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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 AUGUST 8, 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
PRESS RELEASE
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CN LOGO
FOR IMMEDIATE RELEASE
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Stock symbols: TSE : CNR / NYSE: CNI
www.cn.ca
---------
CN reports second-quarter 2002 financial results
o Second-quarter 2002 net income and diluted earnings per share of $280
million and $1.39, respectively, compared with adjusted net income
and diluted EPS (1) of $240 million and $1.21 for second-quarter 2001
o Revenues of $1,551 million, up 11 per cent on the strength of WC
acquisition and increased petroleum and chemicals, automotive and
intermodal traffic
o Strong six-month free cash flow of $356 million
MONTREAL, July 22, 2002 - Canadian National today reported second-quarter 2002
net income of $280 million, an increase of 17 per cent over adjusted net income
(1) of $240 million for the same quarter of 2001.
Diluted earnings per share for the second quarter of 2002 were $1.39, up 15 per
cent from adjusted diluted earnings per share (1) of $1.21 for the year-earlier
period.
Reported net income for the second quarter of 2001 was $217 million, or $1.10
per diluted share.
Operating income for second-quarter 2002 increased 10 per cent to $490 million
from $444 million - excluding the effect of a special charge to operations to
recognize the costs of a workforce adjustment program - for the same quarter of
2001. Including the special charge, operating income for second-quarter 2001
was $346 million.
1
CANADIAN NATIONAL RAILWAY COMPANY
PRESS RELEASE
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Revenues for the most recent quarter rose 11 per cent to $1,551 million, while
operating expenses were $1,061 million. Excluding the special charge,
second-quarter 2001 operating expenses were $948 million; including it,
operating expenses were $1,046 million.
CN President and Chief Executive Officer Paul M. Tellier said: "We are pleased
with these results, which were achieved in a difficult environment for our
grain and coal units. The Wisconsin Central acquisition, and the strong
performance of our petroleum and chemicals, automotive and intermodal units,
drove a 17 per cent increase in net income, and 15 per cent rise in earnings
per share for the second quarter. Free cash flow for the first half of 2002 was
also strong, rising to $356 million from $208 million for the comparable period
of 2001. In sum, the strength of our service-sensitive merchandise business and
intermodal unit more than offset tough conditions for CN's grain and coal
segments.
"CN's petroleum and chemicals unit benefited from the inclusion of WC revenues,
market share gains and strong sulfur shipments to the United States and to
offshore markets. Continuing high motor vehicle production, particularly in the
U.S., boosted our automotive revenue sharply. And the improvement in intermodal
revenues reflected stronger Canadian retail sales, higher volumes on expedited
trains in the Canadian domestic segment, and increased overseas traffic in
spite of the loss of some overseas moves. Grain revenues were significantly
affected again by the poor 2001/2002 Canadian crop, while coal revenues
declined as a result of reduced demand from power utilities and weak Canadian
coal exports to offshore markets.
"CN's strength is its service-sensitive merchandise business - petroleum and
chemicals, forest products, metals and minerals, and automotive -- which is
growing faster than the rail industry average as a result of our disciplined,
scheduled railroad service. This service edge positions CN for further market
share gains in its merchandise segments, with continued economic recovery
expected for the balance of the year. However, CN remains cautious about
business prospects for the second half of 2002, as there are signs of
uncertainty in the overall level of consumer and business confidence."
Five of CN's seven business units experienced revenue gains in the second
quarter of 2002: petroleum and chemicals (28 per cent); forest products (24 per
cent); metals and minerals (18 per cent); automotive (14 per cent); and
intermodal (seven per cent). Revenues declined for coal (eight per cent), and
grain and fertilizers (seven per cent).
Total carloadings for second-quarter 2002 rose 12 per cent to 1,059 thousand.
CN's operating ratio for the most recent three-month period was 68.4 per cent,
compared with 68.1 per cent, excluding the special charge, for the year-earlier
quarter.
2
CANADIAN NATIONAL RAILWAY COMPANY
PRESS RELEASE
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The increase in operating expenses for second-quarter 2002 was largely
attributable to the consolidation of WC operating expenses, higher expenses for
labor and fringe benefits, equipment rents, and casualty and other, partially
offset by lower fuel costs.
First-half 2002 results
Net income for the first half of 2002 was $510 million, compared with adjusted
net income(1) of $442 million for the comparable period of 2001.
Diluted earnings per share for the first six months of 2002 were $2.54 per
share, up from adjusted diluted earnings per share (1) of $2.24 for the
year-earlier period.
Reported net income for the first six months of 2001 was $492 million, or $2.49
per diluted share.
Operating income for the first half of 2002 was $896 million, compared with
$829 million - excluding the effect of the special charge - for the same period
of 2001. Including the special charge, operating income for first-half 2001 was
$731 million.
First-half 2002 revenues increased 10 per cent to $3,060 million, while
operating expenses were $2,164 million. Excluding the special charge, operating
expenses for the first six months of 2001 were $1,961 million; including it,
operating expenses were $2,059 million.
Five of CN's business units reported increased revenues for the first six
months of 2002: forest products (28 per cent); petroleum and chemicals (23 per
cent); metals and minerals (21 per cent); automotive (17 per cent); intermodal
(three per cent). Revenues declined for grain and fertilizers (12 per cent) and
coal (nine per cent).
Total carloadings for the first half of 2002 increased eight per cent to 2,058
thousand.
(1) Adjusted net income and diluted earnings per share for the second quarter
and first half of 2001 exclude 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 $110 million deferred income tax recovery (55 cents per
share) resulting from the enactment of lower corporate tax rates in Canada. In
addition, CN's first-half 2001 results exclude a gain from the sale of CN's 50
per cent interest in the Detroit River Tunnel Company, equal to $73 million
after-tax, or 36 cents per diluted share. 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).
3
CANADIAN NATIONAL RAILWAY COMPANY
PRESS RELEASE
-------------------------------------------------------------------------------
The financial results in this press release are reported in Canadian dollars
and were determined on the basis of 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 risk factors.
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.
- 30 -
Contacts:
Media Investment Community
----- --------------------
Mark Hallman Robert Noorigian
System Director, Media Relations Vice-President, Investor Relations
(416) 217-6390 (514) 399-0052
4
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF INCOME (U.S. GAAP)
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(In millions, except per share data)
Three months ended Six months ended
June 30 June 30
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2002 2001 2002 2001
(Unaudited)
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Revenues $ 1,551 $ 1,392 $ 3,060 $ 2,790
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Operating expenses excluding special charge 1,061 948 2,164 1,961
Special charge (Note 3) -- 98 -- 98
--------------------------------------------------------------------------------------
Total operating expenses 1,061 1,046 2,164 2,059
Operating income 490 346 896 731
Interest expense (91) (78) (187) (158)
Other income (loss) (Note 4) 23 (90) 61 22
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Income before income taxes 422 178 770 595
Income tax (expense) recovery (Note 5) (142) 39 (260) (103)
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Net income (Note 10) $ 280 $ 217 $ 510 $ 492
======================================================================================
Earnings per share (Note 10)
Basic $ 1.44 $ 1.13 $ 2.64 $ 2.57
Diluted $ 1.39 $ 1.10 $ 2.54 $ 2.49
Weighted-average number of shares
Basic 193.9 192.0 193.5 191.7
Diluted 203.3 200.9 203.1 200.4
======================================================================================
See accompanying notes to consolidated financial statements.
5
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF OPERATING INCOME (U.S. GAAP)
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(In millions)
Three months ended June 30 Six months ended June 30
--------------------------------- ------------------------
Variance Variance
2002 2001 Fav (Unfav) 2002 2001 Fav (Unfav)
---------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues
Petroleum and chemicals $ 271 $ 212 28% $ 544 $ 443 23%
Metals and minerals 138 117 18% 260 214 21%
Forest products 334 269 24% 659 514 28%
Coal 81 88 (8%) 158 173 (9%)
Grain and fertilizers 255 275 (7%) 524 596 (12%)
Intermodal 261 244 7% 496 481 3%
Automotive 159 139 14% 310 266 17%
Other items 52 48 8% 109 103 6%
--------------------------------------------------------------- ------------------
1,551 1,392 11% 3,060 2,790 10%
Operating expenses
Labor and fringe benefits 430 370 (16%) 891 748 (19%)
Purchased services 143 132 (8%) 280 265 (6%)
Depreciation and amortization 144 131 (10%) 285 263 (8%)
Fuel 114 121 6% 226 264 14%
Equipment rents 92 75 (23%) 179 151 (19%)
Material 57 51 (12%) 118 114 (4%)
Operating taxes 42 37 (14%) 83 81 (2%)
Casualty and other 39 31 (26%) 102 75 (36%)
Special charge (Note 3) -- 98 100% -- 98 100%
--------------------------------------------------------------- ------------------
1,061 1,046 (1%) 2,164 2,059 (5%)
--------------------------------------------------------------- ------------------
Operating income $ 490 $ 346 42% $ 896 $ 731 23%
===============================================================================================================
Operating ratio (excluding special charge) 68.4% 68.1% (0.3) 70.7% 70.3% (0.4)
===============================================================================================================
See accompanying notes to consolidated financial statements.
6
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED BALANCE SHEET (U.S. GAAP)
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(In millions)
June 30 December 31 June 30
2002 2001 2001
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(Unaudited) (Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 93 $ 53 $ 30
Accounts receivable (Note 6) 675 645 662
Material and supplies 163 133 136
Deferred income taxes (Note 5) 125 153 140
Other 185 180 142
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1,241 1,164 1,110
Properties 18,732 19,145 15,880
Other assets and deferred charges (Note 2) 866 914 382
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Total assets $20,839 $21,223 $17,372
===============================================================================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable and accrued charges $ 1,355 $ 1,374 $ 1,272
Current portion of long-term debt (Note 6) 832 163 281
Other 83 132 82
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2,270 1,669 1,635
Deferred income taxes (Note 5) 4,560 4,591 3,404
Other liabilities and deferred credits 1,217 1,345 1,159
Long-term debt (Note 6) 4,500 5,764 3,873
Convertible preferred securities (Note 7) 347 366 348
Shareholders' equity:
Common shares (Note 7) 4,499 4,442 4,402
Accumulated other comprehensive income 31 58 36
Retained earnings 3,415 2,988 2,515
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7,945 7,488 6,953
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Total liabilities and shareholders' equity $20,839 $21,223 $17,372
===============================================================================================
See accompanying notes to consolidated financial statements
7
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (U.S. GAAP)
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(In millions)
Three months ended Six months ended
June 30 June 30
------------------ ----------------
2002 2001 2002 2001
---------------------------------------------------------------------------------------------------
(Unaudited)
Common shares (1)
Balance, beginning of period $ 4,473 $ 4,385 $ 4,442 $ 4,349
Stock options exercised and conversion of convertible
preferred securities (Note 7) 26 17 57 53
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Balance, end of period $ 4,499 $ 4,402 $ 4,499 $ 4,402
====================================================================================================
Accumulated other comprehensive income
Balance, beginning of period $ 92 $ 97 $ 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 219 123 208 (29)
Unrealized foreign exchange gain (loss) on translation of
the net investment in foreign operations (315) (196) (303) 51
Unrealized holding gain (loss) on investment in
360networks Inc. -- 22 -- (129)
Unrealized holding gain (loss) on fuel derivative
instruments (Note 8) 4 2 55 (5)
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Other comprehensive loss before income taxes (92) (49) (40) (112)
Income tax recovery (expense) on other comprehensive loss
(Note 5) 31 (12) 13 (3)
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Other comprehensive loss (61) (61) (27) (115)
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Balance, end of period $ 31 $ 36 $ 31 $ 36
====================================================================================================
Retained earnings
Balance, beginning of period $ 3,176 $ 2,335 $ 2,988 $ 2,098
Net income 280 217 510 492
Dividends (41) (37) (83) (75)
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Balance, end of period $ 3,415 $ 2,515 $ 3,415 $ 2,515
====================================================================================================
See accompanying notes to consolidated financial statements.
(1) The Company issued 0.6 million and 1.4 million shares for the three and
six months ended June 30, 2002, respectively, as a result of stock options
exercised and the conversion of convertible preferred securities. At June
30, 2002, the Company had 194.1 million common shares outstanding.
8
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (U.S. GAAP)
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(In millions)
Three months ended Six months ended
June 30 June 30
------------------ ----------------
2002 2001 2002 2001
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(Unaudited)
Operating activities
Net income $ 280 $ 217 $ 510 $ 492
Non-cash items in income:
Depreciation and amortization 146 132 288 266
Deferred income taxes (Note 5) 85 (70) 156 17
Gain on sale of investment (Note 4) -- -- -- (101)
Write-down of investment (Note 4) -- 99 -- 99
Special charge (Note 3) -- 98 -- 98
Changes in:
Accounts receivable 15 51 (41) 51
Material and supplies (10) (1) (33) (26)
Accounts payable and accrued charges 31 56 20 (107)
Other net current assets and liabilities (12) (6) (12) (3)
Payments for workforce reductions (47) (40) (94) (89)
Other (13) (49) (37) (105)
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Cash provided from operating activities 475 487 757 592
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Investing activities
Net additions to properties (242) (269) (362) (398)
Other, net (28) (12) 44 89
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Cash used by investing activities (270) (281) (318) (309)
-------------------------------------------------------------------------------------------------------
Dividends paid (41) (37) (83) (75)
Financing activities
Issuance of long-term debt 1,035 236 1,890 504
Reduction of long-term debt (1,182) (430) (2,260) (742)
Issuance of common shares 25 15 54 45
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Cash used by financing activities (122) (179) (316) (193)
-------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 42 (10) 40 15
Cash and cash equivalents, beginning of period 51 40 53 15
-------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 93 $ 30 $ 93 $ 30
=======================================================================================================
See accompanying notes to consolidated financial statements
9
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP)
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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 June 30, 2002,
December 31 and June 30, 2001, its results of operations, changes in
shareholders' equity and cash flows for the three and six months ended June 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 six months ended June 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 $1,533 million, $236 million, $1.23 per basic share and $1.19
per diluted share, respectively, for the three months ended June 30, 2001 and
$3,069 million, $518 million, $2.70 per basic share and $2.61 per diluted
share, respectively, for the six months ended June 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 (loss)
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 June 2001, the Company recorded a reduction of $78 million 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 six months ended June 30,
2001, a deferred income tax recovery of $110 million was recorded in the
Consolidated statement of income and a deferred income tax expense of $32
million was recorded in Other comprehensive income.
Note 6 - Financing activities
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. At June 30, 2002, the Company had entirely repaid
its borrowings of U.S.$172 million (Cdn$273 million) outstanding at December
31, 2001. At June 30, 2002, letters of credit under the revolving credit
facilities amounted to $292 million.
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.
10
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP)
-------------------------------------------------------------------------------
dollar equivalent. The revolving credit facilities will mature within the next
twelve months and while the Company's intent is to renew the existing revolving
credit facilities, the refinancing has not been renegotiated and, as such, the
outstanding balance of U.S.$209 million (Cdn$317 million) of commercial paper
has been included in the current portion of long-term debt at June 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 June 30, 2002, pursuant to the agreement,
$168 million and U.S.$113 million (Cdn$171 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.
As of June 30, 2002, approximately U.S.$1 million principal amount of the
Securities were surrendered for conversion into common shares.
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
At June 30, 2002, a portion of the Company's fuel requirement is being 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 June 30, 2002,
Accumulated other comprehensive income included an unrealized holding gain of
$17 million, $11 million after tax, ($38 million unrealized holding loss, $25
million after tax at December 31, 2001) of which $12 million relates to
derivative instruments that will mature within the next twelve months.
Note 9 - Commitments
At June 30, 2002, the Company had commitments to acquire railroad ties, rail,
freight cars and locomotives at an aggregate cost of $267 million ($52 million
at December 31, 2001).
11
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 six months ended June 30, 2002 as explained in Note 2, the comparability of
the results of operations for the three and six months ended June 30, 2002 and
2001 is also impacted by the following items:
Three months ended Six months ended
June 30 June 30
------------------ ----------------
2002 2001 2001 2002 2001 2001
pro pro
forma(1) forma(1)
-----------------------------------------------------------------------------------------------------------
(In millions) (Unaudited)
Income before income taxes, excluding undernoted items $ 422 $ 375 $ 403 $ 770 $ 691 $ 729
Income tax expense (142) (135) (144) (260) (249) (261)
-----------------------------------------------------------------------------------------------------------
Adjusted net income 280 240 259 510 442 468
Undernoted items, net of tax:
Special charge for workforce reductions -- (62) (62) -- (62) (62)
Write-down of net investment in 360networks Inc. -- (71) (71) -- (71) (71)
Deferred income tax recovery -- 110 110 -- 110 110
Gain on sale of Detroit River Tunnel Company -- -- -- -- 73 73
-- (23) (23) -- 50 50
-----------------------------------------------------------------------------------------------------------
Net income $ 280 $ 217 $ 236 $ 510 $ 492 $ 518
===========================================================================================================
The following table provides a reconciliation between basic and diluted
earnings per share:
Three months ended Six months ended
June 30 June 30
------------------ ----------------
2002 2001 2001 2002 2001 2001
pro pro
forma(1) forma(1)
-----------------------------------------------------------------------------------------------------------
(In millions, except per share data) (Unaudited)
Net income $ 280 $ 217 $ 236 $ 510 $ 492 $ 518
Income impact on assumed conversion of preferred
securities 3 3 3 6 6 6
------------------------------------------------------------------------------------------------------------
$ 283 $ 220 $ 239 $ 516 $ 498 $ 524
Weighted-average shares outstanding 193.9 192.0 192.0 193.5 191.7 191.7
Effect of dilutive securities and stock options 9.4 8.9 8.9 9.6 8.7 8.7
------------------------------------------------------------------------------------------------------------
Weighted-average diluted shares outstanding 203.3 200.9 200.9 203.1 200.4 200.4
Basic earnings per share $ 1.44 $ 1.13 $ 1.23 $ 2.64 $ 2.57 $ 2.70
Diluted earnings per share $ 1.39 $ 1.10 $ 1.19 $ 2.54 $ 2.49 $ 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.
12
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 six months ended June 30, 2002 and 2001 would have been as follows:
Three months Six months
ended June 30 ended June 30
------------- -------------
2002 2001 2002 2001
----------------------------------------------------------------
Net income (in millions) $ 273 $ 212 $ 497 $ 482
Basic earnings per share $ 1.41 $ 1.10 $ 2.57 $ 2.51
Diluted earnings per share $ 1.36 $ 1.07 $ 2.48 $ 2.44
================================================================
These amounts include compensation cost as calculated using the Black-Scholes
option-pricing model with the assumptions:
Three and six months ended June 30
2002 2001
----------------------------------------------------------------------------
Expected option life (years) 7.0 7.0
Risk-free interest rate 5.79% 5.36%
Expected stock price volatility 30% 30%
Average dividend per share $ 0.86 $ 0.78
============================================================================
Three months Six months
ended June 30 ended June 30
------------- -------------
2002 2001 2002 2001
------------------------------------------------------------------
Weighted average fair value
of options granted $ 30.61 $ 24.54 $ 30.98 $ 18.76
13
CANADIAN NATIONAL RAILWAY COMPANY
SELECTED RAILROAD STATISTICS (U.S. GAAP)
-------------------------------------------------------------------------------
Three months ended Six months ended
June 30 June 30
------------------ ----------------
2002 2001(1) 2002 2001(1)
------------------------------------------------------------------------------------------------------
(Unaudited)
Rail operations
Freight revenues ($ millions) 1,499 1,344 2,951 2,687
Gross ton miles (millions) 78,835 73,077 153,990 147,455
Revenue ton miles (RTM) (millions) 40,332 38,104 79,621 77,358
Route miles (includes Canada and the U.S.) 17,837 15,479 17,837 15,479
Operating expenses per RTM (cents)(2) 2.63 2.49 2.72 2.53
Freight revenue per RTM (cents) 3.72 3.53 3.71 3.47
Carloads (thousands) 1,059 947 2,058 1,899
Freight revenue per carload ($) 1,415 1,419 1,434 1,415
Diesel fuel consumed (Liters in millions) 350 328 713 682
Average fuel price ($/Liter) 0.32 0.36 0.31 0.37
Revenue ton miles per liter of fuel consumed 115 116 112 113
Gross ton miles per liter of fuel consumed 225 223 216 216
Diesel fuel consumed (U.S. gallons in millions) 92 87 188 180
Average fuel price ($/U.S. gallon) 1.20 1.30 1.18 1.36
Revenue ton miles per U.S. gallon of fuel consumed 438 438 424 430
Gross ton miles per U.S. gallon of fuel consumed 857 840 819 819
Locomotive bad order ratio (%) (3) 6.8 7.0 6.9 7.5
Freight car bad order ratio (%) 6.0 5.4 6.1 5.9
-----------------------------------------------------------------------------------------------------
Productivity(2)
Operating ratio (%) 68.4 68.1 70.7 70.3
Freight revenue per route mile ($ thousands) 84 87 165 174
Revenue ton miles per route mile (thousands) 2,261 2,462 4,464 4,998
Freight revenue per average number of employees ($ thousands) 64 60 129 122
Revenue ton miles per average number of employees (thousands) 1,720 1,694 3,478 3,509
-----------------------------------------------------------------------------------------------------
Employees
Number at end of period 23,708 22,817 23,708 22,817
Average number during period 23,454 22,499 22,895 22,047
Labor and fringe benefits expense per RTM (cents) 1.07 0.97 1.12 0.97
Injury frequency rate per 200,000 person hours 2.6 4.0 3.0 4.3
Accident rate per million train miles 2.1 2.0 2.1 1.8
-----------------------------------------------------------------------------------------------------
Financial
Debt to total capitalization ratio (% at end of period) 41.7 39.3 41.7 39.3
Return on assets (% at end of period) 1.6 1.5 3.0 3.4
=====================================================================================================
(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.
14
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY INFORMATION (U.S. GAAP)
-------------------------------------------------------------------------------
Three months ended June 30 Six months ended June 30
-------------------------- ------------------------
Variance Variance
2002 2001(1) Fav (Unfav) 2002 2001(1) Fav (Unfav)
------------------------------------------------------------------------------------------------------
(Unaudited)
Revenue ton miles (millions)
Petroleum and chemicals 7,357 5,745 28% 14,684 12,118 21%
Metals and minerals 3,158 2,736 15% 6,438 5,094 26%
Forest products 8,570 7,521 14% 16,692 14,506 15%
Coal 3,609 4,058 (11%) 6,914 7,994 (14%)
Grain and fertilizers 9,282 10,492 (12%) 19,113 22,951 (17%)
Intermodal 7,442 6,773 10% 14,071 13,205 7%
Automotive 914 779 17% 1,709 1,490 15%
------------------------------------------------------- ------------------
40,332 38,104 6% 79,621 77,358 3%
Freight revenue / RTM (cents)
Total freight revenue per RTM 3.72 3.53 5% 3.71 3.47 7%
Business units:
Petroleum and chemicals 3.68 3.69 -- 3.70 3.66 1%
Metals and minerals 4.37 4.28 2% 4.04 4.20 (4%)
Forest products 3.90 3.58 9% 3.95 3.54 12%
Coal 2.24 2.17 3% 2.29 2.16 6%
Grain and fertilizers 2.75 2.62 5% 2.74 2.60 5%
Intermodal 3.51 3.60 (3%) 3.52 3.64 (3%)
Automotive 17.40 17.84 (2%) 18.14 17.85 2%
------------------------------------------------------- ------------------
Carloads (thousands)
Petroleum and chemicals 146 123 19% 291 257 13%
Metals and minerals 104 67 55% 190 126 51%
Forest products 151 124 22% 301 243 24%
Coal 127 128 (1%) 247 266 (7%)
Grain and fertilizers 135 144 (6%) 277 298 (7%)
Intermodal 312 282 11% 585 555 5%
Automotive 84 79 6% 167 154 8%
------------------------------------------------------- ------------------
1,059 947 12% 2,058 1,899 8%
Freight revenue / carload (dollars)
Total freight revenue per carload 1,415 1,419 -- 1,434 1,415 1%
Business units:
Petroleum and chemicals 1,856 1,724 8% 1,869 1,724 8%
Metals and minerals 1,327 1,746 (24%) 1,368 1,698 (19%)
Forest products 2,212 2,169 2% 2,189 2,115 3%
Coal 638 688 (7%) 640 650 (2%)
Grain and fertilizers 1,889 1,910 (1%) 1,892 2,000 (5%)
Intermodal 837 865 (3%) 848 867 (2%)
Automotive 1,893 1,759 8% 1,856 1,727 7%
------------------------------------------------------------------------------------------------------
(1) 2001 data exclude WC which was acquired and consolidated effective October
9, 2001.
15
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY INFORMATION
PRO FORMA CONSOLIDATED STATEMENT OF INCOME (U.S. GAAP)
-------------------------------------------------------------------------------
(In millions, except per share data)
Three months ended June 30 Six months ended June 30
-------------------------- ------------------------
2002 2001 Variance 2002 2001 Variance
pro forma(1) Fav (Unfav) pro forma(1) Fav (Unfav)
------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues
Petroleum and chemicals $ 271 $ 234 16% $ 544 $ 488 11%
Metals and minerals 138 144 (4%) 260 264 (2%)
Forest products 334 329 2% 659 635 4%
Coal 81 96 (16%) 158 188 (16%)
Grain and fertilizers 255 290 (12%) 524 626 (16%)
Intermodal 261 251 4% 496 495 --
Automotive 159 139 14% 310 266 17%
Other items 52 50 4% 109 107 2%
---------------------------------------------------------------- -------------------
1,551 1,533 1% 3,060 3,069 --
Operating expenses
Labor and fringe benefits 430 415 (4%) 891 840 (6%)
Purchased services 143 141 (1%) 280 287 2%
Depreciation and amortization 144 141 (2%) 285 283 (1%)
Fuel 114 132 14% 226 287 21%
Equipment rents 92 83 (11%) 179 166 (8%)
Material 57 58 2% 118 131 10%
Operating taxes 42 39 (8%) 83 85 2%
Casualty and other 39 36 (8%) 102 86 (19%)
Special charge -- 98 100% -- 98 100%
---------------------------------------------------------------- -------------------
1,061 1,143 7% 2,164 2,263 4%
Operating income 490 390 26% 896 806 11%
Interest expense (91) (104) (187) (211)
Other income (loss) 23 (80) 61 38
---------------------------------------------------------------- -------------------
Income before income taxes 422 206 770 633
Income tax (expense) recovery (142) 30 (260) (115)
---------------------------------------------------------------- -------------------
Net income $ 280 $ 236 $ 510 $ 518
===============================================================================================================
Operating ratio (excluding special charge) 68.4% 68.2% (0.2) 70.7% 70.5% (0.2)
===============================================================================================================
Diluted earnings per share $ 1.39 $ 1.19 $ 2.54 $ 2.61
Adjusted diluted earnings per share (2) $ 1.39 $ 1.30 $ 2.54 $ 2.36
Diluted weighted-average number of shares 203.3 200.9 203.1 200.4
===============================================================================================================
(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.
16
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY PRO FORMA INFORMATION (U.S. GAAP)
-------------------------------------------------------------------------------
Three months ended June 30 Six months ended June 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 7,357 6,039 22% 14,684 12,738 15%
Metals and minerals 3,158 3,527 (10%) 6,438 6,741 (4%)
Forest products 8,570 8,384 2% 16,692 16,279 3%
Coal 3,609 4,381 (18%) 6,914 8,644 (20%)
Grain and fertilizers 9,282 10,736 (14%) 19,113 23,444 (18%)
Intermodal 7,442 6,823 9% 14,071 13,305 6%
Automotive 914 781 17% 1,709 1,493 14%
------------------------------------------------------- ------------------
40,332 40,671 (1%) 79,621 82,644 (4%)
Freight revenue / RTM (cents)
Total freight revenue per RTM 3.72 3.65 2% 3.71 3.58 4%
Business units:
Petroleum and chemicals 3.68 3.87 (5%) 3.70 3.83 (3%)
Metals and minerals 4.37 4.08 7% 4.04 3.92 3%
Forest products 3.90 3.92 (1%) 3.95 3.90 1%
Coal 2.24 2.19 2% 2.29 2.17 6%
Grain and fertilizers 2.75 2.70 2% 2.74 2.67 3%
Intermodal 3.51 3.68 (5%) 3.52 3.72 (5%)
Automotive 17.40 17.80 (2%) 18.14 17.82 2%
------------------------------------------------------- ------------------
Carloads (thousands)
Petroleum and chemicals 146 131 11% 291 275 6%
Metals and minerals 104 113 (8%) 190 208 (9%)
Forest products 151 155 (3%) 301 309 (3%)
Coal 127 137 (7%) 247 285 (13%)
Grain and fertilizers 135 152 (11%) 277 312 (11%)
Intermodal 312 296 5% 585 583 --
Automotive 84 79 6% 167 154 8%
------------------------------------------------------- ------------------
1,059 1,063 -- 2,058 2,126 (3%)
Freight revenue / carload (dollars)
Total freight revenue per carload 1,415 1,395 1% 1,434 1,393 3%
Business units:
Petroleum and chemicals 1,856 1,786 4% 1,869 1,775 5%
Metals and minerals 1,327 1,274 4% 1,368 1,269 8%
Forest products 2,212 2,123 4% 2,189 2,055 7%
Coal 638 701 (9%) 640 660 (3%)
Grain and fertilizers 1,889 1,908 (1%) 1,892 2,006 (6%)
Intermodal 837 848 (1%) 848 849 --
Automotive 1,893 1,759 8% 1,856 1,727 7%
------------------------------------------------------------------------------------------------------
(1) The pro forma data has been prepared assuming the Company had acquired WC
on January 1, 2001.
17
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
Second quarter and first six 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 six months ended June 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 $280 million ($1.44 per basic
share or $1.39 per diluted share) for the quarter ended June 30, 2002 compared
to consolidated net income of $217 million ($1.13 per basic share or $1.10 per
diluted share) in the second quarter of 2001, an increase of $63 million ($0.31
per basic share or $0.29 per diluted share). Consolidated net income for the
six months ended June 30, 2002 was $510 million ($2.64 per basic share or $2.54
per diluted share) compared to $492 million ($2.57 per basic share or $2.49 per
diluted share) in the same period of 2001.
Operating income was $490 million for the second quarter of 2002 compared to
$346 million in the same quarter of 2001. For the first half of the year,
operating income was $896 million compared to $731 million in the same period
of 2001.
The three and six-month periods ended June 30, 2001 included items impacting
the comparability of the results of operations to those in the respective
periods of 2002. In the second quarter of 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, $71 million after tax ($0.37 per
basic share or $0.35 per diluted share), and a $110 million deferred income tax
recovery ($0.57 per basic share or $0.55 per diluted share) resulting from the
enactment of lower corporate tax rates in Canada. In the first quarter of 2001,
the Company recorded 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 $40 million ($0.19 per basic share or $0.18 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 six months ended June 30, 2002, net income
increased by $68 million ($0.33 per basic share or $0.30 per diluted share),
from $442 million ($2.31 per basic share or $2.24 per diluted share) for the
same period in 2001.
Excluding the 2001 special charge, operating income for the second quarter of
2002 increased to $490 million from $444 million for the same period last year,
an increase of $46 million, or 10%. The operating ratio, excluding the 2001
special charge, increased to 68.4% in the current quarter from 68.1% in the
second quarter of 2001, a 0.3-point increase. For the six-month period ended
June 30, 2002,
18
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
operating income excluding the 2001 special charge, increased by $67 million,
or 8%, to $896 million. The six-month operating ratio, excluding the 2001
special charge, increased to 70.7% in 2002 from 70.3% in 2001, a 0.4-point
increase.
Comparison to 2001 pro forma
Excluding the 2001 items previously discussed, net income in the current
quarter increased by $21 million ($0.09 per basic and diluted share) from pro
forma net income of $259 million ($1.35 per basic share or $1.30 per diluted
share) in the comparative 2001 quarter. For the six months ended June 30, 2002,
net income, excluding the 2001 items previously discussed, increased by $42
million ($0.20 per basic share or $0.18 per diluted share) from pro forma net
income of $468 million ($2.44 per basic share or $2.36 per diluted share) in
the same period in 2001.
Revenues for the second quarter of 2002 increased by $18 million, or 1%, when
compared to pro forma revenues of $1,533 million in the same 2001 period. For
the six-month period ended June 30, 2002, revenues decreased by $9 million when
compared to pro forma revenues of $3,069 million in the same period last year.
Excluding the 2001 special charge, operating expenses in the current quarter
increased by $16 million, or 2%, from pro forma operating expenses of $1,045
million in the same quarter of 2001. For the first half of 2002, operating
expenses amounted to $2,164 million, relatively unchanged from pro forma
operating expenses, excluding the special charge, of $2,165 million in the same
period last year.
Operating income for the second quarter of 2002 increased to $490 million when
compared to pro forma operating income, excluding the special charge, of $488
million in the comparable 2001 quarter. The operating ratio, excluding the 2001
special charge, increased slightly to 68.4% in the current quarter from the pro
forma operating ratio of 68.2% in the second quarter of 2001. For the sixmonth
period ended June 30, 2002, operating income was $896 million, a decrease of $8
million, from pro forma operating income, excluding the special charge, of $904
million in the comparable 2001 period. The six-month operating ratio, excluding
the 2001 special charge, increased slightly to 70.7% in 2002 from the pro forma
operating ratio of 70.5% in 2001.
Revenues
Revenues in the second quarter of 2002 totalled $1,551 million compared to
$1,392 million during the same period in 2001, an increase of $159 million, or
11%. Revenues for the first half of 2002 were $3,060 million, an increase of
$270 million, or 10%, from the same period last year. The increase in the
quarter was mainly attributable to the consolidation of WC revenues and to
gains in petroleum and chemicals, automotive, and intermodal. Partly offsetting
these gains were lower Canadian grain, and coal revenues. Contributing to the
six-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 6% in the quarter and 3% in the six-month period
when compared to the same periods in 2001. Freight revenue per revenue ton mile
for the quarter and first half of the year, increased by 5% and 7%,
respectively, when compared to the same periods last year.
Petroleum and chemicals: Revenues increased by $59 million, or 28%, for the
quarter and $101 million, or 23%, for the first six months when compared to the
same periods in 2001. Growth was driven by the inclusion of WC revenues, market
share gains in various sectors, and strong sulfur shipments to both the United
States and offshore markets. Revenue per revenue ton mile for the quarter
remained unchanged and increased by 1% during the first six 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 CN traffic.
Metals and minerals: Revenues increased by $21 million, or 18%, for the quarter
and $46 million, or 21%, for the first six months when compared to the same
periods in 2001. The inclusion of WC revenues, market share gains in the
non-ferrous segment, particularly aluminum, and increased
19
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
construction materials traffic, contributed to the growth in both the quarter
and first half of the year. Partly offsetting these increases were a temporary
reduction in cement shipments and one-time gains in 2001. Revenue per revenue
ton mile increased by 2% in the quarter mainly due to a shift to shorter haul
traffic. The 4% decline during the first six months was mainly attributable to
the inclusion of certain lower-rated WC traffic.
Forest products: Revenues increased by $65 million, or 24%, for the quarter and
$145 million, or 28%, for the first six months when compared to the same
periods in 2001. Growth in the quarter and first six months was attributable to
the inclusion of WC revenues and increased lumber and panels traffic, which
benefited from strong housing markets in both Canada and the United States.
These gains were partly offset by continued weakness in the pulp and paper
markets. The increase in revenue per revenue ton mile of 9% in the quarter and
12% in the first half was mainly due to the inclusion of shorter haul WC
traffic and the effect of the weaker Canadian dollar.
Coal: Revenues decreased by $7 million, or 8%, for the quarter and $15 million,
or 9%, for the first six months when compared to the same periods in 2001. The
decline in both the quarter and first half of 2002 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 3% in the quarter was mainly due
to a decrease in longer haul traffic. The 6% increase in the first six months
is also attributable to an increase in rates tied to commodity prices and the
effect of the weaker Canadian dollar.
Grain and fertilizers: Revenues decreased by $20 million, or 7%, for the
quarter and $72 million, or 12%, for the first six months when compared to the
same periods in 2001. The decline in both the quarter and first six months of
2002 reflected a significant deterioration in the 2001/2002 Canadian grain crop
that was partly offset by increases in the fertilizer segment and higher
soybean shipments from the United States. The 5% increase in revenue per
revenue ton mile in both the quarter and first half of 2002 was mainly due to
an increase in the regulated grain rates and a decline in longer haul traffic.
Intermodal: Revenues increased by $17 million, or 7%, for the quarter and $15
million, or 3%, for the first six months when compared to the same periods in
2001. The increase in both the quarter and first half of 2002 was mainly due to
stronger Canadian retail sales, higher volumes on expedited trains in the
Canadian domestic segment and increased overseas traffic in spite of the loss
of some overseas moves. The 3% decrease in revenue per revenue ton mile in both
the quarter and first half of 2002 was mainly attributable to the elimination
of the fuel surcharge at the end of 2001 and an increase in the average length
of haul.
Automotive: Revenues increased by $20 million, or 14%, for the quarter and $44
million, or 17%, for the first six months when compared to the same periods in
2001, reflecting stronger motor vehicle production particularly in the United
States. For the quarter, the 2% decrease in revenue per revenue ton mile was
mainly attributable to an increase in longer haul traffic. For the first six
months, the 2% increase was mainly attributable to the weaker Canadian dollar,
which more than offset the increase in the average length of haul.
20
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
Operating expenses
In the second quarter of 2002, operating expenses amounted to $1,061 million
compared to $1,046 million in the same quarter of 2001. Operating expenses for
the first half of 2002 were $2,164 million compared to $2,059 million in the
same period of 2001.
Excluding the 2001 special charge for workforce reductions, operating expenses
for the current quarter increased by $113 million, or 12%, from $948 million in
the same period of 2001. For the first half of the year, operating expenses,
excluding the 2001 special charge, increased by $203 million, or 10%, from
$1,961 million in the same period last year. The increases in the quarter and
first six months of 2002 were mainly due to the consolidation of WC operating
expenses, higher expenses for labor and fringe benefits, equipment rents and
casualty and other, partially offset by lower fuel costs.
Labor and fringe benefits: Labor and fringe benefit expenses in 2002 increased
by $60 million, or 16%, for the second quarter and $143 million, or 19%, for
the first half when compared to the same 2001 periods. The increase was mainly
attributable to the inclusion of WC labor expense of $40 million for the
quarter and $85 million for the six-month period, wage increases and higher
benefit expenses, including health and welfare and other postretirement
benefits. The impact of the weaker Canadian dollar on U.S. denominated expenses
also contributed to the increase in the six-month period ended June 30, 2002.
Purchased services: The costs of purchased services increased by $11 million,
or 8%, for the quarter and $15 million, or 6%, for the six-month period ended
June 30, 2002, when compared to corresponding periods in 2001. The increase was
mainly due to the inclusion of WC purchased services expense and higher
derailment-related expenses in the second quarter of 2002 that were partially
offset by lower crew transportation and lodging expenses.
Depreciation and amortization: Depreciation and amortization expense for the
quarter and six months ended June 30, 2002, increased by $13 million, or 10%,
and $22 million, or 8%, respectively, from the comparable 2001 periods, due
mainly to the inclusion of WC depreciation expense.
Fuel: The decrease in the second quarter of $7 million, or 6%, and $38 million,
or 14%, in the first half of 2002, when compared to the respective periods in
2001, was primarily due to a decrease in the average price of fuel, partially
offset by the inclusion of WC fuel expense.
Equipment rents: These expenses increased by $17 million, or 23%, in the
quarter and $28 million, or 19%, for the first half of the year, when compared
to the same periods in 2001. The increase in the quarter and the first half of
the year was mainly due to the inclusion of WC equipment rents and lower net
car hire income.
Material: For the quarter and six months ended June 30, 2002, material costs
increased by $6 million, or 12%, and $4 million, or 4%, respectively, from the
comparable periods in 2001, due mainly to the inclusion of WC material costs
that were partly offset by lower locomotive and car maintenance costs.
Operating taxes: Operating taxes increased by $5 million, or 14%, during the
second quarter of 2002 and $2 million, or 2%, during the six-month period ended
June 30, 2002 when compared to the corresponding periods in 2001, mainly due to
the inclusion of WC operating taxes and one-time provincial sales tax
recoveries in 2001 that were partly offset by capital and sales tax recoveries
in 2002.
Casualty and other: These expenses increased by $8 million, or 26%, in the
current quarter and by $27 million, or 36%, for the first six months of 2002,
when compared to the corresponding 2001 periods. The increase in both the
quarter and six-month period is mainly due to higher expenses for casualty and
legal claims, including occupational-related claims, the inclusion of WC
casualty and other expenses, and higher derailment-related expenses in the
second quarter of 2002. Partially offsetting these increases were lower
expenses related to environmental matters and, bad debt expenses in the first
half of 2002.
21
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
Other
Interest expense: Interest expense for the second quarter increased by $13
million, or 17%, from the comparable 2001 quarter and $29 million, or 18%, in
the first six months of 2002 versus the equivalent 2001 period. Lower interest
expense related to the maturity of certain notes was more than offset by the
financing related to the acquisition of WC and the consolidation of WC interest
expense.
Other income: Excluding the impact of the 2001 DRT and 360networks Inc.
transactions previously discussed, other income for the second quarter of 2002
increased to $23 million from $9 million in the comparable 2001 quarter, and
increased to $61 million for the first half of 2002 from $20 million in the
first half of last year. The increase was mainly due to the inclusion of WC's
equity in earnings of English Welsh and Scottish Railway (EWS) of $4 million
for the quarter and $15 million for the first half of 2002 and higher gains on
disposal of surplus assets.
Income tax expense: The Company recorded an income tax expense of $142 million
for the current quarter and an income tax recovery of $39 million for the
corresponding period in 2001. Income tax expense was $260 million for the six
months ended June 30, 2002 and $103 million for the comparable 2001 period.
When compared to 2001, the increase in income tax expense for both the quarter
and sixmonth period is mainly due to a $110 million deferred income tax
recovery recorded in June 2001 that resulted from the enactment of lower
corporate tax rates in Canada. The effective tax rate for the quarter and six
months ended June 30, 2002 was 33.6% and 33.8%, respectively. The effective tax
rate for the comparative 2001 periods was 36.0%, excluding the deferred income
tax recovery and the income tax effect on the special charge, the DRT
transaction and the charge for 360networks Inc.
22
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 $475 million
and $757 million for the three and six-month periods ended June 30, 2002,
respectively, compared to $487 million and $592 million for the same 2001
periods. Net income, excluding non-cash items, generated cash of $511 million
for the current quarter and $954 million for the six months ended June 30,
2002, compared to $476 million and $871 million in the corresponding 2001
periods. Cash generated in the first six months of 2002 was partially consumed
by payments for workforce reductions and income taxes of $94 million and $67
million, respectively, compared to $89 million and $59 million, respectively,
for the same period last year. Payments for casualty and legal claims,
including amounts paid for workers' compensation, for the first half of 2002
and 2001 were $68 million and $78 million, respectively.
Investing activities: Cash used by investing activities in the quarter and six
months ended June 30, 2002 amounted to $270 million and $318 million,
respectively, compared to $281 million and $309 million for the comparable
periods in 2001. The Company's investing activities in the first half of 2002
included net proceeds of $68 million from the sale of its investment in Tranz
Rail Holdings Limited, whereas the comparative period included proceeds of $112
million from the sale of DRT. Net capital expenditures amounted to $242 million
and $362 million in the three and six months ended June 30, 2002, respectively,
a decrease of $27 million and $36 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 $41 million for the second quarter and $83 million for the first six months
of 2002 compared to $37 million and $75 million, respectively, at the rate of
$0.195 per share, for the same periods in 2001.
Free cash flow
The Company generated $164 million and $356 million of free cash flow for the
three and six months ended June 30, 2002, respectively, compared to $169
million and $208 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 $122 million
for the second quarter and $316 million for the six months ended June 30, 2002
compared to $179 million and $193 million in the same periods of 2001. In 2002,
the Company's issuances and repayments of long-term debt related principally to
the Company's commercial paper and revolving credit facilities.
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. At June 30, 2002, the Company had entirely repaid
its borrowings of U.S.$172 million (Cdn$273 million) outstanding at December
31, 2001. At June 30, 2002, letters of credit under the revolving credit
facilities amounted to $292 million.
23
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
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 within the next twelve
months and while the Company's intent is to renew the existing revolving credit
facilities, the refinancing has not been renegotiated and, as such, the
outstanding balance of U.S.$209 million (Cdn$317 million) of commercial paper
has been included in the current portion of long-term debt at June 30, 2002.
Shelf registration statement
At June 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 June 30, 2002, pursuant to the agreement, $168 million and
U.S.$113 million (Cdn$171 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 aware
of any adverse trend, event or condition that would affect the Company's
current credit standing.
24
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 June 30, 2002:
Contractual obligations
(In millions)
Contract Type 2003- 2005- 2007 &
Total 2002 2004 2006 thereafter
-------------------------------------------------------------------------------
Debentures, notes and other $4,490 $ 14 $1,204 $ 559 $2,713
Capital leases (a) 842 72 174 84 512
-------------------------------------------------------------------------------
Long-term debt $5,332 $ 86 $1,378 $ 643 $3,225
Operating leases (b) 1,221 111 393 292 425
-------------------------------------------------------------------------------
Total obligations $6,553 $ 197 $1,771 $ 935 $3,650
===============================================================================
Commercial commitments
(In millions)
Commitment Type 2003- 2005- 2007 &
Total 2002 2004 2006 thereafter
-------------------------------------------------------------------------------
Standby letters of credit (c) $ 384 $ 320 $ 63 $ 1 $ --
Other commercial commitments (d) 267 36 231 -- --
-------------------------------------------------------------------------------
Total commitments $ 651 $ 356 $ 294 $ 1 $ --
===============================================================================
(a) Excludes $486 million of imputed interest on capital leases at rates
ranging from approximately 3.0% to 11.9%.
(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 June 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 $292 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 to be sufficient to meet its future
obligations and fund anticipated capital expenditures.
25
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
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.
As of June 30, 2002, approximately U.S.$1 million principal amount of the
Securities were surrendered for conversion into common shares.
On July 3, 2002, the closing price of the Company's common shares exceeded the
conversion price of US$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 merger involves the integration of two previously independent businesses to
provide shippers enhanced rail services over a coordinated network. There can
be no assurance that there will be realization of rail service and other
efficiencies or synergies that are expected to be derived from the merger.
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.
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 and environmental matters. 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
26
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
be adequate for these matters, the final outcome with respect to actions
outstanding or pending at June 30, 2002, or 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, as they are not
reasonably estimable. 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 continue to work with an independent actuarial
firm and will consider the results of an actuarial based approach to evaluate
the sufficiency of its provision for occupational claims. 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 June 30, 2002, the Company had aggregate reserves for legal matters of
$250 million ($277 million at December 31, 2001), of which approximately $143
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
27
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
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 June 30, 2002, the Company had aggregate accruals for environmental costs
of $103 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 postretirement 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, assumptions are made regarding
the valuation of benefit obligations and performance of plan assets. Delayed
recognition of differences between actual results and those assumed is a
guiding principle of these standards. This approach allows for a smooth
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 postretirement 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 SFAS No. 87 and SFAS No. 106, respectively.
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 is regularly monitored, and losses due to
counterparty nonperformance 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.
28
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
At June 30, 2002, the Company hedged approximately 46% of the estimated 2002
fuel consumption, 41% of the estimated 2003 fuel consumption and 7% of the
estimated 2004 fuel consumption. This represented approximately 348 million
U.S. gallons at an average price of U.S.$0.606 per U.S. gallon.
For the three months ended June 30, 2002, the Company realized a negligible
loss from its fuel hedging activities, compared to a $2 million gain in the
same period last year. For the first half of 2002, the Company's hedging
activities resulted in a realized loss of $9 million compared to a $4 million
gain in the same period of 2001.
Other comprehensive income for the quarters ended June 30, 2002 and 2001,
included an unrealized gain of $4 million, $2 million after tax, and $2
million, $1 million after tax, respectively, resulting from the Company's fuel
hedging activities. For the first half of 2002 and 2001, other comprehensive
income included an unrealized gain of $55 million, $36 million after tax, and
an unrealized loss of $5 million, $3 million after tax, respectively.
At June 30, 2002, Accumulated other comprehensive income included an unrealized
holding gain of $17 million, $11 million after tax, ($38 million unrealized
holding loss, $25 million after tax at December 31, 2001) of which $12 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
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
As of July 2002, the Company had achieved ratified settlements with bargaining
units representing 98% of the Company's Canadian unionized workforce. These
agreements are generally for a three-year period effective until December 31,
2003.
The general approach to labor negotiations by U.S. Class 1 railroads is to
bargain on a collective national
29
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
basis. For several years now, 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. Local negotiations result in settlements that better address both
the employees' concerns and preferences and the railways' actual operating
environment. There are risks associated with negotiating locally. Presidents
and Congress have demonstrated that they will step in to avoid national
strikes, while a local dispute may not generate federal intervention, making an
extended work stoppage more likely. The Company believes the potential mutual
benefits of local bargaining outweigh the risks.
As of July 2002, the Company had in place agreements with bargaining units
representing all the 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, 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 across a
number of markets. Following a significant reduction in interest rates and a
major depletion in inventories, the North American economy rebounded in the
first part of 2002. While continued growth is expected throughout the year, the
speed of the recovery will depend on overall consumer and business confidence,
which currently show signs of uncertainty. The Company will continue to
leverage its strong service capabilities but remains cautious about business
prospects in the second half of the year.
30
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (U.S. GAAP)
-------------------------------------------------------------------------------
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.
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 inflationadjusted 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.
31
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF INCOME (CANADIAN GAAP)
-------------------------------------------------------------------------------
(in millions, except per share data)
Three months ended Six months ended
June 30 June 30
------------------------ -----------------------
2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues $ 1,551 $ 1,392 $ 3,060 $ 2,790
-----------------------------------------------------------------------------------------------------------------------------------
Operating expenses excluding special charge 1,166 1,049 2,303 2,085
Special charge (Note 4) -- 98 -- 98
-----------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 1,166 1,147 2,303 2,183
Operating income 385 245 757 607
Interest expense (88) (74) (179) (149)
Other income (loss) (Note 5) 23 (90) 61 20
-----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 320 81 639 478
Income tax expense (108) (41) (216) (167)
-----------------------------------------------------------------------------------------------------------------------------------
Net income (Note 10) $ 212 $ 40 $ 423 $ 311
===================================================================================================================================
Earnings per share (Note 10)
Basic $ 1.08 $ 0.19 $ 2.16 $ 1.59
Diluted $ 1.04 $ 0.19 $ 2.08 $ 1.55
Weighted-average number of shares
Basic 193.9 192.0 193.5 191.7
Diluted 203.3 200.9 203.1 200.4
===================================================================================================================================
See accompanying notes to consolidated financial statements.
32
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF OPERATING INCOME (CANADIAN GAAP)
-------------------------------------------------------------------------------
(in millions)
Three months ended June 30 Six months ended June 30
------------------------------------ ----------------------------------
Variance Variance
2002 2001 Fav (Unfav) 2002 2001 Fav (Unfav)
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues
Petroleum and chemicals $ 271 $ 212 28% $ 544 $ 443 23%
Metals and minerals 138 117 18% 260 214 21%
Forest products 334 269 24% 659 514 28%
Coal 81 88 (8%) 158 173 (9%)
Grain and fertilizers 255 275 (7%) 524 596 (12%)
Intermodal 261 244 7% 496 481 3%
Automotive 159 139 14% 310 266 17%
Other items 52 48 8% 109 103 6%
-------------------------------------------------------------------------------- ---------------------
1,551 1,392 11% 3,060 2,790 10%
Operating expenses
Labor and fringe benefits 498 421 (18%) 986 830 (19%)
Purchased services 154 139 (11%) 298 276 (8%)
Depreciation and amortization 124 122 (2%) 245 230 (7%)
Fuel 114 121 6% 226 264 14%
Equipment rents 94 77 (22%) 181 153 (18%)
Material 76 72 (6%) 146 147 1%
Operating taxes 42 37 (14%) 83 81 (2%)
Casualty and other 64 60 (7%) 138 104 (33%)
Special charge (Note 4) -- 98 100% -- 98 100%
-------------------------------------------------------------------------------- ---------------------
1,166 1,147 (2%) 2,303 2,183 (5%)
-------------------------------------------------------------------------------- ---------------------
Operating income $ 385 $ 245 57% $ 757 $ 607 25%
===================================================================================================================================
Operating ratio (excluding special charge) 75.2% 75.4% 0.2 75.3% 74.7% (0.6)
===================================================================================================================================
See accompanying notes to consolidated financial statements.
33
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED BALANCE SHEET (CANADIAN GAAP)
-------------------------------------------------------------------------------
(in millions)
June 30 December 31 June 30
2002 2001 2001
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 93 $ 53 $ 30
Accounts receivable (Note 6) 675 645 662
Material and supplies 163 133 136
Deferred income taxes 125 153 140
Other 173 180 141
------------------------------------------------------------------------------------------------------------------------------------
1,229 1,164 1,109
Properties 16,183 16,723 13,683
Other assets and deferred charges (Note 3) 848 901 370
------------------------------------------------------------------------------------------------------------------------------------
Total assets $ 18,260 $ 18,788 $ 15,162
===================================================================================================================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable and accrued charges $ 1,351 $ 1,374 $ 1,268
Current portion of long-term debt (Note 6) 832 163 281
Other 87 101 81
------------------------------------------------------------------------------------------------------------------------------------
2,270 1,638 1,630
Deferred income taxes 3,632 3,729 2,580
Other liabilities and deferred credits 1,169 1,296 1,149
Long-term debt (Note 6) 4,500 5,764 3,873
Shareholders' equity:
Common shares (Note 7) 3,266 3,209 3,169
Convertible preferred securities (Note 7) 326 327 327
Contributed surplus 178 178 178
Currency translation 71 133 77
Retained earnings 2,848 2,514 2,179
------------------------------------------------------------------------------------------------------------------------------------
6,689 6,361 5,930
------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 18,260 $ 18,788 $ 15,162
===================================================================================================================================
See accompanying notes to consolidated financial statements.
34
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (CANADIAN GAAP)
-------------------------------------------------------------------------------
(in millions)
Three months ended Six months ended
June 30 June 30
------------------------ -----------------------
2002 2001 2002 2001
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Common shares (1)
Balance, beginning of period $ 3,240 $ 3,154 $ 3,209 $ 3,124
Stock options exercised and conversion of convertible
preferred securities (Note 7) 26 15 57 45
------------------------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 3,266 $ 3,169 $ 3,266 $ 3,169
===================================================================================================================================
Convertible preferred securities (2)
Balance, beginning of period $ 327 $ 327 $ 327 $ 327
Converted shares (Note 7) (1) -- (1) --
------------------------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 326 $ 327 $ 326 $ 327
===================================================================================================================================
Contributed surplus
------------------------------------------------------------------------------------------------------------------------------------
Balance, beginning and end of period $ 178 $ 178 $ 178 $ 178
===================================================================================================================================
Currency translation
------------------------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 71 $ 77 $ 71 $ 77
===================================================================================================================================
Retained earnings
Balance, beginning of period $ 2,680 $ 2,179 $ 2,514 $ 1,949
Net income 212 40 423 311
Dividends (44) (40) (89) (81)
------------------------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 2,848 $ 2,179 $ 2,848 $ 2,179
===================================================================================================================================
See accompanying notes to consolidated financial statements.
(1) The Company issued 0.6 million and 1.4 million shares for the three and
six months ended June 30, 2002, respectively, as a result of stock options
exercised and the conversion of convertible preferred securities. At June
30, 2002, the Company had 194.1 million common shares outstanding.
(2) At June 30, 2002, the Company had 4.6 million convertible preferred
securities outstanding. (See Note 7)
35
CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (CANADIAN GAAP)
-------------------------------------------------------------------------------
(in millions)
Three months ended Six months ended
June 30 June 30
------------------------- --------------------------
2002 2001 2002 2001
(Unaudited)
Operating activities
Net income $ 212 $ 40 $ 423 $ 311
Non-cash items in income:
Depreciation and amortization 126 123 248 233
Deferred income taxes 51 10 112 81
Gain on sale of investment (Note 5) -- -- -- (101)
Write-down of investment (Note 5) -- 99 -- 99
Special charge (Note 4) -- 98 -- 98
Changes in:
Accounts receivable 15 51 (41) 49
Material and supplies (10) (1) (33) (26)
Accounts payable and accrued charges 32 46 16 (104)
Other net current assets and liabilities (12) (10) (12) (3)
Payments for workforce reductions (47) (40) (94) (89)
Other (17) (41) (44) (111)
------------------------------------------------------------------------------------------------------------------------------------
Cash provided from operating activities 350 375 575 437
------------------------------------------------------------------------------------------------------------------------------------
Investing activities
Net additions to properties (133) (181) (204) (268)
Other, net (7) 12 73 120
------------------------------------------------------------------------------------------------------------------------------------
Cash used by investing activities (140) (169) (131) (148)
------------------------------------------------------------------------------------------------------------------------------------
Dividends paid (46) (37) (88) (85)
Financing activities
Issuance of long-term debt 1,035 236 1,890 504
Reduction of long-term debt (1,182) (430) (2,260) (742)
Issuance of common shares 25 15 54 45
------------------------------------------------------------------------------------------------------------------------------------
Cash used by financing activities (122) (179) (316) (193)
------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 42 (10) 40 11
Cash and cash equivalents, beginning of period 51 40 53 19
------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 93 $ 30 $ 93 $ 30
===================================================================================================================================
See accompanying notes to consolidated financial statements.
36
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CANADIAN GAAP)
-------------------------------------------------------------------------------
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 June 30, 2002,
December 31 and June 30, 2001, its results of operations, changes in
shareholders' equity and cash flows for the three and six months ended June 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
The Company has made certain changes in accounting policies to conform to new
accounting standards.
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 six months ended June 30, 2002,
no compensation expense was recognized as no performancebased 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 six months ended June 30, 2002, the Company granted 3.2 million
conventional options. For the three and six months ended June 30, 2002, 0.6
million and 1.4 million, respectively, of previously issued stock options were
exercised.
37
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CANADIAN GAAP)
-------------------------------------------------------------------------------
Had compensation cost been determined as if the fair value based accounting
approach had been used for all awards granted for the three and six months
ended June 30, 2002, the Company's net income and earnings per share would have
been as follows:
Three months Six months
ended ended
June 30, 2002 June 30, 2002
-------------------------------------------------------------------------------
Net income (in millions) $ 207 $ 415
Basic earnings per share $ 1.05 $ 2.11
Diluted earnings per share $ 1.02 $ 2.04
===============================================================================
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 and six months
ended June 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 Six months
ended ended
June 30, 2002 June 30, 2002
-------------------------------------------------------------------------------
Weighted average fair
value of options granted $ 30.61 $ 30.98
===============================================================================
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 six months ended June 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 $1,533 million, $52 million, $0.26 per basic and diluted share,
respectively, for the three months ended June 30, 2001 and $3,069 million, $329
million, $1.68 per basic share and $1.64 per diluted share, respectively, for
the six months ended June 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 (loss)
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
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. At June 30, 2002, the Company had entirely repaid
its borrowings of U.S.$172 million (Cdn$273 million) outstanding at December
31, 2001. At June 30, 2002, letters of credit under the revolving credit
facilities amounted to $292 million.
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
38
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CANADIAN GAAP)
-------------------------------------------------------------------------------
mature within the next twelve months and while the Company's intent is to renew
the existing revolving credit facilities, the refinancing has not been
renegotiated and, as such, the outstanding balance of U.S.$209 million (Cdn$317
million) of commercial paper has been included in the current portion of
long-term debt at June 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 June 30, 2002, pursuant to the agreement,
$168 million and U.S.$113 million (Cdn$171 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.
As of June 30, 2002, approximately U.S.$1 million principal amount of the
Securities were surrendered for conversion into common shares.
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 $17 million at June 30, 2002 ($38 million unrealized
holding loss at December 31, 2001).
Note 9 - Commitments
At June 30, 2002, the Company had commitments to acquire railroad ties, rail,
freight cars and locomotives at an aggregate cost of $267 million ($52 million
at December 31, 2001).
39
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 six months ended June 30, 2002 as explained in Note 3, the comparability of
the results of operations for the three and six months ended June 30, 2002 and
2001 is also impacted by the following items:
Three months ended Six months ended
June 30 June 30
----------------------------------- ---------------------------------
2001 2001
2002 2001 pro forma(1) 2002 2001 pro forma(1)
-----------------------------------------------------------------------------------------------------------------------------------
(In millions) (Unaudited)
Income before income taxes, excluding undernoted items $ 320 $ 278 $ 295 $ 639 $ 574 $ 599
Income tax expense (108) (99) (104) (216) (206) (213)
-----------------------------------------------------------------------------------------------------------------------------------
Adjusted net income 212 179 191 423 368 386
Undernoted items, net of tax:
Special charge for workforce reductions -- (62) (62) -- (62) (62)
Write-down of net investment in 360networks Inc. -- (77) (77) -- (77) (77)
Gain on sale of Detroit River Tunnel Company -- -- -- -- 82 82
-----------------------------------------------------------------------------------------------------------------------------------
-- (139) (139) -- (57) (57)
Net income $ 212 $ 40 $ 52 $ 423 $ 311 $ 329
===================================================================================================================================
The following table provides a reconciliation between basic and diluted
earnings per share:
Three months ended Six months ended
June 30 June 30
----------------------------------- ---------------------------------
2001 2001
2002 2001 pro forma(1) 2002 2001 pro forma(1)
-----------------------------------------------------------------------------------------------------------------------------------
(In millions, except per share data) (Unaudited)
Net income $ 212 $ 40 $ 52 $ 423 $ 311 $ 329
Dividends on convertible preferred securities (3) (3) (3) (6) (6) (6)
-----------------------------------------------------------------------------------------------------------------------------------
Income used for basic earnings per share $ 209 $ 37 $ 49 $ 417 $ 305 $ 323
Weighted-average shares outstanding 193.9 192.0 192.0 193.5 191.7 191.7
Effect of dilutive securities and stock options 9.4 8.9 8.9 9.6 8.7 8.7
-----------------------------------------------------------------------------------------------------------------------------------
Weighted-average diluted shares outstanding 203.3 200.9 200.9 203.1 200.4 200.4
Basic earnings per share $ 1.08 $ 0.19 $ 0.26 $ 2.16 $ 1.59 $ 1.68
Diluted earnings per share $ 1.04 $ 0.19 $ 0.26 $ 2.08 $ 1.55 $ 1.64
===================================================================================================================================
(1) The pro forma figures reflect the Company's results of operations as if
the Company had acquired WC on January 1, 2001.
40
CANADIAN NATIONAL RAILWAY COMPANY
SELECTED RAILROAD STATISTICS (CANADIAN GAAP)
-------------------------------------------------------------------------------
Three months ended Six months ended
June 30 June 30
------------------------ ------------------------
2002 2001(1) 2002 2001(1)
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Rail operations
Freight revenues ($ millions) 1,499 1,344 2,951 2,687
Gross ton miles (millions) 78,835 73,077 153,990 147,455
Revenue ton miles (RTM) (millions) 40,332 38,104 79,621 77,358
Route miles (includes Canada and the U.S.) 17,837 15,479 17,837 15,479
Operating expenses per RTM (cents) (2) 2.89 2.75 2.89 2.70
Freight revenue per RTM (cents) 3.72 3.53 3.71 3.47
Carloads (thousands) 1,059 947 2,058 1,899
Freight revenue per carload ($) 1,415 1,419 1,434 1,415
Diesel fuel consumed (Liters in millions) 350 328 713 682
Average fuel price ($/Liter) 0.32 0.36 0.31 0.37
Revenue ton miles per liter of fuel consumed 115 116 112 113
Gross ton miles per liter of fuel consumed 225 223 216 216
Diesel fuel consumed (U.S. gallons in millions) 92 87 188 180
Average fuel price ($/U.S. gallon) 1.20 1.30 1.18 1.36
Revenue ton miles per U.S. gallon of fuel consumed 438 438 424 430
Gross ton miles per U.S. gallon of fuel consumed 857 840 819 819
Locomotive bad order ratio (%)(3) 6.8 7.0 6.9 7.5
Freight car bad order ratio (%) 6.0 5.4 6.1 5.9
-----------------------------------------------------------------------------------------------------------------------------------
Productivity
Operating ratio (%)(2) 75.2 75.4 75.3 74.7
Freight revenue per route mile ($ thousands) 84 87 165 174
Revenue ton miles per route mile (thousands) 2,261 2,462 4,464 4,998
Freight revenue per average number of employees ($ thousands) 64 60 129 122
Revenue ton miles per average number of employees (thousands) 1,720 1,694 3,478 3,509
-----------------------------------------------------------------------------------------------------------------------------------
Employees
Number at end of period 23,708 22,817 23,708 22,817
Average number during period 23,454 22,499 22,895 22,047
Labor and fringe benefits expense per RTM (cents) 1.23 1.10 1.24 1.07
Injury frequency rate per 200,000 person hours 2.6 4.0 3.0 4.3
Accident rate per million train miles 2.1 2.0 2.1 1.8
-----------------------------------------------------------------------------------------------------------------------------------
Financial
Debt to total capitalization ratio (% at end of period) 44.4 41.2 44.4 41.2
Return on assets (% at end of period) 1.5 0.6 2.9 2.6
===================================================================================================================================
(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.
41
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY INFORMATION (CANADIAN GAAP)
-------------------------------------------------------------------------------
Three months ended June 30 Six months ended June 30
------------------------------------------ -----------------------------------------
Variance Variance
2002 2001(1) Fav (Unfav) 2002 2001(1) Fav (Unfav)
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenue ton miles (millions)
Petroleum and chemicals 7,357 5,745 28% 14,684 12,118 21%
Metals and minerals 3,158 2,736 15% 6,438 5,094 26%
Forest products 8,570 7,521 14% 16,692 14,506 15%
Coal 3,609 4,058 (11%) 6,914 7,994 (14%)
Grain and fertilizers 9,282 10,492 (12%) 19,113 22,951 (17%)
Intermodal 7,442 6,773 10% 14,071 13,205 7%
Automotive 914 779 17% 1,709 1,490 15%
-------------------------------------------------------------------- ---------------------------
40,332 38,104 6% 79,621 77,358 3%
Freight revenue / RTM (cents)
Total freight revenue per RTM 3.72 3.53 5% 3.71 3.47 7%
Business units:
Petroleum and chemicals 3.68 3.69 -- 3.70 3.66 1%
Metals and minerals 4.37 4.28 2% 4.04 4.20 (4%)
Forest products 3.90 3.58 9% 3.95 3.54 12%
Coal 2.24 2.17 3% 2.29 2.16 6%
Grain and fertilizers 2.75 2.62 5% 2.74 2.60 5%
Intermodal 3.51 3.60 (3%) 3.52 3.64 (3%)
Automotive 17.40 17.84 (2%) 18.14 17.85 2%
-------------------------------------------------------------------- ---------------------------
Carloads (thousands)
Petroleum and chemicals 146 123 19% 291 257 13%
Metals and minerals 104 67 55% 190 126 51%
Forest products 151 124 22% 301 243 24%
Coal 127 128 (1%) 247 266 (7%)
Grain and fertilizers 135 144 (6%) 277 298 (7%)
Intermodal 312 282 11% 585 555 5%
Automotive 84 79 6% 167 154 8%
-------------------------------------------------------------------- ---------------------------
1,059 947 12% 2,058 1,899 8%
Freight revenue / carload (dollars)
Total freight revenue per carload 1,415 1,419 -- 1,434 1,415 1%
Business units:
Petroleum and chemicals 1,856 1,724 8% 1,869 1,724 8%
Metals and minerals 1,327 1,746 (24%) 1,368 1,698 (19%)
Forest products 2,212 2,169 2% 2,189 2,115 3%
Coal 638 688 (7%) 640 650 (2%)
Grain and fertilizers 1,889 1,910 (1%) 1,892 2,000 (5%)
Intermodal 837 865 (3%) 848 867 (2%)
Automotive 1,893 1,759 8% 1,856 1,727 7%
-----------------------------------------------------------------------------------------------------------------------------------
(1) 2001 data exclude WC which was acquired and consolidated effective October
9, 2001.
42
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY INFORMATION
PRO FORMA CONSOLIDATED STATEMENT OF INCOME (CANADIAN GAAP)
-------------------------------------------------------------------------------
Three months ended June 30 Six months ended June 30
----------------------------------------- ---------------------------------------
2002 2001 Variance 2002 2001 Variance
pro forma(1) Fav (Unfav) pro forma(1) Fav (Unfav)
-----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Revenues
Petroleum and chemicals $ 271 $ 234 16% $ 544 $ 488 11%
Metals and minerals 138 144 (4%) 260 264 (2%)
Forest products 334 329 2% 659 635 4%
Coal 81 96 (16%) 158 188 (16%)
Grain and fertilizers 255 290 (12%) 524 626 (16%)
Intermodal 261 251 4% 496 495 --
Automotive 159 139 14% 310 266 17%
Other items 52 50 4% 109 107 2%
----------------------------------------------------------------------- ------------------------
1,551 1,533 1% 3,060 3,069 --
Operating expenses
Labor and fringe benefits 498 474 (5%) 986 932 (6%)
Purchased services 154 150 (3%) 298 300 1%
Depreciation and amortization 124 132 6% 245 250 2%
Fuel 114 132 14% 226 287 21%
Equipment rents 94 85 (11%) 181 168 (8%)
Material 76 80 5% 146 165 12%
Operating taxes 42 39 (8%) 83 85 2%
Casualty and other 64 65 2% 138 115 (20%)
Special charge -- 98 100% -- 98 100%
----------------------------------------------------------------------- ------------------------
1,166 1,255 7% 2,303 2,400 4%
Operating income 385 278 38% 757 669 13%
Interest expense (88) (100) (179) (202)
Other income (loss) 23 (80) 61 36
----------------------------------------------------------------------- ------------------------
Income before income taxes 320 98 639 503
Income tax expense (108) (46) (216) (174)
----------------------------------------------------------------------- ------------------------
Net income $ 212 $ 52 $ 423 $ 329
===================================================================================================================================
Operating ratio (excluding special charge) 75.2% 75.5% 0.3 75.3% 75.0% (0.3)
===================================================================================================================================
Diluted earnings per share $ 1.04 $ 0.26 $ 2.08 $ 1.64
Adjusted diluted earnings per share (2) $ 1.04 $ 0.96 $ 2.08 $ 1.93
Diluted weighted-average number of shares 203.3 200.9 203.1 200.4
===================================================================================================================================
(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 and the charge to write down the net investment in 360networks
Inc.
43
CANADIAN NATIONAL RAILWAY COMPANY
SUPPLEMENTARY PRO FORMA INFORMATION (CANADIAN GAAP)
-------------------------------------------------------------------------------
Three months ended June 30 Six months ended June 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 7,357 6,039 22% 14,684 12,738 15%
Metals and minerals 3,158 3,527 (10%) 6,438 6,741 (4%)
Forest products 8,570 8,384 2% 16,692 16,279 3%
Coal 3,609 4,381 (18%) 6,914 8,644 (20%)
Grain and fertilizers 9,282 10,736 (14%) 19,113 23,444 (18%)
Intermodal 7,442 6,823 9% 14,071 13,305 6%
Automotive 914 781 17% 1,709 1,493 14%
----------------------------------------------------------------------- ----------------------------
40,332 40,671 (1%) 79,621 82,644 (4%)
Freight revenue / RTM (cents)
Total freight revenue per RTM 3.72 3.65 2% 3.71 3.58 4%
Business units:
Petroleum and chemicals 3.68 3.87 (5%) 3.70 3.83 (3%)
Metals and minerals 4.37 4.08 7% 4.04 3.92 3%
Forest products 3.90 3.92 (1%) 3.95 3.90 1%
Coal 2.24 2.19 2% 2.29 2.17 6%
Grain and fertilizers 2.75 2.70 2% 2.74 2.67 3%
Intermodal 3.51 3.68 (5%) 3.52 3.72 (5%)
Automotive 17.40 17.80 (2%) 18.14 17.82 2%
----------------------------------------------------------------------- ----------------------------
Carloads (thousands)
Petroleum and chemicals 146 131 11% 291 275 6%
Metals and minerals 104 113 (8%) 190 208 (9%)
Forest products 151 155 (3%) 301 309 (3%)
Coal 127 137 (7%) 247 285 (13%)
Grain and fertilizers 135 152 (11%) 277 312 (11%)
Intermodal 312 296 5% 585 583 --
Automotive 84 79 6% 167 154 8%
----------------------------------------------------------------------- ----------------------------
1,059 1,063 -- 2,058 2,126 (3%)
Freight revenue / carload (dollars)
Total freight revenue per carload 1,415 1,395 1% 1,434 1,393 3%
Business units:
Petroleum and chemicals 1,856 1,786 4% 1,869 1,775 5%
Metals and minerals 1,327 1,274 4% 1,368 1,269 8%
Forest products 2,212 2,123 4% 2,189 2,055 7%
Coal 638 701 (9%) 640 660 (3%)
Grain and fertilizers 1,889 1,908 (1%) 1,892 2,006 (6%)
Intermodal 837 848 (1%) 848 849 --
Automotive 1,893 1,759 8% 1,856 1,727 7%
-----------------------------------------------------------------------------------------------------------------------------------
(1) The pro forma data has been prepared assuming the Company had acquired WC
on January 1, 2001.
44
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
Second quarter and first six 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 six months ended June 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 $212 million ($1.08 per basic
share or $1.04 per diluted share) for the quarter ended June 30, 2002 compared
to consolidated net income of $40 million ($0.19 per basic and diluted share)
in the second quarter of 2001, an increase of $172 million ($0.89 per basic
share or $0.85 per diluted share). Consolidated net income for the six months
ended June 30, 2002 was $423 million ($2.16 per basic share or $2.08 per
diluted share) compared to $311 million ($1.59 per basic share or $1.55 per
diluted share) in the same period of 2001.
Operating income was $385 million for the second quarter of 2002 compared to
$245 million in the same quarter of 2001. For the first half of the year,
operating income was $757 million compared to $607 million in the same period
of 2001.
The three and six-month periods ended June 30, 2001 included items impacting
the comparability of the results of operations to those in the respective
periods of 2002. In the second quarter of 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) and a charge to write down its net
investment in 360networks Inc. of $99 million, $77 million after tax ($0.41 per
basic share or $0.39 per diluted share). In the first quarter of 2001, the
Company recorded 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 current quarter increased
by $33 million ($0.16 per basic share or $0.15 per diluted share) from net
income of $179 million ($0.92 per basic share or $0.89 per diluted share) for
the same quarter last year. For the six months ended June 30, 2002, net income
increased by $55 million ($0.27 per basic share or $0.24 per diluted share),
from $368 million ($1.89 per basic share or $1.84 per diluted share) for the
same period in 2001.
Excluding the 2001 special charge, operating income for the second quarter of
2002 increased to $385 million from $343 million for the same period last year,
an increase of $42 million, or 12%. The operating ratio, excluding the 2001
special charge, improved to 75.2% in the current quarter from 75.4% in the
second quarter of 2001. For the six-month period ended June 30, 2002, operating
income excluding the 2001 special charge, increased by $52 million, or 7%, to
$757 million. The six-month operating ratio, excluding the 2001 special charge,
45
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
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increased to 75.3% in 2002 from 74.7% in 2001, a 0.6-point increase.
Comparison to 2001 pro forma
Excluding the 2001 items previously discussed, net income in the current
quarter increased by $21 million ($0.09 per basic share and $0.08 per diluted
share) from pro forma net income of $191 million ($0.99 per basic share or
$0.96 per diluted share) in the comparative 2001 quarter. For the six months
ended June 30, 2002, net income, excluding the 2001 items previously discussed,
increased by $37 million ($0.18 per basic share or $0.15 per diluted share)
from pro forma net income of $386 million ($1.98 per basic share or $1.93 per
diluted share) in the same period in 2001.
Revenues for the second quarter of 2002 increased by $18 million, or 1%, when
compared to pro forma revenues of $1,533 million in the same 2001 period. For
the six-month period ended June 30, 2002, revenues decreased by $9 million when
compared to pro forma revenues of $3,069 million in the same period last year.
Excluding the 2001 special charge, operating expenses in the current quarter
increased by $9 million, or 1%, from pro forma operating expenses of $1,157
million in the same quarter of 2001. For the first half of 2002, operating
expenses amounted to $2,303 million, relatively unchanged from pro forma
operating expenses, excluding the special charge, of $2,302 million in the same
period last year.
Operating income for the second quarter of 2002 increased to $385 million when
compared to pro forma operating income, excluding the special charge, of $376
million in the comparable 2001 quarter. The operating ratio, excluding the 2001
special charge, improved to 75.2% in the current quarter from the pro forma
operating ratio of 75.5% in the second quarter of 2001. For the six-month
period ended June 30, 2002, operating income was $757 million, a decrease of
$10 million, from pro forma operating income, excluding the special charge, of
$767 million in the comparable 2001 period. The six-month operating ratio,
excluding the 2001 special charge, increased slightly to 75.3% in 2002 from the
pro forma operating ratio of 75.0% in 2001.
Revenues
Revenues in the second quarter of 2002 totalled $1,551 million compared to
$1,392 million during the same period in 2001, an increase of $159 million, or
11%. Revenues for the first half of 2002 were $3,060 million, an increase of
$270 million, or 10%, from the same period last year. The increase in the
quarter was mainly attributable to the consolidation of WC revenues and to
gains in petroleum and chemicals, automotive, and intermodal. Partly offsetting
these gains were lower Canadian grain, and coal revenues. Contributing to the
six-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 6% in the quarter and 3% in the six-month period
when compared to the same periods in 2001. Freight revenue per revenue ton mile
for the quarter and first half of the year, increased by 5% and 7%,
respectively, when compared to the same periods last year.
Petroleum and chemicals: Revenues increased by $59 million, or 28%, for the
quarter and $101 million, or 23%, for the first six months when compared to the
same periods in 2001. Growth was driven by the inclusion of WC revenues, market
share gains in various sectors, and strong sulfur shipments to both the United
States and offshore markets. Revenue per revenue ton mile for the quarter
remained unchanged and increased by 1% during the first six 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 CN traffic.
Metals and minerals: Revenues increased by $21 million, or 18%, for the quarter
and $46 million, or 21%, for the first six months when compared to the same
periods in 2001. The inclusion of WC revenues, market share gains in the
non-ferrous segment, particularly aluminum, and increased construction
materials traffic, contributed to the growth in both the quarter and first half
of the year.
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CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
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Partly offsetting these increases were a temporary reduction in cement
shipments and one-time gains in 2001. Revenue per revenue ton mile increased by
2% in the quarter mainly due to a shift to shorter haul traffic. The 4% decline
during the first six months was mainly attributable to the inclusion of certain
lower-rated WC traffic.
Forest products: Revenues increased by $65 million, or 24%, for the quarter and
$145 million, or 28%, for the first six months when compared to the same
periods in 2001. Growth in the quarter and first six months was attributable to
the inclusion of WC revenues and increased lumber and panels traffic, which
benefited from strong housing markets in both Canada and the United States.
These gains were partly offset by continued weakness in the pulp and paper
markets. The increase in revenue per revenue ton mile of 9% in the quarter and
12% in the first half was mainly due to the inclusion of shorter haul WC
traffic and the effect of the weaker Canadian dollar.
Coal: Revenues decreased by $7 million, or 8%, for the quarter and $15 million,
or 9%, for the first six months when compared to the same periods in 2001. The
decline in both the quarter and first half of 2002 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 3% in the quarter was mainly due
to a decrease in longer haul traffic. The 6% increase in the first six months
is also attributable to an increase in rates tied to commodity prices and the
effect of the weaker Canadian dollar.
Grain and fertilizers: Revenues decreased by $20 million, or 7%, for the
quarter and $72 million, or 12%, for the first six months when compared to the
same periods in 2001. The decline in both the quarter and first six months of
2002 reflected a significant deterioration in the 2001/2002 Canadian grain crop
that was partly offset by increases in the fertilizer segment and higher
soybean shipments from the United States. The 5% increase in revenue per
revenue ton mile in both the quarter and first half of 2002 was mainly due to
an increase in the regulated grain rates and a decline in longer haul traffic.
Intermodal: Revenues increased by $17 million, or 7%, for the quarter and $15
million, or 3%, for the first six months when compared to the same periods in
2001. The increase in both the quarter and first half of 2002 was mainly due to
stronger Canadian retail sales, higher volumes on expedited trains in the
Canadian domestic segment and increased overseas traffic in spite of the loss
of some overseas moves. The 3% decrease in revenue per revenue ton mile in both
the quarter and first half of 2002 was mainly attributable to the elimination
of the fuel surcharge at the end of 2001 and an increase in the average length
of haul.
Automotive: Revenues increased by $20 million, or 14%, for the quarter and $44
million, or 17%, for the first six months when compared to the same periods in
2001, reflecting stronger motor vehicle production particularly in the United
States. For the quarter, the 2% decrease in revenue per revenue ton mile was
mainly attributable to an increase in longer haul traffic. For the first six
months, the 2% increase was mainly attributable to the weaker Canadian dollar,
which more than offset the increase in the average length of haul.
47
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
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Operating expenses
In the second quarter of 2002, operating expenses amounted to $1,166 million
compared to $1,147 million in the same quarter of 2001. Operating expenses for
the first half of 2002 were $2,303 million compared to $2,183 million in the
same period of 2001.
Excluding the 2001 special charge for workforce reductions, operating expenses
for the current quarter increased by $117 million, or 11%, from $1,049 million
in the same period of 2001. For the first half of the year, operating expenses,
excluding the 2001 special charge, increased by $218 million, or 10%, from
$2,085 million in the same period last year. The increases in the quarter and
first six months of 2002 were mainly due to the consolidation of WC operating
expenses, higher expenses for labor and fringe benefits, equipment rents and
casualty and other, partially offset by lower fuel costs.
Labor and fringe benefits: Labor and fringe benefit expenses in 2002 increased
by $77 million, or 18%, for the second quarter and $156 million, or 19%, for
the first half when compared to the same 2001 periods. The increase was mainly
attributable to the inclusion of WC labor expense of $51 million for the
quarter and $103 million for the six-month period, wage increases and higher
benefit expenses, including health and welfare and other postretirement
benefits. The impact of the weaker Canadian dollar on U.S. denominated expenses
also contributed to the increase in the six-month period ended June 30, 2002.
Purchased services: The costs of purchased services increased by $15 million,
or 11%, for the quarter and $22 million, or 8%, for the six-month period ended
June 30, 2002, when compared to corresponding periods in 2001. The increase was
mainly due to the inclusion of WC purchased services expense and higher
derailment-related expenses in the second quarter of 2002 that were partially
offset by lower crew transportation and lodging expenses.
Depreciation and amortization: Depreciation and amortization expense for the
quarter and six months ended June 30, 2002, increased by $2 million, or 2%, and
$15 million, or 7%, respectively, from the comparable 2001 periods, due mainly
to the inclusion of WC depreciation expense.
Fuel: The decrease in the second quarter of $7 million, or 6%, and $38 million,
or 14%, in the first half of 2002, when compared to the respective periods in
2001, was primarily due to a decrease in the average price of fuel, partially
offset by the inclusion of WC fuel expense.
Equipment rents: These expenses increased by $17 million, or 22%, in the
quarter and $28 million, or 18%, for the first half of the year, when compared
to the same periods in 2001. The increase in the quarter and the first half of
the year was mainly due to the inclusion of WC equipment rents and lower net
car hire income.
Material: For the quarter and six months ended June 30, 2002, material costs
increased by $4 million, or 6%, and decreased by $1 million, or 1%,
respectively, from the comparable periods in 2001. Lower locomotive and car
maintenance costs in the quarter and first half of 2002 partly offset the
inclusion of WC material costs in the quarter, and more than offset the
inclusion of WC material costs in the first half of 2002.
Operating taxes: Operating taxes increased by $5 million, or 14%, during the
second quarter of 2002 and $2 million, or 2%, during the six-month period ended
June 30, 2002 when compared to the corresponding periods in 2001, mainly due to
the inclusion of WC operating taxes and one-time provincial sales tax
recoveries in 2001 that were partly offset by capital and sales tax recoveries
in 2002.
Casualty and other: These expenses increased by $4 million, or 7%, in the
current quarter and by $34 million, or 33%, for the first six months of 2002,
when compared to the corresponding 2001 periods. The increase in both the
quarter and six-month period is mainly due to higher expenses for casualty and
legal claims, including occupational-related claims, the inclusion of WC
casualty and other expenses, and higher derailment-related expenses in
48
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
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the second quarter of 2002. Partially offsetting these increases were lower
expenses related to environmental matters and, bad debt expenses in the first
half of 2002.
Other
Interest expense: Interest expense for the second quarter increased by $14
million, or 19%, from the comparable 2001 quarter and $30 million, or 20%, in
the first six months of 2002 versus the equivalent 2001 period. Lower interest
expense related to the maturity of certain notes was more than offset by the
financing related to the acquisition of WC and the consolidation of WC interest
expense.
Other income: Excluding the impact of the 2001 DRT and 360networks Inc.
transactions previously discussed, other income for the second quarter of 2002
increased to $23 million from $9 million in the comparable 2001 quarter and
increased to $61 million for the first half of 2002 from $18 million in the
first half of last year. The increase was mainly due to the inclusion of WC's
equity in earnings of English Welsh and Scottish Railway (EWS) of $4 million
for the quarter and $15 million for the first half of 2002 and higher gains on
disposal of surplus assets.
Income tax expense: The Company recorded an income tax expense of $108 million
for the current quarter and $41 million for the corresponding period in 2001.
Income tax expense was $216 million for the six months ended June 30, 2002 and
$167 million for the comparable 2001 period. The effective tax rate for the
quarter and six months ended June 30, 2002 was 33.8%. The effective tax rate
for the comparative 2001 periods was 35.6% and 35.9%, respectively, excluding
the income tax effect on the special charge, the DRT transaction and the charge
for 360networks Inc.
49
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
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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 $350 million
and $575 million for the three and six-month periods ended June 30, 2002,
respectively, compared to $375 million and $437 million for the same 2001
periods. Net income, excluding non-cash items, generated cash of $389 million
for the current quarter and $783 million for the six months ended June 30,
2002, compared to $370 million and $721 million in the corresponding 2001
periods. Cash generated in the first six months of 2002 was partially consumed
by payments for workforce reductions and income taxes of $94 million and $67
million, respectively, compared to $89 million and $59 million, respectively,
for the same period last year. Payments for casualty and legal claims,
including amounts paid for workers' compensation, for the first half of 2002
and 2001 were $68 million and $78 million, respectively.
Investing activities: Cash used by investing activities in the quarter and six
months ended June 30, 2002 amounted to $140 million and $131 million,
respectively, compared to $169 million and $148 million for the comparable
periods in 2001. The Company's investing activities in the first half of 2002
included net proceeds of $68 million from the sale of its investment in Tranz
Rail Holdings Limited, whereas the comparative period included proceeds of $112
million from the sale of DRT. Net capital expenditures amounted to $133 million
and $204 million in the three and six months ended June 30, 2002, respectively,
a decrease of $48 million and $64 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 $41 million for the second quarter and $83 million for the first
six months of 2002 compared to $37 million and $75 million, respectively, at
the rate of $0.195 per common share for the same periods in 2001. In the second
quarter and first half of 2002, $5 million was paid on the convertible
preferred securities at an annual rate of 5.25%, compared to $10 million in the
first half of 2001 at the same rate.
Free cash flow
The Company generated $164 million and $356 million of free cash flow for the
three and six months ended June 30, 2002, respectively, compared to $169
million and $204 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 $122 million
for the second quarter and $316 million for the six months ended June 30, 2002
compared to $179 million and $193 million in the same periods of 2001. In 2002,
the Company's issuances and repayments of long-term debt related principally to
the Company's commercial paper and revolving credit facilities.
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. At June 30, 2002, the Company had entirely repaid
its borrowings of U.S.$172 million
50
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
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(Cdn$273 million) outstanding at December 31, 2001. At June 30, 2002, letters
of credit under the revolving credit facilities amounted to $292 million.
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 within the next twelve
months and while the Company's intent is to renew the existing revolving credit
facilities, the refinancing has not been renegotiated and, as such, the
outstanding balance of U.S.$209 million (Cdn$317 million) of commercial paper
has been included in the current portion of long-term debt at June 30, 2002.
Shelf registration statement
At June 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 June 30, 2002, pursuant to the agreement, $168 million and
U.S.$113 million (Cdn$171 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 aware
of any adverse trend, event or condition that would affect the Company's
current credit standing.
51
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
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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 June 30, 2002:
Contractual obligations
(In millions)
Contract Type Total 2002 2003-2004 2005-2006 2007 &
thereafter
--------------------------------------------------------------------------------------------------------------------
Debentures, notes and other $ 4,490 $ 14 $ 1,204 $ 559 $ 2,713
Capital leases (a) 842 72 174 84 512
--------------------------------------------------------------------------------------------------------------------
Long-term debt $ 5,332 $ 86 $ 1,378 $ 643 $ 3,225
Operating leases (b) 1,221 111 393 292 425
--------------------------------------------------------------------------------------------------------------------
Total obligations $ 6,553 $ 197 $ 1,771 $ 935 $ 3,650
====================================================================================================================
Commercial commitments
(In millions)
Ccommitments Type Total 2002 2003-2004 2005-2006 2007 &
thereafter
--------------------------------------------------------------------------------------------------------------------
Standby letters of credit (c) $ 384 $ 320 $ 63 $ 1 $ --
Other commercial commitments (d) 267 36 231 -- --
--------------------------------------------------------------------------------------------------------------------
Total commitments $ 651 $ 356 $ 294 $ 1 $ --
====================================================================================================================
(a) Excludes $486 million of imputed interest on capital leases at rates
ranging from approximately 3.0% to 11.9%.
(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 June 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 $292 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 to be sufficient to meet its future
obligations and fund anticipated capital expenditures.
52
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
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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.
As of June 30, 2002, approximately U.S.$1 million principal amount of the
Securities were surrendered for conversion into common shares.
On July 3, 2002, the closing price of the Company's common shares exceeded the
conversion price of US$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 merger involves the integration of two previously independent businesses to
provide shippers enhanced rail services over a coordinated network. There can
be no assurance that there will be realization of rail service and other
efficiencies or synergies that are expected to be derived from the merger.
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 and environmental matters. 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.
53
CANADIAN NATIONAL RAILWAY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS (CANADIAN GAAP)
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Although the Company considers such provisions to be adequate for these
matters, the final outcome with respect to actions outstanding or pending at
June 30, 2002, or 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, as they are not
reasonably estimable. 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 continue to work with an independent actuarial
firm and will consider the results of an actuarial based approach to evaluate
the sufficiency of its provision for occupational claims. 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 June 30, 2002, the Company had aggregate reserves for legal matters of
$250 million ($277 million at December 31, 2001), of which approximately $143
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
54
CANADIAN NATIONAL RAILWAY COMPANY
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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 June 30, 2002, the Company had aggregate accruals for environmental costs
of $103 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 postretirement benefits as required
by CICA Handbook Section 3461 "Employee Future Benefits." Under this accounting
standard, assumptions are made regarding the valuation of benefit obligations
and performance of plan assets. Delayed recognition of differences between
actual results and those assumed is a guiding principle of this standard. This
approach allows for a smooth 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 postretirement 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.
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 is regularly monitored, and losses due to
counterparty nonperformance 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
June 30, 2002, the Company hedged
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CANADIAN NATIONAL RAILWAY COMPANY
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approximately 46% of the estimated 2002 fuel consumption, 41% of the estimated
2003 fuel consumption and 7% of the estimated 2004 fuel consumption. This
represented approximately 348 million U.S. gallons at an average price of
U.S.$0.606 per U.S. gallon.
For the three months ended June 30, 2002, the Company realized a negligible
loss from its fuel hedging activities, compared to a $2 million gain in the
same period last year. For the first half of 2002, the Company's hedging
activities resulted in a realized loss of $9 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 $17 million at June 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
As of July 2002, the Company had achieved ratified settlements with bargaining
units representing 98% of the Company's Canadian unionized workforce. These
agreements are generally for a three-year period effective until December 31,
2003.
The general approach to labor negotiations by U.S. Class 1 railroads is to
bargain on a collective national basis. For several years now, 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. Local negotiations result in settlements
that better address both the employees' concerns and preferences and the
railways' actual operating environment. There are risks associated with
negotiating locally. Presidents and Congress have demonstrated that they will
step in to avoid national strikes, while a local dispute may not generate
federal intervention,
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CANADIAN NATIONAL RAILWAY COMPANY
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making an extended work stoppage more likely. The Company believes the
potential mutual benefits of local bargaining outweigh the risks.
As of July 2002, the Company had in place agreements with bargaining units
representing all the 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, 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 across a number of markets. Following a significant reduction in
interest rates and a major depletion in inventories, the North American economy
rebounded in the first part of 2002. While continued growth is expected
throughout the year, the speed of the recovery will depend on overall consumer
and business confidence, which currently show signs of uncertainty. The Company
will continue to leverage its strong service capabilities but remains cautious
about business prospects in the second half of the year.
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
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CANADIAN NATIONAL RAILWAY COMPANY
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of 1998, a severe ice storm hit eastern Canada, which disrupted operations and
service for the railroad as well as for CN customers.
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 inflationadjusted 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.
58