assumes any duty to update the certification.
/s/ CLAUDE MONGEAU
-----------------------------------
CLAUDE MONGEAU
Executive Vice-President and Chief
Financial Officer
Canadian National Railway Company
DATE: October 24, 2002