Canadian National Railway Company Annual Report 2004

FY2004 Annual Report · Canadian National Railway Company

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2004 Annual Report

This is excellence.

Contents

Financial summary
This is CN

1 This is excellence . . .
7 A message from E. Hunter Harrison
8
11
12 Changing mindsets: IMX and beyond
14 Converting the GLT acquisition
16 BC Rail and CN: a perfect ﬁ t
18 A new approach to service
20 Building a railroader culture
22 CN at a glance
24 A message from the Chairman

In the community
25
28 Glossary of terms
29 Financial Section (U.S. GAAP)
81 Financial Section (Canadian GAAP)

130 Non-GAAP Measures – unaudited
132 Corporate Governance
133 2004 President’s Awards for Excellence
134 Board of Directors
136 Chairman of the Board and

Executive Ofﬁ cers of the Company

137 Shareholder and investor information

Except where otherwise
indicated, all ﬁ nancial infor-
mation reﬂ ected in this docu-
ment is expressed in Canadian
dollars and determined
on the basis of United States
generally accepted accounting
principles (U.S. GAAP).

To CN, an empty rail yard represents
excellence because it means
our assets are out on the network –
moving product,
earning revenue and helping
customers compete.

Looking at our business differently
is key to delivering the
full beneﬁ t of precision railroading to
our customers and shareholders.
It has been integral to our
approach at CN for nearly a decade,
and it is at the root of our
conﬁ dence that we can lead and
grow for years to come.

Canadian National Railway Company

This is the competition.

With the increasing speed, precision and reliability of the CN service plan, we can
provide real value when compared with truck transportation.

Canadian National Railway Company

This is our capacity.

We see the glass as half empty. We have signiﬁ cant capacity in our operations
to handle more trafﬁ c and grow at low incremental cost.

Canadian National Railway Company

This is the engine.

We are cultivating a unique, passionate railroader mentality across our entire workforce – to leverage
the CN scheduled railroading concept and get better at it every day.

Canadian National Railway Company

Revenues
In million $

Adjusted operating ratio (1)
In per cent

(1) 2001 and 2002 have been adjusted
for items affecting the comparability
of the results of operations. See page
130 of this report for a reconciliation
of this non-GAAP measure.

6,750

6,500

6,250

6,000

5,750

5,500

5,250

5,000

This is the scorecard.

We know what we’re supposed to do: deliver value to our shareholders. Do that by delivering value to
our customers. Do that by executing and continuously improving at every level of our business.

Free cash flow (2)
In million $

(2) See page 131 of this report for a

reconciliation of this non-GAAP measure.

CN stock performance
January 1, 2000 to December 31, 2004

January 1, 2000 = 100

CNR
CNI
S&P 500
S&P/TSX

1,050

÷«900

÷«750

÷«600

÷«450

÷«300

÷«150

÷÷÷«0

350

300

250

200

150

100

Jan. 1
00

Jan. 1
01

Jan. 1
02

Jan. 1
03

Jan. 1
04

Dec. 31
04

Canadian National Railway Company

This is the limit.

We see no limit to what we can achieve with our business model, operating philosophy and attitude.
There is room to get better in every area of performance.

Canadian National Railway Company

A message from E. Hunter Harrison

Dear shareholders: We’ve built a highly productive and resilient franchise,
capable of delivering results even in the face of signiﬁ cant challenges.
We’ve proven what we can do, but there’s much more for us to prove.
This is CN: a journey that’s far from over.

I remember one of the turning points of my career. I was a young man,

in my ﬁ rst management job at BN’s Memphis yard. W.F. Thompson,

a great railroader who would eventually become a mentor of mine,

was visiting the facility. He looked out at a rail yard packed with cars

and asked me, “Son, what do you see out there?” I was young, and

he was a big, intimidating man. I wanted to say the right thing. My

answer was, “Sir, that’s a lot of business out there in the yard.”

Mr. Thompson’s answer changed forever my view of railroading.

He said, “You know, that’s the problem. You look at a crowded yard

and see a lot of business. I see a lot of delayed trains.”

A passion for seeing things differently

It’s been a tradition throughout CN’s history as a publicly held cor-

poration to look beyond the conventions of traditional railroading to

drive excellence. Those of you familiar with CN’s track record know

that is our central theme.

Since that moment in the Memphis yard long ago, getting the

absolute maximum out of rail assets has been a major focus of mine,

and it’s a passion here at CN. It’s one of the ﬁ ve guiding principles

of successful railroading. The ﬁ rst is providing good service – con-

sistently doing what you say you’ll do. The second is controlling your

costs. The third is asset utilization. The fourth is to make sure you

operate safely, and the ﬁ fth is developing your people. I’ve always

believed that if I focus 90 per cent of my time as leader on the ﬁ fth

principle, the other four will follow naturally.

Without a doubt, CN people enabled the company to translate

improved economic conditions into excellent results for this company

in 2004. Thanks to their dedication and execution, 2004 was a

record year by nearly every measure.

Canadian National Railway Company
Canadian National Railway Company

7
7

Financial summary

$ in millions, except per share data, or unless otherwise indicated

2004(1)

2003(1)

2002(1)

Financial results

Revenues

Operating income

Net income

Diluted earnings per share (2)

Dividend per share (2)

Net capital expenditures

Financial position

Total assets

Long-term debt, including current portion

Shareholders’ equity

Financial ratios (%)

Operating ratio

Debt to total capitalization

$÷6,548
2,168
1,258
4.34
0.78
1,072

$÷5,884

$÷6,110

1,777

1,014

3.49

0.67

1,043

1,469

800

2.65

0.57

938

22,365
5,164
9,284

20,337

21,738

4,658

8,432

5,577

8,369

66.9
35.7

69.8

35.6

76.0

40.0

(1) 2004 includes GLT and BC Rail from May 10 and July 14, respectively. In addition, the Company’s ﬁ nancial results for 2003 and 2002 include items affecting the comparability of the

results of operations as discussed in the Company’s Management’s Discussion and Analysis on pages 32 and 38.

(2) Reﬂ ects a three-for-two common stock split that took effect February 2004.

Employees (average for the year)

2002

2003

2004 (1)

Adjusted diluted earnings per share (dollars) (2) (3)

2002

2003

2004 (1)

Adjusted operating ratio (percentage) (2)

2002

2003

2004 (1)

3.48

3.60

23,190

22,012

22,470

4.34

69.4

69.8

66.9

(1) Includes GLT and BC Rail from May 10, 2004 and July 14, 2004, respectively.
(2) See discussion and reconciliation of these non-GAAP adjusted performance measures in the Company’s Management’s Discussion and Analysis on pages 32, 33 and 38.
(3) Reﬂ ects a three-for-two common stock split that took effect February 2004.

Canadian National Railway Company

Success always comes back to the ﬁ ve principles I’ve preached my entire
career as a railroader: Do what you say you’re going to do, keep your
costs down, get the most out of your assets, don’t get anybody hurt, and
develop your people. We’re doing well. But I know we can do better.

Record ﬁ nancial results

chises. We continue to innovate to improve our products, our ability

It was a banner year for CN. Volumes, measured in revenue ton miles,

to sell them and our customer support capability. Our efforts to

increased in 2004 by 8 per cent over what we achieved in 2003. Total

increase speed, efﬁ ciency and reliability through the execution of the

revenues grew by 11 per cent year-over-year to a record $6,548 million,

CN precision railroading concept are ongoing and never-ending.

despite a strong Canadian dollar that continued to negatively affect

The GLT and BC Rail transactions extended our reach and

the translation of our U.S. dollar-denominated revenues.

created opportunities to improve trafﬁ c ﬂ ows. These acquisitions

Revenues from the Great Lakes Transportation LLC railroads

also strengthened CN’s ability to grow in the steel, forest products

and related holdings (GLT) and BC Rail transactions began to con-

and coal industries. Both GLT and BC Rail have been accretive to

tribute to CN results starting in May and July of 2004, respectively.

CN’s earnings from day one; our proven step-by-step integration

Excluding the conversion impact of the stronger Canadian dollar –

model proceeded smoothly throughout 2004.

approximately $255 million – our revenues grew 16 per cent in 2004;

CN’s groundbreaking Intermodal Excellence product – called

of that, 6 per cent was due to our two acquisitions, indicating the

IMX – exceeded our expectations in 2004, contributing signiﬁ cantly

strength of our core franchise.

to the bottom line. There’s still plenty of room for improvement in

Our operating ratio for the year was a record 66.9 per cent.

this business, and there are more customers that can beneﬁ t from

Driven by our ability to absorb volume growth at low incremental

the speed and efﬁ ciency of scheduling all intermodal operations.

cost, performance in this key measure improved 2.9 percentage points

Meanwhile, we are expanding the IMX precision railroading mindset

when compared with the 69.8 operating ratio we reported for 2003.

in our carload business and starting another journey of industry

Perhaps the most dramatic yardstick for CN ﬁ nancial perfor-

innovation with Carload Excellence.

mance in 2004 was in the area of free cash ﬂ ow. Here, our business

The creation of a dedicated CN service department in 2004

model and success in executing it delivered powerful results: record

promises to do more than increase the value we can bring to custom-

free cash ﬂ ow in 2004 of $1,025 million, a signiﬁ cant increase over

ers. This initiative represents a broader enhancement of the way we

the $578 million we generated in 2003.*

run our business in which dedicated marketing, sales and service

We are committed to rewarding our investors for their conﬁ -

functions create new opportunities for continuous performance

dence in us. In early 2005, we announced CN’s ninth consecu-

improvement. Now, CN has marketing professionals focused solely

tive dividend increase. In fourth quarter 2004 we announced our

on product design and pricing; sales professionals free to concen-

intention to repurchase up to 14 million shares of CN stock between

trate exclusively on selling; service professionals whose mandate is

November 1, 2004 and October 31, 2005.

to help customers and improve CN’s ability to meet their needs.

Rail transportation still has unrealized potential for growth.

A solid foundation for continued performance

By working together as an industry, there are signiﬁ cant opportuni-

Our performance in 2004 was the result of years of work, of strate-

ties to improve transit times, increase capacity, reduce congestion

gies begun several years ago, of a superior and highly effective

and become a more competitive transportation option. In 2004,

business model and operating philosophy – factors that also form

we announced a number of network initiatives and co-production

a solid base for growth in the future.

agreements with Canadian Paciﬁ c Railway. We continued our rout-

In other words, this story is by no means over.

ing protocol initiative with a series of agreements announced with

I am convinced that our performance is sustainable. We have

our U.S. interline partners. Our opportunity is to expedite trafﬁ c by

just begun to realize the beneﬁ ts from the GLT and BC Rail fran-

reducing the number of handlings, shortening routes and avoiding

the most congested gateways.

*See page 42 of this report for a reconciliation of this non-GAAP measure.

Canadian National Railway Company

Our future boils down to one word: Change. Embracing change,
and driving it. Being resilient while always searching for ways
to change for the better. Looking at things from new and different
angles. And not giving up on a good idea. That’s what we’ve got
to do across the company.

We see future growth in overseas trafﬁ c, particularly to and

with the “Railroad MBA,” it’s why I’m spending the time I am

from Asia through Canada’s west coast. With its growing economy,

with the training program that’s come to be known as “Hunter

China is particularly important, both as a destination for natural

Camps,” and it’s why we’re investing what we are in other people-

resources and merchandise located along CN’s network, and as

development initiatives throughout the organization.

an originator of containers bound for points in North America. In

I believe the capacity for people to learn and improve is limit-

fourth quarter 2004, CN announced the establishment of ofﬁ ces in

less. That belief is behind my conﬁ dence that this journey is far

Shanghai and Beijing with the objective of growing the railroad’s

from over.

share of China-North America trafﬁ c. With our signiﬁ cant presence

We are going to continue to build on what we’ve accomplished

in the port of Vancouver and what we see as the potential for Prince

together so far. I can see it happening, one person at a time – that

Rupert as a gateway, we believe we are well positioned to beneﬁ t

light going on, that look I see on someone’s face when he or she sees

from increasing trade between China and North America.

his or her place in what we’re trying to accomplish. What is most

Managing change, moving forward

doing. It’s seeing our workforce get on board the CN train.

The success we have had so far is the result of our ability to meet

For each CN individual and for this company, I truly believe that

gratifying to me is seeing people get passionate about what we’re

challenges by managing change. Continuing to improve and develop

the sky’s the limit.

this ability is the key to our future. When I say managing change, I

mean more than just reacting to it. We have to lead change. That

Sincerely,

starts with developing the right culture, which doesn’t happen over-

night. I’ve seen the CN culture steadily evolve since I ﬁ rst got here

almost seven years ago. We are trying to get every single employee

to adopt the CN railroader mentality – a passion for excellence in

everything we do, even the smallest things; a resistance to accept-

ing the status quo, a drive to look for innovative ways to improve

E. Hunter Harrison

performance in every corner of our business.

President and Chief Executive Ofﬁ cer

To a signiﬁ cant degree, we have gotten to this point by bucking

conventional wisdom – in our precision railroading operating model,

in our labor agreements, in our intermodal and carload products, in

the way we are organized and how we work with other railroads –

and that’s how we’re going to continue to build on our leadership.

Embracing change and driving it.

My top priority as I lead this company is to develop our people.

The way I see it, if we continue to get smarter, move up the learning

curve and work better together as a team, that alone has powerful

potential to drive growth. That’s why we’re doing what we’re doing

Canadian National Railway Company

We are constantly striving to get the

most out of our unique CN precision

railroading approach, whether by

challenging the way we do things in

order to do them better, or by extending
This is CN. the network upon
which we apply our model. In 2004, we

converted on a number of initiatives

and focused on developing the engine

that will continue to take us forward:

our people.

Canadian National Railway Company

Changing mindsets:

Canadian National Railway Company

IMX and beyond

In 2003, CN introduced Intermodal

we can extend our disciplined operating

Next is to apply the IMX mindset

Excellence – IMX – an entirely new

practices to additional activities.

to our carload business with Carload

approach to operating our most complex

IMX is more than a program or

Excellence, or CX, which we launched

business. IMX applies the discipline

product. It’s a mindset – at CN and,

in 2004. By utilizing equipment reser-

and precision of scheduled railroading

more important, among CN customers.

vations, off-peak pricing and our new

to remove randomness, smooth trafﬁ c

Equipment, gate and train reservations

interline route protocols, CX is bringing

ﬂ ows, reduce transit times and improve

maximize customer access to ﬁ xed

fundamental change to the way carload

reliability. One year later, the results are

capacity and improve customers’

shipping is done. Like IMX, CX has real

showing in steadily increasing customer

ability to plan; day-of-the-week and

potential to free additional capacity,

acceptance and improved margins. As

seasonal pricing provides opportuni-

smooth trafﬁ c ﬂ ows, improve asset

we continue to improve our execution,

ties to both CN and its customers

performance and increase proﬁ tability.

to better manage costs.

Canadian National Railway Company

Converting

Canadian National Railway Company

the GLT acquisition

Initiated in late 2003 and closed in mid-2004, CN’s acquisi-

In addition, it extended our network with port and rail assets

tion of the Great Lakes Transportation LLC railroads and

in Pennsylvania.

related holdings (GLT) represented a twofold strategy – ﬁ rst,

Equally important, the GLT acquisition strengthened

to enhance our rail network in a key corridor, and second,

CN’s position as a hauler of bulk commodities for the U.S. steel

to build our bulk commodities franchise serving the steel

industry, which is in the midst of a recovery. In addition, we

industry. The transaction gave CN ownership of a key 17-mile

now are beneﬁ ting from growing world demand for iron ore

segment of track in the Duluth, Minnesota/Superior, Wisconsin

that reﬂ ects dramatic changes in the global economy.

area and 64 miles of parallel track just north of there, two

important enhancements in our fast-growing western corridor.

Canadian National Railway Company

BC Rail and CN:

When we announced CN’s partnership with BC Rail in late 2003, we knew it would be a perfect strategic ﬁ t. Approved and

closed in mid-2004, the transaction is already delivering results.

The joining of CN and BC Rail strengthens our franchise and growth prospects, particularly in forest products, and

expands our presence in British Columbia. Plans for new facilities in Prince George offer operational beneﬁ ts, while the addition

of BC Rail track to our western network provides a number of signiﬁ cant opportunities to improve trafﬁ c ﬂ ow and serve

our customers better, many of which we already have implemented.

Meanwhile, our partnership with BC Rail strengthens CN’s commitment to the development of the port of Prince Rupert,

which we believe holds potential as a gateway for growing trade between North America and Asia.

Canadian National Railway Company

a perfect ﬁ t

Canadian National Railway Company

A new approach

Canadian National Railway Company

to service

CN has steadily increased the effective-

ness of its sales force by reﬁ ning the

organizational structure and transform-

ing the traditional order-taker mentality

to a more proactive, solutions-oriented

approach. As our sales professionals

continue to improve and excel, we

are raising the quality of service after

the sale with a new, fully dedicated

service department.

The CN Service Department

provides a new level of responsiveness

and expertise to help customers quickly

resolve issues beyond normal shipment

tracking and transactional questions

and maximize the beneﬁ t they can draw

from our precision railroading model.

We have assembled a group of highly

experienced railroaders from a broad

range of expertise, from operations,

service design, sales and marketing to

accounting and traditional customer

service. CN service professionals have

the tools and authority to coordinate

solutions across the CN system – provid-

ing customers new avenues for faster

and more consistent problem resolution.

Canadian National Railway Company

Building

To power CN’s future, we aspire always to become better rail-

The “Railroad MBA” is a tailored 12- to 18-month program

roaders. Two unique CN programs designed to help us achieve

in which CN managers take a leave of absence from their

that goal gained momentum in 2004 – “Hunter Camps” and

regular positions to gain hands-on experience in every aspect

the “Railroad MBA.”

of CN’s operations. Participants rotate through key areas

To develop CN’s next generation of performers and lead-

of the business, learning to lay track, repair engines, run

ers, we have instituted a program that has become known

trains and manage the network, developing railroading skills,

across the company as “Hunter Camps.” In each session – four

knowledge and perspective that add tremendous value to

were held in 2003, eight in 2004, 12 are planned for 2005

their capabilities.

along with a video – Hunter Harrison spends three days with

In both programs we’re breaking new ground to build a

a group of 20–25 CN employees, passing on the knowledge

strong railroader culture at CN. One person at a time, creating

of his 40-plus years in this business.

an unstoppable passion to improve, lead and excel. This is

our future; this is CN.

Canadian National Railway Company

a railroader culture

Canadian National Railway Company

CN at a glance

Statistical summary

CN derives revenue
from a balanced mix
of goods moving
over a network
of approximately
19,300 route miles
of track spanning
North America.
CN is the only rail
network on the
continent to con-
nect three coasts –
the Paciﬁ c, the
Atlantic and the
Gulf of Mexico.

Route miles (includes Canada and the U.S.)

Carloads (thousands)

Gross ton miles (millions)

Revenue ton miles (millions)

Employees (average for the year)

Diesel fuel consumed (U.S. gallons in millions)

Average fuel price per U.S. gallon (dollars) (2)

(1) Includes GLT and BC Rail from May 10, 2004 and July 14, 2004, respectively.
(2) Includes the impact of the Company’s hedging program.

2004 data

Petroleum and chemicals

Metals and minerals

Forest products

Coal

Grain and fertilizers

Intermodal

Automotive

2004 (1)

19,304
4,654
332,807
175,355
22,470
391
÷«1.30

2003

17,544

4,177

313,593

162,901

22,012

374

÷«1.21

2002

17,821

4,153

309,102

159,259

23,190

369

÷«1.20

Certain of the comparative statistical data and
productivity measures have been restated to
reﬂ ect changes to estimated data previously reported.

Freight
revenues
(millions)

$1,123

713

1,452

284

1,053

1,117

510

Revenue ton
miles (RTM)
(millions)

32,618

16,421

38,414

13,614

39,965

31,002

3,321

Freight
revenue
per RTM
(cents)

3.44

4.34

3.78

2.09

2.63

3.60

15.36

Freight revenues
2004 percentage data

18%

17%

23%

11%

18% Petroleum and chemicals
11% Metals and minerals
23% Forest products
5% Coal
17% Grain and fertilizers
18% Intermodal
8% Automotive

Revenue – traffic mix
Per cent

23%

34%

20%

23% Canadian domestic
20% Overseas
34% Transborder
23% U.S. domestic

Petroleum and chemicals

Metals and minerals

Forest products

We believe the
balance of our
business mix
positions us well
to face economic
ﬂ uctuations
and enhances
our potential to
grow revenue.

Canadian National Railway Company

Petroleum and chemicals comprise
a wide range of commodities includ-
ing petroleum, liqueﬁ ed petroleum
gas, plastics and oleﬁ ns, sulfur and
chemicals products. Most of CN’s
petroleum and chemicals shipments
originate in Alberta, eastern Canada
and the Gulf of Mexico, and are
destined for customers in Canada,
the United States and overseas.

CN’s metals and minerals
commodity group consists primarily
of nonferrous base metals, iron ore,
steel, equipment and parts and
construction materials. The
company’s superior rail access to
major mines, ports and smelters
throughout North America has
made the company a leader in the
transportation of copper, lead,
zinc concentrates, iron ore, reﬁ ned
metals and aluminum.

CN is the largest carrier of forest
products in North America. This
commodity group includes various
types of lumber, panels, wood chips,
woodpulp, printing paper, liner-
board and newsprint. In Canada,
CN enjoys superior access to the
major ﬁ ber-producing regions. In
the United States, CN is strategically
located to serve both the mid-
western and southern U.S. corridors
with interline capabilities to other
Class 1 railroads.

Fort Nelson

Prince Rupert

Prince George

Dawson Creek

Edmonton

Whistler

Kamloops

Calgary

Vancouver

CN – North America’s railroad

Saskatoon

Winnipeg

Thunder Bay

Hearst

Oba

Quebec

Montreal

Moncton

Halifax

Duluth

Sault Ste. Marie

Toronto

Minneapolis/St. Paul

Stevens Point

Fond du Lac

Green Bay

Sarnia

Buffalo

Fort Dodge

Waterloo

Chicago

Sioux City

Omaha

Topeka

Cedar
Rapids

Springfield

Council
Bluffs

Kansas City

St. Louis

East
St. Louis

Conneaut

Detroit

Pittsburgh

Cincinnati

Tulsa

Memphis

Counce

Alliance

Dallas

Shreveport

Jackson

Baton
Rouge

Houston

Beaumont

Port Arthur

Galveston

Birmingham

Mobile

Gulfport
New Orleans

Laredo

Monterrey

Corpus
Christi

San Luis Potosí

Tampico

Mexico City

Veracruz

Lazaro Cardenas

KCS

KCS/TFM Alliance

Coal

Grain and fertilizers

Intermodal

Automotive

CN moves both Canadian and U.S.
thermal coal. Canadian thermal
coal is delivered to power utilities
primarily in eastern Canada. U.S.
thermal coal is transported from
mines in southern Illinois or from
western U.S. mines via interchange
with other railroads to utilities in the
Midwest and southeastern United
States. CN also moves metallurgi-
cal coal to export markets via
the Canadian west coast ports of
Vancouver and Prince Rupert.

CN’s grain and fertilizer business
transports commodities grown
in western Canada and the U.S.
Midwest. The majority of western
Canadian grain carried by CN is
for export. In the United States,
CN handles grain grown in Illinois
and Iowa for export, as well as
for domestic processing facilities
and feed markets. CN also serves
producers of potash, urea and
other fertilizers.

CN leads the industry with its
innovative IMX intermodal service
offering. At CN, intermodal business
consists of two segments. The ﬁ rst
segment, domestic, is responsible
for consumer products and manu-
factured goods, operating through
both retail and wholesale channels.
The second, the international
segment, handles import and export
container trafﬁ c, serving the ports
of Vancouver, Montreal, Halifax and
New Orleans.

CN is a leading carrier of auto-
motive products originating in
southwestern Ontario, Michigan
and Mississippi. This commodity
group moves both ﬁ nished vehicles
and parts within the United States,
Canada and Mexico. CN also serves
shippers of import vehicles via the
ports of Halifax and Vancouver,
and through interchange with other
railroads.

Canadian National Railway Company

A message from the Chairman

Dear fellow shareholders:
In an improved but still-challenging
environment, CN achieved or surpassed
nearly all its ﬁ nancial objectives,
successfully closed two important
acquisitions and extended its track
record of delivering solid value to its
shareholders. On behalf of the CN Board,
I commend the management team
and all of our employees for another
year of outstanding accomplishment.

Canadian National Railway Company

The CN Board is very pleased with the performance of our

company under the leadership of Hunter Harrison and his team.

Hunter has a rare gift, a combination of broad strategic vision and a

hands-on management style that I believe is a force, not just within

CN, but also throughout the industry. The Board was delighted

with Hunter’s decision during the year to accept an extension of his

employment contract with the company through 2008.

At the same time, we are gratiﬁ ed to see the depth of talent

the company is developing at all levels of the organization. It has

long been a priority of the Board to see CN build upon the strength

of its management team, to attract – and retain – the best and

brightest minds in the industry. We believe the company is perform-

ing exceedingly well in this critical area.

The Board of Directors is particularly proud of its corporate

governance. I am pleased to report that in 2004 CN rose to a rank

of ﬁ fth out of more than 200 Canadian companies in the Globe and

Mail Report on Business Annual Review of Corporate Governance

in Canada. Based on the Review’s evaluation of board composition,

share holding and compensation, shareholder rights, and disclosure,

CN scored 93 points out of a possible 100. Shareholders can view

and obtain copies of CN corporate governance guidelines, as well as

key committee charters and other information, on our Web site at

www.cn.ca/cngovernance.

Our drive for ongoing improvement as a Board continued in

2004. During the year we initiated a peer review process in which

each Director was evaluated against a number of criteria by his or

her fellow Board members. Our goal is to remain constantly vigilant

for opportunities to become more effective representatives of our

shareholders’ best interests.

Each year, I have expressed the Board’s conﬁ dence in the future

of this company. We have seen CN consistently deliver outstanding

results, but perhaps most encouraging is the solid foundation that

underpins our performance. CN has a superior business model, a

solid balance sheet, and likely the best leadership team and work-

force in the rail industry, with an insatiable drive to get better.

We on the Board believe this combination adds up to excellence

that is sustainable in the long term.

I am grateful to my fellow Board members for their integrity,

wisdom and dedication, as well as to our investors for their contin-

ued support. Our future shines brighter than ever. As Hunter might

say, stay aboard. This train is running strong.

Sincerely,

David McLean, O.B.C., LL.D.

Chairman of the Board

In the community

Canadian National Railway Company

All aboard . . .

Safety is one of CN’s guiding principles.
Within our operations and in our com-
munities, it guides our decisions and
actions every day. The goal of our com-
munity safety program is to help save
lives and prevent injuries on or near our
railroad property and at crossings.

The CN All Aboard for Safety program

For more than 20 years in Canada and the United States, CN

employees, from management to police ofﬁ cers and risk managers,

from train crews to retirees, have been promoting the importance

of safety at highway/railroad crossings and warning of the dangers

of trespassing on railroad property. In 2004, we renamed this

comprehensive community safety effort All Aboard for Safety.

Promoting safety to students Every year, CN makes All Aboard

for Safety presentations to more than 100,000 students in more than

700 schools throughout Canada and the United States. The presenta-

tions include videos, demonstrations and information handouts.

Safety blitzes CN holds “safety blitzes” at busy rail crossings

with local police services to help make drivers aware of the impor-

tance of safety.

Canadian National Railway Company

for safety.

The CN safety train Little Obie, CN’s safety train, travels to CN

Community outreach CN employees staff All Aboard for Safety

communities across North America to promote safety in a fun and

displays at community events such as safety villages, Police Safety

highly memorable way to thousands of children at community events

Week, family days, fairs, shopping malls and trade shows, talking to

and parades. Little Obie is a scale model of a CN locomotive measur-

more than 100,000 children and adults every year about safety. They

ing six feet high with authentic details such as a full-sized train horn

also make presentations to school bus drivers, truck drivers, driver’s

along with a caboose.

education classes and adult groups.

Community safety partnerships Part of the strength of CN’s

Mock train-vehicle collisions CN brings real-life drama to the

All Aboard for Safety program is the collaborative relationship we’ve

community through high-proﬁ le events. Working closely with

cultivated with our major community safety partners: Operation

emergency measures organizations, CN conducts simulations of

Lifesaver, a public education program focused on rail safety, and

train-vehicle collisions. High school drama students volunteer to

Mothers Against Drunk Driving (MADD). In Canada, we also support

play the role of injured victims to demonstrate the potentially dire

the Safe Communities Foundation, an organization that helps com-

consequences of unsafe practices around rail crossings.

munities implement safety programs; Safe Kids Canada, an injury

prevention program for children; and SMARTRISK, an injury preven-

Throughout our operations and out in our communities, safety

tion program for students in high school.

is a deep, cultural commitment at CN. Increasingly, one hears the

CN works closely with local, provincial, state and federal

following refrain among CN employees: “Have a safe day!”

agencies, the Royal Canadian Mounted Police, ﬁ reﬁ ghters and

paramedics. We all share a common goal – to help prevent injuries

and save lives.

Canadian National Railway Company

Glossary of terms

Average length of haul – The average distance in miles one ton is
carried. Computed by dividing total ton miles by tons of freight.

Carload – A one-car shipment of freight from one consignor to one
consignee.

Route miles – The miles of right-of-way owned or leased and operated
by the designated railroad. Route miles exclude mainline trackage oper-
ated under trackage rights. In multiple track territories only one mainline
track counts as route miles.

Car velocity – Car velocity is an average speed calculation, expressed
in miles per day, of the car movements from time of release at one
location to arrival at the destination.

Scheduled railroad – Running a scheduled railroad is a disciplined
process that handles individual car movements according to a speciﬁ c
plan where possible and that manages expectations to meet agreed-
upon customer commitments.

Class 1 railroad – As determined by the Surface Transportation
Board, a freight railroad with annual operating revenues that exceed
a threshold indexed to a base of $250 million in 1991 U.S. dollars.
The threshold in 2003 was $277.7 million.

Gross ton miles – The number of tons behind the locomotives (cars
and contents) including company service equipment multiplied by
the miles of road moved from originating to destination stations on a
designated railroad.

Siding – A track auxiliary to the main track for meeting or passing
trains, or in the case of industrial siding, a track serving various indus-
trial customers.

Trip plan – A trip plan is a detailed chain of train handling events
describing how a car(s) can be handled from the shipper’s door to the
consignee’s door. Trip plans are expressed in hours and are tailored to
a speciﬁ c customer location, day of week and time of release.

Intermodal service – In railroad transportation, the movement of
trailers or containers on railroad freight cars.

Unit train – A train with a ﬁ xed, coupled consist of cars operated con-
tinuously in shuttle service under load from origin and delivered intact at
destination and returning usually for reloading at the same origin.

Linehaul – The movement of trains between terminals and stations on
the main or branch lines of the road, exclusive of switching movements.

Main track – A track extending through and between stations upon
which trains are operated.

Operating ratio – The ratio of operating expenses to operating
revenues.

Revenue ton mile – The movement of a ton of freight over one mile
for revenue.

Right-of-way – A strip of land of various widths upon which a rail
track is built.

Rolling stock – Transportation equipment on wheels, especially
locomotives and freight cars.

Waybill – The document covering a shipment and showing the forward-
ing and receiving stations, the name of consignor and consignee, the
car initials and number, the routing, the description and weight of the
commodity, instructions for special services, the rate, total charges,
advances and the waybill reference for previous services, and the
amount prepaid.

Yard – A system of tracks within deﬁ ned limits, designed for switching
services.

Yard dwell – Yard dwell is the average duration, expressed in hours,
that cars spend in a speciﬁ c operating terminal.

Canadian National Railway Company

Financial Section (U.S. GAAP)

Contents

Canadian National Railway Company

Selected Railroad Statistics

30
31 Management’s Discussion and Analysis
53 Management Report
Auditors’ Report
53
Consolidated Statement of Income
54
Consolidated Statement of Comprehensive Income
55
Consolidated Balance Sheet
56
Consolidated Statement of Changes in Shareholders’ Equity
57
Consolidated Statement of Cash Flows
58

Notes to Consolidated Financial Statements

59
61
62
63
63
64
64
64
64
66
67
67
69
71
71
71
72
72
72
74
76
77
80

1 Summary of significant accounting policies
2 Accounting changes
3 Acquisitions
4 Accounts receivable
5 Properties
6 Intangible and other assets
7 Credit facility
8 Accounts payable and accrued charges
9 Other liabilities and deferred credits
10 Long-term debt
11 Capital stock and convertible preferred securities
12 Stock plans
13 Pensions
14 Interest expense
15 Other income (loss)
16 Income taxes
17 Segmented information
18 Earnings per share
19 Major commitments and contingencies
20 Financial instruments
21 Other comprehensive income (loss)
22 Reconciliation of United States and Canadian generally accepted accounting principles
23 Comparative figures

U.S. GAAP

Canadian National Railway Company

Selected Railroad Statistics

Year ended December 31,

Statistical operating data

Freight revenues ($ millions)
Gross ton miles (GTM) (millions)
Revenue ton miles (RTM) (millions)
Carloads (thousands)
Route miles (includes Canada and the U.S.)
Employees (end of period)
Employees (average during period)

Productivity
Operating ratio (%)

Adjusted operating ratio (%) (2)
Freight revenue per RTM (cents)
Freight revenue per carload ($)
Operating expenses per GTM (cents)
Adjusted operating expenses per GTM (cents) (2)
Labor and fringe benefits expense per GTM (cents)
Adjusted labor and fringe benefits expense per GTM (cents) (2)
GTMs per average number of employees (thousands)
Diesel fuel consumed (U.S. gallons in millions)
Average fuel price ($/U.S. gallon) (3)
GTMs per U.S. gallon of fuel consumed

Safety indicators

Injury frequency rate per 200,000 person hours
Accident rate per million train miles

2004 (1)

2003

2002

6,252
332,807
175,355
4,654
19,304
22,679
22,470

66.9
66.9
3.57
1,343
1.32
1.32
0.55
0.55
14,811
391
1.30
851

2.6
1.6

5,694
313,593
162,901
4,177
17,544
21,489
22,012

69.8
69.8
3.50
1,363
1.31
1.31
0.54
0.54
14,246
374
1.21
838

5,901
309,102
159,259
4,153
17,821
22,114
23,190

76.0
69.4
3.71
1,421
1.50
1.37
0.59
0.56
13,329
369
1.20
838

2.9
2.0

3.0
2.0

(1)

(2)

Includes GLT and BC Rail from May 10, 2004 and July 14, 2004, respectively.

2002 has been adjusted for items affecting the comparability of the results of operations. See discussion and reconciliation of these non-GAAP adjusted performance measures in the
Company’s Management’s Discussion and Analysis on page 38.

(3)

Includes the impact of the Company’s hedging program.

Certain of the comparative statistical data and related productivity measures have been restated to reflect changes to estimated data previously reported.

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

Management’s discussion and analysis (MD&A) relates to the financial condition and results of operations of Canadian National Railway Company
(CN) together with its wholly owned subsidiaries, including the railroads and related holdings of Great Lakes Transportation LLC (GLT) as of
May 10, 2004 and BC Rail as of July 14, 2004. 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 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 and stock-based compensation. A reconciliation of the U.S. to Canadian GAAP financial statements is pro-
vided in Note 22 to the Company’s Consolidated Financial Statements. The Company’s objective is to provide meaningful and relevant information
reflecting the Company’s financial condition and results of operations. In certain instances, the Company may make reference to certain non-GAAP
measures that, from management’s perspective, are useful measures of performance. In such instances, the reader is advised to read all informa-
tion provided in the MD&A in conjunction with the Company’s 2004 Annual Consolidated Financial Statements and notes thereto.

Business profile

CN, directly and through its subsidiaries, is engaged in the rail and
related transportation business. CN’s network of approximately 19,300
route miles of track spans Canada and mid-America, connecting three
coasts: the Atlantic, the Pacific and the Gulf of Mexico. CN’s revenues
are derived from seven commodity groups consisting of the movement
of a diversified and balanced portfolio of goods which positions it well
to face economic fluctuations and enhances its potential to grow rev-
enues. In 2004, no individual commodity group accounted for more than
22% of revenues. The sources of revenue also reflect a balanced mix of
destinations. In 2004, 23% of revenues came from U.S. domestic traffic,
34% from transborder traffic, 23% from Canadian domestic traffic and
20% from overseas traffic. The Company originates approximately 85%
of traffic moving along its network, which allows it both to capitalize on
service advantages and build on opportunities to efficiently use assets.

Strategy

CN is committed to creating value for both its customers and sharehold-
ers. By providing quality and cost-effective service, CN seeks to create
value for its customers, which solidifies existing customer relationships,
while enabling it to pursue new ones. Sustainable financial performance
is a critical element of shareholder value, which CN strives to achieve
by pursuing revenue growth, steadily increasing profitability, solid free
cash flow generation and an adequate return on investment. CN’s
business strategy is guided by five core values: providing good service,
controlling costs, focusing on asset utilization, committing to safety and
developing employees.

Overview

For 2005 and the foreseeable future, CN’s challenge is to remain at
the forefront of rail industry financial performance and to build value
for shareholders and customers by aiming to make the railroad the
continent’s best-performing transportation company.

CN’s plan is premised on the deployment of its business model to
generate quality revenues, while leveraging capacity and maintaining
its current level of plant quality.

The “scheduled railroad” is the foundation for the Company’s
business model. For CN’s merchandise business, the scheduled railroad,
which is defined as a trip plan for every car measured in hours, has

reduced transit times, improved the consistency of CN’s transportation
product, dramatically improved productivity and helped to improve
network capacity. In 2003, the Company began to apply the same prin-
ciples of scheduled railroading to its intermodal business through the
IMX initiative. IMX is designed to smooth demand and balance the flow
of intermodal traffic through pre-defined daily train capacity, slot, gate
and equipment reservations, and day-of-the-week pricing.

CN’s acquisition and control of Illinois Central and Wisconsin
Central, in 1999 and 2001, respectively, extended the Company’s reach
into the central and southern United States. Among the benefits of single
line service afforded by these transactions have been improved transit
and cycle times for freight cars and the penetration of new markets.
The acquisition of GLT in May 2004 has permitted new efficien-
cies in train operations north of Duluth/Superior in the key Winnipeg-
Chicago corridor and positioned CN as a major player in the supply
chain for the United States steel industry in the midst of a strong
recovery. The purchase of BC Rail in July 2004 not only grew CN’s for-
est products business substantially, but also expanded the railroad’s
capacity in British Columbia, where the Port of Prince Rupert has the
potential to become an important gateway for traffic moving to and
from Asia and the heartland of North America.

Over the past five years, the Company has also invested heavily in

new locomotives and freight cars, extended sidings and centralized traf-
fic control to permit the operation of longer, more efficient trains. These
strategic initiatives have improved service, reduced costs and created
a fluid North American rail network that can accommodate business
growth at low incremental cost. The Company intends to continue to
make targeted capital expenditures to improve plant capacity as war-
ranted by market conditions and satisfactory returns on investment.
The Company intends to pursue further operating efficiencies by
optimizing its workforce, improving asset utilization, reducing accidents
and related costs, and continuing to focus on legal claims and health
care costs. The Company partners with connecting carriers to implement
routing protocol agreements for carload freight and pursues co-produc-
tion initiatives to further improve service, generate system capacity and
gradually reduce costs.

The Company’s ultimate goal is to generate profitable, sustain-
able growth at low incremental cost by striving to improve yield and
increase market share to maximize its return on assets.

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Financial highlights

In millions, except per share data, or unless otherwise indicated

2004

2003

2002

Financial results

Revenues

Operating income

Net income

Operating ratio

Basic earnings per share

Diluted earnings per share

Dividend declared per share

Financial position

Total assets

Total long-term financial liabilities

Financial results

2004 compared to 2003
In 2004, net income increased by $244 million, or 24%, when com-
pared to 2003, with diluted earnings per share rising 24%. Revenues
increased by $664 million, or 11%, due to the inclusion of $351 million
of GLT and BC Rail revenues, core business growth in a strong North
American economy, and an improved Canadian grain crop, which were
partly offset by the translation impact of the stronger Canadian dollar
on U.S. dollar denominated revenues of $255 million.

Operating expenses increased by $273 million, or 7%, driven
mainly by the inclusion of $228 million of GLT and BC Rail expenses,
higher labor and fringe benefits, increased fuel costs and higher casu-
alty and other expense, which were partly offset by the translation
impact of the stronger Canadian dollar on U.S. dollar denominated
expenses of $170 million and lower equipment rents.

The operating ratio, defined as operating expenses as a percent-
age of revenues, was 66.9% in 2004 compared to 69.8% in 2003, a
2.9-point betterment.

The results for the year ended December 31, 2004 included the

results of operations of GLT as of May 10, 2004 and BC Rail as of
July 14, 2004. Also in 2004, a strike by the Company’s employees
represented by the Canadian Auto Workers (CAW) union (the “CAW
strike”) in the first quarter, negatively impacted operating income and
net income by $35 million and $24 million, respectively. The significant
appreciation in the Canadian dollar relative to the U.S. dollar which has
impacted the conversion of the Company’s U.S. dollar denominated rev-
enues and expenses, resulted in a reduction in net income of approxi-
mately $45 million for 2004.

$÷6,548
$÷2,168
$÷1,258

66.9%

$÷÷4.41
$÷÷4.34

$÷÷0.78

$22,365
$10,822

$÷5,884

$÷1,777

$÷1,014

69.8%

$÷÷3.54

$÷÷3.49

$÷÷0.67

$20,337

$÷9,928

$÷6,110

$÷1,469

$÷÷«800

76.0%

$÷÷2.71

$÷÷2.65

$÷÷0.57

$21,738

$11,180

For the year ended December 31, 2003, the Company’s results of
operations included a fourth-quarter deferred income tax expense of
$79 million resulting from the enactment of higher corporate tax rates
in the province of Ontario. Also included in 2003 was a cumulative ben-
efit of $75 million, $48 million after tax, resulting from a change in the
accounting for removal costs for certain track structure assets pursuant
to the requirements of Statement of Financial Accounting Standards
(SFAS) No. 143, “Accounting for Asset Retirement Obligations,” as
explained in Note 2 to the attached Annual Consolidated Financial
Statements. This change in policy will result in lower depreciation
expense and higher labor and fringe benefits and other expenses in
the period in which removal costs are incurred. For the year ended
December 31, 2003, this change in policy resulted in an increase to
net income of $2 million ($0.01 per basic and diluted share).

2004 compared to 2003 – Adjusted performance measures
The year ended December 31, 2003 included items impacting the com-
parability of the results of operations (see reconciliation of adjusted
performance measures presented herein).

In 2003, the Company recorded a fourth-quarter deferred income
tax expense of $79 million resulting from the enactment of higher cor-
porate tax rates and a cumulative benefit of $75 million, $48 million
after tax, as discussed herein.

Excluding these items, net income was $1,258 million ($4.41 per
basic share or $4.34 per diluted share) in 2004 compared to adjusted
net income of $1,045 million ($3.65 per basic share or $3.60 per
diluted share) in 2003, an increase of $213 million, or 20%.

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

Reconciliation of adjusted performance measures

Management believes that non-GAAP measures such as adjusted net income and the resulting adjusted performance measures for such items as
operating income, operating ratio and per share data are useful measures of performance that can facilitate period-to-period comparisons as they
exclude items that do not arise as part of the normal day-to-day operations or that could potentially distort the analysis of trends in business per-
formance. The exclusion of specified items in the adjusted measures below does not imply that they are necessarily non-recurring. These adjusted
measures do not have any standardized meaning prescribed by GAAP and may, therefore, not be comparable to similar measures presented by
other companies. The reader is advised to read all information provided in the MD&A in conjunction with the Company’s Annual Consolidated
Financial Statements and notes thereto.

In millions, except per share data, or unless otherwise indicated

Year ended December 31,

2004

2003

Reported

Change
in policy

Rate
enactment

Adjusted

Revenues

Operating expenses

Operating income

Interest expense

Other income (loss)

Income before income taxes and cumulative effect of change in accounting policy

Income tax expense

Income before cumulative effect of change in accounting policy

Cumulative effect of change in accounting policy, net of applicable taxes

Net income

Operating ratio

Basic earnings per share

Diluted earnings per share

Revenues

Year ended December 31,

Total revenues (millions)

Rail freight

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Carloads (thousands)

Revenue/Carload (dollars)

2004

$6,548

2003 % Change

$5,884

11%

$6,252
175,355
3.57
4,654
1,343

$5,694

162,901

3.50

4,177

1,363

10%

11%

(1%)

Revenues for the year ended December 31, 2004 totaled $6,548 mil-
lion compared to $5,884 million in 2003. The increase of $664 million,
or 11%, was mainly due to the inclusion of GLT and BC Rail revenues

$6,548

4,380

2,168

(294)

(20)

1,854

(596)

1,258

–

$1,258

66.9%

$÷4.41

$÷4.34

$5,884

4,107

1,777

(315)

1,483

(517)

966

$1,014

69.8%

$÷3.54

$÷3.49

$÷÷–

$÷–

–

(48)

$(48)

$5,884

4,107

1,777

(315)

1,483

(438)

1,045

–

$79

$1,045

69.8%

$÷3.65

$÷3.60

of $351 million, strong merchandise revenue, an improved Canadian
grain crop, and a higher fuel surcharge. Partially offsetting these gains
was the translation impact of the stronger Canadian dollar on U.S. dollar
denominated revenue. Revenue ton miles, measuring the volume of
freight transported by the Company, increased by 8% relative to 2003.
Freight revenue per revenue ton mile, a measurement of yield defined
as revenue earned on the movement of a ton of freight over one mile,
increased by 2% when compared to 2003. In 2004, freight revenue per
revenue ton mile was positively affected by freight rate increases and
an overall decrease in the average length of haul, and was negatively
affected by the translation impact of the stronger Canadian dollar.

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Petroleum and chemicals

Year ended December 31,

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$1,123
32,618
3.44

2003 % Change

$1,058

30,901

3.42

Petroleum and chemicals comprise a wide range of commodities, includ-
ing chemicals, sulfur, plastics, petroleum and gas products. Most of the
Company’s petroleum and chemicals shipments originate in the Gulf of
Mexico, Alberta and eastern Canada, and are destined for customers in
Canada, the United States and overseas. The performance of this com-
modity group is closely correlated with the North American economy.
For the year ended December 31, 2004, revenues for this commodity
group increased by $65 million, or 6%, from 2003. The increase was due
to freight rate improvements in several key segments, particularly in the
first half of the year, the inclusion of $25 million of BC Rail revenues
(primarily sulfur), higher offshore demand for Canadian sulfur, a shift
from offshore to Canadian suppliers for petroleum gas and a higher fuel
surcharge. These gains were partially offset by the translation impact
of the stronger Canadian dollar. Freight revenue per revenue ton mile
increased by 1% due to freight rate improvements and a decrease in
the average length of haul, partly offset by the translation impact of
the stronger Canadian dollar.

Petroleum and chemicals

Percentage of revenues

Carloads*

In thousands

and sand) and cement. The Company has access to major cement and
aggregate producers in Canada as well as in the U.S. Metals and miner-
als traffic is sensitive to fluctuations in the economy. For the year ended
December 31, 2004, revenues for this commodity group increased by
$186 million, or 35%, from 2003. The increase is mainly due to the
inclusion of $126 million of GLT revenues, higher volumes of iron ore,
largely from new business, freight rate improvements, and increased
shipments of raw materials and metal bars. Partially offsetting these
gains was the translation impact of the stronger Canadian dollar.
Revenue per revenue ton mile increased by 14% in 2004, mainly due
to GLT shorter-haul traffic which was partly offset by the translation
impact of the stronger Canadian dollar.

Metals and minerals

Percentage of revenues

Carloads*

In thousands

9
0
8

21%

24%

55% Metals
24% Minerals
21% Iron ore

55%

8
8
3

6
9
3

6
5
2

7
8
2

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

7
8
5

4
0
6

7
3
6

Forest products

2
1
5

9
1
5

Year ended December 31,

43%

57%

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$1,452
38,414
3.78

2003 % Change

$1,284

34,516

3.72

13%

11%

57% Petroleum and plastics
43% Chemicals

* Includes Wisconsin Central Transportation

Corporation (WC) from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

Metals and minerals

Year ended December 31,

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$713
16,421
4.34

2003 % Change

$527

13,876

3.80

35%

18%

14%

The metals and minerals commodity group consists primarily of nonfer-
rous base metals, iron ore, steel, equipment and parts and construction
materials. The Company’s superior rail access to major mines, ports and
smelters throughout North America has made the Company a transpor-
tation leader of copper, lead, zinc concentrates, iron ore, refined metals
and aluminum. Construction materials are mainly aggregates (stone

The forest products commodity group includes various types of lumber,
panels, wood chips, wood pulp, printing paper, linerboard and news-
print. The Company has superior rail access to the western and eastern
Canadian fiber-producing regions, which are among the largest fiber
source areas in North America. In the United States, the Company is
strategically located to serve both the midwest and southern U.S. cor-
ridors with interline capabilities to other Class 1 railroads. The key driv-
ers for the various commodities are: for newsprint, advertising lineage
and overall economic conditions in the United States; for fibers (mainly
wood pulp), the consumption of paper worldwide; and for lumber and
panels, housing starts and renovation activities in the United States.
Although demand for forest products can be cyclical, the Company’s
geographical advantages and product diversity tend to reduce the
impact of market fluctuations. For the year ended December 31, 2004,
revenues for this commodity group increased by $168 million, or 13%,
from 2003. The increase was largely due to the inclusion of $85 mil-
lion of BC Rail revenues (mainly lumber and panels), continued solid
demand for lumber, freight rate improvements and a higher fuel sur-
charge. The translation impact of the stronger Canadian dollar partially
offset these gains. Revenue per revenue ton mile increased by 2% in

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

2004 as the benefit of freight rate improvements and a positive change
in traffic mix were partially offset by the translation impact of the
stronger Canadian dollar.

Forest products

Percentage of revenues

Carloads*

In thousands

Grain and fertilizers

Year ended December 31,

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$1,053
39,965
2.63

2003 % Change

$938

35,556

2.64

12%

–

The grain and fertilizers commodity group depends primarily on
crops grown and fertilizers processed in western Canada and the U.S.
Midwest. The grain segment consists of three primary commodities:
food grains, mainly wheat; oilseeds and oilseed products, primarily
canola seed, oil and meal; and feed grains, including feed barley, feed
wheat and corn. Production of grain varies considerably from year to
year, affected primarily by weather conditions. Grain exports are vola-
tile, reflecting the size of the crop produced, international market condi-
tions and foreign government policy. In the U.S., grain grown in Illinois
and Iowa is exported, as well as transported to domestic processing
facilities and feed markets. The Company also serves producers of pot-
ash, ammonium nitrate, urea and other fertilizers. For the year ended
December 31, 2004, revenues for this commodity group increased by
$115 million, or 12%, from 2003. The increase reflects higher Canadian
wheat and barley exports, which was partially offset by weak ship-
ments of U.S. soybeans due to tight supply, a shift in exports from the
Gulf to the Pacific Northwest and the translation impact of the stronger
Canadian dollar. Revenue per revenue ton mile remained flat as the
benefit of freight rate improvements was offset by an increase in the
average length of haul and the translation impact of the stronger
Canadian dollar.

Grain and fertilizers

Percentage of revenues

Carloads*

In thousands

12%

13%

28%

7
6
5

0
9
5

5
3
5

8
4
5

2
7
5

23%

24%

28% Food grain
24% Oilseeds
23% Feed grain

13% Fertilizers
12% Potash

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

12%

26%

0
0
6

4
9
5

3
5
6

33%

6
8
4

1
0
5

29%

33% Lumber
29% Fibers

26% Paper
12% Panels

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

Coal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2004

$284
13,614
2.09

2003 % Change

$261

13,659

1.91

–

The coal commodity group consists primarily of thermal grades of bitu-
minous coal. Canadian thermal coal is delivered to power utilities pri-
marily in eastern Canada, while in the United States, thermal coal is
transported from mines served in southern Illinois, or from western U.S.
mines via interchange with other railroads, to major utilities in the
Midwest and southeast United States. The coal business also includes the
transport of metallurgical coal, which is largely exported to steel markets
in Japan and other Asian markets. For the year ended December 31, 2004,
revenues for this commodity group increased by $23 million, or 9%,
from 2003. The increase was due to higher coal shipments to U.S. utili-
ties and the inclusion of GLT and BC Rail revenues of $20 million, partly
offset by metallurgical mine closures in western Canada and the trans-
lation impact of the stronger Canadian dollar. The revenue per revenue
ton mile increase of 9% was mainly due to a decrease in the average
length of haul and a positive change in traffic mix that were partly off-
set by the translation impact of the stronger Canadian dollar.

Coal

Percentage of revenues

Carloads*

In thousands

18%

8
2
5

7
1
5

9
9
4

1
7
4

6
8
4

82%

82% Coal
18% Petroleum coke

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

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U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Intermodal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2004

$1,117
31,002
3.60

Automotive

2003 % Change

Year ended December 31,

$1,101

31,168

3.53

(1%)

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$510
3,321
15.36

2003 % Change

$525

3,225

16.28

(3%)

(6%)

The intermodal commodity group is comprised of two segments: domes-
tic and international. The domestic segment is responsible for consumer
products and manufactured goods, operating through both retail and
wholesale channels while the international segment handles import
and export container traffic, serving the ports of Vancouver, Montreal,
Halifax and New Orleans. The domestic segment is driven by consumer
markets, with growth generally tied to the economy. The international
segment is driven mainly by North American economic conditions.
For the year ended December 31, 2004, revenues for this commodity
group increased by $16 million, or 1%, from 2003. Revenues for 2004
benefited from heavy import volumes through the Port of Vancouver,
freight rate improvements and a higher fuel surcharge. Revenues were
negatively affected by the first quarter CAW strike, the closure of the
Company’s smaller terminal facilities in the U.S., the discontinuance
of the Roadrailer service and the translation impact of the stronger
Canadian dollar. Revenue per revenue ton mile increased by 2% in
2004 driven by a positive change in traffic mix and freight rate improve-
ments that were partly offset by an increase in the average length of
haul and the translation impact of the stronger Canadian dollar.

Intermodal

Percentage of revenues

Carloads*

In thousands

The automotive commodity group moves both finished vehicles and
parts, originating in southwestern Ontario, Michigan and Mississippi,
destined for the United States, Canada and Mexico. The Company’s
broad coverage, including its access to all of the Canadian assembly
plants, enables it to consolidate full trainloads of automotive traf-
fic for delivery to connecting railroads at key interchange points.
The Company also serves shippers of import vehicles via the ports of
Halifax and Vancouver, and through interchange with other railroads.
The Company’s automotive revenues are closely correlated to auto-
motive production and sales in North America. For the year ended
December 31, 2004, revenues for this commodity group decreased by
$15 million, or 3%, from 2003. The decrease was due to the translation
impact of the stronger Canadian dollar that was partially offset by the
benefit of new finished vehicle traffic that began in late 2003. Revenue
per revenue ton mile decreased by 6% in 2004 due to the translation
impact of the stronger Canadian dollar.

Automotive

Percentage of revenues

Carloads*

In thousands

18%

8
1
3

7
0
3

8
8
2

5
9
2

7
3
2
,
1

6
7
2
,
1

2
0
2
,
1

1
2
1
,
1

3
0
1
,
1

48%

52%

52% Domestic
48% International

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

82%

82% Finished vehicles
18% Auto parts

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

Other
In 2004, other revenues increased by $106 million, when compared
to 2003, mainly due to revenues from GLT’s maritime division of
$90 million.

Canadian National Railway Company

U.S. GAAP

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Management’s Discussion and Analysis

Operating expenses
Operating expenses amounted to $4,380 million in 2004 compared to
$4,107 million in 2003. The increase of $273 million, or 7%, in 2004
was mainly due to the inclusion of $228 million of GLT and BC Rail
expenses, higher expenses for labor and fringe benefits, increased
fuel costs and higher casualty and other expense. Partly offsetting the
increase was the translation impact of the stronger Canadian dollar
on U.S. dollar denominated expenses and lower equipment rents. The
month-long CAW strike had a minimal impact on overall operating
expenses for the year ended December 31, 2004 as the benefit from
lower labor and fringe benefit expenses was mostly offset by increases
in other expense categories.

In millions

Year ended December 31,

2004

2003

Labor and fringe benefits

Purchased services and material

Depreciation and amortization

Fuel

Equipment rents

Casualty and other

Total

Amount

$1,819

746

598

528

244

445

$4,380

% of
revenue

27.8%
11.4%
9.1%
8.1%
3.7%
6.8%
66.9%

Amount

$1,698

703

554

469

293

390

% of
revenue

28.9%

11.9%

9.4%

8.0%

5.0%

6.6%

$4,107

69.8%

Labor and fringe benefits: Labor and fringe benefits includes wages,
payroll taxes, and employee benefits such as incentive compensation,
stock-based compensation, health and welfare, pensions and other
post-employment benefits. These expenses increased by $121 million,
or 7%, in 2004 as compared to 2003. The increase was attributable to
the inclusion of GLT and BC Rail labor expense of $91 million, higher
wages and employee benefits, including increased costs for stock-based
compensation, and charges and adjustments relating to the workforce
reduction provision. Partly offsetting these factors were the translation
impact of the stronger Canadian dollar, the effects of a reduced work-
force, lower expenses for pensions and other post-retirement benefits
and wage and benefits savings during the CAW strike.

Purchased services and material: Purchased services and material pri-
marily includes the costs of services purchased from outside contractors,
materials used in the maintenance of the Company’s track, facilities
and equipment, transportation and lodging for train crew employees,
utility costs and the net costs of operating facilities jointly used by the
Company and other railroads. These expenses increased by $43 mil-
lion, or 6%, in 2004 as compared to 2003. The increase was due to
the inclusion of $77 million of GLT and BC Rail expenses, higher repair
and maintenance expenses, partly related to the CAW strike, and other
strike-related costs. Partly offsetting the increase was the translation
impact of the stronger Canadian dollar and lower net expenses for
operating joint facilities.

Depreciation and amortization: Depreciation and amortization relates to
the Company’s rail operations. These expenses increased by $44 million,
or 8%, in 2004 as compared to 2003. The increase was mainly due to
the inclusion of GLT and BC Rail expenses of $30 million and the impact
of net capital additions, partially offset by the translation impact of the
stronger Canadian dollar.

Fuel: Fuel expense includes the cost of fuel consumed by locomotives,
intermodal equipment and other vehicles. These expenses increased by
$59 million, or 13%, in 2004 as compared to 2003. The increase was
mainly due to a higher average price per gallon, net of the impact of
the hedging program, the inclusion of GLT and BC Rail expenses of
$21 million and higher volumes. The increase was partly offset by the
translation impact of the stronger Canadian dollar, increased productiv-
ity and a fuel excise tax refund in the second quarter.

Equipment rents: Equipment rents includes rental expense for the use
of freight cars owned by other railroads or private companies and for
the short or long-term lease of freight cars, locomotives and intermodal
equipment, net of rental income from other railroads for the use of the
Company’s cars and locomotives. These expenses decreased by $49 mil-
lion, or 17%, in 2004 as compared to 2003. The decrease was due to
higher car hire income, including that of BC Rail, the translation impact
of the stronger Canadian dollar and a reduction in car hire expenses
that were partly offset by higher lease expense for freight cars.

Casualty and other: Casualty and other includes expenses for personal
injuries, environmental, freight and property damage, insurance, bad
debt and operating taxes, as well as travel and travel-related expenses.
These expenses increased by $55 million, or 14%, in 2004 as compared
to 2003. The increase was due to higher expenses for personal injuries,
the inclusion of GLT and BC Rail expenses of $14 million, increased
environmental expenses and favorable adjustments to U.S. property
taxes in 2003. Partially offsetting the increase was the translation
impact of the stronger Canadian dollar.

Other
Interest expense: Interest expense decreased by $21 million, or 7%, for
the year ended December 31, 2004 as compared to 2003 as the benefit
of lower interest rates on issued debt to replace matured debt and the
translation impact of the stronger Canadian dollar were partly offset by
interest expense on debt related to the Company’s recent acquisitions.

Other income (loss): In 2004, the Company recorded a loss of $20 mil-
lion compared to income of $21 million in 2003. The change from
income to loss in 2004 was due to lower gains on disposal of surplus
properties and lower equity income from the Company’s investment in
English Welsh and Scottish Railway (EWS) as a result of restructured
operations.

Income tax expense: The Company recorded income tax expense
of $596 million for the year ended December 31, 2004 compared to
$517 million in 2003. The effective tax rate for the year ended
December 31, 2004 was 32.1% compared to 34.9% in 2003. The decrease
in the effective tax rate in 2004 was mainly due to higher deferred
income tax expense in 2003 resulting from the enactment of higher
corporate tax rates in the province of Ontario, which was partly offset
by net favorable adjustments relating to the resolution of matters per-
taining to prior years’ income taxes.

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

2003 compared to 2002
For the year ended December 31, 2003, the Company recorded consoli-
dated net income of $1,014 million ($3.54 per basic share) compared to
$800 million ($2.71 per basic share) for the year ended December 31, 2002.
Diluted earnings per share were $3.49 for 2003 compared to $2.65 in
2002. The Company’s operating income for 2003 was $1,777 million
compared to $1,469 million in 2002, and its operating ratio, defined as
operating expenses as a percentage of revenues, was 69.8% in 2003
compared to 76.0% in 2002 (see discussion on adjusted per formance
measures herein).

The Company’s results of operations for the year ended December 31,
2003 included a cumulative benefit of $75 million, or $48 million after
tax, resulting from a change in the accounting for removal costs for
certain track structure assets pursuant to the requirements of SFAS
No. 143, “Accounting for Asset Retirement Obligations,” as explained
in Note 2 to the attached Annual Consolidated Financial Statements.

2003 compared to 2002 – Adjusted performance measures
The years ended December 31, 2003 and 2002 included items impact-
ing the comparability of the results of operations (see reconciliation of
adjusted performance measures presented herein).

In 2003, the Company recorded a fourth quarter deferred
income tax expense of $79 million resulting from the enactment of

higher corporate tax rates in the province of Ontario. The year ended
December 31, 2002 included fourth quarter charges of $281 million,
or $173 million after tax, to increase the Company’s provision for U.S.
personal injury and other claims, and $120 million, or $79 million after
tax, for workforce reductions.

Excluding these items, adjusted net income was $1,045 million
($3.65 per basic share or $3.60 per diluted share) in 2003 compared
to adjusted net income of $1,052 million ($3.57 per basic share or
$3.48 per diluted share) for 2002, a decrease of $7 million, or 1%.
Operating income for 2003 decreased by $93 million, or 5%, compared
to adjusted operating income of $1,870 million for 2002. The operating
ratio for 2003 was 69.8% compared to the adjusted operating ratio of
69.4% in 2002, a 0.4-point increase.

The decrease in adjusted net income and adjusted operating
income in 2003 was due to the significant year-over-year apprecia-
tion in the Canadian dollar relative to the U.S. dollar. This significant
appreciation in the Canadian dollar impacted the conversion of the
Company’s U.S. dollar denominated revenues and expenses and accord-
ingly, reduced 2003 revenues, operating income and net income by
approximately $380 million, $120 million and $62 million, respectively.
This decrease in adjusted net income was partly offset by net deferred
income tax recoveries of $44 million in 2003 relating mainly to the
resolution of matters pertaining to prior years’ income taxes.

Reconciliation of adjusted performance measures

In millions, except per share data, or unless otherwise indicated

Year ended December 31,

2003

Adjusted

Reported

2002

Personal

injury Workforce
reductions
charge

Change
in policy

Rate
enactment

$÷« –

$÷ –

Revenues

Operating expenses

Operating income

Interest expense

Other income

Income before income taxes and cumulative
effect of change in accounting policy

Income tax expense

Income before cumulative effect of
change in accounting policy

Cumulative effect of change in accounting

policy, net of applicable taxes

Net income

Operating ratio

Basic earnings per share

Diluted earnings per share

Reported

$«5,884

4,107

1,777

(315)

1,483

(517)

966

$1,014

69.8%

$÷3.54

$÷3.49

–

(48)

$(48)

$«5,884

4,107

1,777

(315)

1,483

(438)

1,045

–

$«6,110

4,641

1,469

(361)

1,184

(384)

800

–

$÷÷« –

(281)

281

–

281

(108)

173

–

Adjusted

$«6,110

4,240

$÷÷«–

(120)

120

1,870

–

120

(41)

–

(361)

1,585

(533)

1,052

–

$79

$1,045

$÷«800

$«173

$ ««79

$1,052

69.8%

$÷3.65

$÷3.60

76.0%

$÷2.71

$÷2.65

69.4%

$÷3.57

$÷3.48

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

Revenues

Forest products

Year ended December 31,

2003

2002 % Change

Year ended December 31,

2003

2002 % Change

Total revenues (millions)

$5,884

$6,110

(4%)

Revenues (millions)

Rail freight

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Carloads (thousands)

Revenue/Carload (dollars)

$5,694

$5,901

162,901

159,259

3.50

4,177

1,363

3.71

4,153

1,421

(4%)

(6%)

(4%)

Revenues for the year ended December 31, 2003 totaled $5,884 million
compared to $6,110 million in 2002. The decrease of $226 million, or
4%, was mainly due to the higher Canadian dollar, which negatively
impacted the translation of U.S. dollar denominated revenue, continued
weakness in coal shipments and a slowdown in the automotive sector.
Partially offsetting these losses were increased intermodal, metals and
minerals and petroleum and chemicals volumes. For 2003, revenue ton
miles, measuring the volume of freight transported by the Company,
increased by 2% relative to 2002. Freight revenue per revenue ton mile,
a measurement of yield defined as revenue earned on the movement
of a ton of freight over one mile, decreased by 6% when compared to
2002, reflecting the higher Canadian dollar.

Petroleum and chemicals

Year ended December 31,

2003

2002 % Change

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

$1,058

30,901

3.42

$1,102

30,006

3.67

(4%)

(7%)

Revenues for the year ended December 31, 2003 decreased by $44 mil-
lion, or 4%, from 2002. The decrease was due to the translation impact
of the stronger Canadian dollar, partially offset by higher U.S. and
offshore demand for Canadian sulfur and strong demand for liquefied
petroleum gas due to cold weather conditions at the beginning of 2003.
Revenue per revenue ton mile decreased by 7% from 2002 due to the
translation impact of the stronger Canadian dollar.

Metals and minerals

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2003

$527

2002 % Change

$521

13,876

13,505

3.80

3.86

(2%)

Revenues for the year ended December 31, 2003 increased by $6 million,
or 1%, from 2002. The increase was due to improved market conditions
and increased market share for steel in 2003 and new ore traffic which
began in the second quarter of 2002 and the last quarter of 2003.
These gains were largely offset by the translation impact of the stronger
Canadian dollar. Revenue per revenue ton mile decreased by 2% from
2002 due to the translation impact of the stronger Canadian dollar
which was partially offset by a positive change in traffic mix.

RTMs (millions)

Revenue/RTM (cents)

$1,284

34,516

3.72

$1,323

33,551

3.94

(3%)

(6%)

Revenues for the year ended December 31, 2003 decreased by $39 mil-
lion, or 3%, from 2002. The decrease was due to the translation impact
of the stronger Canadian dollar that was partially offset by solid demand
for lumber and pulp and paper. Revenue per revenue ton mile decreased
by 6% from 2002 due to the translation impact of the stronger Canadian
dollar which more than offset the continued improvement in pricing
and a positive change in traffic mix.

Coal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2003

2002 % Change

$261

13,659

1.91

$326

13,886

2.35

(20%)

(2%)

(19%)

Revenues for the year ended December 31, 2003 decreased by $65 mil-
lion, or 20%, from 2002. The decrease was due to reduced coal produc-
tion in western Canada, the translation impact of the stronger Canadian
dollar and a metallurgical mine closure. Revenue per revenue ton mile
decreased by 19% from 2002 mainly due to a change in traffic mix, an
increase in the average length of haul, and the translation impact of
the stronger Canadian dollar.

Grain and fertilizers

Year ended December 31,

2003

2002 % Change

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

$938

35,556

2.64

$986

35,773

2.76

(5%)

(1%)

(4%)

Revenues for the year ended December 31, 2003 decreased by $48 mil-
lion, or 5%, from 2002. The decrease was mainly due to the translation
impact of the stronger Canadian dollar and a decrease in Canadian
export wheat shipments due to the smaller 2002/2003 Canadian crop.
Partially offsetting these decreases were increased Canadian canola
shipments and strong U.S. corn shipments to North American markets.
Revenue per revenue ton mile decreased by 4% from 2002 as the trans-
lation impact of the stronger Canadian dollar was partially offset by a
decrease in the average length of haul.

Intermodal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2003

2002 % Change

$1,101

31,168

3.53

$1,052

29,257

3.60

(2%)

Revenues for the year ended December 31, 2003 increased by $49 mil-
lion, or 5%, from 2002. The increase was mainly due to increased
import volumes, the higher fuel surcharge in 2003 to offset the

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

significant increase in fuel costs and new traffic through the Port of
Vancouver. Partially offsetting these gains was reduced traffic in the
domestic segment due to the closure of smaller terminal facilities in
the U.S. Revenue per revenue ton mile decreased by 2% from 2002
due to the translation impact of the stronger Canadian dollar and an
increase in the average length of haul, partially offset by the higher
fuel surcharge.

In 2002, the Company had recorded a workforce reduction charge

of $120 million in a renewed drive to improve productivity across all
its corporate and operating functions. Reductions relating to this ini-
tiative and the 2001 workforce reduction charge of $98 million were
completed in 2003. The charges included payments for severance, early
retirement incentives and bridging to early retirement to be made to
affected employees.

Automotive

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2003

$525

3,225

16.28

2002 % Change

$591

3,281

18.01

(11%)

(2%)

(10%)

Revenues for the year ended December 31, 2003 decreased by $66 mil-
lion, or 11%, from 2002. The decrease was primarily due to the transla-
tion impact of the stronger Canadian dollar, weaker North American
vehicle sales and production, and a change in shipping patterns for a
significant customer. Revenue per revenue ton mile decreased by 10%
from 2002 mainly due to the translation impact of the stronger Canadian
dollar and a significant increase in the average length of haul.

Operating expenses
Operating expenses amounted to $4,107 million in 2003 compared to
$4,641 million in 2002. The decrease was mainly due to the charges
recorded in the fourth quarter of 2002 for personal injury and other
claims and workforce reductions, and the translation impact of the
stronger Canadian dollar on U.S. dollar denominated expenses. Partly
offsetting these decreases were higher casualty and other expenses
and higher fuel costs.

In millions

Year ended December 31,

2003

2002

Labor and fringe benefits

Purchased services and material

Depreciation and amortization

Fuel

Equipment rents

Casualty and other

Total

Amount

$1,698

703

554

469

293

390

% of
revenue

28.9%

11.9%

9.4%

8.0%

5.0%

6.6%

Amount

$1,837

778

584

459

346

637

$4,107

69.8%

$4,641

% of
revenue

30.1%

12.7%

9.6%

7.5%

5.7%

10.4%

76.0%

Labor and fringe benefits: Labor and fringe benefits expenses in 2003
decreased by $139 million, or 8%, as compared to 2002. The decrease
was mainly due to the workforce reduction charge of $120 million
recorded in the fourth quarter of 2002, the effects of a reduced work-
force and the translation impact of the stronger Canadian dollar. Higher
wages and employee benefits, including increased costs for pensions
resulting from a change in management’s assumption for the expected
long-term rate of return on pension plan assets from 9% to 8%, partly
offset the decrease.

Purchased services and material: Purchased services and material
expenses in 2003 decreased by $75 million, or 10%, as compared to
2002. The decrease was mainly due to lower expenses for consulting
and professional services, lower discretionary spending (courier, com-
munication charges, occupancy costs, etc.), reflecting the Company’s
continued focus on cost containment, and the translation impact of
the stronger Canadian dollar.

Depreciation and amortization: Depreciation and amortization expenses
in 2003 decreased by $30 million, or 5%, as compared to 2002.
Reduced depreciation for certain asset classes pursuant to the adop-
tion of SFAS No. 143, “Accounting for Asset Retirement Obligations,”
and the translation impact of the stronger Canadian dollar were partly
offset by increases related to net capital additions. In accordance with
SFAS No. 143, the Company changed its accounting policy for certain
track structure assets to exclude removal costs as a component of
depreciation expense where the inclusion of such costs would result in
accumulated depreciation balances exceeding the historical cost basis
of the assets. For the year ended December 31, 2003, this change in
policy had the effect of reducing depreciation expense by $18 million.

Fuel: Fuel expense in 2003 increased by $10 million, or 2%, as com-
pared to 2002. The increase was mainly due to a higher average price
per gallon, net of the impact of the hedging program, and higher vol-
umes. These increases were partly offset by the translation impact of
the stronger Canadian dollar.

Equipment rents: Equipment rents in 2003 decreased by $53 million,
or 15%, as compared to 2002. The decrease was due to the Company’s
continued focus on asset utilization, which resulted in lower lease
expense for freight cars and locomotives and a reduction in net car
hire expense. Also contributing to the decrease was the translation
impact of the stronger Canadian dollar and a reduction in intermodal
car hire rates.

Casualty and other: Casualty and other expenses in 2003 decreased by
$247 million, or 39%, as compared to 2002, which included a fourth
quarter charge of $281 million to increase the provision for U.S. per-
sonal injury and other claims. Excluding this charge, the increase was
mainly due to higher expenses for personal injury claims and increased
insurance premiums. Partly offsetting the increase were lower travel-
related expenses and lower provincial capital taxes.

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

Other
Interest expense: Interest expense decreased by $46 million to $315 mil-
lion for the year ended December 31, 2003 as compared to 2002. The
decrease was mainly due to the translation impact of the stronger
Canadian dollar, the conversion of the convertible preferred securities in
July 2002, and lower interest rates on new debt to replace matured debt.

Other income: In 2003, the Company recorded other income of $21
million compared to $76 million in 2002. The decrease was mainly due
to lower right of way fees due to the termination of a contract in late
2002, lower income from the Company’s equity investments, and real-
ized foreign exchange losses in 2003.

Income tax expense: The Company recorded income tax expense
of $517 million for the year ended December 31, 2003 compared
to $384 million in 2002. The effective tax rate for the year ended
December 31, 2003 was 34.9% compared to 32.4% in 2002. The
increase was mainly due to a $79 million deferred income tax expense
recorded in the fourth quarter of 2003 resulting from the enactment
of higher corporate tax rates in the province of Ontario, which was
partly offset by net favorable adjustments relating to the resolution
of matters pertaining to prior years’ income taxes of $44 million and
lower corporate income tax rates in Canada.

Summary of quarterly financial data – unaudited

In millions, except per share data

Revenues

Operating income

Net income

Basic earnings per share

Diluted earnings per share

Dividend declared per share

2004

Third

Second

$1,709

$÷«591

$÷«346

$÷1.21

$÷1.19

$1,665

$÷«575

$÷«326

$÷1.14

$÷1.13

Fourth

$1,736

$÷«607

$÷«376

$÷1.32

$÷1.29

$0.195

First

$1,438
$÷«395
$÷«210

$÷0.74
$÷0.73

$0.195

2003

Third

Second

$1,413

$÷«454

$÷«294

$÷1.04

$÷1.02

$1,463

$÷«437

$÷«244

$÷0.85

$÷0.84

Fourth

$1,512

$÷«512

$÷«224

$÷0.79

$÷0.78

$0.167

First

$1,496

$÷«374

$÷«252

$÷0.86

$÷0.85

$0.167

The volume of goods and commodities transported by the Company during the year is influenced by seasonal weather conditions, general
economic conditions, cyclical demand for rail transportation, and competitive forces in the transportation marketplace. Operating expenses reflect
the impact of freight volumes, seasonal weather conditions, labor costs, fuel prices, and the Company’s productivity initiatives.

The Company’s quarterly results include items that affect the quarter-over-quarter comparability of the results of operations. The Company’s

results of operations for 2004 included GLT as of May 10, 2004 and BC Rail as of July 14, 2004. First-quarter 2004 results were affected by the
month-long CAW strike, which negatively impacted operating income and net income by $35 million and $24 million, respectively. In 2003, the
Company recorded a fourth-quarter deferred income tax expense of $79 million resulting from the enactment of higher corporate tax rates in the
province of Ontario and a first-quarter cumulative benefit of $75 million, $48 million after tax, pursuant to SFAS No. 143 as previously discussed.
Also affecting comparability was the significant appreciation in the Canadian dollar relative to the U.S. dollar which has impacted the conversion
of the Company’s U.S. dollar denominated revenues and expenses and resulted in a reduction in net income of approximately $45 million for
2004, particularly in the first quarter.

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 require-
ments through its revolving credit facility, the issuance of debt and/or
equity, and the sale of a portion of its accounts receivable through a
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
$2,139 million for the year ended December 31, 2004 compared to
$1,976 million for 2003. Net cash receipts from customers and others
were $6,501 million for the year ended December 31, 2004 compared
to $6,022 million in 2003. In 2004, payments for employee services,

suppliers and other expenses were $3,628 million, an increase of
$366 million when compared to 2003. Also consuming cash in 2004
were payments for interest, workforce reductions and personal injury
and other claims of $282 million, $93 million and $106 million, respec-
tively, compared to $325 million, $155 million and $126 million, respec-
tively, in 2003. In 2004, pension contributions and payments for income
taxes were $161 million and $92 million, respectively, compared to
$92 million and $86 million, respectively, in 2003. The Company increased
the level of accounts receivable sold under its accounts receivable
securitization program by $12 million in 2004 and $132 million in
2003. Payments in 2005 for workforce reductions are expected to be
$90 million while pension contributions are expected to be approxi-
mately $120 million.

As at December 31, 2004, the Company had outstanding informa-

tion technology service contracts of $18 million.

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Investing activities: Cash used by investing activities in 2004 amounted
to $2,411 million compared to $1,075 million in 2003. The Company’s
investing activities in 2004 included $984 million related to the acquisi-
tion of BC Rail and $547 million related to the acquisition of GLT, net
proceeds of $141 million from the EWS capital reorganization and
$52 million from the sale of its Canac Inc. and Beltpack subsidiar-
ies. Net capital expenditures for the year ended December 31, 2004
amounted to $1,072 million, an increase of $29 million over 2003.
The following table details capital expenditures for 2004 and 2003.

In millions

Year ended December 31,

Rail infrastructure

Rolling stock

Information technology and other

Less: capital leases

Net capital expenditures

2004

$÷«769
253
210
1,232

160

2003

$÷«762

168

160

1,090

$1,072

$1,043

The Company expects that its capital expenditures will increase in
2005 due to the acquisition of rolling stock and increased expenditures
required for ongoing renewal of the basic plant and other acquisitions
and investments required to improve the Company’s operating effi-
ciency and customer service.

As at December 31, 2004, the Company had commitments to acquire

railroad ties, rail, freight cars, locomotives and other equipment at an
aggregate cost of $194 million ($211 million at December 31, 2003).

Dividends: During 2004, the Company paid dividends totaling $222 mil-
lion to its shareholders at the quarterly rate of $0.195 per share com-
pared to $191 million at the rate of $0.167 per share, in 2003.

Free cash flow
The Company generated $1,025 million of free cash flow for the year
ended December 31, 2004, compared to $578 million in 2003. Free cash
flow does not have any standardized meaning prescribed by GAAP and
may, therefore, not be comparable to similar measures presented by
other companies. The Company believes that free cash flow is a useful
measure of performance as it demonstrates the Company’s ability to
generate cash after the payment of capital expenditures and dividends.
The Company defines free cash flow as cash provided from operating
activities, excluding changes in the level of accounts receivable sold
under the securitization program, less investing activities and dividends
paid, and adjusted for significant acquisitions as they are not indicative
of normal day-to-day investments in the Company’s asset base, calcu-
lated as follows:

In millions

Year ended December 31,

2004

2003

Cash provided from operating activities

$«2,139

$«1,976

Less:

Investing activities

Dividends paid

Cash provided (used) before financing activities

Adjustments:

Change in accounts receivable sold

Acquisition of BC Rail & GLT

Free cash flow

(2,411)
(222)
(494)

(1,075)

(191)

710

(12)
1,531
$«1,025

(132)

–

$÷÷578

Financing activities: Cash provided from financing activities totaled
$511 million for the year ended December 31, 2004 compared to cash
used by financing activities of $605 million in 2003. In July 2004, the
Company issued U.S.$300 million (Cdn$395 million) of 4.25% Notes
due 2009 and U.S.$500 million (Cdn$658 million) of 6.25% Debentures
due 2034. In March 2004, the Company had repaid U.S.$266 million
(Cdn$355 million) of 7.00% 10-year Notes with cash on hand and the
proceeds received from the issuance of commercial paper. In May 2003,
the Company had repaid U.S.$150 million (Cdn$207 million) of 6.625%
10-year Notes and U.S.$100 million (Cdn$138 million) of 6.75% 10-year
Notes with the proceeds received in March 2003 from the issuance of
U.S.$400 million (Cdn$586 million) 4.40% Notes due 2013. In 2004 and
2003, issuances and repayments of long-term debt related principally to
the Company’s commercial paper and revolving credit facility.

In 2004, the Company used $273 million to repurchase 4.0 million

common shares under its current share repurchase program whereas
in 2003, the Company used $656 million to repurchase the remaining
15.0 million common shares under its previous share repurchase pro-
gram initiated in 2002.

During 2004, the Company recorded $160 million in capital lease

obligations ($47 million in 2003) related to new equipment and the
exercise of purchase options on existing equipment.

The Company has access to various financing arrangements:

Revolving credit facility
The Company has a U.S.$1,000 million three-year revolving credit facil-
ity expiring in December 2005, which it intends to renew before such
date. The credit facility provides for borrowings at various interest rates,
including the Canadian prime rate, bankers’ acceptance rates, the U.S.
federal funds effective rate and the London Interbank Offer Rate, plus
applicable margins. The credit facility agreement contains customary
financial covenants, based on U.S. GAAP, including limitations on debt
as a percentage of total capitalization and maintenance of tangible net
worth above pre-defined levels, with which the Company has been in
compliance. The Company’s borrowings of U.S.$180 million (Cdn$233
million) outstanding at December 31, 2003 at an average interest
rate of 1.49% were entirely repaid in the first quarter of 2004. As at
December 31, 2004, the Company had borrowings under its revolving
credit facility of U.S.$90 million (Cdn$108 million) at an average inter-
est rate of 2.77% and letters of credit drawn of $342 million.

Commercial paper
The Company has a commercial paper program, which is backed by a por-
tion of its revolving credit facility, enabling it to issue commercial paper
up to a maximum aggregate principal amount of $800 million, or the U.S.
dollar equivalent. As the revolving credit facility will mature within the
next twelve months and the refinancing has not been renegotiated, the
outstanding balance of U.S.$211 million (Cdn$254 million) of commercial
paper at an average interest rate of 2.37% has been included in the
current portion of long-term debt at December 31, 2004. The Company
had no commercial paper outstanding at December 31, 2003.

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

Shelf registration statement
On July 9, 2004, the Company issued U.S.$300 million (Cdn$395 mil-
lion) of 4.25% Notes due 2009 and U.S.$500 million (Cdn$658 million)
of 6.25% Debentures due 2034. The debt offering was made under the
Company’s shelf prospectus and registration statement filed in October
2003. Accordingly, the amount available under the shelf prospectus
and registration statement has been reduced to U.S.$200 million. The

Company used the net proceeds of U.S.$790 million to finance a portion
of the acquisition costs of BC Rail and GLT.

The Company’s access to current and alternate sources of financing at
competitive costs is dependent on its credit rating. The Company is not
currently aware of any adverse trend, event or condition that would
affect the Company’s credit rating.

Contractual obligations

In the normal course of business, the Company incurs contractual obligations. The following table sets forth the Company’s contractual obligations
for the following items as at December 31, 2004:

In millions

Long-term debt obligations (a)

Capital lease obligations (b)

Operating lease obligations

Purchase obligations (c)

Total obligations

Total

$4,403
1,103
992
212
$6,710

2005

$÷«497

113

206

191

$1,007

2006

$308

106

194

$618

2007

$÷60

130

146

$341

2008

$207

116

$378

2009

$363

2010 and
thereafter

$2,968

609

240

–

$549

$3,817

(a) Presented net of unamortized discounts, of which $838 million relates to non-interest bearing notes due in 2094 assumed as part of the BC Rail acquisition and excludes capital lease

obligations of $761 million which are included in “Capital lease obligations.”

(b) Includes $342 million of imputed interest on capital leases at rates ranging from approximately 2.23% to 13.13%.

(c) Includes commitments for railroad ties, rail, freight cars, locomotives and other equipment and outstanding information technology service contracts.

For 2005 and the foreseeable future, the Company expects cash flow from operations and from its various sources of financing to be sufficient to
meet its debt repayments and future obligations, and to fund anticipated capital expenditures.

Acquisitions

BC Rail
In November 2003, the Company entered into an agreement with
British Columbia Railway Company, a corporation owned by the
Government of the Province of British Columbia (Province), to acquire
all the issued and outstanding shares of BC Rail Ltd. and all the part-
nership units of BC Rail Partnership (collectively BC Rail), and the right
to operate over BC Rail’s roadbed under a long-term lease, for a pur-
chase price of $1 billion.

fair value of BC Rail’s assets acquired, owned and leased, and liabilities
assumed at acquisition, as presented in Note 3 – Acquisitions, of the
Company’s Annual Consolidated Financial Statements, is subject to a
final valuation, the impact of which is not expected to have a material
effect on the results of operations.

Great Lakes Transportation LLC’s Railroads and Related Holdings
In October 2003, the Company, through an indirect wholly owned
subsidiary, entered into an agreement for the acquisition of GLT for a
purchase price of U.S.$380 million.

On July 2, 2004, the Company reached a consent agreement with

As of April 2004, the Company received all necessary regulatory

Canada’s Competition Bureau, allowing for the closing of the trans-
action, whereby the Company reaffirmed its commitment to share
merger efficiencies with BC Rail shippers and assure them competitive
transportation options through its Open Gateway Rate and Service
Commitment. The consent agreement also maintains competitive rates
and service for grain shippers in the Peace River region.

On July 14, 2004, the Company completed its acquisition of
BC Rail and began a phased integration of the companies’ operations.
The acquisition was financed by debt and cash on hand.

The Company accounted for the acquisition using the purchase

method of accounting as required by SFAS No. 141, “Business
Combinations,” and SFAS No. 142, “Goodwill and Other Intangible
Assets.” As such, the consolidated financial statements of the Company
include the assets, liabilities and results of operations of BC Rail as of
July 14, 2004, the date of acquisition. The Company’s cost to acquire
BC Rail of $991 million includes purchase price adjustments and trans-
action costs. The preliminary purchase price allocation, based on the

approvals, including the U.S. Surface Transportation Board (STB) ruling
rendered on April 9, 2004.

On May 10, 2004, the Company completed its acquisition of GLT

and began a phased integration of the companies’ operations. The
acquisition was financed by debt and cash on hand.

The Company accounted for the acquisition using the purchase

method of accounting. As such, the consolidated financial statements
of the Company include the assets, liabilities and results of operations
of GLT as of May 10, 2004, the date of acquisition. The Company’s cost
to acquire GLT of U.S.$395 million (Cdn$547 million) includes purchase
price adjustments and transaction costs. The preliminary purchase price
allocation, based on the fair value of GLT’s assets acquired and liabili-
ties assumed at acquisition, as presented in Note 3 – Acquisitions, of
the Company’s Annual Consolidated Financial Statements, is subject to
a final valuation, the impact of which is not expected to have a mate-
rial effect on the results of operations.

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

These acquisitions involve the integration of two previously inde-
pendent businesses to provide shippers enhanced rail services over a
coordinated network. There can be no assurance that CN will be able to
integrate its business with that of either BC Rail or GLT without encoun-
tering operational difficulties or experiencing the loss of key employees
or customers, or that the rail service levels and other efficiencies or syn-
ergies expected from these acquisitions will be attained.

Investment in English Welsh and Scottish Railway (EWS) –
Capital reorganization

The Company elected to have the maximum allowable number of

shares cancelled under the plan, thereby reducing its ownership interest
of EWS to approximately 31% on a fully diluted basis (13.7 million shares)
compared to approximately 37% on a fully diluted basis (43.7 million
shares) prior to the capital reorganization. In the first quarter of 2004,
the Company received £57.7 million (Cdn$141 million) in cash and a
note receivable of £23.9 million (Cdn$58 million) from EWS.

Off balance sheet arrangements

Accounts receivable securitization program
The Company has an accounts receivable securitization program,
expiring in June 2006, under which it may sell, on a revolving basis, a
maximum of $450 million of eligible freight trade and other receivables
outstanding at any point in time, to an unrelated trust. The Company
has a contingent residual interest of approximately 10% of receivables
sold, which is recorded in Other current assets.

The Company is subject to customary reporting requirements for

which failure to perform could result in termination of the program. In
addition, the trust is subject to customary credit rating requirements,
which if not met could also result in termination of the program. The
Company monitors these reporting and credit rating requirements for
any trends, events or conditions that could cause such termination.
The accounts receivable securitization program provides the
Company with readily available short-term financing for general corpo-
rate uses. In the event the program is terminated before its scheduled
maturity, the Company expects to meet its future payment obligations
through its various sources of financing, including its revolving credit
facility and commercial paper program, and/or access to capital markets.
At December 31, 2004, pursuant to the agreement, $445 million

had been sold compared to $448 million at December 31, 2003.

Guarantees and indemnifications
In the normal course of business, the Company, including certain of its
subsidiaries, enters into agreements that may involve providing certain
guarantees or indemnifications to third parties and others, which extend
over the term of the agreement. These include, but are not limited to,
residual value guarantees on operating leases, standby letters of credit
and surety bonds, and indemnifications that are customary for the type
of transaction or for the railway business.

Effective January 1, 2003, the Company is required to recognize a
liability for the fair value of the obligation undertaken in issuing certain
guarantees on the date the guarantee is issued or modified. Where the
Company expects to make a payment in respect of a guarantee, a liability
will be recognized to the extent that one has not yet been recognized.

The nature of these guarantees or indemnifications, the maximum

potential amount of future payments, the carrying amount of the
liability, if any, and the nature of any recourse provisions are disclosed
in Note 19 – Major commitments and contingencies of the Company’s
Annual Consolidated Financial Statements.

Financial instruments

The Company has limited involvement with derivative financial instru-
ments and does not use them for trading purposes. Collateral or other
security to support financial instruments subject to credit risk is usually
not obtained. While the Company is exposed to counterparty credit risk
in the event of non-performance, the credit standing of counterparties
or their guarantors is regularly monitored, and losses due to counter-
party non-performance are not anticipated.

Fuel
To mitigate the effects of fuel price changes on its operating margins
and overall profitability, the Company has a systematic hedging pro-
gram 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. However, in the fourth quarter of 2004, the
Company did not enter into any swap positions on crude and heating
oil. At December 31, 2004, the Company had hedged approximately
50% of the estimated 2005 fuel consumption, representing approxi-
mately 203 million U.S. gallons at an average price of U.S.$0.74 per U.S.
gallon, and 17% of the estimated 2006 fuel consumption, representing
69 million U.S. gallons at an average price of U.S.$0.89 per U.S. gallon.

Realized gains from the Company’s fuel hedging activities
were $112 million, $49 million and $3 million for the years ended
December 31, 2004, 2003 and 2002, respectively.

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

Interest rate
In the first quarter of 2004, in anticipation of future debt issuances,
the Company had entered into treasury lock transactions for a notional
amount of U.S.$380 million to fix the treasury component on these
future debt issuances. Upon expiration in June 2004, these treasury rate
locks were rolled into new contracts expiring in September 2004, at an
average locked-in rate of 5.106%. The Company settled these treasury
locks at a gain of U.S.$9 million (Cdn$12 million) upon the pricing of
the U.S.$500 million 6.25% Debentures due 2034, subsequently issued
on July 9, 2004. Beginning July 9, 2004, upon the issuance of debt,
the realized gain of $12 million accumulated in other comprehensive
income will be recorded into income, as a reduction of interest expense,
over the term of the debt based on the interest payment schedule.
At December 31, 2004, Accumulated other comprehensive loss

included an unamortized gain of $12 million, $8 million after tax.

Recent accounting pronouncement

In December 2004, the Financial Accounting Standards Board (FASB)
issued SFAS No. 123(R), “Share-Based Payment,” which requires
expensing of all options issued, modified or settled based on the grant-
date fair value and recognizing the expense over the period during
which an employee is required to provide service (vesting period). The
standard also requires that cash settled awards be measured at fair
value at each reporting date until ultimate settlement. This standard is
effective as of the beginning of the first interim reporting period after
June 15, 2005. The Company has elected to apply the modified prospec-
tive approach, which requires compensation cost to be recognized for
unvested awards based on their grant-date fair value. Pursuant to the
application of this standard, stock-based compensation expense for
the second half of 2005 will increase by approximately $10 million for
awards outstanding at December 31, 2004.

Common stock

Share repurchase program
On October 26, 2004, the Board of Directors of the Company approved
a share repurchase program which allows for the repurchase of up to
14.0 million common shares between November 1, 2004 and October 31,
2005 pursuant to a normal course issuer bid, at prevailing market prices.
As at December 31, 2004, 4.0 million common shares have been repur-
chased for $273 million, at an average price of $68.31 per share.

Common stock split
On January 27, 2004, the Board of Directors of the Company approved
a three-for-two common stock split which was effected in the form of
a stock dividend of one-half additional common share of CN payable
for each share held. The stock dividend was paid on February 27, 2004,
to shareholders of record on February 23, 2004. All equity-based ben-
efit plans were adjusted to reflect the issuance of additional shares or
options due to the declaration of the stock split. All share and per share
data has been adjusted to reflect the stock split.

Outstanding share data
As at January 25, 2005, the Company had 283.1 million common shares
outstanding.

Critical accounting policies

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 liabili-
ties, 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 personal injury and other claims,
environmental claims, depreciation, pensions and other post-retirement
benefits, and income taxes, based upon currently available information.
Actual results could differ from these estimates. The following account-
ing policies require management’s more significant judgments and
estimates in the preparation of the Company’s consolidated financial
statements and as such, are considered to be critical. The following
information should be read in conjunction with the Company’s Annual
Consolidated Financial Statements and notes thereto.

Management has discussed the development and selection of the

Company’s critical accounting estimates with the Audit, Finance and
Risk Committee of the Company’s Board of Directors and the Audit,
Finance and Risk Committee has reviewed the Company’s related
disclosures herein.

In Canada, employee injuries are governed by the workers’ com-

pensation legislation in each province whereby employees may be
awarded either a lump sum or future stream of payments depending on
the nature and severity of the injury. Accordingly, the Company accounts
for costs related to employee work-related injuries based on actuarially
developed estimates of the ultimate cost associated with such injuries,
including compensation, health care and administration costs. For all
other legal actions, the Company maintains, and regularly updates on
a case-by-case basis, provisions for such items when the expected loss
is both probable and can be reasonably estimated based on currently
available information.

Assumptions used in estimating the ultimate costs for Canadian
employee injury claims consider, among others, the discount rate, the
rate of inflation, wage increases and health care costs. The Company
periodically reviews its assumptions to reflect currently available infor-
mation. Over the past three years, the Company has not changed any of
these assumptions. For all other legal claims in Canada, estimates are
based on case history, trends and judgment.

In the United States, employee work-related injuries, including
occupational disease claims, are compensated according to the provi-
sions of the Federal Employers’ Liability Act (FELA) and represent a
major expense for the railroad industry. The FELA system, which requires
either the finding of fault through the U.S. jury system or individual set-
tlements, has contributed to the significant increase in the Company’s
personal injury expense in recent years. In view of the Company’s

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

growing presence in the United States and the increase in the number
of occupational disease claims over the past few years, an actuarial
study was conducted in 2002, and in the fourth quarter of 2002 the
Company changed its methodology for estimating its liability for U.S.
personal injury and other claims, including occupational disease claims
and claims for property damage, from a case-by-case approach to an
actuarial-based approach. Consequently, and as discussed in Note 2 to
the Annual Consolidated Financial Statements, the Company recorded a
charge of $281 million ($173 million after tax) to increase its provision
for these claims.

Under the actuarial-based approach, the Company accrues the
expected cost for personal injury and property damage claims and
asserted occupational disease claims, based on actuarial estimates of
their ultimate cost. A liability for the minimum amount of unasserted
occupational disease claims is also accrued to the extent they can be
reasonably estimated. The amount recorded reflects a 25-year horizon
as the Company expects that a large majority of these cases will be
received over such period.

For the U.S. personal injury and other claims liability, historical
claim data is used to formulate assumptions relating to the expected
number of claims and average cost per claim (severity) for each year.
Changes in any one of these assumptions could materially affect
Casualty and other expense as reported in the Company’s results of
operations. For example, a 5% change in the number of claims or sever-
ity would have the effect of changing the provision by approximately
$23 million and the annual expense by approximately $8 million.

In 2004, the Company’s expenses for personal injury and other
claims, net of recoveries, were $149 million ($127 million in 2003 and
$393 million in 2002) and payments for such items were $106 million
($126 million in 2003 and $156 million in 2002). As at December 31,
2004, the Company had aggregate reserves for personal injury and
other claims of $642 million ($590 million at December 31, 2003).

Environmental claims
Regulatory compliance
A risk of environmental liability is inherent in railroad and related trans-
portation 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 compli-
ance and capital costs, on an ongoing basis, associated with environ-
mental regulatory compliance and clean-up requirements in its railroad
operations and relating to its past and present ownership, operation or
control of real property. Environmental expenditures that relate to cur-
rent 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 as the Superfund law, as well as similar state laws generally
impose joint and several liability for clean-up and enforcement costs
on current and former owners and operators of a site without regard
to fault or the legality of the original conduct. The Company has been
notified that it is a potentially responsible party for study and clean-up
costs at approximately 17 Superfund sites for which investigation and
remediation payments are or will be made or are yet to be determined
and, in many instances, is one of several potentially responsible parties.
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 based on the results of a four-phase
assessment conducted on a site-by-site basis. Cost scenarios established
by external consultants based on extent of contamination and expected
costs for remedial efforts are used by the Company to estimate the
costs related to a particular site. A liability is initially 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. Adjustments to initial estimates are recorded as additional
information becomes available. Based on the information currently
available, the Company considers its provisions to be adequate.

At December 31, 2004, most of the Company’s properties not
acquired through recent acquisitions have reached the final assessment
stage and therefore costs related to such sites have been anticipated.
For properties acquired through recent acquisitions, the Company
obtains assessments from both external and internal consultants and
a liability has been or will be accrued based on such assessments.

Unknown existing environmental concerns
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 due to:

(i)

(ii)

the lack of specific technical information available with respect to
many sites;

the absence of any government authority, third-party orders, or
claims with respect to particular sites;

(iii) the potential for new or changed laws and regulations and for
development of new remediation technologies and uncertainty
regarding the timing of the work with respect to particular sites;

(iv) the ability to recover costs from any third parties with respect to

particular sites;

and as such, costs related to future remediation will be accrued in the
period they become known.

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

Future occurrences
In the operation of a railroad, it is possible that derailments, explosions
or other accidents may occur that could cause harm to human health
or to the environment. As a result, the Company may incur costs in
the future, which may be material, to address any such harm, includ-
ing costs relating to the performance of clean-ups, natural resource
damages and compensatory or punitive damages relating to harm to
individuals or property.

In 2004, the Company’s expenses relating to environmental matters,
net of recoveries, were $10 million ($6 million in both 2003 and 2002)
and payments for such items were $8 million ($12 million in 2003
and $16 million in 2002). As at December 31, 2004, the Company had
aggregate accruals for environmental costs of $113 million ($83 million
as at December 31, 2003). The Company anticipates that the majority
of the liability will be paid out over the next five years.

Depreciation
Railroad properties are carried at cost less accumulated depreciation
including asset impairment write-downs. The Company follows the
group method of depreciation for railroad properties and, as such,
depreciates the cost of railroad properties, less net salvage value, on a
straight-line basis over their estimated useful lives. In addition, under
the group method of depreciation, the cost of railroad properties, less
net salvage value, retired or disposed of in the normal course of busi-
ness, is charged to accumulated depreciation.

Assessing the reasonableness of the estimated useful lives of prop-

erties requires judgment and is based on currently available informa-
tion, including periodic depreciation studies conducted by the Company.
The Company’s U.S. properties are subject to comprehensive deprecia-
tion studies conducted by external consultants as required by the STB.
Depreciation studies for Canadian properties are not required by regula-
tion and are therefore conducted internally. Studies are performed on
specific asset groups on a periodic basis. The studies consider, among
others, the analysis of historical retirement data using recognized life
analysis techniques, and the forecasting of asset life characteristics.
Changes in circumstances, such as technological advances, changes
to the Company’s business strategy, changes in the Company’s capital
strategy or changes in regulations can result in the actual useful lives
differing from the Company’s estimates.

A change in the remaining useful life of a group of assets, or their

estimated net salvage, will affect the depreciation rate used to amortize
the group of assets and thus affect depreciation expense as reported
in the Company’s results of operations. A change of one year in the
composite useful life of the Company’s fixed asset base would impact
annual depreciation expense by approximately $12 million.

Depreciation studies are a means of ensuring that the assumptions

used to estimate the useful lives of particular asset groups are still
valid and where they are not, they serve as the basis to establish the
new depreciation rates to be used on a prospective basis. In 2004, the
Company conducted a comprehensive study for its Canadian properties
and U.S. rolling stock and equipment. The study did not have a signifi-
cant effect on depreciation expense.

In 2004, the Company recorded total depreciation and amortiza-

tion expense of $602 million ($560 million in 2003 and $591 million in
2002). At December 31, 2004, the Company had Properties of $19,715
million, net of accumulated depreciation of $9,232 million ($18,305 mil-
lion in 2003, net of accumulated depreciation of $9,038 million).

Pensions and other post-retirement benefits
The Company accounts for pensions and other post-retirement benefits
as required by SFAS No. 87, “Employers’ Accounting for Pensions,” and
SFAS No. 106, “Employers’ Accounting for Post-retirement Benefits
Other Than Pensions,” respectively. Under these accounting standards,
assumptions are made regarding the valuation of benefit obligations
and performance of plan assets. Deferred recognition of differences
between actual results and those assumed is a guiding principle of
these standards. This approach allows for a gradual recognition of
changes in benefit obligations and plan performance over the expected
average remaining service life of the employee group covered by the
plans. The Company has various pension plans, however, the following
description pertaining to pensions relates generally to the Company’s
main pension plan, the CN Pension Plan.

The Canadian plans have a measurement date of December 31
whereas the U.S. plans have a measurement date of September 30. For
pensions and other post-retirement benefits, assumptions are required
for, among others, the discount rate, the expected long-term rate of
return on plan assets, the rate of compensation increase, health care
cost trend rates, mortality rates, employee early retirements, termina-
tions or disability. Changes in these assumptions result in actuarial
gains or losses which in accordance with SFAS No. 87 and SFAS No. 106,
the Company has elected to amortize over the expected average
remaining service life of the employee group covered by the plans only
to the extent that the unrecognized net actuarial gains and losses are
in excess of 10% of the greater of the beginning of year balances of
the projected benefit obligation or market-related value of plan assets.
The future effect on the Company’s results of operations is dependent
on economic conditions, employee demographics, mortality rates and
investment performance.

The Company sets its discount rate assumption annually to reflect
the rates available on high-quality, fixed-income debt instruments with
a duration of approximately 12 years, which is expected to match the
timing and amount of expected benefit payments. High quality debt
instruments are corporate bonds with a rating of AA or better. A dis-
count rate of 5.75%, based on bond yields prevailing at December 31,
2004, was considered appropriate by the Company and is supported by
reports issued by third party advisors. A one-percentage-point decrease
in the discount rate would cause annual net periodic benefit cost to
increase by approximately $33 million whereas a one-percentage-point
increase would not have a material change in net periodic benefit cost
as the Company amortizes actuarial gains and losses over the expected
average remaining service life of the employee group covered by the
plans, only to the extent they are in excess of 10% of the greater of
the beginning of year balances of the projected benefit obligation or
market-related value of plan assets.

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

To develop its expected long-term rate of return assumption used
in the calculation of net periodic benefit cost applicable to the market-
related value of assets, the Company considers both its past experience
and future estimates of long-term investment returns, the expected
composition of the plans’ assets as well as the expected long-term
market returns in the future. The Company has elected to use a market-
related value of assets, whereby realized and unrealized gains/losses
and appreciation/depreciation in the value of the investments are recog-
nized over a period of five years, while investment income is recognized
immediately. The Company follows a disciplined investment strategy,
which limits concentration of investments by asset class, foreign cur-
rency, sector or company. The Investment Committee of the Board of
Directors has approved an investment policy that establishes long-term
asset mix targets based on a review of historical returns achieved by
worldwide investment markets. Investment managers may deviate from
these targets but their performance is evaluated in relation to the mar-
ket performance of the target mix. The Company does not anticipate the
return on plan assets to fluctuate materially from related capital market
indices. The Investment Committee reviews investments regularly with
specific approval required for major investments in illiquid securities.
The policy also permits the use of derivative financial instruments to
implement asset mix decisions or to hedge existing or anticipated expo-
sures. The Pension Plan does not invest in the securities of the Company
or its subsidiaries. During the last ten years ended December 31, 2004,
the CN Pension Plan earned an annual average rate of return of 9.8%.
The actual and market-related value rates of return on plan assets for
the last five years were as follows:

Rates of return

Actual

Market-related value

2004

11.7%
6.3%

2003

9.6%

7.0%

2002

2001

2000

(0.3)%

7.4%

(1.4)%

10.2%

10.5%

13.7%

For that same period, the Company used a long-term rate of return
assumption on the market-related value of plan assets not exceeding
9% to compute net periodic benefit cost. In 2003, the Company had
reduced the expected long-term rate of return on plan assets from 9%
to 8% to reflect management’s view of long-term investment returns.
The effect of this change in management’s assumption was to increase
net periodic benefit cost in 2003 by approximately $50 million.

Based on the fair value of the assets held as at December 31, 2004,
the plan assets are comprised of 56% in Canadian and foreign equities,
34% in debt securities, 3% in real estate assets and 7% in other assets.
The long-term asset allocation percentages are not expected to differ
materially from the current composition.

and it is assumed that the rate will decrease gradually to 6% in 2013
and remain at that level thereafter. A one-percentage-point change in
either the rate of compensation increase or the health care cost trend
rate would not cause a material change to the Company’s net periodic
benefit cost for both pensions and other post-retirement benefits.

For pension funding purposes, an actuarial valuation is required at
least on a triennial basis. However, for the last 15 years, the Company
has conducted an annual actuarial valuation to account for pensions.
The latest actuarial valuation of the CN Pension Plan was conducted
as at December 31, 2003 and indicated a funding excess. Total con-
tributions for all of the Company’s pension plans are expected to be
approximately $120 million in each of 2005, 2006 and 2007 based on
the plans’ current position. The assumptions discussed above are not
expected to have a significant impact on the cash funding requirements
of the pension plans. The Canadian Institute of Actuaries (CIA) has
adopted a new standard that will be used to calculate the values that
pension plan members are entitled to receive on termination of employ-
ment. The new standard will impact the calculation of the pension plan
liabilities under a solvency or wind-up scenario when the Company
conducts an actuarial valuation for purposes of determining the fund-
ing position of the Company’s Canadian pension plans. The standard is
effective in February 2005 and may significantly impact future funding
requirements.

For pensions, the Company recorded consolidated net periodic ben-
efit cost of $22 million and $49 million in 2004 and 2003, respectively,
and no net periodic benefit cost in 2002. Consolidated net periodic ben-
efit cost for other post-retirement benefits was $29 million, $33 million
and $25 million in 2004, 2003 and 2002, respectively. At December 31,
2004, the Company’s accrued benefit cost for post-retirement benefits
other than pensions was $309 million ($164 million at December 31,
2003). In addition, at December 31, 2004, the Company’s consolidated
pension benefit obligation and accumulated post-retirement benefit
obligation (APBO) were $13,137 million and $319 million, respectively
($12,020 million and $309 million at December 31, 2003).

The Medicare Prescription Drug, Improvement, and Modernization

Act of 2003 (the “Act”), signed into law in the United States in
December 2003, provides for prescription drug benefits under Medicare,
as well as a federal subsidy to sponsors of retiree health care benefit
plans that provide prescription drug benefits that have been concluded
to be actuarially equivalent to the Medicare benefit. Pursuant to FASB
Staff Position 106-2, “Accounting and Disclosure Requirements Related
to the Medicare Prescription Drug, Improvement and Modernization Act
of 2003,” adopted on July 1, 2004, the Company evaluated and deter-
mined the prescription drug benefits provided by its health care plans
to be actuarially equivalent to the Medicare benefit under the Act. The
Company measured the effects of the Act on the APBO as of January 1,
2004 and, as such, the APBO was reduced by $49 million. Net periodic
benefit cost for the year ended December 31, 2004 was reduced by
$7 million due to the effects of the Act.

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

In 2004, with the acquisitions of GLT and BC Rail, the Company assumed two additional defined benefit plans. The following table provides the

Company’s plan assets by category, benefit obligation at end of year and Company and employee contributions by major pension plan:

In millions

Plan assets by category

Equity securities

Debt securities

Real estate

Other

Total

Benefit obligation at end of year

Company contributions in 2004

Employee contributions in 2004

December 31, 2004

CN
Pension Plan

BC Rail
Pension Plan

U.S. and
Other Plans

Total

$÷6,812

3,888

348

1,208

$12,256

$12,172

$÷÷÷«74

$÷÷÷«55

$312

212

$613

$626

$÷20

$÷÷–

$105

$÷7,229

$184

$339

$÷71

$÷÷–

4,154

365

1,305

$13,053

$13,137

$÷÷«165

$÷÷÷«55

Income taxes
The Company follows the asset and liability method of accounting for
income taxes. Under the asset and liability method, the change in the
net deferred income tax asset or liability is included in the computation
of net income. Deferred income tax assets and liabilities are measured
using enacted income tax rates expected to apply to taxable income in
the years in which temporary differences are expected to be recovered
or settled. As a result, a projection of taxable income is required for
those years, as well as an assumption of the ultimate recovery/settle-
ment period for temporary differences. The projection of future taxable
income is based on management’s best estimate and may vary from
actual taxable income. On an annual basis, the Company assesses its
need to establish a valuation allowance for its deferred income tax
assets and if it is deemed more likely than not that its deferred income
tax assets will not be realized based on its taxable income projec-
tions, a valuation allowance is recorded. As at December 31, 2004, the
Company expects that its deferred income tax assets will be recovered
from future taxable income and therefore, has not set up a valuation
allowance. In addition, Canadian and U.S. tax rules and regulations are
subject to interpretation and require judgment by the Company that
may be challenged by the taxation authorities. The Company believes
that its provisions for income taxes are adequate pertaining to any
assessments from the taxation authorities.

The Company’s deferred income tax assets are mainly composed
of temporary differences related to accruals for workforce reductions,
personal injury and other claims, environmental and other post-retire-
ment benefits, and losses and tax credit carryforwards. The majority of
these accruals will be paid out over the next five years. The Company’s
deferred income tax liabilities are mainly composed of temporary dif-
ferences related to properties and prepaid benefit cost for pensions. The
reversal of temporary differences is expected at future-enacted income
tax rates which could change due to fiscal budget changes and/or
changes in income tax laws. As a result, a change in the timing and/or
the income tax rate at which the components will reverse, could materi-
ally affect deferred income tax expense as recorded in the Company’s
results of operations. A one-percentage-point change in the Company’s
reported effective income tax rate would have the effect of changing

the income tax expense by $19 million in 2004. In the fourth quarter
of 2003, the Company had recorded an increase of $81 million to its
net deferred income tax liability resulting from the enactment of higher
corporate tax rates in the province of Ontario. As a result, for the year
ended December 31, 2003, a deferred income tax expense of $79 mil-
lion was recorded in income and $2 million was recorded in Other
comprehensive loss.

For the year ended December 31, 2004, the Company recorded
total income tax expense of $596 million ($517 million in 2003 and
$384 million in 2002) of which $366 million was for deferred income
taxes ($411 million in 2003 and $272 million in 2002). The Company’s
net deferred income tax liability at December 31, 2004 was $4,359 mil-
lion ($4,425 million at December 31, 2003).

Business risks

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 below
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.

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

where an extensive highway network and population centers, located
relatively close to one another, have encouraged significant competi-
tion 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.

In addition to trucking competition, and 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.

The significant consolidation of rail systems in the United States
has resulted in larger rail systems that are able to offer seamless ser-
vices in larger market areas and accordingly, compete effectively with
the Company in certain markets. This requires the Company to consider
transactions that would similarly enhance its own service, such as its
acquisitions of BC Rail and the GLT carriers. 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 com-
petitive position. No assurance can be given that competitive pressures
will not lead to reduced revenues, profit margins or both.

Environmental matters
The Company’s operations are subject to numerous federal, provin-
cial, state, municipal and local environmental laws and regulations in
Canada and the United States concerning, among other things, emis-
sions 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 railroad and related trans-
portation 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 compli-
ance and capital costs, on an ongoing basis, associated with environ-
mental regulatory compliance and clean-up requirements in its railroad
operations and relating to its past and present ownership, operation or
control of real property.

While the Company believes that it has identified the costs likely to

be incurred for environmental matters in the next several years, based
on known information, the Company’s ongoing efforts to identify poten-
tial 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.

In railroad and related transportation operations, it is possible that

derailments, explosions or other accidents may occur that could cause
harm to human health or to the environment. As a result, the Company
may incur costs in the future, which may be material, to address any
such harm, including costs relating to the performance of clean-ups,
natural resource damages and compensatory or punitive damages relat-
ing to harm to individuals or property.

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. Also,
additional contaminated sites yet unknown may be discovered or future
operations may result in accidental releases. For these reasons, there
can be no assurance that material liabilities or costs related to envi-
ronmental 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.

Personal injury and other claims
In the normal course of its operations, the Company becomes involved
in various legal actions, including claims relating to personal injuries,
occupational disease and damage to property. The Company maintains
provisions for such items, which it considers to be adequate for all of
its outstanding or pending claims. The final outcome with respect to
actions outstanding or pending at December 31, 2004, or with respect
to future claims, cannot be predicted with certainty, and therefore
there can be no assurance that their resolution will not have a material
adverse effect on the Company’s financial position or results of opera-
tions in a particular quarter or fiscal year.

Canadian National Railway Company

U.S. GAAP

Management’s Discussion and Analysis

been conducted with government assistance. On December 29, 2004,
the Minister of Labour also referred to the Canadian Industrial Relations
Board (CIRB) a question respecting the maintenance of essential ser-
vices should there be a strike or lockout involving these groups. Until
the Board renders its decision, the right to strike or lockout is sus-
pended. In addition to the Board’s decision, at least 72 hours’ strike or
lockout notice would be required prior to any legal strike or lockout.
In the third quarter of 2004, the Company acquired BC Rail. At
December 2004, the Company had reached implementing agreements
for BC Rail employees with the Council of Trade Unions and its mem-
bers, representing all unions, regarding the integration of the various
collective agreements.

In the first quarter of 2004, the Company’s shopcraft forces, cleri-
cal workers and intermodal yard employees, represented by the CAW
had rejected three tentative agreements signed by the CAW and the
Company on January 23, 2004. The strike that ensued lasted one month
and disrupted the Company’s operations and affected operating income
by approximately $35 million in the first quarter of 2004. There can be
no assurance that the Company will be able to have all its collective
agreements renewed and ratified without any other strikes or lockouts,
or that such strikes or lockouts or the resolution of these collective
bargaining negotiations will not have a material adverse effect on the
Company’s financial position or results of operations.

U.S. workforce
The general approach to labor negotiations by U.S. Class 1 railroads is
to bargain on a collective national basis. Grand Trunk Western (GTW),
Duluth, Winnipeg and Pacific (DWP), ICRR, CCP Holdings, Inc. (CCP) and
Wisconsin Central Transportation Corporation (WC), have bargained
on a local basis rather than holding national, industry wide negotia-
tions because it results in agreements that better address both the
employees’ concerns and preferences, and the railways’ actual operat-
ing environment. However, local negotiations may not generate federal
intervention in a strike or lockout situation, since a dispute may be
localized. The Company believes the potential mutual benefits of local
bargaining outweigh the risks.

As of January 2005, the Company had in place agreements with
bargaining units representing the entire unionized workforce at ICRR,
GTW, DWP, CCP and GLT, and 93% of the unionized workforce at WC.
Agreements in place have various moratorium provisions, ranging from
the end of 2001 to the end of 2005, which preserve the status quo in
respect of given areas during the terms of such moratoriums. Several
of these agreements are currently under renegotiation and several will
open for negotiation in 2005.

Negotiations are ongoing with the bargaining units with which the

Company does not have agreements or settlements. Until new agree-
ments are reached or the processes of the Railway Labor Act have been
exhausted, the terms and conditions of existing agreements or policies
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 there will not be any such work action and that
the resolution of these negotiations 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 as
to (i) economic regulation by the STB (the successor to the Interstate
Commerce Commission) and (ii) safety by the Federal Railroad
Administration. As such, various Company business transactions must
gain prior regulatory approval, with attendant risks and uncertainties.
The Company is also subject to a variety of health, safety, security, labor,
environmental and other regulations, all of which can affect its com-
petitive position and profitability.

The CTA Review Panel, which was appointed by the federal govern-
ment to carry out a comprehensive review of the Canadian transporta-
tion legislation, issued its report to the Minister of Transport at the
end of June 2001. The report was released to the public on July 18, 2001
and contains numerous recommendations for legislative changes affect-
ing all modes of transportation, including rail. On February 25, 2003,
the Canadian Minister of Transport released its policy document
Straight Ahead – A Vision for Transportation in Canada and tabled in
the House of Commons Bill C-26 entitled An Act to Amend the Canada
Transportation Act and the Railway Safety Act, to enact the VIA Rail
Canada Act and to make consequential amendments to other Acts.
Bill C-26 died on the Order Paper (was terminated) when Parliament
was prorogued on November 12, 2003. No assurance can be given
that any future legislative action by the federal government pursuant
to the report’s recommendations and the policy document, or other
future governmental initiatives will not materially adversely affect the
Company’s financial position or results of operations.

The U.S. Congress has had under consideration for several years

various pieces of legislation that would increase federal economic
regulation of the railroad industry. In addition, the STB is authorized
by statute to commence regulatory proceedings if it deems them to be
appropriate. No assurance can be given that any future regulatory initia-
tives by the U.S. federal government will not materially adversely affect
the Company’s operations, or its competitive and financial position.

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

American Railroads to develop and put in place an extensive industry-
wide security plan. While the Company will continue to work closely
with the CBSA, CBP, and other Canadian and U.S. agencies, as above,
no assurance can be given that future decisions by the U.S. and/or
Canadian governments on homeland security matters, or joint decisions
by the industry in response to threats to the North American rail net-
work, will not materially adversely affect the Company’s operations, or
its competitive and financial position.

In October 2002, the Company became the first North American
railroad to gain membership in the U.S. Customs Service‘s Customs-
Trade Partnership Against Terrorism (C-TPAT). C-TPAT is a joint govern-
ment-business initiative designed to build cooperative relationships that
strengthen overall supply chain and border security on goods exported
to the U.S. The Company is also designated as a low-risk carrier under
the Customs Self-Assessment (CSA) program, a CBSA program designed
to expedite the cross-border movement of goods of CSA-accredited
importing companies for goods imported into Canada.

The Company’s ownership of the former Great Lakes Transportation

vessels is subject to regulation by the U.S. Coast Guard and the
Department of Transportation, Maritime Administration, which regu-
late the ownership and operation of vessels operating on the Great
Lakes and in U.S. coastal waters. On February 4, 2004, the Maritime
Administration and the U.S. Coast Guard issued a Joint Notice of
Proposed Rulemaking, proposing modifications to the regulations gov-
erning vessel documentation for lease financing for vessels engaged
in the coastwise trade. In addition, the U.S. Congress has from time to
time considered modifications to the legislation governing the United
States coastwise trade. As a result of maritime legislation enacted in
2004, the regulations governing the Company’s acquisition of these
vessels should not be affected. No assurance can be given that any
future legislative or regulatory initiatives by the U.S. federal government
will not materially adversely affect the Company’s operations, or its
competitive and financial position.

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 commodi-
ties carried by the Company experience cyclicality in demand. Many of
the bulk commodities the Company transports move offshore and are
affected more by global rather than North American economic condi-
tions. The Company’s results of operations can be expected to reflect
these conditions because of the significant fixed costs inherent in rail-
road operations.

Although the Company conducts its business and receives rev-
enues 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. Based on the Company’s current operations,
the estimated annual impact on net income of a year-over-year one-
cent change in the Canadian dollar relative to the U.S. dollar is approxi-
mately $8 million. 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 mar-
ketplace and thereby affect the Company’s revenues and expenses.

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 adversely affected.

In addition to the inherent risks of the business cycle, the

Company’s operations are occasionally susceptible to severe weather
conditions, which can disrupt operations and service for the railroad as
well as for the Company’s customers. Recent severe drought conditions
in western Canada, for instance, significantly reduced bulk commodity
revenues, principally grain.

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 infla-
tion-adjusted basis, assuming that all operating assets are replaced
at current price levels, would be substantially greater than historically
reported amounts.

Controls and procedures

The Company’s Chief Executive Officer and its Chief Financial Officer,
after evaluating the effectiveness of the Company’s “disclosure controls
and procedures” (as defined in Exchange Act Rules 13a-15(e) and 15d-
15(e)) as of December 31, 2004, have concluded that the Company’s
disclosure controls and procedures were adequate and effective and
designed to ensure that material information relating to the Company
and its consolidated subsidiaries would have been made known to
them. During the fourth quarter ending December 31, 2004, there was
no change in the Company’s internal control over financial reporting
that has materially affected, or is reasonably likely to materially affect,
the Company’s internal control over financial reporting.

Global, as well as North American trade conditions, including trade
barriers on certain commodities, may interfere with the free circulation
of goods across Canada and the United States.

Additional information, including the Company’s 2003 Annual Information
Form and Form 40-F, may be found on SEDAR at www.sedar.com and on
EDGAR at www.sec.gov/edgar.shtml, respectively.

Potential terrorist actions can have a direct or indirect impact on

the transportation infrastructure, including railway infrastructure in
North America, and interfere with the free flow of goods. International
conflicts can also have an impact on the Company’s markets.

Montreal, Canada
January 25, 2005

Canadian National Railway Company

U.S. GAAP

Management Report

Auditors’ Report

The accompanying consolidated financial statements of Canadian
National Railway Company and all information in this annual report
are the responsibility of management and have been approved by the
Board of Directors.

The financial statements have been prepared by management in

conformity with generally accepted accounting principles in the United
States. These statements include some amounts that are based on best
estimates and judgments. Financial information used elsewhere in the
annual report is consistent with these financial statements.

Management of the Company, in furtherance of the integrity and
objectivity of data in the financial statements, has developed and main-
tains a system of internal accounting controls and supports an exten-
sive program of internal audits. Management believes that this system
of internal accounting controls provides reasonable assurance that
financial records are reliable and form a proper basis for preparation
of financial statements, and that assets are properly accounted for and
safeguarded.

The Board of Directors carries out its responsibility for the financial
statements in this report principally through its Audit, Finance and Risk
Committee, consisting solely of outside directors. The Audit, Finance and
Risk Committee reviews the Company’s consolidated financial state-
ments and annual report and recommends their approval by the Board
of Directors. Also, the Audit, Finance and Risk Committee meets regu-
larly with the Chief, Internal Audit, and with the shareholders’ auditors.
These consolidated financial statements have been audited by

KPMG LLP, who have been appointed as the sole auditors of the
Company by the shareholders.

To the Board of Directors of Canadian National Railway Company

We have audited the consolidated balance sheets of Canadian National
Railway Company as at December 31, 2004 and 2003 and the consoli-
dated statements of income, comprehensive income, changes in share-
holders’ equity and cash flows for each of the years in the three-year
period ended December 31, 2004. These financial statements are the
responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with Canadian generally

accepted auditing standards and with the standards of the Public
Company Accounting Oversight Board (United States). Those standards
require that we plan and perform an audit to obtain reasonable assur-
ance whether the financial statements are free of material misstate-
ment. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant esti-
mates made by management, as well as evaluating the overall financial
statement presentation.

In our opinion, these consolidated financial statements present
fairly, in all material respects, the financial position of the Company
as at December 31, 2004 and 2003, and the results of its operations
and its cash flows for each of the years in the three-year period ended
December 31, 2004, in accordance with generally accepted accounting
principles in the United States.

On January 25, 2005, we reported separately to the shareholders of
the Company on consolidated financial statements for the same period,
prepared in accordance with Canadian generally accepted accounting
principles.

Claude Mongeau
Executive Vice-President and Chief Financial Officer

January 25, 2005

KPMG LLP
Chartered Accountants

Montreal, Canada
January 25, 2005

Serge Pharand
Vice-President and Corporate Comptroller

January 25, 2005

U.S. GAAP

Canadian National Railway Company

Consolidated Statement of Income

In millions, except per share data

Year ended December 31,

2004

2003

2002

Revenues

Petroleum and chemicals
Metals and minerals
Forest products
Coal

Grain and fertilizers

Intermodal
Automotive
Other items

Total revenues

Operating expenses

Labor and fringe benefits
Purchased services and material
Depreciation and amortization
Fuel
Equipment rents
Casualty and other (Note 2)

Total operating expenses

Operating income
Interest expense (Note 14)
Other income (loss) (Note 15)

Income before income taxes and cumulative effect of change in accounting policy
Income tax expense (Note 16)

Income before cumulative effect of change in accounting policy
Cumulative effect of change in accounting policy (net of applicable taxes) (Note 2)

Net income

Basic earnings per share (Note 18)

Income before cumulative effect of change in accounting policy
Net income

Diluted earnings per share (Note 18)

Income before cumulative effect of change in accounting policy
Net income

$1,123
713
1,452
284
1,053
1,117
510
296

6,548

1,819
746
598
528
244
445

4,380

2,168
(294)
(20)

1,854
(596)

1,258
–

$1,058
527
1,284
261
938
1,101
525
190

5,884

1,698
703
554
469
293
390

4,107

1,777
(315)
21

1,483
(517)

966
48

$1,102
521
1,323
326
986
1,052
591
209

6,110

1,837
778
584
459
346
637

4,641

1,469
(361)
76

1,184
(384)

800
–

$1,258

$1,014

$÷«800

$÷4.41
$÷4.41

$÷4.34
$÷4.34

$÷3.38
$÷3.54

$÷3.33
$÷3.49

$÷2.71
$÷2.71

$÷2.65
$÷2.65

See accompanying notes to consolidated financial statements.

Canadian National Railway Company

U.S. GAAP

Year ended December 31,

2004

2003

Consolidated Statement of Comprehensive Income

In millions

Net income

Other comprehensive income (loss) (Note 21) :

Unrealized foreign exchange gain on translation of U.S. dollar denominated long-term

debt designated as a hedge of the net investment in U.S. subsidiaries
Unrealized foreign exchange loss on translation of the net investment in

foreign operations

Unrealized holding gain on fuel derivative instruments (Note 20)
Realized gain on settlement of interest rate swaps (Note 20)
Minimum pension liability adjustment (Note 13)

Other comprehensive income (loss) before income taxes
Income tax (expense) recovery on other comprehensive income (loss)

Other comprehensive income (loss)

Comprehensive income

$1,258

$«1,014

326

(428)
54
12
8

(28)
9

(19)

754

(1,101)
8
–
7

(332)
106

(226)

2002

$800

(40)
68
–
(20)

59
(20)

$1,239

$÷÷788

$839

See accompanying notes to consolidated financial statements.

U.S. GAAP

Canadian National Railway Company

Consolidated Balance Sheet

In millions

Assets

Current assets:

Cash and cash equivalents
Accounts receivable (Note 4)
Material and supplies
Deferred income taxes (Note 16)

Other

Properties (Note 5)
Intangible and other assets (Note 6)

Total assets

Liabilities and shareholders’ equity

Current liabilities:

Accounts payable and accrued charges (Note 8)
Current portion of long-term debt (Note 10)

Other

Deferred income taxes (Note 16)
Other liabilities and deferred credits (Note 9)
Long-term debt (Note 10)

Shareholders’ equity:

Common shares (Note 11)
Accumulated other comprehensive loss (Note 21)
Retained earnings

December 31,

2004

2003

$÷«÷147
793
127
364
279

1,710
19,715
940

$22,365

$÷«÷130
529
120
125
223

1,127
18,305
905

$20,337

$÷1,605
578
76

$÷1,421
483
73

2,259
4,723
1,513
4,586

4,706
(148)
4,726

9,284

1,977
4,550
1,203
4,175

4,664
(129)
3,897

8,432

Total liabilities and shareholders’ equity

$22,365

$20,337

On behalf of the Board:

David G.A. McLean
Director

E. Hunter Harrison
Director

See accompanying notes to consolidated financial statements.

Canadian National Railway Company

U.S. GAAP

Consolidated Statement of Changes in Shareholders’ Equity

In millions

Balances December 31, 2001
Net income
Stock options exercised (Notes 11, 12)
Conversion of convertible preferred securities (Note 11)
Share repurchase program (Note 11)
Other comprehensive income (Note 21)
Dividends ($0.57 per share)

Balances December 31, 2002
Net income
Stock options exercised and other (Notes 11, 12)
Share repurchase program (Note 11)
Other comprehensive loss (Note 21)
Dividends ($0.67 per share)

Balances December 31, 2003
Net income
Stock options exercised and other (Notes 11, 12)
Share repurchase program (Note 11)
Other comprehensive loss (Note 21)
Dividends ($0.78 per share)

Balances December 31, 2004

Issued and
outstanding
common
shares

289.1
–
2.7
9.0
(4.5)
–
–

296.3
–
2.9
(15.0)
–
–

284.2
–
2.9
(4.0)
–
–

Common
shares

$«4,442
–
75
340
(72)
–
–

4,785
–
122
(243)
–
–

4,664
–
108
(66)
–
–

Accumulated
other
comprehensive
income (loss)

Retained
earnings

Total
shareholders’
equity

$÷«÷58
–
–
–
–
39
–

97
–
–
–
(226)
–

(129)
–
–
–
(19)
–

$«2,988
800
–
–
(131)
–
(170)

3,487
1,014
–
(413)
–
(191)

3,897
1,258
–
(207)
–
(222)

$«7,488
800
75
340
(203)
39
(170)

8,369
1,014
122
(656)
(226)
(191)

8,432
1,258
108
(273)
(19)
(222)

283.1

$4,706

$«(148)

$4,726

$9,284

See accompanying notes to consolidated financial statements.

U.S. GAAP

Canadian National Railway Company

Consolidated Statement of Cash Flows

In millions

Operating activities
Net income

Year ended December 31,

2004

2003

2002

$÷1,258

$÷1,014

$÷÷800

Adjustments to reconcile net income to net cash provided from operating activities:

Depreciation and amortization
Deferred income taxes (Note 16)
Equity in earnings of English Welsh and Scottish Railway (Note 15)
Charge to increase U.S. personal injury and other claims liability (Note 2)

Workforce reduction charge (Note 9)

Cumulative effect of change in accounting policy (Note 2)

Other changes in:

Accounts receivable
Material and supplies

Accounts payable and accrued charges
Other net current assets and liabilities

Other

Cash provided from operating activities

Investing activities

Net additions to properties
Acquisition of BC Rail (Note 3)
Acquisition of GLT (Note 3)

Other, net

Cash used by investing activities

Dividends paid

Financing activities

Issuance of long-term debt
Reduction of long-term debt
Issuance of common shares (Note 11)
Repurchase of common shares (Note 11)

Cash provided from (used by) financing activities

Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of year

Cash and cash equivalents, end of year

Supplemental cash flow information

Net cash receipts from customers and other
Net cash payments for:

Employee services, suppliers and other expenses
Interest (Note 14)

Workforce reductions (Note 9)

Personal injury and other claims (Note 19)
Pensions (Note 13)
Income taxes (Note 16)

Cash provided from operating activities

See accompanying notes to consolidated financial statements.

Canadian National Railway Company

U.S. GAAP

602
366
4
–
–
–

(233)
10
5
21
106

2,139

(1,072)
(984)
(547)
192

(2,411)

(222)

8,277
(7,579)
86
(273)

511

17
130

560
411
(17)
–
–
(48)

153
(3)
(96)
(29)
31

591
272
(33)
281
120
–

(80)
–
(154)
(18)
(167)

1,976

1,612

(1,043)
–
–
(32)

(1,075)

(191)

4,109
(4,141)
83
(656)

(605)

105
25

(938)
–
–
14

(924)

(170)

3,146
(3,558)
69
(203)

(546)

(28)
53

$÷÷«147

$«««««130

$««««««25

$÷6,501

$÷6,022

$«6,285

(3,628)
(282)
(93)
(106)
(161)
(92)

(3,262)
(325)
(155)
(126)
(92)
(86)

(3,784)
(398)
(177)
(156)
(93)
(65)

$÷2,139

$÷1,976

$«1,612

Notes to Consolidated Financial Statements

Canadian National Railway Company (CN or the Company), directly and through its subsidiaries, is engaged in the rail and related transportation
business. CN 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, Alabama, and the key cities of Toronto, Buffalo, Chicago, Detroit, Duluth, Minnesota/
Superior, Wisconsin, Green Bay, Wisconsin, Minneapolis/St. Paul, Memphis, St. Louis and Jackson, Mississippi, with connections to all points in
North America. CN’s revenues are derived from the movement of a diversified and balanced portfolio of goods, including petroleum and chemicals,
grain and fertilizers, coal, metals and minerals, forest products, intermodal and automotive.

1 Summary of significant accounting policies

These consolidated financial statements are expressed in Canadian
dollars, except where otherwise indicated, and have been prepared in
accordance with accounting principles generally accepted in the United
States (U.S. GAAP). Significant differences between the accounting
principles applied in the accompanying financial statements and those
under Canadian generally accepted accounting principles (Canadian
GAAP) are quantified and explained in Note 22 to the financial state-
ments. 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 rev-
enues 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 personal injury and
other claims, environmental claims, depreciation, pensions and other
post-retirement benefits, and income taxes, based upon currently avail-
able information. Actual results could differ from these estimates.

A. Principles of consolidation
These consolidated financial statements include the accounts of all
subsidiaries, including Great Lakes Transportation LLC’s railroads and
related holdings (GLT) and BC Rail for which the Company acquired
control and consolidated effective May 10, 2004 and July 14, 2004,
respectively. The Company’s investments in which it has significant
influence are accounted for using the equity method and all other
investments are accounted for using the cost method.

B. Revenues
Freight revenues are recognized on services performed by the Company,
based on the percentage of completed service method. Costs associated
with movements are recognized as the service is performed.

C. Foreign exchange
All of the Company’s United States (U.S.) operations are self-sustain-
ing foreign entities with the U.S. dollar as their functional currency. The
Company also has an equity investment in an international affiliate
based in the United Kingdom with the British pound as its functional
currency. Accordingly, the U.S. operations’ assets and liabilities and the
Company’s foreign equity investment are translated into Canadian dol-
lars at the rate in effect at the balance sheet date and the revenues and
expenses are translated at average exchange rates during the year. All
adjustments resulting from the translation of the foreign operations are
recorded in Other comprehensive income (loss) (Note 21).

The Company designates the U.S. dollar denominated long-term
debt of the parent company as a foreign exchange hedge of its net
investment in U.S. subsidiaries. Accordingly, unrealized foreign exchange

gains and losses, from the dates of designation, on the translation of
the U.S. dollar denominated long-term debt are also included in Other
comprehensive income (loss).

D. Cash and cash equivalents
Cash and cash equivalents include highly liquid investments purchased
three months or less from maturity and are stated at cost, which
approximates market value.

E. Accounts receivable
Accounts receivable are recorded at cost net of the provision for doubt-
ful accounts that is based on expected collectibility. Any gains or losses
on the sale of accounts receivable are calculated by comparing the
carrying amount of the accounts receivable sold to the total of the cash
proceeds on sale and the fair value of the retained interest in such
receivables on the date of transfer. Fair values are determined on a dis-
counted cash flow basis. Costs related to the sale of accounts receivable
are recognized in earnings in the period incurred.

F. Material and supplies
Inventory is valued at weighted-average cost for ties, rails, fuel and new
materials in stores, and at estimated utility or sales value for usable
secondhand, obsolete and scrap materials.

G. Properties
Railroad properties are carried at cost less accumulated depreciation
including asset impairment write-downs. Labor, materials and other
costs associated with the installation of rail, ties, ballast and other track
improvements are capitalized to the extent they meet the Company’s
minimum threshold for capitalization. Included in property addi-
tions are the costs of developing computer software for internal use.
Maintenance costs are expensed as incurred.

The cost of railroad properties, less net salvage value, retired or
disposed of in the normal course of business is charged to accumulated
depreciation, in accordance with the group method of depreciation. The
Company reviews the carrying amounts of properties held and used
whenever events or changes in circumstances indicate that such carry-
ing amounts may not be recoverable based on future undiscounted cash
flows. Assets that are deemed impaired as a result of such review are
recorded at the lower of carrying amount or fair value.

Assets held for sale are measured at the lower of their carrying
amount or fair value, less cost to sell. Losses resulting from significant
line sales are recognized in income when the asset meets the criteria
for classification as held for sale whereas losses resulting from aban-
donment are recognized in income when the asset ceases to be used.
Gains are recognized in income when they are realized.

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

Summary of significant accounting policies (continued)

H. Depreciation
The cost of properties, including those under capital leases, net of asset
impairment write-downs, is depreciated on a straight-line basis over
their estimated useful lives as follows:

Asset class

Track and roadway

Rolling stock

Buildings

Other

Annual rate

The Company follows the group method of depreciation for railroad

properties and, as such, conducts comprehensive depreciation studies
on a periodic basis to assess the reasonableness of the lives of proper-
ties based upon current information and historical activities. Changes in
estimated useful lives are accounted for prospectively.

I. Intangible assets
Intangible assets relate to customer contracts and relationships
assumed through recent acquisitions and are being amortized on a
straight-line basis over 40 to 50 years.

J. Pensions
Pension costs are determined using actuarial methods. Net periodic
benefit cost is charged to income and includes:

(i)

the cost of pension benefits provided in exchange for employees’
services rendered during the year,

(ii)

the interest cost of pension obligations,

(iii) the amortization of the initial net transition obligation on a

straight-line basis over the expected average remaining service life
of the employee group covered by the plans,

(iv) the amortization of prior service costs and amendments over the

expected average remaining service life of the employee group
covered by the plans,

(v)

the expected long-term return on pension fund assets, and

(vi) the amortization of cumulative unrecognized net actuarial gains

and losses in excess of 10% of, the greater of the beginning of year
balances of the projected benefit obligation or market-related value
of plan assets, over the expected average remaining service life of
the employee group covered by the plans.

The pension plans are funded through contributions determined in

accordance with the projected unit credit actuarial cost method.

K. Post-retirement benefits other than pensions
The Company accrues the cost of post-retirement benefits other than
pensions using actuarial methods. These benefits, which are funded
by the Company as they become due, include life insurance programs,
medical benefits and free rail travel benefits.

The Company amortizes the cumulative unrecognized net actuarial
gains and losses in excess of 10% of the projected benefit obligation at
the beginning of the year, over the expected average remaining service
life of the employee group covered by the plans.

L. Personal injury claims
In Canada, the Company accounts for costs related to employee work-
related injuries based on actuarially developed estimates of the ultimate
cost associated with such injuries, including compensation, health care
and administration costs.

In the U.S., the Company accrues the expected cost for personal

injury claims and asserted occupational disease claims, based on
actuarial estimates of their ultimate cost. A liability for the minimum
amount of unasserted occupational disease claims is also accrued to
the extent they can be reasonably estimated.

M. Environmental expenditures
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 opera-
tions and which are not expected to contribute to current or future
operations are expensed. Liabilities are recorded when environmental
assessments and/or remedial efforts are likely, and when the 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.

N. Income taxes
The Company follows the asset and liability method of accounting for
income taxes. Under the asset and liability method, the change in the
net deferred tax asset or liability is included in the computation of net
income. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which
temporary differences are expected to be recovered or settled.

O. Derivative financial instruments
The Company uses derivative financial instruments in the management
of its fuel exposure, and may use them from time to time, in the man-
agement of its interest rate and foreign currency exposures. Derivative
instruments are recorded on the balance sheet at fair value and the
changes in fair value are recorded in earnings or other comprehensive
income (loss) depending on the nature and effectiveness of the hedge
transaction. Income and expense related to hedged derivative financial
instruments are recorded in the same category as that generated by
the underlying asset or liability.

P. Stock-based compensation
The Company follows the fair value based approach for stock option
awards and had prospectively applied this method of accounting to
all awards granted, modified or settled on or after January 1, 2003, as
explained in Note 2 – Accounting changes. The Company follows the
intrinsic value method for cash settled awards.

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

Prior to 2003, compensation cost was recorded for the intrinsic
value of the Company’s performance-based stock option awards and
no compensation cost was recognized for the Company’s conventional
awards, in accordance with Accounting Principles Board Opinion (APB)
25, “Accounting for Stock Issued to Employees,” and related interpreta-
tions. If compensation cost had been determined based upon fair values
at the date of grant for awards under all plans, the Company’s pro forma
net income and earnings per share would have been as follows:

Year ended December 31,

2004

2003

Net income, as reported (in millions)

Add (deduct) compensation cost,

net of applicable taxes, determined under:

Fair value method for all awards granted
after Jan. 1, 2003 (SFAS No. 123)

Intrinsic value method for performance-based
awards granted prior to 2003 (APB 25)

Fair value method for all awards (SFAS No. 123)

Pro forma net income (in millions)

Basic earnings per share, as reported

Basic earnings per share, pro forma

Diluted earnings per share, as reported

Diluted earnings per share, pro forma

$1,258

$1,014

9
(78)
$1,227

$÷4.41
$÷4.30

$÷4.34
$÷4.23

(53)

$÷«984

$÷3.54

$÷3.43

$÷3.49

$÷3.39

2002

$«800

–

(45)

$«764

$2.71

$2.59

$2.65

$2.53

Compensation cost related to stock option awards under the fair
value based approach was calculated using the Black-Scholes option-
pricing model with the following assumptions:

Year ended December 31,

2004 (1)

2003

Expected option life (years)

Risk-free interest rate

Expected stock price volatility

Average dividend per share

–
–
–
–

5.0

4.12%

30%

$÷0.67

2002

7.0

5.79%

30%

$÷0.57

Year ended December 31,

2004 (1)

2003

2002

Weighted average fair value of options granted

$«–

$11.88

$20.65

(1) The Company did not grant any stock option awards in 2004.

Q. Recent accounting pronouncement
In December 2004, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 123(R),
“Share-Based Payment,” which requires expensing of all options issued,
modified or settled based on the grant-date fair value and recognizing
the expense over the period during which an employee is required to
provide service (vesting period). The standard also requires that cash
settled awards be measured at fair value at each reporting date until
ultimate settlement. This standard is effective as of the beginning of
the first interim reporting period after June 15, 2005. The Company has
elected to apply the modified prospective approach, which requires
compensation cost to be recognized for unvested awards based on
their grant-date fair value. Pursuant to the application of this stan-
dard, stock-based compensation expense for the second half of 2005
will increase by approximately $10 million for awards outstanding at
December 31, 2004.

2 Accounting changes

2003
Asset retirement obligations
Effective January 1, 2003, the Company adopted the recommenda-
tions of the FASB’s SFAS No. 143, “Accounting for Asset Retirement
Obligations.” SFAS No. 143 requires that the fair value of an asset
retirement obligation be recorded as a liability only when there is a
legal obligation associated with a removal activity. The Company has
concluded that no legal obligation exists for its various removal pro-
grams. In accordance with SFAS No. 143, the Company changed its
accounting policy for certain track structure assets to exclude removal
costs as a component of depreciation expense where the inclusion of
such costs would result in accumulated depreciation balances exceeding
the historical cost basis of the assets. As a result, a cumulative benefit
of $75 million, or $48 million after tax, was recorded for the amount
of removal costs accrued in accumulated depreciation on certain track
structure assets at January 1, 2003. This change in policy will result in
lower depreciation expense and higher labor and fringe benefits and
other expenses in the period in which removal costs are incurred. For
the year ended December 31, 2003, this change in policy resulted in an
increase to net income of $2 million ($0.01 per basic and diluted share).
Had the Company applied this accounting policy retroactively to 2002,
pro forma net income and earnings per share would have been as follows:

Net income, as reported (in millions)

Effect of SFAS No. 143

Pro forma net income (in millions)

Basic earnings per share, as reported

Basic earnings per share, pro forma

Diluted earnings per share, as reported

Diluted earnings per share, pro forma

Year ended December 31,

2002

$«800

$«806

$2.71

$2.73

$2.65

$2.67

Stock-based compensation
Effective January 1, 2003, the Company voluntarily adopted the fair
value based approach of SFAS No. 123, “Accounting for Stock-Based
Compensation,” as amended by SFAS No. 148, “Accounting for Stock-
Based Compensation – Transition and Disclosure.” The Company elected
to prospectively apply this method of accounting to all stock option
awards granted, modified or settled on or after January 1, 2003, as
permitted by SFAS No. 148. Prior to 2003, the Company accounted for
stock-based compensation in accordance with APB 25, “Accounting for
Stock Issued to Employees,” and related interpretations. Accordingly,
compensation cost was recorded for the intrinsic value of the
Company’s performance-based stock option awards and no compen-
sation cost was recognized for the Company’s conventional awards.
In 2003, the Company granted 3.0 million stock options, which
will be expensed over their vesting period based on their estimated fair
value on the date of grant, determined using the Black-Scholes option-
pricing model. For the year ended December 31, 2003, the Company
recorded compensation cost of $23 million, of which $10 million ($0.03
per basic and diluted share) was related to the change in policy. For the
year ended December 31, 2002, the Company recorded compensation
cost of $9 million.

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

2 Accounting changes (continued)

2002
U.S. personal injury and other claims
In the fourth quarter of 2002, the Company changed its methodology
for estimating its liability for U.S. personal injury and other claims,
including occupational disease claims and claims for property dam-
age, from a case-by-case approach to an actuarial-based approach.
Consequently, for the year ended December 31, 2002, the Company
recorded a charge of $281 million ($173 million after tax) to increase
its provision for these claims.

Under the actuarial-based approach, the Company accrues the
expected cost for personal injury and property damage claims and
asserted occupational disease claims, based on actuarial estimates of
their ultimate cost. The Company is unable to estimate the total cost
for unasserted occupational disease claims. However, a liability for
unasserted occupational disease claims was accrued to the extent they
were reasonably estimable.

Under the case-by-case approach, a liability was recorded only
when the expected loss was both probable and reasonably estimable
based on currently available information. In addition, the Company did
not record a liability for unasserted claims, as such amounts could not
be reasonably estimated under the case-by-case approach.

In 2002, the Company’s U.S. personal injury and other claims
expense, including the above-mentioned charge, was $362 million. Had
the Company continued to apply the case-by-case approach to its U.S.
personal injury and other claims liability, recognizing the effects of the
actual claims experience for existing and new claims in the fourth quarter,
these expenses would have been approximately $135 million in 2002.

3 Acquisitions

On July 2, 2004, the Company reached a consent agreement with

On July 14, 2004, the Company completed its acquisition of BC
Rail and began a phased integration of the companies’ operations. The
acquisition was financed by debt and cash on hand.

The Company accounted for the acquisition using the pur-
chase method of accounting as required by SFAS No. 141, “Business
Combinations” and SFAS No. 142, “Goodwill and Other Intangible

Assets.” As such, the accompanying consolidated financial statements
include the assets, liabilities and results of operations of BC Rail as of
July 14, 2004, the date of acquisition. The Company’s cost to acquire BC
Rail of $991 million includes purchase price adjustments and transac-
tion costs. The following table reflects the preliminary purchase price
allocation, based on the fair value of BC Rail’s assets acquired, owned
and leased, and liabilities assumed at acquisition, which is subject to a
final valuation, the impact of which is not expected to have a material
effect on the results of operations.

In millions

Current assets

Deferred income taxes

Properties

Other assets

Total assets acquired

Current liabilities

Other liabilities and deferred credits

Long-term debt

Total liabilities assumed

Net assets acquired

July 14, 2004

$÷«202

397

620

1,222

142

231

$÷«991

As of April 2004, the Company received all necessary regulatory

approvals, including the U.S. Surface Transportation Board (STB) ruling
rendered on April 9, 2004.

On May 10, 2004, the Company completed its acquisition of GLT

and began a phased integration of the companies’ operations. The
acquisition was financed by debt and cash on hand.

The Company accounted for the acquisition using the purchase
method of accounting. As such, the accompanying consolidated finan-
cial statements include the assets, liabilities and results of operations
of GLT as of May 10, 2004, the date of acquisition. The Company’s cost
to acquire GLT of U.S.$395 million (Cdn$547 million) includes purchase
price adjustments and transaction costs. The following table reflects the
preliminary purchase price allocation, based on the fair value of GLT’s
assets acquired and liabilities assumed at acquisition, which is subject
to a final valuation, the impact of which is not expected to have a
material effect on the results of operations.

In millions

Current assets

Properties

Intangible and other assets

Total assets acquired

Current liabilities

Deferred income taxes

Other liabilities and deferred credits

Total liabilities assumed

Net assets acquired

May 10, 2004

$÷÷«67

977

1,131

290

230

584

$÷«547

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

If the Company had acquired BC Rail and GLT on January 1, 2003,
based on their respective historical amounts, net of the amortization
of the difference between the Company’s cost to acquire BC Rail and
GLT and their respective net assets (based on preliminary estimates of
the fair values of BC Rail’s and GLT’s assets and liabilities), revenues,
income before cumulative effect of change in accounting policy, net
income, and basic and diluted earnings per share for the year ended
December 31, 2004 and 2003 would have been as follows:

4 Accounts receivable

In millions

Freight

Trade

Accrued

Non-freight

Provision for doubtful accounts

December 31,

2004

2003

$414
93
356
863
(70)
$793

$252

277

584

(55)

$529

In millions, except per share data

Year ended December 31,

Revenues

Income before cumulative effect of
change in accounting policy

Net income

Basic earnings per share

Income before cumulative effect of
change in accounting policy

Net income

Diluted earnings per share

Income before cumulative effect of
change in accounting policy

Net income

2004

2003

$6,773

$6,428

$1,272
$1,272

$1,026

$1,077

$÷4.46
$÷4.46

$÷3.58

$÷3.76

$÷4.39
$÷4.39

$÷3.53

$÷3.70

The pro forma figures for both BC Rail and GLT do not reflect syn-

ergies, and accordingly, do not account for any potential increases in
operating income, any estimated cost savings or facilities consolidation.

The Company has an accounts receivable securitization program,
expiring in June 2006, under which it may sell, on a revolving basis, a
maximum of $450 million of eligible freight trade and other receivables
outstanding at any point in time, to an unrelated trust. The Company
has a contingent residual interest of approximately 10% of receivables
sold, which is recorded in Other current assets. The Company has
retained the responsibility for servicing, administering and collecting
freight receivables sold. Other income (loss) included $9 million in each
of 2004, 2003 and 2002, for costs related to the agreement, which fluc-
tuate with changes in prevailing interest rates.

At December 31, 2004, pursuant to the agreement, $445 million

had been sold compared to $448 million at December 31, 2003.

5 Properties

In millions

Track, roadway and land

Rolling stock

Buildings

Other

Capital leases included in properties

Track and roadway

Rolling stock

Buildings

Other

December 31, 2004

Accumulated
depreciation

$6,300

1,549

877

506

Cost

$21,524

4,336

2,009

1,078

$28,947

$9,232

$÷÷«395

1,155

113

119

$÷÷÷«5

241

$÷1,782

$÷«262

Net

$15,224
2,787
1,132
572
$19,715

$÷÷«390
914
106
110
$÷1,520

December 31, 2003

Accumulated
depreciation

$6,122

1,498

918

500

Cost

$20,613

3,942

1,867

921

Net

$14,491

2,444

949

421

$27,343

$9,038

$18,305

$÷÷÷«41

1,213

105

$÷÷÷«2

260

$÷÷÷«39

953

$÷1,383

$÷«274

$÷1,109

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

6 Intangible and other assets

7 Credit facility

In millions

December 31,

Prepaid benefit cost (Note 13)

Investments (A)

Deferred receivables

Intangible assets (B)

Note receivable from EWS

Unamortized debt issue costs

Other

2004

$515
166
77
69
57
35
21
$940

2003

$411

367

–

$905

A. Investments
As at December 31, 2004, the Company had $157 million ($356 million
at December 31, 2003) of investments accounted for under the equity
method and $9 million ($11 million at December 31, 2003) of invest-
ments accounted for under the cost method.

Investment in English Welsh and Scottish Railway (EWS)
As at December 31, 2004, the Company owned approximately 32%
of EWS, a company which provides most of the rail freight services in
Great Britain and operates freight trains through the English Channel
tunnel, and accounted for this investment using the equity method. At
December 31, 2004, the excess of the Company’s share of the book
value of EWS’ net assets over the carrying value of the investment was
not significant.

On January 6, 2004, EWS shareholders approved a plan to reduce
the EWS share capital to enable cash to be returned to the shareholders
by offering them the ability to cancel a portion of their EWS shares. For
each share cancelled, EWS shareholders would receive a combination of
cash and notes receivable. The Company elected to have the maximum
allowable number of shares cancelled under the plan, thereby reducing
its ownership interest in EWS to approximately 31% on a fully diluted
basis (13.7 million shares) compared to approximately 37% on a fully
diluted basis (43.7 million shares) prior to the capital reorganization. In
the first quarter of 2004, the Company received £57.7 million (Cdn$141
million) in cash and a note receivable of £23.9 million (Cdn$58 million)
from EWS. The note receivable is due in 2009, carries interest at 8% and
is redeemable in whole or in part at any time by EWS, at the principal
amount together with accrued but unpaid interest up to the date of
repayment.

B. Intangible assets
Intangible assets relate to customer contracts and relationships
assumed through the GLT acquisition.

The Company has a U.S.$1,000 million three-year revolving credit facil-
ity expiring in December 2005, which it intends to renew before such
date. The credit facility provides for borrowings at various interest rates,
including the Canadian prime rate, bankers’ acceptance rates, the U.S.
federal funds effective rate and the London Interbank Offer Rate, plus
applicable margins. The credit facility agreement contains customary
financial covenants, based on U.S. GAAP, including limitations on debt
as a percentage of total capitalization and maintenance of tangible net
worth above pre-defined levels. The Company has been in compliance
with these financial covenants. The Company’s borrowings of U.S.$180
million (Cdn$233 million) outstanding at December 31, 2003 at an
average interest rate of 1.49% were entirely repaid in the first quarter
of 2004. At December 31, 2004, the Company had borrowings under its
revolving credit facility of U.S.$90 million (Cdn$108 million) at an aver-
age interest rate of 2.77% and letters of credit drawn of $342 million.
The Company’s commercial paper program is backed by its revolv-
ing credit facility. As at December 31, 2004, the Company had U.S.$211
million (Cdn$254 million) of commercial paper outstanding at an aver-
age interest rate of 2.37%, compared to no commercial paper outstand-
ing as at December 31, 2003.

8 Accounts payable and accrued charges

December 31,

In millions

Trade payables

Income and other taxes

Payroll-related accruals

Accrued charges

Personal injury and other claims provision

Accrued interest

Workforce reduction provisions

Other

2004

$÷«491
310
259
179
118
106
90
52
$1,605

2003

$÷«444

270

205

131

123

$1,421

9 Other liabilities and deferred credits

In millions

December 31,

2004

2003

Personal injury and other claims provision,

net of current portion

Workforce reduction provisions, net of current portion (A)

Accrual for post-retirement benefits other than pensions (B)

Accrued benefit cost for pensions (Note 13)

Environmental reserve, net of current portion

Additional minimum pension liability (Note 13)

Deferred credits and other

$÷«524
149
284
156
93
22
285
$1,513

$÷«467

136

139

126

243

$1,203

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

A. Workforce reduction provisions
The workforce reduction provisions, which cover employees in both
Canada and the United States, are mainly comprised of payments related
to severance, early retirement incentives and bridging to early retirement,
the majority of which will be disbursed within the next five years. In
2004, liabilities assumed through recent acquisitions and other charges
and adjustments increased the provisions by $107 million. Payments have
reduced the provisions by $93 million for the year ended December 31,
2004 ($155 million for the year ended December 31, 2003). As at
December 31, 2004, the aggregate provisions, including the current por-
tion, amounted to $239 million ($225 million as at December 31, 2003).

In 2002, the Company had announced 1,146 job reductions in a
renewed drive to improve productivity in all its corporate and operating
functions, and recorded a charge of $120 million, $79 million after tax.
Reductions relating to this charge were completed in 2003.

(iv) Weighted-average assumptions

December 31,

2004

2003

2002

To determine benefit obligation

Discount rate

Rate of compensation increase

To determine net periodic benefit cost

Discount rate

Rate of compensation increase

5.90%
3.75%

6.00%
3.75%

6.00%

3.75%

6.69%

4.00%

6.69%

4.00%

7.14%

4.00%

(v) For measurement purposes, increases in the per capita cost of cov-
ered health care benefits were assumed to be 14% for 2005 and 15%
for 2004. It is assumed that the rate will decrease gradually to 6% in
2013 and remain at that level thereafter.

A one-percentage-point change in the assumed health care cost

trend rates would have the following effect:

B. Post-retirement benefits other than pensions

In millions

One-percentage-point

Increase

Decrease

$÷2

$÷(2)

(24)

Effect on total service and interest costs

Effect on benefit obligation

The Medicare Prescription Drug, Improvement, and Modernization Act
of 2003 (the “Act”), signed into law in the United States in December
2003, provides for prescription drug benefits under Medicare, as well
as a federal subsidy to sponsors of retiree health care benefit plans
that provide prescription drug benefits that have been concluded to
be actuarially equivalent to the Medicare benefit. Pursuant to FASB
Staff Position 106-2, “Accounting and Disclosure Requirements Related
to the Medicare Prescription Drug, Improvement and Modernization
Act of 2003,” adopted on July 1, 2004, the Company evaluated and
determined the prescription drug benefits provided by its health care
plans to be actuarially equivalent to the Medicare benefit under the
Act. The Company measured the effects of the Act on the accumulated
post-retirement benefit obligation (APBO) as of January 1, 2004 and, as
such, the APBO was reduced by $49 million. Net periodic benefit cost
for the year ended December 31, 2004 was reduced by $7 million due
to the effects of the Act.

(vi) The estimated future benefit payments for each of the next five
years and the subsequent five-year period are as follows:

(i) Change in benefit obligation

In millions

Year ended December 31,

Benefit obligation at beginning of year

Acquisition of GLT and BC Rail

Amendments

Actuarial (gain) loss

Interest cost

Service cost

Foreign currency changes

Benefits paid

2004

$«309

151

(12)

(111)

(25)

(18)

2003

$311

–

(44)

(18)

Benefit obligation at end of year

$«319

$309

The Company uses a measurement date of September 30 for its U.S. plans and December 31
for its Canadian plans.

(ii) Funded status

In millions

December 31,

Unfunded benefit obligation at end of year

Unrecognized net actuarial gain (loss)

Unrecognized prior service cost

Accrued benefit cost for post-retirement benefits

other than pensions (including current portion)

2004

$319
6
(16)

2003

$«309

(112)

(33)

$309

$«164

(iii) Components of net periodic benefit cost

In millions

Year ended December 31,

Interest cost

Service cost

Amortization of prior service cost

Recognized net actuarial loss

Net periodic benefit cost

2004

$17
8
3
1
$29

2003

$18

2002

$15

In millions

2005

2006

2007

2008

2009

$33

$25

Years 2010 to 2014

$÷20

130

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

10 Long-term debt

In millions

Debentures and notes: (A)

Canadian National series:

7.00% 10-year notes

6.45% Puttable Reset Securities (PURS) (B)

4.25% 5-year notes (C)

6.38% 10-year notes (C)

4.40% 10-year notes (C)

6.80% 20-year notes (C)

7.63% 30-year debentures

6.90% 30-year notes (C)

7.38% 30-year debentures (C)

6.25% 30-year notes (C)

Illinois Central series:

7.75% 10-year notes

6.98% 12-year notes

6.63% 10-year notes

5.00% 99-year income debentures

7.70% 100-year debentures

Wisconsin Central series:

6.63% 10-year notes

BC Rail series:

Currency
in which
payable

Maturity

Mar. 15, 2004

July 15, 2006

Aug. 1, 2009

Oct. 15, 2011

Mar. 15, 2013

July 15, 2018

May 15, 2023

July 15, 2028

Oct. 15, 2031

Aug. 1, 2034

May 1, 2005

July 12, 2007

June 9, 2008

Dec. 1, 2056

Sept. 15, 2096

April 15, 2008

U.S.$

Non-interest bearing 90-year subordinated notes (D)

July 14, 2094

CDN$

Total debentures and notes

Other:

Revolving credit facility (A) (Note 7)

Commercial paper (E) (Note 7)

Capital lease obligations and other (F)

Total other

Less:

Current portion of long-term debt

Net unamortized discount

U.S.$

Various

December 31,

2004

2003

$÷«÷÷–

$÷«344

301

361

482

241

181

572

241

602

120

151

181

4,008

843

4,851

108

254

805

1,167

6,018

578

854

1,432

324

–

518

259

194

615

259

–

129

162

194

3,617

–

3,617

233

–

822

1,055

4,672

483

497

A. The Company’s debentures, notes and revolving credit facility are
unsecured.

B. The PURS contain imbedded simultaneous put and call options at
par. At the time of issuance, the Company sold the option to call the
securities on July 15, 2006 (the reset date). If the call option is exer-
cised, the imbedded put option is automatically triggered, resulting in
the redemption of the original PURS. The call option holder will then
have the right to remarket the securities at a new coupon rate for an
additional 30-year term ending July 15, 2036. The new coupon rate will
be determined according to a pre-set mechanism based on market con-
ditions then prevailing. If the call option is not exercised, the put option
is deemed to have been exercised, resulting in the redemption of the
PURS on July 15, 2006.

C. These debt securities are redeemable, in whole or in part, at the
option of the Company, at any time, at the greater of par and a formula
price based on interest rates prevailing at the time of redemption.

$4,586

$4,175

D. The Company records these notes as a discounted debt of $5 million,
using an imputed interest rate of 5.75%. The discount of $838 million is
included in the net unamortized discount.

E. The Company has a commercial paper program, which is backed by
its revolving credit facility, enabling it to issue commercial paper up to
a maximum aggregate principal amount of $800 million, or the U.S. dol-
lar equivalent. At December 31, 2004, the amounts outstanding under
both the revolving credit facility and the commercial paper program
have been presented as short-term debt given the maturity in December
2005 of the revolving credit facility. During 2003, the commercial paper
debt was due within one year but was classified as long-term debt,
reflecting the Company’s intent and contractual ability to refinance
the short-term borrowing through subsequent issuances of commercial
paper or drawing down on the revolving credit facility.

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

F. Interest rates for the capital leases range from approximately
2.23% to 13.13% with maturity dates in the years 2005 through 2025.
The imputed interest on these leases amounted to $342 million as at
December 31, 2004 and $395 million as at December 31, 2003.

The capital lease obligations are secured by properties with a
net carrying amount of $1,080 million as at December 31, 2004 and
$1,110 million as at December 31, 2003.

During 2004, the Company recorded $160 million in assets it
acquired through the exercise of purchase options on existing leases
and leases for new equipment ($47 million in 2003). An equivalent
amount was recorded in debt.

G. Long-term debt maturities, including repurchase arrangements and
capital lease repayments on debt outstanding as at December 31, 2004,
for the next five years and thereafter, are as follows:

In millions

2005

2006

2007

2008

2009

2010 and thereafter

$÷«578

376

154

230

427

3,399

H. The aggregate amount of debt payable in U.S. currency as at
December 31, 2004 is U.S.$4,022 million (Cdn$4,845 million) and
U.S.$3,273 million (Cdn$4,236 million) as at December 31, 2003.

I. The Company has U.S.$200 million available under its currently
effective shelf prospectus and registration statement providing for
the issuance of debt securities in one or more offerings.

11 Capital stock and convertible preferred securities

A. Authorized capital stock
The authorized capital stock of the Company is as follows:
•
•

Unlimited number of Common Shares, without par value
Unlimited number of Class A Preferred Shares, without par value
issuable in series
Unlimited number of Class B Preferred Shares, without par value
issuable in series

•

B. Issued and outstanding common shares
During 2004, the Company issued 2.9 million shares (2.9 million shares
in 2003 and 2.7 million shares in 2002) related to stock options exer-
cised. The total number of common shares issued and outstanding was
283.1 million as at December 31, 2004.

In 2002, the Company issued 9.0 million common shares related to

the conversion of the Company’s convertible preferred securities.

C. Convertible preferred securities (“Securities”)
On May 6, 2002, the Company met the conditions required to terminate
the Securities holders’ right to convert their Securities into common
shares of the Company, and had 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.$25.65 per
share for a specified period, and all accrued interest on the Securities

had been paid. On July 3, 2002, Securities that had not been previously
surrendered for conversion were deemed converted, resulting in the
issuance of 9.0 million common shares of the Company.

In 1999, the Company had issued 6.9 million 5.25% Securities due
on June 30, 2029, at U.S.$33.33 per Security. These Securities were sub-
ordinated securities convertible into common shares of CN at the option
of the holder at an original conversion price of U.S.$25.65 per common
share, representing an original conversion rate of 1.2995 common
shares for each Security.

D. Share repurchase program
On October 26, 2004, the Board of Directors of the Company approved
a share repurchase program which allows for the repurchase of up to
14.0 million common shares between November 1, 2004 and October 31,
2005 pursuant to a normal course issuer bid, at prevailing market prices.
As at December 31, 2004, 4.0 million common shares have been repur-
chased for $273 million, at an average price of $68.31 per share.

The Company’s previous share repurchase program initiated in
2002 allowed for the repurchase of up to 19.5 million common shares
between October 25, 2002 and October 24, 2003 pursuant to a normal
course issuer bid, at prevailing market prices. By October 2003, the
Company had completed its program, repurchasing 19.5 million com-
mon shares for $859 million, at an average price of $44.04 per share
(15.0 million and 4.5 million shares in 2003 and 2002, respectively).

E. Common stock split
On January 27, 2004, the Board of Directors of the Company approved
a three-for-two common stock split which was effected in the form of
a stock dividend of one-half additional common share of CN payable
for each share held. The stock dividend was paid on February 27, 2004,
to shareholders of record on February 23, 2004. All equity-based ben-
efit plans were adjusted to reflect the issuance of additional shares or
options due to the declaration of the stock split. All share and per share
data has been adjusted to reflect the stock split.

12 Stock plans

The Company has various stock-based incentive plans for eligible
employees. A description of the Company’s major plans is provided
below:

Employee share investment plan
The Company has an Employee Share Investment Plan (ESIP) giving
eligible employees the opportunity to subscribe for up to 10% (6% prior
to 2003) of their gross salaries to purchase shares of the Company’s
common stock on the open market and to have the Company invest,
on the employees’ behalf, a further 35% of the amount invested by the
employees, up to 6% of their gross salaries. Participation at December 31,
2004 was 10,073 employees (8,894 at December 31, 2003 and 8,911
at December 31, 2002). The total number of ESIP shares purchased
on behalf of employees, including the Company’s contributions, was
723,663 in 2004, 855,210 in 2003 and 746,189 in 2002, resulting in a
pre-tax charge to income of $11 million, $8 million and $9 million for
the years ended December 31, 2004, 2003 and 2002, respectively.

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

12 Stock plans (continued)

Stock-based plans
Compensation cost for awards under all stock-based plans was $65 mil-
lion, $23 million and $9 million for the years ended December 31, 2004,
2003 and 2002, respectively.

A. Restricted share units
In 2004, the Company granted approximately 1.2 million restricted
share units (RSUs) to designated management employees entitling them
to receive payout in cash based on the Company’s share price. The RSUs
granted are generally scheduled for payout after three years and vest
upon the attainment of targets relating to return on invested capital
over the three-year period and to the Company’s share price during
the three-month period ending December 31, 2006. If specified targets
related to the Company’s 20-day average share price are attained
during any period ending on or after December 31, 2005, payout can
be accelerated. For the year ended December 31, 2004, the Company
recorded compensation cost of $36 million for RSUs.

B. Mid-term incentive share unit plan
The mid-term incentive share unit plan, approved by the Board of
Directors in 2001, entitled designated senior management employees to
receive payout on June 30, 2004. The share units vested conditionally
upon the attainment of targets relating to the Company’s share price
during the six-month period ending June 30, 2004. On June 30, 2004,
upon the partial attainment of these targets, the Company recorded
additional compensation cost of $13 million based on the number of
share units vested multiplied by the Company’s share price on such
date. For the year ended December 31, 2003, the Company recorded
compensation cost of $7 million related to the plan and no compensa-
tion cost was recorded for 2002.

C. Voluntary incentive deferral plan
The Company has a voluntary incentive deferral plan (VIDP), provid-
ing eligible senior management employees the opportunity to elect to
receive their annual incentive bonus payment and other eligible incen-
tive payments in deferred share units (DSUs). For each participant, the
Company will grant 25% of DSUs, which will vest over a period of four
years. A DSU is equivalent to a common share of the Company and
also earns dividends when normal cash dividends are paid on common
shares. The number of DSUs received by each participant is established
using the average closing price for the 20 trading days prior to and
including the date of the incentive payment. The value of each partici-
pant’s DSUs is payable in cash at the time of cessation of employment.

At December 31, 2004, the total liability under the VIDP was $22

million, representing 354,745 units outstanding under the plan. For the
year ended December 31, 2004, the Company recognized an expense of
$7 million related to the plan.

D. Stock options
The Company has stock option plans for eligible employees to acquire
common shares of the Company upon vesting at a price equal to the
market value of the common shares at the date of granting. The options
are exercisable during a period not exceeding 10 years. The right to
exercise options generally accrues over a period of four years of contin-
uous employment. Options are not generally exercisable during the first
12 months after the date of grant. At December 31, 2004, an additional
1.2 million common shares remained authorized for future issuances
under these plans.

Options issued by the Company include conventional options,
which vest over a period of time, performance options, which vest upon
the attainment of Company targets relating to the operating ratio and
unlevered return on investment, and performance-accelerated options,
which vest on the sixth anniversary of the grant or prior if certain
Company targets relating to return on investment and revenues are
attained. The total conventional, performance, and performance-acceler-
ated options outstanding at December 31, 2004 were 8.9 million, 1.3
million and 2.9 million, respectively.

Changes in the Company’s stock options are as follows:

Outstanding at December 31, 2001 (1)
Granted

Canceled and expired

Exercised

Outstanding at December 31, 2002 (1)
Granted

Canceled and expired

Exercised

Outstanding at December 31, 2003 (1)
Granted

Canceled and expired

Exercised

Outstanding at December 31, 2004 (1)

Weighted-
average
exercise price

Number
of options

In millions

14.9

4.8

(0.3)

(2.7)

16.7

3.0

(0.6)

(2.9)

16.2

–

(0.2)

(2.9)

13.1

$29.08

$51.19

$37.99

$26.11

$35.67

$40.95

$45.11

$26.60

$37.16

–

$42.58

$28.70

$38.85

(1) Includes IC and WC converted stock options translated to Canadian dollars using the

foreign exchange rate in effect at the balance sheet date.

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

Stock options outstanding and exercisable as at December 31, 2004 were as follows:

Range of exercise prices

$ 9.00–$16.02

$18.13–$27.08

$27.31–$33.35

$37.17–$49.21

$51.05–$58.44

Balance at December 31, 2004 (1)

Options outstanding

Options exercisable

Number
of options

In millions

0.2

1.6

4.1

3.1

4.1

13.1

Weighted-
average years
to expiration

Weighted-
average
exercise price

$15.40

$23.33

$32.10

$40.98

$51.19

$38.85

Weighted-
average
exercise price

Number
of options

In millions

0.2

1.6

3.3

1.1

2.0

8.2

$15.40

$23.33

$31.82

$41.03

$51.20

$35.55

(1) Includes IC and WC converted stock options translated to Canadian dollars using the foreign exchange rate in effect at the balance sheet date.

At December 31, 2003 and 2002, the Company had 7.5 million and 7.4 million options exercisable at a weighted-average exercise price of

$31.39 and $29.34, respectively.

Compensation cost for awards of employee stock options granted,

modified or settled on or after January 1, 2003 was determined using
the fair value based approach in accordance with SFAS No. 123,
“Accounting for Stock-Based Compensation,“ as amended by SFAS
No. 148, “Accounting for Stock-Based Compensation – Transition and
Disclosure,“ as explained in Note 2 – Accounting changes. Prior to
2003, compensation cost was recorded for the intrinsic value of the
Company’s performance-based stock option awards and no compensa-
tion cost was recognized for the Company’s conventional stock option
awards, in accordance with APB 25, “Accounting for Stock Issued to
Employees,” and related interpretations. Compensation cost recognized
for stock option awards was $9 million, $16 million and $9 million
in 2004, 2003 and 2002, respectively. Disclosures required under the
fair value measurement and recognition method for awards under all
plans, as prescribed by SFAS No. 123, “Accounting for Stock-Based
Compensation,” as well as the assumptions used to calculate com-
pensation cost related to stock option awards are presented in
Note 1 – Summary of significant accounting policies.

13 Pensions

The Company has various retirement benefit plans under which sub-
stantially all of its employees are entitled to benefits at retirement
age, generally based on compensation and length of service and/or
contributions. The information in the tables that follow pertains to all
such plans. However, the following descriptions relate solely to the
Company’s main pension plan, the CN Pension Plan (the Pension Plan),
unless otherwise specified.

performs certain duties, which include holding legal title to the assets
of the CN Pension Trust Funds and ensuring that the Company, as
Administrator, complies with the provisions of the Pension Plan and
the related legislation. The Company utilizes a measurement date of
December 31 for the Pension Plan.

Funding policy
Employee contributions to the Pension Plan are determined by the
plan rules. Company contributions are in accordance with the require-
ments of the Government of Canada legislation, The Pension Benefits
Standards Act, 1985, and are determined by actuarial valuations con-
ducted at least on a triennial basis. These valuations are made in accor-
dance with legislative requirements and with the recommendations of
the Canadian Institute of Actuaries for the valuation of pension plans.
The latest actuarial valuation of the Pension Plan was conducted as at
December 31, 2003 and indicated a funding excess. Total contributions
for all of the Company’s pension plans are expected to be approxi-
mately $120 million in each of 2005, 2006 and 2007 based on the
plans’ current position. All of the Company’s contributions are expected
to be in the form of cash.

Description of fund assets
The assets of the Pension Plan are accounted for separately in the CN
Pension Trust Funds and consist of cash and short-term investments,
bonds, mortgages, Canadian and foreign equities, real estate, and
oil and gas assets. The assets of the Pension Plan have a fair market
value of $12,256 million as at December 31, 2004 ($11,573 million at
December 31, 2003). The Pension Plan’s target percentage allocation
and weighted-average asset allocations as at December 31, 2004 and
2003, by asset category are as follows:

Plan assets by category

Target
Allocation

December 31,

2004

Equity securities

Debt securities

Real estate

Other

53%
40%
4%
3%
100%

56%
34%
3%
7%
100%

2003

56%

38%

100%

U.S. GAAP

Canadian National Railway Company

$11,671
611
165
55
(15)
1,371
(805)
$13,053

$11,182

–

(15)

1,049

(695)

$11,671

December 31,

2004

2003

$«(84)
368
75
$359

$(349)

540

$«285

2003

$«411

(126)

(30)

$«285

In millions

Year ended December 31,

2004

2003

Notes to Consolidated Financial Statements

13 Pensions (continued)

(b) Change in plan assets

The Company follows a disciplined investment strategy, which lim-
its concentration of investments by asset class, foreign currency, sector
or company. The Investment Committee of the Board of Directors has
approved an investment policy that establishes long-term asset mix
targets based on a review of historical returns achieved by worldwide
investment markets. Investment managers may deviate from these
targets but their performance is evaluated in relation to the market
performance of the target mix. The Company does not anticipate the
return on plan assets to fluctuate materially from related capital market
indices. The Investment Committee reviews investments regularly with
specific approval required for major investments in illiquid securities.
The policy also permits the use of derivative financial instruments to
implement asset mix decisions or to hedge existing or anticipated expo-
sures. The Pension Plan does not invest in the securities of the Company
or its subsidiaries.

Fair value of plan assets at beginning of year

Acquisition of GLT and BC Rail

Employer contributions

Plan participants’ contributions

Foreign currency changes

Actual return on plan assets

Benefit payments and transfers

Fair value of plan assets at end of year

In millions

Deficiency of fair value of plan assets over
benefit obligation at end of year (1)

Unrecognized net actuarial loss (1)
Unrecognized prior service cost

Net amount recognized

Weighted-average assumptions

December 31,

2004

2003

2002

(1) Subject to future reduction for gain sharing under the terms of the plan.

To determine benefit obligation

Discount rate

Rate of compensation increase

To determine net periodic benefit cost

Discount rate

Rate of compensation increase

Expected return on plan assets

5.75%
3.75%

6.00%
3.75%
8.00%

(d) Amount recognized in the Consolidated Balance Sheet

6.00%

3.75%

6.50%

4.00%

In millions

December 31,

6.50%

4.00%

8.00%

6.50%

4.00%

9.00%

Prepaid benefit cost (Note 6)

Accrued benefit cost (Note 9)

Additional minimum pension liability (Note 9)

Accumulated other comprehensive loss (Note 21)

Net amount recognized

2004

$«515
(156)
(22)
22
$«359

Information about the Company’s defined benefit pension plans:

(a) Change in benefit obligation

In millions

Year ended December 31,

2004

2003

(e) Additional information

In millions

Year ended December 31,

2004

2003

2002

Adjustment to minimum pension liability as a

component of other comprehensive income (loss)

$(20)

The accumulated benefit obligation for all defined benefit pension
plans was $12,450 million and $11,381 million at December 31, 2004
and 2003, respectively. The projected benefit obligation, accumu-
lated benefit obligation, and fair value of plan assets for the pension
plan with an accumulated benefit obligation in excess of plan assets
were $98 million, $93 million, and $86 million, respectively, as at
December 31, 2004, and $103 million, $98 million, and $74 million,
respectively, as at December 31, 2003.

Benefit obligation at beginning of year

Acquisition of GLT and BC Rail

Interest cost

Actuarial loss

Service cost

Plan participants’ contributions

Foreign currency changes

Benefit payments and transfers

Benefit obligation at end of year

$12,020
684
733
349
124
55
(23)
(805)
$13,137

$11,376

(f) Components of net periodic benefit cost

–

720

482

103

(26)

(695)

$12,020

In millions

Year ended December 31,

Service cost

Interest cost

Amortization of net transition obligation

Amortization of prior service cost

Expected return on plan assets

Recognized net actuarial loss

Net periodic benefit cost

2004

$«124
733
–
19
(857)
3
$÷«22

2003

$«103

720

(819)

2002

$«108

722

(874)

$÷«49

$÷÷«–

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

(g) Estimated future benefit payments

The following table provides tax information for Canada and the

The estimated future benefit payments for each of the next five years
and the subsequent five-year period are as follows:

United States:

In millions

Year ended December 31,

2004

2003

2002

(1) Before cumulative effect of change in accounting policy.

Significant components of deferred income tax assets and liabilities

In millions

2005

2006

2007

2008

2009

Income before income taxes (1)
Canada

$÷«957

U.S.

821

845

869

893

Current income taxes

Canada

Years 2010 to 2014

4,760

U.S.

14 Interest expense

In millions

Year ended December 31,

Interest on debt and capital leases

Interest income

Cash interest payments

15 Other income (loss)

In millions

Year ended December 31,

Gain on disposal of properties

Investment income

Foreign exchange gain (loss)

Equity in earnings of English Welsh
and Scottish Railway (Note 6)

Net real estate costs

Other

16 Income taxes

2004

$294
–
$294

$282

2004

$«32
5
(2)

(4)
(18)
(33)
$(20)

2003

$316

(1)

$315

$325

2003

$«56

(3)

(19)

(31)

2002

$361

–

$361

$398

2002

$«41

(15)

(13)

Deferred income taxes

Canada

U.S.

are as follows:

In millions

Deferred income tax assets

Workforce reduction provisions

Personal injury claims and other reserves

Post-retirement benefits

Losses and tax credit carryforwards

Deferred income tax liabilities

Net prepaid benefit cost for pensions

$«21

$«76

Properties and other

Total net deferred income tax liability

The Company’s consolidated effective income tax rate differs from the
statutory Federal tax rate. The reconciliation of income tax expense is
as follows:

Canada

U.S.

2004

22.1%

2003

2002

Total net deferred income tax liability

24.1%

26.1%

Net current deferred income tax asset

Long-term deferred income tax liability

In millions

Year ended December 31,

Federal tax rate

Income tax expense at the statutory

Federal tax rate

Income tax (expense) recovery resulting from:

Provincial and other taxes

Deferred income tax adjustments

due to rate enactments

Gain on disposals and dividends
Adjustments to prior years’ income taxes (1)

Other

Income tax expense

Cash payments for income taxes

$÷«(410)

$÷«(358)

$÷«(309)

(263)

(199)

(140)

5
10
11
51
$÷«(596)

$÷«÷«92

(79)

–

$÷«(517)

$÷«(384)

$÷«÷«86

$÷«÷«65

(1) Adjustments relating mainly to the resolution of matters pertaining to prior years’ income

taxes.

$1,501
353
$1,854

$÷(222)
(8)
$÷(230)

$÷(244)
(122)
$÷(366)

$1,322

$1,101

161

$1,483

$1,184

$÷÷(94)

$÷(130)

(12)

$÷(106)

$÷(112)

$÷(377)

$÷(221)

(34)

(51)

$÷(411)

$÷(272)

December 31,

2004

2003

$÷÷«86
197
115
278
676

121
4,914
5,035
$4,359

$1,349
3,010
$4,359

$4,359
364
$4,723

$÷÷«81

254

477

102

4,800

4,902

$4,425

$1,527

2,898

$4,425

125

$4,550

It is more likely than not that the Company will realize its deferred
income tax assets from the generation of future taxable income, as the
payments for provisions, reserves and accruals are made and losses
and tax credit carryforwards are utilized. At December 31, 2004, the
Company had $794 million of operating loss carryforwards, mainly
resulting from the BC Rail acquisition, available to reduce future taxable
income expiring between 2005 and 2023.

The Company recognized tax credits of $4 million in 2004 for
research and development expenditures ($15 million in 2003 and $9
million in 2002) not previously recognized, which reduced the cost of
properties.

U.S. GAAP

Canadian National Railway Company

Operating

Capital

$206

$÷«113

194

146

116

240

106

130

609

$992

1,103

342

$÷«761

Notes to Consolidated Financial Statements

17 Segmented information

19 Major commitments and contingencies

The Company operates in one business segment with operations in
Canada and the United States.

Information on geographic areas

In millions

Year ended December 31,

2004

2003

2002

A. Leases
The Company has lease commitments for locomotives, freight cars and
intermodal equipment, many of which provide the option to purchase
the leased items at fixed values during or at the end of the lease term.
As at December 31, 2004, the Company’s commitments under operating
and capital leases were $992 million and $1,103 million, respectively.
Minimum lease payments in each of the next five years and thereafter
are as follows:

Revenues

Canada

U.S.

In millions

Properties

Canada

U.S.

$4,126
2,422
$6,548

$3,707

2,177

$5,884

$3,726

2,384

$6,110

In millions

December 31,

2004

2003

$÷9,945
9,770
$19,715

$÷8,934

9,371

$18,305

2005

2006

2007

2008

2009

2010 and thereafter

18 Earnings per share

Year ended December 31,

2004

2003

2002

Basic earnings per share

Income before cumulative effect

of change in accounting policy

Cumulative effect of change in accounting policy

Net income

Diluted earnings per share

Income before cumulative effect

of change in accounting policy

Cumulative effect of change in accounting policy

Net income

$4.41
–
$4.41

$4.34
–
$4.34

$3.38

0.16

$3.54

$3.33

0.16

$3.49

$2.71

–

$2.71

$2.65

–

$2.65

The following table provides a reconciliation between basic and

diluted earnings per share:

In millions

Year ended December 31,

Net income

Income impact on assumed conversion of

preferred securities (Note 11)

Weighted-average shares outstanding

Effect of dilutive securities and stock options

Weighted-average diluted shares outstanding

2004

2003

$1,258

$1,014

2002

$800

–
$1,258

285.1
4.8
289.9

–

$1,014

$806

286.8

3.9

290.7

295.0

9.2

304.2

For the years ended December 31, 2003 and 2002, the weighted-

average number of stock options that were not included in the calcula-
tion of diluted earnings per share, as their inclusion would have had an
anti-dilutive impact, was 6.0 million and 4.8 million, respectively. The
2003 and 2002 figures have been adjusted for the three-for-two com-
mon stock split (see Note 11(E)).

Less: imputed interest on capital leases at rates

ranging from approximately 2.23% to 13.13%

Present value of minimum lease payments included in debt

Rent expense for operating leases was $242 million, $230 million

and $269 million for the years ended December 31, 2004, 2003 and
2002, respectively. Contingent rentals and sublease rentals were not
significant.

B. Other commitments
As at December 31, 2004, the Company had commitments to acquire
railroad ties, rail, freight cars, locomotives and other equipment at an
aggregate cost of $194 million. Furthermore, as at December 31, 2004,
the Company had outstanding information technology service contracts
of $18 million and agreements with fuel suppliers to purchase approxi-
mately 56% of its anticipated 2005 volume, 19% of its anticipated
2006 volume, and 2% of its anticipated 2007 volume at market prices
prevailing on the date of the purchase.

C. Contingencies
In the normal course of its operations, the Company becomes involved
in various legal actions, including claims relating to personal injuries,
occupational disease and damage to property.

In Canada, employee injuries are governed by the workers’ com-

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

In the United States, employee work-related injuries, including
occupational disease claims, are compensated according to the provi-
sions of the Federal Employers’ Liability Act (FELA), which requires
either the finding of fault through the U.S. jury system or individual
settlements, and represent a major expense for the railroad industry.
The Company follows an actuarial-based approach and accrues the
expected cost for personal injury and property damage claims and
asserted occupational disease claims, based on actuarial estimates of
their ultimate cost. A liability for the minimum amount of unasserted
occupational disease claims is also accrued to the extent they can be
reasonably estimated. The amount recorded reflects a 25-year horizon
as the Company expects that a large majority of these cases will be
received over such period.

Although the Company considers such provisions to be adequate

for all its outstanding and pending claims, the final outcome with
respect to actions outstanding or pending at December 31, 2004, or
with respect to future claims, cannot be predicted with certainty, and
therefore there can be no assurance that their resolution will not have
a material adverse effect on the Company’s financial position or results
of operations in a particular quarter or fiscal year.

D. Environmental matters
The Company’s operations are subject to federal, provincial, state,
municipal and local regulations under environmental laws and regula-
tions concerning, among other things, emissions into the air; discharges
into waters; the generation, handling, storage, transportation, treat-
ment 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 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 in its railroad operations and relating to its
past and present ownership, operation or control of real property.

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 prop-
erties 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 the costs of complying with
environmental laws and containing or remediating contamination can-
not be reasonably estimated due to:

(i)

(ii)

the lack of specific technical information available with respect to
many sites;

the absence of any government authority, third-party orders, or
claims with respect to particular sites;

(iii) the potential for new or changed laws and regulations and for
development of new remediation technologies and uncertainty
regarding the timing of the work with respect to particular sites;

(iv) the ability to recover costs from any third parties with respect to

particular sites; and

therefore, the likelihood of any such costs being incurred or whether
such costs would be material to the Company cannot be determined
at this time. There can thus 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. Although the effect on operat-
ing results and liquidity cannot be reasonably estimated, management
believes, based on current information, that environmental matters will
not have a material adverse effect on the Company’s financial condition
or competitive position. Costs related to any future remediation will be
accrued in the year in which they become known.

In 2004, the Company’s expenses relating to environmental matters,

In addition, related environmental capital expenditures were
$13 million in 2004, $23 million in 2003 and $19 million in 2002. The
Company expects to incur capital expenditures relating to environmen-
tal matters of approximately $20 million in 2005, $17 million in 2006
and $16 million in 2007.

E. Guarantees and indemnifications
In the normal course of business, the Company, including certain of its
subsidiaries, enters into agreements that may involve providing certain
guarantees or indemnifications to third parties and others, which extend
over the term of the agreement. These include, but are not limited to,
residual value guarantees on operating leases, standby letters of credit
and surety bonds, and indemnifications that are customary for the type
of transaction or for the railway business.

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

19 Major commitments and contingencies (continued)

Effective January 1, 2003, the Company is required to recognize a

liability for the fair value of the obligation undertaken in issuing certain
guarantees on the date the guarantee is issued or modified. In addition,
where the Company expects to make a payment in respect of a guar-
antee, a liability will be recognized to the extent that one has not yet
been recognized.

Guarantee of residual values of operating leases
The Company has guaranteed a portion of the residual values of certain
of its assets under operating leases with expiry dates between 2005
and 2012, for the benefit of the lessor. If the fair value of the assets,
at the end of their respective lease term, is less than the fair value,
as estimated at the inception of the lease, then the Company must,
under certain conditions, compensate the lessor for the shortfall. At
December 31, 2004, the maximum exposure in respect of these guaran-
tees was $97 million, of which $8 million has been recorded. Of that
amount, $6 million represents the expected cash outlay for such guar-
antees, while the remaining $2 million represents the Company’s obli-
gation to stand ready and honor the guarantees that were entered
into subsequent to January 1, 2003. There are no recourse provisions
to recover any amounts from third parties.

Other guarantees
The Company, including certain of its subsidiaries, has granted irrevo-
cable standby letters of credit and surety bonds, issued by highly rated
financial institutions, to third parties to indemnify them in the event the
Company does not perform its contractual obligations. As at December 31,
2004, the maximum potential liability under these guarantees was
$439 million of which $359 million was for workers’ compensation
and other employee benefits and $80 million was for equipment under
leases and other. During 2004, the Company granted guarantees for
which no liability has been recorded, as they relate to the Company’s
future performance.

As at December 31, 2004, the Company had not recorded any
additional liability with respect to these guarantees, as the Company
does not expect to make any additional payments associated with
these guarantees. The guarantee instruments mature at various dates
between 2005 and 2007.

CN Pension Plan, CN 1935 Pension Plan and BC Rail Ltd Pension Plan
The Company has indemnified and held harmless the current trustee
and the former trustee of the Canadian National Railways Pension
Trust Funds, the trustee of the BC Rail Ltd Pension Trust Fund, and the
respective officers, directors, employees and agents of such trustees,
from any and all taxes, claims, liabilities, damages, costs and expenses
arising out of the performance of their obligations under the relevant
trust agreements and trust deeds, including in respect of their reliance
on authorized instructions of the Company or for failing to act in the
absence of authorized instructions. These indemnifications survive the
termination of such agreements or trust deeds. As at December 31,
2004, the Company had not recorded a liability associated with these
indemnifications, as the Company does not expect to make any pay-
ments pertaining to these indemnifications.

General indemnifications
In the normal course of business, the Company has provided indem-
nifications, customary for the type of transaction or for the railway
business, in various agreements with third parties, including indemnifi-
cation provisions where the Company would be required to indemnify
third parties and others. Indemnifications are found in various types
of contracts with third parties which include, but are not limited to,
(a) contracts granting the Company the right to use or enter upon
property owned by third parties such as leases, easements, trackage
rights and sidetrack agreements; (b) contracts granting rights to oth-
ers to use the Company’s property, such as leases, licenses and ease-
ments; (c) contracts for the sale of assets and securitization of accounts
receivable; (d) contracts for the acquisition of services; (e) financing
agreements; (f) trust indentures, fiscal agency agreements, underwriting
agreements or similar agreements relating to debt or equity securities
of the Company and engagement agreements with financial advisors;
(g) transfer agent and registrar agreements in respect of the Company’s
securities; (h) trust agreements relating to pension plans and other
plans, including those establishing trust funds to secure payment to
certain officers and senior employees of special retirement compensa-
tion arrangements; (i) master agreements with financial institutions
governing derivative transactions; and (j) settlement agreements with
insurance companies or other third parties whereby such insurer or
third party has been indemnified for any present or future claims relat-
ing to insurance policies, incidents or events covered by the settlement
agreements. To the extent of any actual claims under these agreements,
the Company maintains provisions for such items, which it considers
to be adequate. Due to the nature of the indemnification clauses, the
maximum exposure for future payments may be material. However,
such exposure cannot be determined with certainty.

In 2004 and 2003, the Company entered into various indemnifica-
tion contracts with third parties for which the maximum exposure for
future payments cannot be determined with certainty. As a result, the
Company was unable to determine the fair value of these guarantees
and accordingly, no liability was recorded. As at December 31, 2004,
the carrying value for guarantees for which the Company was able to
determine the fair value, was $1 million. There are no recourse provi-
sions to recover any amounts from third parties.

20 Financial instruments

A. Risk management
The Company has limited involvement with derivative financial instru-
ments in the management of its fuel, foreign currency and interest rate
exposures, and does not use them for trading purposes.

(i) Credit risk
In the normal course of business, the Company monitors the financial
condition of its customers and reviews the credit history of each new
customer.

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

regularly monitored. As a result, losses due to counterparty non-perfor-
mance are not anticipated. The total risk associated with the Company’s
counterparties was immaterial at December 31, 2004. The Company
believes there are no significant concentrations of credit risk.

(ii) Fuel
To mitigate the effects of fuel price changes on its operating margins
and overall profitability, the Company has a systematic hedging pro-
gram 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. However, in the fourth quarter of 2004, the
Company did not enter into any swap positions on crude and heating
oil. At December 31, 2004, the Company had hedged approximately 50%
of the estimated 2005 fuel consumption, representing approximately
203 million U.S. gallons at an average price of U.S.$0.74 per U.S. gallon,
and 17% of the estimated 2006 fuel consumption, representing
69 million U.S. gallons at an average price of U.S.$0.89 per U.S. gallon.
The changes in the fair value of the swap positions are highly cor-
related to changes in the price of fuel and therefore, these fuel hedges
are being accounted for as cash flow hedges, whereby the effective
portion of the cumulative change in the market value of the derivative
instruments has been recorded in Accumulated other comprehensive
loss. The amounts in Accumulated other comprehensive loss will be
reclassified into income upon the ultimate consumption of the hedged
fuel. To the extent that the cumulative change in the fair value of the
swap positions does not offset the cumulative change in the price of
fuel, the ineffective portion of the hedge will be recognized into income
immediately. In the event that the fuel hedge is discontinued and
the forecasted purchase of fuel is not expected to occur, the amount
in Accumulated other comprehensive loss would be reclassified into
income immediately.

Realized gains from the Company’s fuel hedging activities, which are
recorded in fuel expense, were $112 million, $49 million, and $3 million
for the years ended December 31, 2004, 2003 and 2002, respectively.

At December 31, 2004, Accumulated other comprehensive loss
included an unrealized gain of $92 million, $62 million after tax ($38
million unrealized gain, $26 million after tax at December 31, 2003),
of which $81 million relates to derivative instruments that will mature
within the next year and are presented in Other current assets. The
Company did not recognize any material gains or losses in 2004, 2003
and 2002 due to hedge ineffectiveness as the Company’s derivative
instruments have been highly effective in hedging the changes in cash
flows associated with forecasted purchases of diesel fuel.

(iii) Interest rate
In the first quarter of 2004, in anticipation of future debt issuances,
the Company had entered into treasury lock transactions for a notional
amount of U.S.$380 million to fix the treasury component on these
future debt issuances. Upon expiration in June 2004, these treasury rate
locks were rolled into new contracts expiring in September 2004, at an
average locked-in rate of 5.106%. The Company settled these treasury
locks at a gain of U.S.$9 million (Cdn$12 million) upon the pricing
of the U.S.$500 million 6.25% Debentures due 2034, subsequently
issued on July 9, 2004. These derivatives were accounted for as cash
flow hedges whereby the cumulative change in the market value of

the derivative instruments was recorded in Other comprehensive loss.
Beginning July 9, 2004, upon the issuance of debt, the realized gain of
$12 million accumulated in other comprehensive income (loss) will be
recorded into income, as a reduction of interest expense, over the term
of the debt based on the interest payment schedule.

At December 31, 2004, Accumulated other comprehensive loss

included an unamortized gain of $12 million, $8 million after tax.

(iv) Foreign currency
Although the Company conducts its business and receives revenues pri-
marily 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 trans-
ported by the Company more or less competitive in the world market-
place and thereby affect the Company’s revenues and expenses.

For the purpose of minimizing volatility of earnings resulting from

the conversion of U.S. dollar denominated long-term debt into the
Canadian dollar, the Company designates the U.S. dollar denominated
long-term debt of the parent company as a foreign exchange hedge
of its net investment in U.S. subsidiaries. As a result, from the dates of
designation, unrealized foreign exchange gains and losses on the trans-
lation of the Company’s U.S. dollar denominated long-term debt are
recorded in Accumulated other comprehensive loss.

(v) Other
The Company does not currently have any derivative instruments not
designated as hedging instruments.

B. Fair value of financial instruments
Generally accepted accounting principles define the fair value of a
financial instrument as the amount at which the instrument could
be exchanged in a current transaction between willing parties. The
Company uses the following methods and assumptions to estimate the
fair value of each class of financial instruments for which the carrying
amounts are included in the Consolidated Balance Sheet under the fol-
lowing captions:

(i) Cash and cash equivalents, Accounts receivable, Other current assets,
Accounts payable and accrued charges, and Other current liabilities:
The carrying amounts approximate fair value because of the short
maturity of these instruments.

(ii) Other assets:
Investments: The Company has various debt and equity investments for
which the carrying value approximates the fair value, with the excep-
tion of a cost investment for which the fair value was estimated based
on the Company’s proportionate share of its net assets.

(iii) Long-term debt:
The fair value of the Company’s long-term debt is estimated based on
the quoted market prices for the same or similar debt instruments, as
well as discounted cash flows using current interest rates for debt with
similar terms, company rating, and remaining maturity.

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

20 Financial instruments (continued)

In millions

The following table presents the carrying amounts and estimated fair
values of the Company’s financial instruments as at December 31, 2004
and 2003 for which the carrying values on the Consolidated Balance
Sheet are different from their fair values:

In millions

December 31, 2004

December 31, 2003

Carrying
amount

Fair
value

Carrying
amount

Fair
value

Unrealized foreign exchange gain on translation
of U.S. dollar denominated long-term debt
designated as a hedge of the net investment
in U.S. subsidiaries

Unrealized foreign exchange loss on translation
of the net investment in foreign operations

Unrealized holding gain on fuel derivative

instruments (Note 20)

Financial assets

Investments

Financial liabilities

Long-term debt

(including current portion)

$÷«166

$÷«220

$÷«367

$÷«420

Minimum pension liability adjustment (Note 13)

Deferred income tax (DIT) rate enactment

Other comprehensive loss

$÷«(332)

$«106

$(226)

$5,164

$5,857

$4,658

$5,128

In millions

Year ended December 31, 2003

Before
tax
amount

Income tax
(expense)
recovery

Net of
tax
amount

$÷««754

$(245)

$«509

(1,101)

358

(743)

–

(2)

(3)

(2)

Year ended December 31, 2002

Before
tax
amount

Income tax
(expense)
recovery

Net of
tax
amount

Unrealized foreign exchange gain on translation
of U.S. dollar denominated long-term debt
designated as a hedge of the net investment
in U.S. subsidiaries

Unrealized foreign exchange loss on translation
of the net investment in foreign operations

Unrealized holding gain on fuel derivative

instruments (Note 20)

Minimum pension liability adjustment (Note 13)

Other comprehensive income

$«51

(40)

(20)

$«59

$(17)

$«34

(27)

(23)

$(20)

(13)

$«39

21 Other comprehensive income (loss)

A. Components of Other comprehensive income (loss) and the related
tax effects are as follows:

In millions

Unrealized foreign exchange gain on translation
of U.S. dollar denominated long-term debt
designated as a hedge of the net investment
in U.S. subsidiaries

Unrealized foreign exchange loss on translation
of the net investment in foreign operations

Unrealized holding gain on fuel derivative

instruments (Note 20)

Realized gain on settlement of interest

rate swaps (Note 20)

Minimum pension liability adjustment (Note 13)

Year ended December 31, 2004

Before
tax
amount

Income tax
(expense)
recovery

Net of
tax
amount

$«326

$(106)

$«220

(428)

140

(18)

(4)

(3)

(288)

Other comprehensive loss

$÷(28)

$÷÷«9

$÷(19)

B. Changes in the balances of each classification within Accumulated other comprehensive income (loss) are as follows:

In millions

Balance at January 1, 2002

Period change

Balance at December 31, 2002

Period change

Balance at December 31, 2003

Period change

Balance at December 31, 2004

Foreign
exchange –
Net investment
in foreign
operations

Foreign
exchange –
U.S.$ debt

Holding gain
(loss) on
fuel derivative
instruments

Realized gain
on settlement
of interest
rate swaps

Minimum
pension
liability
adjustment

Accumulated
other
comprehensive
income (loss)

DIT rate
enactment

$(221)

$«347

$(25)

(187)

509

322

220

(27)

320

(743)

(423)

(288)

$«542

$(711)

$«62

$–

–

$(11)

(13)

(24)

(20)

$(15)

$(32)

–

(32)

(2)

(34)

–

$(34)

$÷«58

(226)

(129)

(19)

$(148)

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

22 Reconciliation of United States and Canadian generally

This change effectively harmonizes the Company’s Canadian and

accepted accounting principles

The Consolidated Financial Statements of the Company are expressed
in Canadian dollars and are prepared in accordance with U.S. GAAP
which conform, in all material respects, with Canadian GAAP except
as follows:

A. Reconciliation of net income
The application of Canadian GAAP would have the following effects on
the net income as reported:

In millions

Year ended December 31,

Net income – U.S. GAAP

Adjustments in respect of:

Property capitalization, net of depreciation

Stock-based compensation cost

Interest expense

Income tax rate enactments

Interest on convertible preferred securities

Income tax (expense) recovery on current
year Canadian GAAP adjustments

Income before cumulative effect of change

in accounting policy

Cumulative effect of change in accounting

policy (net of applicable taxes)

Net income – Canadian GAAP

2004

$1,258

2003

2002

$1,014

$«800

81
(19)
12
(3)
–

(32)

1,297

–
$1,297

(384)

(27)

–

133

782

(48)

(363)

(9)

–

116

553

–

$÷«734

$«553

(i) Property capitalization
Effective January 1, 2004, the Company changed its capitalization
policy under Canadian GAAP, on a prospective basis, to conform with
the Canadian Institute of Chartered Accountants (CICA) Handbook
Section 3061, “Properties, Plant and Equipment.” The change was made
in response to the CICA Handbook Section 1100, “Generally Accepted
Accounting Principles,” issued in July 2003.

The Company’s accounting for Properties under Canadian
GAAP had been based on the rules and regulations of the Canadian
Transportation Agency’s (CTA) Uniform Classification of Accounts, which
for railways in Canada, were considered Canadian GAAP prior to the
issuance of Section 1100. Under the CTA rules, the Company capitalized
only the material component of track replacement costs, to the extent
it met the Company’s minimum threshold for capitalization. In accor-
dance with the CICA Handbook Section 3061, “Properties, Plant and
Equipment,” the Company now capitalizes the cost of labor, material
and related overhead associated with track replacement activities pro-
vided they meet the Company’s minimum threshold for capitalization.
Also, all major expenditures for work that extends the useful life and/or
improves the functionality of bridges, other structures and freight cars,
are capitalized.

U.S. GAAP capitalization policy. However, since the change was applied
prospectively, there continues to be a difference in depreciation and
amortization expense between Canadian and U.S. GAAP relating to the
difference in the amounts previously capitalized under Canadian and
U.S. GAAP as at January 1, 2004.

(ii) Interest expense
In the first quarter of 2004, in anticipation of future debt issu-
ances, the Company had entered into treasury lock transactions for a
notional amount of U.S.$380 million to fix the treasury component on
these future debt issuances. Under U.S. GAAP, these derivatives were
accounted for as cash flow hedges whereby the cumulative change in
the market value of the derivative instruments was recorded in Other
comprehensive loss. On July 9, 2004, upon the pricing and subsequent
issuance of U.S.$500 million 6.25% Debentures due 2034, the Company
settled these treasury-rate locks and realized a gain of $12 million.
Under U.S. GAAP, this gain was recorded in Other comprehensive loss
and will be amortized and recorded into income, as a reduction of inter-
est expense, over the term of the debt based on the interest payment
schedule. Under Canadian GAAP, this gain was recorded immediately
into income, as a reduction of interest expense.

(iii) Stock-based compensation cost
As explained in Note 2, effective January 1, 2003, the Company volun-
tarily adopted the recommendations of SFAS No. 123, “Accounting for
Stock-Based Compensation,” and applied the fair value based approach
prospectively to all awards of employee stock options granted, modified
or settled on or after January 1, 2003. Under Canadian GAAP, effective
January 1, 2003, the Company adopted the fair value based approach
of the CICA’s Handbook Section 3870, “Stock-Based Compensation and
Other Stock-Based Payments.” The Company retroactively applied the
fair value method of accounting to all awards of employee stock options
granted, modified or settled on or after January 1, 2002 and restated
the 2002 comparative period to reflect this change in accounting policy.
Compensation cost attributable to employee stock options granted prior
to January 1, 2003 continues to be a reconciling difference.

(iv) Convertible preferred securities
As explained in Note 11, the Convertible preferred securities (Securities)
were converted into common shares of the Company on July 3, 2002.
Prior to such date, the Securities were treated as equity under Canadian
GAAP, whereas under U.S. GAAP they were treated as debt. Consequently,
the interest on the Securities until July 3, 2002 was treated as a dividend
for Canadian GAAP but as interest expense for U.S. GAAP.

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

22 Reconciliation of United States and Canadian generally

accepted accounting principles (continued)

under U.S. GAAP, the resulting deferred income tax expense or recovery
is recorded when the rates are enacted, whereas under Canadian GAAP,
when they are substantively enacted. In 2004, under U.S. GAAP, the
Company recorded a decrease to its net deferred income tax liability of
$5 million resulting from the enactment of lower corporate tax rates in
the province of Alberta, with the corresponding decrease of $2 million
under Canadian GAAP. In 2003, under U.S. GAAP, the Company recorded
an increase to its net deferred income tax liability resulting from the
enactment of higher corporate tax rates in the province of Ontario.
As a result, the Company recorded deferred income tax expense of
$79 million and $2 million in income and Other comprehensive loss,
respectively. For Canadian GAAP, the corresponding increase to the net
deferred income tax liability was $33 million.

(vi) Cumulative effect of change in accounting policy
As explained in Note 2, in accordance with SFAS No. 143, “Accounting
for Asset Retirement Obligations,” the Company changed its account-
ing policy for certain track structure assets to exclude removal costs
as a component of depreciation expense where the inclusion of such
costs would result in accumulated depreciation balances exceeding
the historical cost basis of the assets. As a result, a cumulative benefit
of $75 million, or $48 million after tax, was recorded for the amount

C. Reconciliation of significant balance sheet items

In millions

Current assets – U.S. GAAP

Derivative instruments

Deferred income taxes related to derivative instruments

Other

Current assets – Canadian GAAP

Properties – U.S. GAAP

Property capitalization, net of depreciation

Cumulative effect of change in accounting policy

Properties – Canadian GAAP

Intangible and other assets – U.S. GAAP

Derivative instruments

Intangible and other assets – Canadian GAAP

Deferred income tax liability – U.S. GAAP

Cumulative effect of prior years’ adjustments to income

Income taxes on current year Canadian GAAP adjustments to income

Income taxes on cumulative effect of change in accounting policy

Income taxes on translation of U.S. to Canadian GAAP adjustments

Income taxes on minimum pension liability adjustment

Income taxes on derivative instruments

Income taxes on settlement of interest rate swaps recorded in Other comprehensive loss

Income tax rate enactments

Other

Deferred income tax liability – Canadian GAAP

of removal costs accrued in accumulated depreciation on certain track
structure assets at January 1, 2003. Under Canadian GAAP, the recom-
mendations of Handbook Section 3110, “Asset Retirement Obligations,”
which are similar to those under SFAS No. 143, were effective for the
Company’s fiscal year beginning January 1, 2004 and did not have
an impact on the Canadian GAAP financial statements since removal
costs, as a component of depreciation expense, have not resulted in
accumulated depreciation balances exceeding the historical cost basis
of the assets.

B. Earnings per share
The earnings per share calculation under U.S. GAAP differs from
Canadian GAAP essentially due to differences in the earnings figures:

In millions

Year ended December 31,

Net income – Canadian GAAP

Dividends on convertible preferred securities

Weighted-average shares outstanding

Effect of dilutive securities and stock options

Weighted-average diluted shares outstanding

Year ended December 31,

Basic earnings per share

Diluted earnings per share

2004

$1,297
–
$1,297

285.1
4.5
289.6

2004

$4.55
$4.48

2003

$734

–

$734

286.8

3.9

290.7

2003

$2.56

$2.52

December 31,

2004

$÷1,710
(81)
29
(4)
$÷1,654

$19,715
(2,952)
(75)
$16,688

$÷÷«940
(11)
$÷÷«929

$÷4,723
(1,204)
32
(27)
28
7
(1)
(4)
41
(4)
$÷3,591

2002

$553

$547

295.0

9.2

304.2

2002

$1.85

$1.82

2003

$÷1,127

(33)

–

(2)

$÷1,092

$18,305

(3,072)

(75)

$15,158

$÷÷«905

(5)

$÷÷«900

$÷4,550

(1,071)

(133)

(27)

(12)

–

(5)

$÷3,365

Canadian National Railway Company

U.S. GAAP

Notes to Consolidated Financial Statements

In millions

Other liabilities and deferred credits – U.S. GAAP

Stock-based compensation

Minimum pension liability

Other

Other liabilities and deferred credits – Canadian GAAP

Common shares – U.S. GAAP

Capital reorganization

Stock-based compensation

Foreign exchange loss on convertible preferred securities

Costs related to the sale of shares

Share repurchase program

Common shares – Canadian GAAP

Contributed surplus – U.S. GAAP

Dividend in kind with respect to land transfers

Costs related to the sale of shares

Other transactions and related income tax effect

Share repurchase program

Capital reorganization

Contributed surplus – Canadian GAAP

Accumulated other comprehensive loss – U.S. GAAP

Unrealized foreign exchange loss on translation of U.S. to Canadian GAAP adjustments, net of applicable taxes

Derivative instruments, net of applicable taxes

Unamortized gain on settlement of interest rate swaps, net of applicable taxes

Income tax rate enactments

Minimum pension liability adjustment, net of applicable taxes

Currency translation – Canadian GAAP

Retained earnings – U.S. GAAP

Cumulative effect of prior years’ adjustments to income

Cumulative effect of change in accounting policy

Current year adjustments to net income

Share repurchase program

Cumulative dividend on convertible preferred securities

Capital reorganization

Dividend in kind with respect to land transfers

Other transactions and related income tax effect

Retained earnings – Canadian GAAP

December 31,

2004

$÷1,513
–
(22)
(3)
$÷1,488

$÷4,706
(1,300)
(18)
(12)
33
178
$÷3,587

$÷÷÷÷«–
(248)
(33)
(18)
(26)
489
$÷÷«164

$÷÷(148)
89
(62)
(8)
34
15
$÷÷÷(80)

$÷4,726
(1,928)
(48)
39
(152)
(38)
811
248
18
$÷3,676

2003

$÷1,203

(20)

(30)

–

$÷1,153

$÷4,664

(1,300)

(17)

(12)

162

$÷3,530

$÷÷÷÷«–

(248)

(33)

(18)

(24)

489

$÷÷«166

$÷÷(129)

(26)

–

$÷÷÷(38)

$÷3,897

(1,696)

(48)

(232)

(138)

(38)

811

248

$÷2,822

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

22 Reconciliation of United States and Canadian generally

accepted accounting principles (continued)

(i) Shareholders’ equity
As permitted under Canadian GAAP, the Company eliminated its accu-
mulated deficit of $811 million as of June 30, 1995 through a reduc-
tion of the capital stock in the amount of $1,300 million, and created
a contributed surplus of $489 million. Such a reorganization within
Shareholders’ equity is not permitted under U.S. GAAP.

Under Canadian GAAP, the dividend in kind declared in 1995 (with
respect to land transfers) and other capital transactions were deducted
from Contributed surplus. For U.S. GAAP purposes, these amounts would
have been deducted from Retained earnings.

Under Canadian GAAP, costs related to the sale of shares have
been deducted from Contributed surplus. For U.S. GAAP purposes, these
amounts would have been deducted from Common shares.

Under Canadian GAAP, the cost resulting from the repurchase of
shares was allocated first to Common shares, then to Contributed sur-
plus and finally to Retained earnings. Under U.S. GAAP, the cost would
have been allocated to Common shares followed by Retained earnings.
For Canadian and U.S. GAAP purposes, the Company designates
the U.S. dollar denominated long-term debt of the parent company as a
foreign exchange hedge of its net investment in U.S. subsidiaries. Under
Canadian GAAP, the resulting net unrealized foreign exchange loss from
the date of designation, has been included in Currency translation. For
U.S. GAAP purposes, the resulting net unrealized foreign exchange loss
has been included as part of Accumulated other comprehensive loss, a
separate component of Shareholders’ equity, as required under SFAS No.
130, “Reporting Comprehensive Income.”

(ii) Minimum pension liability adjustment
At each measurement date, if the Company’s pension plans have an
accumulated benefit obligation in excess of the fair value of the plan
assets, under U.S. GAAP, this gives rise to an additional minimum pen-
sion liability. As a result, an intangible asset is recognized up to the
amount of the unrecognized prior service cost and the difference is
recorded in Accumulated other comprehensive loss, a separate compo-
nent of Shareholders’ equity. There are no requirements under Canadian
GAAP to record a minimum pension liability adjustment.

(iii) Derivative instruments
Under U.S. GAAP, pursuant to SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities,” as amended by SFAS No. 138,
“Accounting for Certain Derivative Instruments and Certain Hedging
Activities,” the Company records in its balance sheet the fair value
of derivative instruments used in its hedging activities. Changes in
the market value of these derivative instruments have been recorded
in Accumulated other comprehensive loss, a separate component
of Shareholders’ equity. There are no similar requirements under
Canadian GAAP.

(iv) Convertible preferred securities
As explained in Note 11, the Convertible preferred securities (Securities)
were converted into common shares of the Company on July 3,
2002. Prior to such date, the Securities were treated as equity under
Canadian GAAP, whereas under U.S. GAAP they were treated as debt.
Consequently, the initial costs related to the issuance of the Securities,
net of amortization, which were previously deferred and amortized for
U.S. GAAP, have since been reclassified to equity.

23 Comparative figures

Certain figures, previously reported for 2003 and 2002, have been
reclassified to conform with the basis of presentation adopted in the
current year.

Canadian National Railway Company

U.S. GAAP

Financial Section (Canadian GAAP)

Contents

Canadian National Railway Company

82 Management’s Discussion and Analysis
105 Management Report
105
106
107
108
109

Auditors’ Report
Consolidated Statement of Income
Consolidated Balance Sheet
Consolidated Statement of Changes in Shareholders’ Equity
Consolidated Statement of Cash Flows

Notes to Consolidated Financial Statements

11 Capital stock and convertible preferred securities

110
112
113
113
114
114
114
115
115
116 10 Long-term debt
117
118 12 Stock plans
120 13 Pensions
121 14 Interest expense
121 15 Other income (loss)
121 16 Income taxes
122 17 Segmented information
122 18 Earnings per share
123
125 20 Financial instruments
126
129 22 Comparative figures

19 Major commitments and contingencies

21 Reconciliation of Canadian and United States generally accepted accounting principles

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Management’s discussion and analysis (MD&A) relates to the financial condition and results of operations of Canadian National Railway Company
(CN) together with its wholly owned subsidiaries, including the railroads and related holdings of Great Lakes Transportation LLC (GLT) as of
May 10, 2004 and BC Rail as of July 14, 2004. 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 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 and stock-based compensation. A reconciliation of the Canadian to U.S. GAAP financial statements is provided
in Note 21 to the Company’s Consolidated Financial Statements. The Company’s objective is to provide meaningful and relevant information
reflecting the Company’s financial condition and results of operations. In certain instances, the Company may make reference to certain non-GAAP
measures that, from management’s perspective, are useful measures of performance. In such instances, the reader is advised to read all informa-
tion provided in the MD&A in conjunction with the Company’s 2004 Annual Consolidated Financial Statements and notes thereto.

Business profile

CN, directly and through its subsidiaries, is engaged in the rail and
related transportation business. CN’s network of approximately 19,300
route miles of track spans Canada and mid-America, connecting three
coasts: the Atlantic, the Pacific and the Gulf of Mexico. CN’s revenues
are derived from seven commodity groups consisting of the movement
of a diversified and balanced portfolio of goods which positions it well
to face economic fluctuations and enhances its potential to grow reve-
nues. In 2004, no individual commodity group accounted for more than
22% of revenues. The sources of revenue also reflect a balanced mix of
destinations. In 2004, 23% of revenues came from U.S. domestic traffic,
34% from transborder traffic, 23% from Canadian domestic traffic and
20% from overseas traffic. The Company originates approximately 85%
of traffic moving along its network, which allows it both to capitalize on
service advantages and build on opportunities to efficiently use assets.

Strategy

Overview

CN’s plan is premised on the deployment of its business model to
generate quality revenues, while leveraging capacity and maintaining
its current level of plant quality.

Over the past five years, the Company has also invested heavily in

The Company’s ultimate goal is to generate profitable, sustain-
able growth at low incremental cost by striving to improve yield and
increase market share to maximize its return on assets.

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

Financial highlights

In millions, except per share data, or unless otherwise indicated

2004

2003

2002

Financial results

Revenues

Operating income

Net income

Operating ratio

Basic earnings per share

Diluted earnings per share

Dividend declared per share

Financial position

Total assets

Total long-term financial liabilities

Financial results

Change in property capitalization policy
Effective January 1, 2004, the Company changed its capitalization
policy, on a prospective basis, to conform with the Canadian Institute
of Chartered Accountants (CICA) Handbook Section 3061, “Properties,
Plant and Equipment.” The change was made in response to the CICA
Handbook Section 1100, “Generally Accepted Accounting Principles,”
issued in July 2003, as explained in Note 2 – Accounting changes, of
the Company’s Annual Consolidated Financial Statements.

The Company’s accounting for Properties had been based on the
rules and regulations of the Canadian Transportation Agency’s (CTA)
Uniform Classification of Accounts, which for railways in Canada, were
considered Canadian GAAP prior to the issuance of Section 1100. Under
the CTA rules, the Company capitalized only the material component of
track replacement costs, to the extent it met the Company’s minimum
threshold for capitalization. In accordance with the CICA Handbook
Section 3061, “Properties, Plant and Equipment,” the Company now
capitalizes the cost of labor, material and related overhead associated
with track replacement activities provided they meet the Company’s
minimum threshold for capitalization. Also, all major expenditures for
work that extends the useful life and/or improves the functionality of
bridges, other structures and freight cars, are capitalized. The change in
policy had the effect of decreasing 2004 operating expenses by $464
million, $312 million after tax.

2004 compared to 2003
In 2004, net income increased by $563 million, or 77%, when com-
pared to 2003, with diluted earnings per share rising 78%. Excluding
the change in capitalization policy as discussed herein, net income
increased by $251 million, or 34%, when compared to 2003.

Revenues increased by $664 million, or 11%, due to the inclusion
of $351 million of GLT and BC Rail revenues, core business growth in
a strong North American economy, and an improved Canadian grain
crop, which were partly offset by the translation impact of the stronger
Canadian dollar on U.S. dollar denominated revenues of $255 million.
Operating expenses decreased by $198 million, or 4%. The
decrease was mainly due to the change in the property capitalization
policy, which mainly affected labor, purchased services and material,

$÷6,548
$÷2,230
$÷1,297

65.9%

$÷÷4.55
$÷÷4.48

$÷÷0.78

$19,271
$÷9,665

$÷5,884

$÷1,368

$÷÷«734

76.8%

$÷÷2.56

$÷÷2.52

$÷÷0.67

$17,150

$÷8,693

$÷6,110

$÷1,098

$÷÷«553

82.0%

$÷÷1.85

$÷÷1.82

$÷÷0.57

$18,924

$10,108

and casualty and other, the translation impact of the stronger Canadian
dollar on U.S. dollar denominated expenses of $170 million and lower
equipment rents. Partly offsetting the decrease was the inclusion of
GLT and BC Rail expenses of $228 million, and otherwise higher labor
and fringe benefits, increased fuel costs and higher casualty and other
expense.

The operating ratio, defined as operating expenses as a percentage

of revenues, was 65.9% in 2004 compared to 76.8% in 2003, a 10.9-
point betterment, mainly due to the change in the property capitaliza-
tion policy.

The results for the year ended December 31, 2004 included the

For the year ended December 31, 2003, the Company’s results of
operations included a fourth-quarter deferred income tax expense of
$33 million resulting from the enactment of higher corporate tax rates
in the province of Ontario.

2004 compared to 2003 – Adjusted performance measures
The year ended December 31, 2003 included an item impacting the
comparability of the results of operations (see reconciliation of adjusted
performance measures presented herein).

In 2003, the Company recorded a fourth-quarter deferred income
tax expense of $33 million resulting from the enactment of higher cor-
porate tax rates, as discussed herein.

Excluding this item, net income was $1,297 million ($4.55 per
basic share or $4.48 per diluted share) in 2004 compared to adjusted
net income of $767 million ($2.67 per basic share or $2.63 per diluted
share) in 2003, an increase of $530 million, or 69%.

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Reconciliation of adjusted performance measures

In millions, except per share data, or unless otherwise indicated

Year ended December 31,

Revenues

Operating expenses

Operating income

Interest expense

Other income (loss)

Income before income taxes

Income tax expense

Net income

Operating ratio

Basic earnings per share

Diluted earnings per share

2004

Reported

$«6,548

4,318

2,230

(282)

(20)

1,928

(631)

$1,297

65.9%

$÷4.55

$÷4.48

$«5,884

4,516

1,368

(317)

1,072

(338)

$÷«734

76.8%

$÷2.56

$÷2.52

2003

Rate
enactment

$÷–

–

$33

Adjusted

$«5,884

4,516

1,368

(317)

1,072

(305)

$÷«767

76.8%

$÷2.67

$÷2.63

Revenues

Year ended December 31,

Total revenues (millions)

Rail freight

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Carloads (thousands)

Revenue/Carload (dollars)

2004

$6,548

2003 % Change

$5,884

11%

$6,252
175,355
3.57
4,654
1,343

$5,694

162,901

3.50

4,177

1,363

10%

11%

(1%)

Revenues for the year ended December 31, 2004 totaled $6,548 million
compared to $5,884 million in 2003. The increase of $664 million, or
11%, was mainly due to the inclusion of GLT and BC Rail revenues

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

Petroleum and chemicals

Year ended December 31,

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$1,123
32,618
3.44

2003 % Change

$1,058

30,901

3.42

Petroleum and chemicals

Percentage of revenues

Carloads*

In thousands

Metals and minerals

Percentage of revenues

Carloads*

In thousands

9
0
8

21%

24%

55% Metals
24% Minerals
21% Iron ore

55%

8
8
3

6
9
3

6
5
2

7
8
2

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

7
8
5

4
0
6

7
3
6

Forest products

2
1
5

9
1
5

Year ended December 31,

43%

57%

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$1,452
38,414
3.78

2003 % Change

$1,284

34,516

3.72

13%

11%

57% Petroleum and plastics
43% Chemicals

* Includes Wisconsin Central Transportation

Corporation (WC) from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

Metals and minerals

Year ended December 31,

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$713
16,421
4.34

2003 % Change

$527

13,876

3.80

35%

18%

14%

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

2004 as the benefit of freight rate improvements and a positive change
in traffic mix were partially offset by the translation impact of the
stronger Canadian dollar.

Forest products

Percentage of revenues

Carloads*

In thousands

Grain and fertilizers

Year ended December 31,

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$1,053
39,965
2.63

2003 % Change

$938

35,556

2.64

12%

–

Grain and fertilizers

Percentage of revenues

Carloads*

In thousands

12%

13%

28%

7
6
5

0
9
5

5
3
5

8
4
5

2
7
5

23%

24%

28% Food grain
24% Oilseeds
23% Feed grain

13% Fertilizers
12% Potash

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

12%

26%

0
0
6

4
9
5

3
5
6

33%

6
8
4

1
0
5

29%

33% Lumber
29% Fibers

26% Paper
12% Panels

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

Coal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2004

$284
13,614
2.09

2003 % Change

$261

13,659

1.91

–

The coal commodity group consists primarily of thermal grades of
bituminous coal. Canadian thermal coal is delivered to power utilities
primarily in eastern Canada, while in the United States, thermal coal
is transported from mines served in southern Illinois, or from western
U.S. mines via interchange with other railroads, to major utilities in
the Midwest and southeast United States. The coal business also
includes the transport of metallurgical coal, which is largely exported
to steel markets in Japan and other Asian markets. For the year ended
December 31, 2004, revenues for this commodity group increased by
$23 million, or 9%, from 2003. The increase was due to higher coal
shipments to U.S. utilities and the inclusion of GLT and BC Rail revenues
of $20 million, partly offset by metallurgical mine closures in western
Canada and the translation impact of the stronger Canadian dollar.
The revenue per revenue ton mile increase of 9% was mainly due to a
decrease in the average length of haul and a positive change in traffic
mix that were partly offset by the translation impact of the stronger
Canadian dollar.

Coal

Percentage of revenues

Carloads*

In thousands

18%

8
2
5

7
1
5

9
9
4

1
7
4

6
8
4

82%

82% Coal
18% Petroleum coke

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

Intermodal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2004

$1,117
31,002
3.60

Automotive

2003 % Change

Year ended December 31,

$1,101

31,168

3.53

(1%)

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$510
3,321
15.36

2003 % Change

$525

3,225

16.28

(3%)

(6%)

The intermodal commodity group is comprised of two segments: domes-
tic and international. The domestic segment is responsible for consumer
products and manufactured goods, operating through both retail and
wholesale channels while the international segment handles import
and export container traffic, serving the ports of Vancouver, Montreal,
Halifax and New Orleans. The domestic segment is driven by consumer
markets, with growth generally tied to the economy. The international
segment is driven mainly by North American economic conditions.
For the year ended December 31, 2004, revenues for this commodity
group increased by $16 million, or 1%, from 2003. Revenues for 2004
benefited from heavy import volumes through the Port of Vancouver,
freight rate improvements and a higher fuel surcharge. Revenues were
negatively affected by the first quarter CAW strike, the closure of the
Company’s smaller terminal facilities in the U.S., the discontinuance
of the Roadrailer service and the translation impact of the stronger
Canadian dollar. Revenue per revenue ton mile increased by 2% in 2004
driven by a positive change in traffic mix and freight rate improvements
that were partly offset by an increase in the average length of haul and
the translation impact of the stronger Canadian dollar.

Intermodal

Percentage of revenues

Carloads*

In thousands

The automotive commodity group moves both finished vehicles and
parts, originating in southwestern Ontario, Michigan and Mississippi,
destined for the United States, Canada and Mexico. The Company’s
broad coverage, including its access to all of the Canadian assembly
plants, enables it to consolidate full trainloads of automotive traffic for
delivery to connecting railroads at key interchange points. The Company
also serves shippers of import vehicles via the ports of Halifax and
Vancouver, and through interchange with other railroads. The Company’s
automotive revenues are closely correlated to automotive production
and sales in North America. For the year ended December 31, 2004,
revenues for this commodity group decreased by $15 million, or 3%,
from 2003. The decrease was due to the translation impact of the
stronger Canadian dollar that was partially offset by the benefit of new
finished vehicle traffic that began in late 2003. Revenue per revenue
ton mile decreased by 6% in 2004 due to the translation impact of the
stronger Canadian dollar.

Automotive

Percentage of revenues

Carloads*

In thousands

18%

8
1
3

7
0
3

8
8
2

5
9
2

7
3
2
,
1

6
7
2
,
1

2
0
2
,
1

1
2
1
,
1

3
0
1
,
1

48%

52%

52% Domestic
48% International

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

82%

82% Finished vehicles
18% Auto parts

* Includes WC from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

Other
In 2004, other revenues increased by $106 million, when compared
to 2003, mainly due to revenues from GLT’s maritime division of
$90 million.

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Operating expenses
Operating expenses amounted to $4,318 million in 2004 compared to
$4,516 million in 2003. The decrease was mainly due to the change in
the property capitalization policy of $464 million, which mainly affected
labor, purchased services and material, and casualty and other, the
translation impact of the stronger Canadian dollar and lower equip-
ment rents. Partly offsetting the decrease was the inclusion of GLT and
BC Rail expenses of $228 million, higher labor and fringe benefits,
increased fuel costs and higher casualty and other expense. The month-
long CAW strike had a minimal impact on overall operating expenses
for the year ended December 31, 2004 as the benefit from lower labor
and fringe benefit expenses was mostly offset by increases in other
expense categories.

In millions

Year ended December 31,

2004

2003

Labor and fringe benefits

Purchased services and material

Depreciation and amortization

Fuel

Equipment rents

Casualty and other

Total

Amount

$1,838

746

517

528

244

445

$4,318

% of
revenue

28.0%
11.4%
7.9%
8.1%
3.7%
6.8%
65.9%

Amount

$1,929

879

472

471

299

466

% of
revenue

32.8%

15.0%

8.0%

5.1%

7.9%

$4,516

76.8%

Labor and fringe benefits: Labor and fringe benefits includes wages,
payroll taxes, and employee benefits such as incentive compensation,
stock-based compensation, health and welfare, pensions and other
post-employment benefits. These expenses decreased by $91 million, or
5%, in 2004 as compared to 2003. The decrease was mainly due to the
change in the property capitalization policy of $204 million, the transla-
tion impact of the stronger Canadian dollar, the effects of a reduced
workforce, lower expenses for pensions and other post-retirement ben-
efits and wage and benefits savings during the CAW strike. Partly off-
setting the decrease was the inclusion of GLT and BC Rail labor expense
of $91 million, higher wages and employee benefits, including increased
costs for stock-based compensation, and charges and adjustments relat-
ing to the workforce reduction provision.

Purchased services and material: Purchased services and material pri-
marily includes the costs of services purchased from outside contractors,
materials used in the maintenance of the Company’s track, facilities
and equipment, transportation and lodging for train crew employees,
utility costs and the net costs of operating facilities jointly used by the
Company and other railroads. These expenses decreased by $133 mil-
lion, or 15%, in 2004 as compared to 2003. The decrease was mainly
due to the change in the property capitalization policy of $176 million,
the translation impact of the stronger Canadian dollar and lower net
expenses for operating joint facilities. Partly offsetting the decrease was
the inclusion of $77 million of GLT and BC Rail expenses, higher repair
and maintenance expenses, partly related to the CAW strike, and other
strike-related costs.

Depreciation and amortization: Depreciation and amortization relates to
the Company’s rail operations. These expenses increased by $45 million,
or 10%, in 2004 as compared to 2003. The increase was mainly due to

the inclusion of GLT and BC Rail expenses of $30 million and the impact
of net capital additions, partially offset by the translation impact of the
stronger Canadian dollar.

Fuel: Fuel expense includes the cost of fuel consumed by locomotives,
intermodal equipment and other vehicles. These expenses increased by
$57 million, or 12%, in 2004 as compared to 2003. The increase was
mainly due to a higher average price per gallon, net of the impact of
the hedging program, the inclusion of GLT and BC Rail expenses of $21
million and higher volumes. The increase was partly offset by the trans-
lation impact of the stronger Canadian dollar, increased productivity
and a fuel excise tax refund in the second quarter.

Equipment rents: Equipment rents includes rental expense for the use
of freight cars owned by other railroads or private companies and for
the short or long-term lease of freight cars, locomotives and intermodal
equipment, net of rental income from other railroads for the use of the
Company’s cars and locomotives. These expenses decreased by $55 mil-
lion, or 18%, in 2004 as compared to 2003. The decrease was due to
higher car hire income, including that of BC Rail, the translation impact
of the stronger Canadian dollar and a reduction in car hire expenses
that were partly offset by higher lease expense for freight cars.

Casualty and other: Casualty and other includes expenses for personal
injuries, environmental, freight and property damage, insurance, bad
debt and operating taxes, as well as travel and travel-related expenses.
These expenses decreased by $21 million, or 5%, in 2004 as compared
to 2003. The decrease was due to the change in the property capitaliza-
tion policy of $76 million and the translation impact of the stronger
Canadian dollar. Partly offsetting the decrease were higher expenses for
personal injuries, the inclusion of GLT and BC Rail expenses of $14 mil-
lion, increased environmental expenses and favorable adjustments
to U.S. property taxes in 2003.

Other
Interest expense: Interest expense decreased by $35 million, or 11%, for
the year ended December 31, 2004 as compared to 2003. The decrease
was due to lower interest rates on issued debt to replace matured debt,
a realized gain on the settlement of interest rate swaps and the transla-
tion impact of the stronger Canadian dollar that were partly offset by
interest expense on debt related to the Company’s recent acquisitions.

Other income (loss): In 2004, the Company recorded a loss of $20
million compared to income of $21 million in 2003. The change from
income to loss in 2004 was due to lower gains on disposal of surplus
properties and lower equity income from the Company’s investment in
English Welsh and Scottish Railway (EWS) as a result of restructured
operations.

Income tax expense: The Company recorded income tax expense of
$631 million for the year ended December 31, 2004 compared to $338
million in 2003. The effective tax rate for the year ended December 31,
2004 was 32.7% compared to 31.5% in 2003. The increase in the effec-
tive tax rate in 2004 was mainly due to higher pre-tax income gener-
ated in the current year, which was primarily a result of the change in
capitalization policy.

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

2003 compared to 2002
For the year ended December 31, 2003, the Company recorded consoli-
dated net income of $734 million ($2.56 per basic share) compared to
$553 million ($1.85 per basic share) for the year ended December 31,
2002. Diluted earnings per share were $2.52 for 2003 compared to $1.82
in 2002. The Company’s operating income for 2003 was $1,368 million
compared to $1,098 million in 2002, and its operating ratio, defined as
operating expenses as a percentage of revenues, was 76.8% in 2003
compared to 82.0% in 2002 (see discussion on adjusted per formance
measures herein).

In 2003, the Company recorded a fourth quarter deferred income
tax expense of $33 million resulting from the enactment of higher cor-
porate tax rates in the province of Ontario. The year ended December 31,
2002 included fourth quarter charges of $281 million, or $173 million
after tax, to increase the Company’s provision for U.S. personal injury

and other claims, and $120 million, or $79 million after tax, for work-
force reductions.

Excluding these items, adjusted net income was $767 million
($2.67 per basic share or $2.63 per diluted share) in 2003 compared
to adjusted net income of $805 million ($2.71 per basic share or $2.65
per diluted share) for 2002, a decrease of $38 million, or 5%. Operating
income for 2003 decreased by $131 million, or 9%, compared to
adjusted operating income of $1,499 million for 2002. The operating
ratio for 2003 was 76.8% compared to the adjusted operating ratio of
75.5% in 2002, a 1.3-point increase.

The decrease in adjusted net income and adjusted operating
income in 2003 was due to the significant year-over-year appreciation
in the Canadian dollar relative to the U.S. dollar. This significant appreci-
ation in the Canadian dollar impacted the conversion of the Company’s
U.S. dollar denominated revenues and expenses and accordingly,
reduced revenues, operating income and net income by approximately
$380 million, $110 million and $55 million, respectively. This decrease in
adjusted net income was partly offset by net deferred income tax recov-
eries of $44 million in 2003 relating mainly to the resolution of matters
pertaining to prior years’ income taxes.

Reconciliation of adjusted performance measures

In millions, except per share data, or unless otherwise indicated

Year ended December 31,

2003

Reported

Rate
enactment

Adjusted

Reported

2002

Personal

injury Workforce
reductions
charge

Revenues

Operating expenses

Operating income

Interest expense

Other income

Income before income taxes

Income tax expense

Net income

Operating ratio

Basic earnings per share

Diluted earnings per share

$«5,884

4,516

1,368

(317)

1,072

(338)

$÷«734

76.8%

$÷2.56

$÷2.52

$÷–

–

$33

$«5,884

4,516

1,368

(317)

1,072

(305)

$÷«767

76.8%

$÷2.67

$÷2.63

$6,110

5,012

1,098

(353)

821

(268)

$«÷÷ –

(281)

281

–

281

(108)

Adjusted

$«6,110

4,611

$«÷÷ –

(120)

120

1,499

–

120

(41)

(353)

1,222

(417)

$÷«553

$«173

$÷«79

$÷«805

82.0%

$÷1.85

$÷1.82

75.5%

$÷2.71

$÷2.65

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Revenues

Forest products

Year ended December 31,

2003

2002 % Change

Year ended December 31,

2003

2002 % Change

Total revenues (millions)

$5,884

$6,110

(4%)

Revenues (millions)

Rail freight

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Carloads (thousands)

Revenue/Carload (dollars)

$5,694

$5,901

162,901

159,259

3.50

4,177

1,363

3.71

4,153

1,421

(4%)

(6%)

(4%)

Petroleum and chemicals

Year ended December 31,

2003

2002 % Change

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

$1,058

30,901

3.42

$1,102

30,006

3.67

(4%)

(7%)

Metals and minerals

Year ended December 31,

2003

2002 % Change

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

$527

13,876

3.80

$521

13,505

3.86

(2%)

Revenues for the year ended December 31, 2003 increased by $6 mil-
lion, or 1%, from 2002. The increase was due to improved market
conditions and increased market share for steel in 2003 and new ore
traffic which began in the second quarter of 2002 and the last quarter
of 2003. These gains were largely offset by the translation impact of the
stronger Canadian dollar. Revenue per revenue ton mile decreased by
2% from 2002 due to the translation impact of the stronger Canadian
dollar which was partially offset by a positive change in traffic mix.

RTMs (millions)

Revenue/RTM (cents)

$1,284

34,516

3.72

$1,323

33,551

3.94

(3%)

(6%)

Revenues for the year ended December 31, 2003 decreased by $39 million,
or 3%, from 2002. The decrease was due to the translation impact of
the stronger Canadian dollar that was partially offset by solid demand
for lumber and pulp and paper. Revenue per revenue ton mile decreased
by 6% from 2002 due to the translation impact of the stronger Canadian
dollar which more than offset the continued improvement in pricing
and a positive change in traffic mix.

Coal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2003

2002 % Change

$261

13,659

1.91

$326

13,886

2.35

(20%)

(2%)

(19%)

Grain and fertilizers

Year ended December 31,

2003

2002 % Change

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

$938

35,556

2.64

$986

35,773

2.76

(5%)

(1%)

(4%)

Intermodal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2003

2002 % Change

$1,101

31,168

3.53

$1,052

29,257

3.60

(2%)

Revenues for the year ended December 31, 2003 increased by $49
million, or 5%, from 2002. The increase was mainly due to increased
import volumes, the higher fuel surcharge in 2003 to offset the

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

Automotive

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2003

$525

3,225

16.28

2002 % Change

$591

3,281

18.01

(11%)

(2%)

(10%)

Revenues for the year ended December 31, 2003 decreased by $66 mil-
lion, or 11%, from 2002. The decrease was primarily due to the transla-
tion impact of the stronger Canadian dollar, weaker North American
vehicle sales and production, and a change in shipping patterns for
a significant customer. Revenue per revenue ton mile decreased by
10% from 2002 mainly due to the translation impact of the stronger
Canadian dollar and a significant increase in the average length of haul.

Operating expenses
Operating expenses amounted to $4,516 million in 2003 compared to
$5,012 million in 2002. The decrease was mainly due to the charges
recorded in the fourth quarter of 2002 for personal injury and other
claims and workforce reductions, and the translation impact of the
stronger Canadian dollar on U.S. dollar denominated expenses. Partly
offsetting these decreases were higher casualty and other expenses
and higher fuel costs.

In millions

Year ended December 31,

2003

2002

Labor and fringe benefits

Purchased services and material

Depreciation and amortization

Fuel

Equipment rents

Casualty and other

Total

Amount

$1,929

879

472

471

299

466

% of
revenue

32.8%

15.0%

8.0%

5.1%

7.9%

Amount

$2,069

908

499

459

353

724

$4,516

76.8%

$5,012

% of
revenue

33.9%

14.9%

8.1%

7.5%

5.8%

11.8%

82.0%

Labor and fringe benefits: Labor and fringe benefits expenses in 2003
decreased by $140 million, or 7%, as compared to 2002. The decrease
was mainly due to the workforce reduction charge of $120 million
recorded in the fourth quarter of 2002, the effects of a reduced work-
force and the translation impact of the stronger Canadian dollar. Higher

wages and employee benefits, including increased costs for pensions
resulting from a change in management’s assumption for the expected
long-term rate of return on pension plan assets from 9% to 8%, partly
offset the decrease.

In 2002, the Company had recorded a workforce reduction charge

Purchased services and material: Purchased services and material
expenses in 2003 decreased by $29 million, or 3%, as compared to
2002. The decrease was mainly due to lower expenses for consulting
and professional services, lower discretionary spending (courier, com-
munication charges, occupancy costs, etc.), reflecting the Company’s
continued focus on cost containment, and the translation impact of the
stronger Canadian dollar. Higher repair expenses for rolling stock partly
offset the decrease.

Depreciation and amortization: Depreciation and amortization expenses
in 2003 decreased by $27 million, or 5%, as compared to 2002, mainly
due to the translation impact of the stronger Canadian dollar.

Fuel: Fuel expense in 2003 increased by $12 million, or 3%, as com-
pared to 2002. The increase was mainly due to a higher average price
per gallon, net of the impact of the hedging program, and higher vol-
umes. These increases were partly offset by the translation impact of
the stronger Canadian dollar.

Equipment rents: Equipment rents in 2003 decreased by $54 million,
or 15%, as compared to 2002. The decrease was due to the Company’s
continued focus on asset utilization, which resulted in lower lease
expense for freight cars and locomotives and a reduction in net car
hire expense. Also contributing to the decrease was the translation
impact of the stronger Canadian dollar and a reduction in intermodal
car hire rates.

Casualty and other: Casualty and other expenses in 2003 decreased by
$258 million, or 36%, as compared to 2002, which included a fourth
quarter charge of $281 million to increase the provision for U.S. per-
sonal injury and other claims. Excluding this charge, the increase was
mainly due to higher expenses for personal injury claims and increased
insurance premiums. Partly offsetting the increase were lower travel-
related expenses and lower provincial capital taxes.

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Other
Interest expense: Interest expense decreased by $36 million to
$317 mil lion for the year ended December 31, 2003 as compared to
2002. The decrease was mainly due to the translation impact of the
stronger Canadian dollar and lower interest rates on new debt to
replace matured debt.

Other income: In 2003, the Company recorded other income of $21 mil-
lion compared to $76 million in 2002. The decrease was mainly due
to lower right of way fees due to the termination of a contract in late
2002, lower income from the Company’s equity investments, and real-
ized foreign exchange losses in 2003.

Summary of quarterly financial data – unaudited

In millions, except per share data

Income tax expense: The Company recorded income tax expense of
$338 million for the year ended December 31, 2003 compared to $268 mil-
lion in 2002. The effective tax rate for the year ended December 31, 2003
was 31.5% compared to 32.6% in 2002. The decrease was mainly due
to net favorable adjustments relating to the resolution of matters pertain-
ing to prior years’ income taxes of $44 million and lower corporate
income tax rates in Canada. Partly offsetting the decrease was a $33 mil-
lion deferred income tax expense recorded in the fourth quarter of
2003 resulting from the enactment of higher corporate tax rates in the
province of Ontario.

Revenues

Operating income

Net income

Basic earnings per share

Diluted earnings per share

Dividend declared per share

2004

Fourth

Third

Second

$1,736

$÷«620

$÷«373

$÷1.31

$÷1.28

$1,709

$÷«609

$÷«367

$÷1.28

$÷1.26

$1,665

$÷«592

$÷«338

$÷1.19

$÷1.17

$0.195

First

$1,438
$÷«409
$÷«219

$÷0.77
$÷0.76

$0.195

2003

Third

Second

$1,413

$÷«329

$÷«208

$÷0.73

$÷0.72

$1,463

$÷«335

$÷«177

$÷0.62

$÷0.61

Fourth

$1,512

$÷«363

$÷«169

$÷0.60

$÷0.59

$0.167

First

$1,496

$÷«341

$÷«180

$÷0.61

$0.167

The volume of goods and commodities transported by the Company during the year is influenced by seasonal weather conditions, general economic
conditions, cyclical demand for rail transportation, and competitive forces in the transportation marketplace. Operating expenses reflect the impact
of freight volumes, seasonal weather conditions, labor costs, fuel prices, and the Company’s productivity initiatives.

The Company’s quarterly results include items that affect the quarter-over-quarter comparability of the results of operations. The Company’s

results of operations for 2004 included GLT as of May 10, 2004 and BC Rail as of July 14, 2004. First-quarter 2004 results were affected by the
month-long CAW strike, which negatively impacted operating income and net income by $35 million and $24 million, respectively. Fourth-quarter
2003 included a deferred income tax expense of $33 million resulting from the enactment of higher corporate tax rates in the province of Ontario.
Also affecting comparability was the significant appreciation in the Canadian dollar relative to the U.S. dollar which has impacted the conversion
of the Company’s U.S. dollar denominated revenues and expenses and resulted in a reduction in net income of approximately $45 million for 2004,
particularly in the first quarter.

Liquidity and capital resources

Operating activities: Cash provided from operating activities was
$2,139 million for the year ended December 31, 2004 compared to
$1,500 million for 2003. Net cash receipts from customers and

others were $6,501 million for the year ended December 31, 2004
compared to $6,022 million in 2003. In 2004, payments for employee
services, suppliers and other expenses were $3,628 million, a decrease
of $108 million when compared to 2003. Also consuming cash in
2004 were payments for interest, workforce reductions and personal
injury and other claims of $282 million, $93 million and $106 million,
respectively, compared to $327 million, $155 million and $126 million,
respectively, in 2003. In 2004, pension contributions and payments for
income taxes were $161 million and $92 million, respectively, compared
to $92 million and $86 million, respectively, in 2003. The Company

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

increased the level of accounts receivable sold under its accounts receiv-
able securitization program by $12 million in 2004 and $132 million
in 2003. Payments in 2005 for workforce reductions are expected to
be $90 million while pension contributions are expected to be approxi-
mately $120 million.

As at December 31, 2004, the Company had outstanding informa-

tion technology service contracts of $18 million.

Investing activities: Cash used by investing activities in 2004 amounted
to $2,411 million compared to $599 million in 2003. The Company’s
investing activities in 2004 included $984 million related to the acquisi-
tion of BC Rail and $547 million related to the acquisition of GLT, net
proceeds of $141 million from the EWS capital reorganization and $52
million from the sale of its Canac Inc. and Beltpack subsidiaries. Net
capital expenditures for the year ended December 31, 2004 amounted
to $1,072 million, an increase of $489 million over 2003, mainly result-
ing from the change in property capitalization. The following table
details capital expenditures for 2004 and 2003.

In millions

Year ended December 31,

Rail infrastructure

Rolling stock

Information technology and other

Less: capital leases

Net capital expenditures

2004

$÷«769
253
210
1,232

160

2003

$373

160

630

$1,072

$583

As at December 31, 2004, the Company had commitments to acquire

railroad ties, rail, freight cars, locomotives and other equipment at an
aggregate cost of $194 million ($211 million at December 31, 2003).

may, therefore, not be comparable to similar measures presented by other
companies. The Company believes that free cash flow is a useful measure
of performance as it demonstrates the Company’s ability to generate cash
after the payment of capital expenditures and dividends. The Company
defines free cash flow as cash provided from operating activities, exclud-
ing changes in the level of accounts receivable sold under the securitiza-
tion program, less investing activities and dividends paid, and adjusted
for significant acquisitions as they are not indicative of normal day-to-day
investments in the Company’s asset base, calculated as follows:

In millions

Year ended December 31,

2004

2003

Cash provided from operating activities

$«2,139

$1,500

Less:

Investing activities

Dividends paid

Cash provided (used) before financing activities

Adjustments:

Change in accounts receivable sold

Acquisition of BC Rail & GLT

Free cash flow

(2,411)
(222)
(494)

(599)

(191)

710

(12)
1,531
$«1,025

(132)

–

$÷«578

In 2004, the Company used $273 million to repurchase 4.0 million

During 2004, the Company recorded $160 million in capital lease

obligations ($47 million in 2003) related to new equipment and the
exercise of purchase options on existing equipment.

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

The Company has access to various financing arrangements:

Commercial paper
The Company has a commercial paper program, which is backed by
a portion of its revolving credit facility, enabling it to issue commercial
paper up to a maximum aggregate principal amount of $800 million,

Contractual obligations

or the U.S. dollar equivalent. As the revolving credit facility will mature
within the next twelve months and the refinancing has not been
renegotiated, the outstanding balance of U.S.$211 million (Cdn$254
million) of commercial paper at an average interest rate of 2.37%
has been included in the current portion of long-term debt at
December 31, 2004. The Company had no commercial paper out-
standing at December 31, 2003.

In the normal course of business, the Company incurs contractual obligations. The following table sets forth the Company’s contractual obligations
for the following items as at December 31, 2004:

In millions

Long-term debt obligations (a)

Capital lease obligations (b)

Operating lease obligations

Purchase obligations (c)

Total obligations

Total

$4,403
1,103
992
212
$6,710

2005

$÷«497

113

206

191

$1,007

2006

$308

106

194

$618

2007

$÷60

130

146

$341

2008

$207

116

$378

2009

$363

2010 and
thereafter

$2,968

609

240

–

$549

$3,817

(a) Presented net of unamortized discounts, of which $838 million relates to non-interest bearing notes due in 2094 assumed as part of the BC Rail acquisition and excludes capital lease

obligations of $761 million which are included in “Capital lease obligations.”

(b) Includes $342 million of imputed interest on capital leases at rates ranging from approximately 2.23% to 13.13%.

(c) Includes commitments for railroad ties, rail, freight cars, locomotives and other equipment and outstanding information technology service contracts.

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

Acquisitions

On July 2, 2004, the Company reached a consent agreement with

On July 14, 2004, the Company completed its acquisition of
BC Rail and began a phased integration of the companies’ operations.
The acquisition was financed by debt and cash on hand.

The Company accounted for the acquisition using the purchase

method of accounting as required by Section 1581, “Business
Combinations,” and Section 3062, “Goodwill and Other Intangible
Assets,” of the CICA. As such, the consolidated financial statements of
the Company include the assets, liabilities and results of operations of
BC Rail as of July 14, 2004, the date of acquisition. The Company’s cost
to acquire BC Rail of $991 million includes purchase price adjustments
and transaction costs. The preliminary purchase price allocation, based
on the fair value of BC Rail’s assets acquired, owned and leased, and
liabilities assumed at acquisition, as presented in Note 3 – Acquisitions,
of the Company’s Annual Consolidated Financial Statements, is subject
to a final valuation, the impact of which is not expected to have a
material effect on the results of operations.

As of April 2004, the Company received all necessary regulatory

approvals, including the U.S. Surface Transportation Board (STB) ruling
rendered on April 9, 2004.

On May 10, 2004, the Company completed its acquisition of GLT

and began a phased integration of the companies’ operations. The
acquisition was financed by debt and cash on hand.

The Company accounted for the acquisition using the purchase

method of accounting. As such, the consolidated financial statements
of the Company include the assets, liabilities and results of operations

of GLT as of May 10, 2004, the date of acquisition. The Company’s cost
to acquire GLT of U.S.$395 million (Cdn$547 million) includes purchase
price adjustments and transaction costs. The preliminary purchase price
allocation, based on the fair value of GLT’s assets acquired and liabili-
ties assumed at acquisition, as presented in Note 3 – Acquisitions, of
the Company’s Annual Consolidated Financial Statements, is subject to
a final valuation, the impact of which is not expected to have a mate-
rial effect on the results of operations.

Investment in English Welsh and Scottish Railway (EWS) –
Capital reorganization

The Company elected to have the maximum allowable number of
shares cancelled under the plan, thereby reducing its ownership inter-
est of EWS to approximately 31% on a fully diluted basis (13.7 million
shares) compared to approximately 37% on a fully diluted basis (43.7
million shares) prior to the capital reorganization. In the first quarter
of 2004, the Company received £57.7 million (Cdn$141 million) in cash
and a note receivable of £23.9 million (Cdn$58 million) from EWS.

Off balance sheet arrangements

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

The Company is subject to customary reporting requirements for

had been sold compared to $448 million at December 31, 2003.

Effective January 1, 2003, the Company is required to disclose its
obligations undertaken in issuing certain guarantees on the date the
guarantee is issued or modified. Where the Company expects to make a
payment in respect of a guarantee, a liability will be recognized to the
extent that one has not yet been recognized.

The nature of these guarantees or indemnifications, the maximum

potential amount of future payments and the nature of any recourse
provisions are disclosed in Note 19 – Major commitments and contin-
gencies of the Company’s Annual Consolidated Financial Statements.

Financial instruments

Company did not enter into any swap positions on crude and heating
oil. At December 31, 2004, the Company had hedged approximately
50% of the estimated 2005 fuel consumption, representing approxi-
mately 203 million U.S. gallons at an average price of U.S.$0.74 per U.S.
gallon, and 17% of the estimated 2006 fuel consumption, representing
69 million U.S. gallons at an average price of U.S.$0.89 per U.S. gallon.

Realized gains from the Company’s fuel hedging activities
were $112 million, $49 million and $3 million for the years ended
December 31, 2004, 2003 and 2002, respectively.

As a result of fuel hedging activities, the Company had an unreal-

ized gain of $92 million at December 31, 2004 compared to $38 million
at December 31, 2003.

Interest rate
In the first quarter of 2004, in anticipation of future debt issuances,
the Company had entered into treasury lock transactions for a notional
amount of U.S.$380 million to fix the treasury component on these
future debt issuances. Upon expiration in June 2004, these treasury rate
locks were rolled into new contracts expiring in September 2004, at an
average locked-in rate of 5.106%. The Company settled these treasury
locks at a gain of U.S.$9 million (Cdn$12 million) upon the pricing of
the U.S.$500 million 6.25% Debentures due 2034, subsequently issued
on July 9, 2004 and recorded the gain immediately into income, as a
reduction of interest expense.

Common stock

Share repurchase program
On October 26, 2004, the Board of Directors of the Company approved
a share repurchase program which allows for the repurchase of up
to 14.0 million common shares between November 1, 2004 and
October 31, 2005 pursuant to a normal course issuer bid, at prevailing
market prices. As at December 31, 2004, 4.0 million common shares
have been repurchased for $273 million, at an average price of
$68.31 per share.

Outstanding share data
As at January 25, 2005, the Company had 283.1 million common shares
outstanding.

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

Critical accounting policies

Management has discussed the development and selection of the

In Canada, employee injuries are governed by the workers’ com-

In the United States, employee work-related injuries, including
occupational disease claims, are compensated according to the provi-
sions of the Federal Employers’ Liability Act (FELA) and represent a
major expense for the railroad industry. The FELA system, which requires
either the finding of fault through the U.S. jury system or individual set-

tlements, has contributed to the significant increase in the Company’s
personal injury expense in recent years. In view of the Company’s
growing presence in the United States and the increase in the number
of occupational disease claims over the past few years, an actuarial
study was conducted in 2002, and in the fourth quarter of 2002 the
Company changed its methodology for estimating its liability for U.S.
personal injury and other claims, including occupational disease claims
and claims for property damage, from a case-by-case approach to an
actuarial-based approach. Consequently, and as discussed in Note 2 to
the Annual Consolidated Financial Statements, the Company recorded a
charge of $281 million ($173 million after tax) to increase its provision
for these claims.

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Known existing environmental concerns
The Company is subject to environmental clean-up and enforce-
ment actions. In particular, the Federal Comprehensive Environmental
Response, Compensation and Liability Act of 1980 (CERCLA), also
known as the Superfund law, as well as similar state laws generally
impose joint and several liability for clean-up and enforcement costs
on current and former owners and operators of a site without regard
to fault or the legality of the original conduct. The Company has been
notified that it is a potentially responsible party for study and clean-up
costs at approximately 17 Superfund sites for which investigation and
remediation payments are or will be made or are yet to be determined
and, in many instances, is one of several potentially responsible parties.
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 based on the results of a four-phase
assessment conducted on a site-by-site basis. Cost scenarios established
by external consultants based on extent of contamination and expected
costs for remedial efforts are used by the Company to estimate the
costs related to a particular site. A liability is initially 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. Adjustments to initial estimates are recorded
as additional information becomes available. Based on the informa-
tion currently available, the Company considers its provisions to be
adequate.

At December 31, 2004, most of the Company’s properties not
acquired through recent acquisitions have reached the final assessment
stage and therefore costs related to such sites have been anticipated.
For properties acquired through recent acquisitions, the Company
obtains assessments from both external and internal consultants and a
liability has been or will be accrued based on such assessments.

(i)

(ii)

the lack of specific technical information available with respect to
many sites;

the absence of any government authority, third-party orders, or
claims with respect to particular sites;

(iii) the potential for new or changed laws and regulations and for
development of new remediation technologies and uncertainty
regarding the timing of the work with respect to particular sites;

(iv) the ability to recover costs from any third parties with respect to

particular sites;

and as such, costs related to future remediation will be accrued in the
period they become known.

Future occurrences
In the operation of a railroad, it is possible that derailments, explosions
or other accidents may occur that could cause harm to human health
or to the environment. As a result, the Company may incur costs in the
future, which may be material, to address any such harm, including
costs relating to the performance of clean-ups, natural resource dam-
ages and compensatory or punitive damages relating to harm to
individuals or property.

Assessing the reasonableness of the estimated useful lives of prop-

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

A change in the remaining useful life of a group of assets, or their

Depreciation studies are a means of ensuring that the assumptions

In 2004, the Company recorded total depreciation and amortiza-

tion expense of $521 million ($478 million in 2003 and $506 million in
2002). At December 31, 2004, the Company had Properties of $16,688
million, net of accumulated depreciation of $6,448 million ($15,158 mil-
lion in 2003, net of accumulated depreciation of $6,265 million).

Pensions and other post-retirement benefits
The Company accounts for pensions and other post-retirement ben-
efits 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. Deferred recognition of differences between actual results and
those assumed is a guiding principle of this standard. This approach
allows for a gradual recognition of changes in benefit obligations and
plan performance over the expected average remaining service life of
the employee group covered by the plans. The Company has various
pension plans, however, the following description pertaining to pen-
sions relates generally to the Company’s main pension plan, the CN
Pension Plan.

The Canadian plans have a measurement date of December 31
whereas the U.S. plans have a measurement date of September 30. For
pensions and other post-retirement benefits, assumptions are required
for, among others, the discount rate, the expected long-term rate of
return on plan assets, the rate of compensation increase, health care
cost trend rates, mortality rates, employee early retirements, termina-
tions or disability. Changes in these assumptions result in actuarial
gains or losses which in accordance with CICA Handbook Section
3461, the Company has elected to amortize over the expected average
remaining service life of the employee group covered by the plans only
to the extent that the unrecognized net actuarial gains and losses are
in excess of 10% of the greater of the beginning of year balances of
the projected benefit obligation or market-related value of plan assets.
The future effect on the Company’s results of operations is dependent
on economic conditions, employee demographics, mortality rates and
investment performance.

The Company sets its discount rate assumption annually to reflect
the rates available on high-quality, fixed-income debt instruments with
a duration of approximately 12 years, which is expected to match the
timing and amount of expected benefit payments. High quality debt
instruments are corporate bonds with a rating of AA or better. A dis-
count rate of 5.75%, based on bond yields prevailing at December 31,
2004, was considered appropriate by the Company and is supported by
reports issued by third party advisors. A one-percentage-point decrease
in the discount rate would cause annual net periodic benefit cost to
increase by approximately $33 million whereas a one-percentage-point
increase would not have a material change in net periodic benefit cost
as the Company amortizes actuarial gains and losses over the expected
average remaining service life of the employee group covered by the
plans, only to the extent they are in excess of 10% of the greater of the
beginning of year balances of the projected benefit obligation or mar-
ket-related value of plan assets.

Rates of return

Actual

Market-related value

2004

11.7%
6.3%

2003

9.6%

7.0%

2002

2001

2000

(0.3)%

7.4%

(1.4)%

10.2%

10.5%

13.7%

Canadian GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

The rate of compensation increase, 3.75% to determine both the
benefit obligation and the net periodic benefit cost, is another signifi-
cant assumption in the actuarial model for pension accounting and is
determined by the Company based upon its long-term plans for such
increases. For other post-retirement benefits, the Company reviews
external data and its own historical trends for health care costs to
determine the health care cost trend rates. For measurement purposes,
the projected health care cost trend rate was 15% in the current year,
and it is assumed that the rate will decrease gradually to 6% in 2013
and remain at that level thereafter. A one-percentage-point change in
either the rate of compensation increase or the health care cost trend
rate would not cause a material change to the Company’s net periodic
benefit cost for both pensions and other post-retirement benefits.

expected to have a significant impact on the cash funding requirements
of the pension plans. The Canadian Institute of Actuaries (CIA) has
adopted a new standard that will be used to calculate the values that
pension plan members are entitled to receive on termination of employ-
ment. The new standard will impact the calculation of the pension plan
liabilities under a solvency or wind-up scenario when the Company
conducts an actuarial valuation for purposes of determining the fund-
ing position of the Company’s Canadian pension plans. The standard is
effective in February 2005 and may significantly impact future funding
requirements.

The Medicare Prescription Drug, Improvement, and Modernization

Act of 2003 (the “Act”), signed into law in the United States in
December 2003, provides for prescription drug benefits under Medicare,
as well as a federal subsidy to sponsors of retiree health care benefit
plans that provide prescription drug benefits that have been concluded
to be actuarially equivalent to the Medicare benefit. Pursuant to guid-
ance by the Financial Accounting Standards Board (FASB) in the United
States, adopted on July 1, 2004, the Company evaluated and deter-
mined the prescription drug benefits provided by its health care plans
to be actuarially equivalent to the Medicare benefit under the Act. The
Company measured the effects of the Act on the APBO as of January 1,
2004 and, as such, the APBO was reduced by $49 million. Net periodic
benefit cost for the year ended December 31, 2004 was reduced by $7
million due to the effects of the Act.

In 2004, with the acquisitions of GLT and BC Rail, the Company assumed two additional defined benefit plans. The following table provides the

Company’s plan assets by category, benefit obligation at end of year and Company and employee contributions by major pension plan:

In millions

Plan assets by category

Equity securities

Debt securities

Real estate

Other

Total

Benefit obligation at end of year

Company contributions in 2004

Employee contributions in 2004

December 31, 2004

CN
Pension Plan

BC Rail
Pension Plan

U.S. and
Other Plans

Total

$÷6,812

3,888

348

1,208

$12,256

$12,172

$÷÷÷«74

$÷÷÷«55

$312

212

$613

$626

$÷20

$÷÷–

$105

$÷7,229

$184

$339

$÷71

$÷÷–

4,154

365

1,305

$13,053

$13,137

$÷÷«165

$÷÷÷«55

100

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

Income taxes
The Company follows the asset and liability method of accounting for
income taxes. Under the asset and liability method, the change in the
net deferred income tax asset or liability is included in the computation
of net income. Deferred income tax assets and liabilities are measured
using substantively enacted income tax rates expected to apply to tax-
able income in the years in which temporary differences are expected
to be recovered or settled. As a result, a projection of taxable income
is required for those years, as well as an assumption of the ultimate
recovery/settlement period for temporary differences. The projection of
future taxable income is based on management’s best estimate and
may vary from actual taxable income. On an annual basis, the Company
assesses its need to establish a valuation allowance for its deferred
income tax assets and if it is deemed more likely than not that its
deferred income tax assets will not be realized based on its taxable
income projections, a valuation allowance is recorded. As at December 31,
2004, the Company expects that its deferred income tax assets will
be recovered from future taxable income and therefore, has not set
up a valuation allowance. In addition, Canadian and U.S. tax rules
and regulations are subject to interpretation and require judgment by
the Company that may be challenged by the taxation authorities. The
Company believes that its provisions for income taxes are adequate
pertaining to any assessments from the taxation authorities.

The Company’s deferred income tax assets are mainly composed
of temporary differences related to accruals for workforce reductions,
personal injury and other claims, environmental and other post-retire-
ment benefits, and losses and tax credit carryforwards. The majority of
these accruals will be paid out over the next five years. The Company’s
deferred income tax liabilities are mainly composed of temporary dif-
ferences related to properties and prepaid benefit cost for pensions. The
reversal of temporary differences is expected at future-substantively-
enacted income tax rates which could change due to fiscal budget
changes and/or changes in income tax laws. As a result, a change in the
timing and/or the income tax rate at which the components will reverse,
could materially affect deferred income tax expense as recorded in the
Company’s results of operations. A one-percentage-point change in the
Company’s reported effective income tax rate would have the effect of
changing the income tax expense by $19 million in 2004. In the fourth
quarter of 2003, the Company had recorded an increase of $33 million
to its net deferred income tax liability resulting from the enactment of
higher corporate tax rates in the province of Ontario.

For the year ended December 31, 2004, the Company recorded
total income tax expense of $631 million ($338 million in 2003 and
$268 million in 2002) of which $401 million was for deferred income
taxes ($232 million in 2003 and $156 million in 2002). The Company’s
net deferred income tax liability at December 31, 2004 was $3,198 mil-
lion ($3,240 million at December 31, 2003).

Business risks

Competition
The Company faces significant competition from a variety of carriers,
including Canadian Pacific Railway Company (CP) which operates the
other major rail system in Canada, serving most of the same industrial
and population centers as the Company, long distance trucking compa-
nies and, in many markets, major U.S. railroads and other Canadian and
U.S. railroads. Competition is generally based on the quality and reliabil-
ity of services provided, price, and the condition and suitability of car-
riers’ 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 competi-
tion 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.

In addition to trucking competition, and to a greater degree than

Canadian GAAP

Canadian National Railway Company

101

Management’s Discussion and Analysis

that the Company will be able to compete effectively against current and
future competitors in the railroad industry and that further consolida-
tion within the railroad industry will not adversely affect the Company’s
competitive position. No assurance can be given that competitive pres-
sures will not lead to reduced revenues, profit margins or both.

While the Company believes that it has identified the costs likely to

In railroad and related transportation operations, it is possible that

Labor negotiations
Canadian workforce
Labor agreements covering approximately 97% of the Company’s
Canadian unionized workforce expired on December 31, 2003. As of
January 2005, the Company has successfully negotiated four collective
agreements with the CAW, retroactive to January 1, 2004, covering the
Company’s shopcraft forces, clerical workers, intermodal yard employ-
ees and owner operators. Agreements were also reached with the
Company’s Rail Traffic Controllers, Toronto Terminal employees and the
Canadian Railway Police Association as well as a United Transportation
Union (UTU) group that represents employees in the Company’s north-
ern Quebec territory (CFIL). In addition, the Company has reached a
tentative labor agreement with the United Steelworkers of America, rep-
resenting approximately 2,250 track, bridges and structures employees,
whose agreement also expired on December 31, 2003. The UTU, rep-
resenting 2,520 brakemen and conductors, the Teamsters Canada Rail
Conference (TCRC), which represents 1,750 locomotive engineers, and
the 630-member International Brotherhood of Electrical Workers (IBEW),
representing close to 40% of the unionized workforce in Canada, filed
for conciliation in the fourth quarter and the negotiations have since
been conducted with government assistance. On December 29, 2004,
the Minister of Labour also referred to the Canadian Industrial Relations
Board (CIRB) a question respecting the maintenance of essential ser-
vices should there be a strike or lockout involving these groups. Until
the Board renders its decision, the right to strike or lockout is sus-
pended. In addition to the Board’s decision, at least 72 hours’ strike or
lockout notice would be required prior to any legal strike or lockout.
In the third quarter of 2004, the Company acquired BC Rail. At
December 2004, the Company had reached implementing agreements
for BC Rail employees with the Council of Trade Unions and its mem-
bers, representing all unions, regarding the integration of the various
collective agreements.

102

Canadian National Railway Company

Canadian GAAP

Management’s Discussion and Analysis

Negotiations are ongoing with the bargaining units with which the

Administration. As such, various Company business transactions must
gain prior regulatory approval, with attendant risks and uncertainties.
The Company is also subject to a variety of health, safety, security, labor,
environmental and other regulations, all of which can affect its com-
petitive position and profitability.

The CTA Review Panel, which was appointed by the federal govern-
ment to carry out a comprehensive review of the Canadian transporta-
tion legislation, issued its report to the Minister of Transport at the
end of June 2001. The report was released to the public on July 18,
2001 and contains numerous recommendations for legislative changes
affecting all modes of transportation, including rail. On February 25,
2003, the Canadian Minister of Transport released its policy document
Straight Ahead – A Vision for Transportation in Canada and tabled in
the House of Commons Bill C-26 entitled An Act to Amend the Canada
Transportation Act and the Railway Safety Act, to enact the VIA Rail
Canada Act and to make consequential amendments to other Acts.
Bill C-26 died on the Order Paper (was terminated) when Parliament
was prorogued on November 12, 2003. No assurance can be given
that any future legislative action by the federal government pursuant
to the report’s recommendations and the policy document, or other
future governmental initiatives will not materially adversely affect the
Company’s financial position or results of operations.

The U.S. Congress has had under consideration for several years

various pieces of legislation that would increase federal economic
regulation of the railroad industry. In addition, the STB is authorized by
statute to commence regulatory proceedings if it deems them to be
appropriate. No assurance can be given that any future regulatory initia-
tives by the U.S. federal government will not materially adversely affect
the Company’s operations, or its competitive and financial position.

The Company is subject to statutory and regulatory directives in
the United States addressing homeland security concerns. These include
new border security arrangements, pursuant to an agreement the
Company and CP entered into with U.S. Customs and Border Protection
(CBP) and the Canada Border Services Agency (CBSA). These require-
ments include advance electronic transmission of cargo information
for U.S.-bound traffic and cargo screening (including gamma ray and
radiation screening), as well as U.S. government imposed restrictions on
the transportation into the United States of certain commodities. In the
fourth quarter of 2003, the CBP issued regulations to extend advance
notification requirements to all modes of transportation and the U.S.
Food and Drug Administration promulgated interim final rules requir-
ing advance notification by all modes for certain food imports into the
United States. The Company has also worked with the Association of
American Railroads to develop and put in place an extensive industry-
wide security plan. While the Company will continue to work closely
with the CBSA, CBP, and other Canadian and U.S. agencies, as above,
no assurance can be given that future decisions by the U.S. and/or
Canadian governments on homeland security matters, or joint decisions
by the industry in response to threats to the North American rail net-
work, will not materially adversely affect the Company’s operations, or
its competitive and financial position.

Canadian GAAP

Canadian National Railway Company

103

Management’s Discussion and Analysis

The Company’s ownership of the former Great Lakes Transportation

Global, as well as North American trade conditions, including trade
barriers on certain commodities, may interfere with the free circulation
of goods across Canada and the United States.

Potential terrorist actions can have a direct or indirect impact on

the estimated annual impact on net income of a year-over-year one-
cent change in the Canadian dollar relative to the U.S. dollar is approxi-
mately $8 million. 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 and expenses.
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 adversely affected.

In addition to the inherent risks of the business cycle, the

Generally accepted accounting principles require the use of historical
cost as the basis of reporting in financial statements. As a result, the
cumulative effect of inflation, which has significantly increased asset
replacement costs for capital-intensive companies such as CN, is not
reflected in operating expenses. Depreciation charges on an inflation-
adjusted basis, assuming that all operating assets are replaced at
current price levels, would be substantially greater than historically
reported amounts.

Controls and procedures

Additional information, including the Company’s 2003 Annual Information
Form and Form 40-F, may be found on SEDAR at www.sedar.com and
on EDGAR at www.sec.gov/edgar.shtml, respectively.

Montreal, Canada
January 25, 2005

104

Canadian National Railway Company

Canadian GAAP

Management Report

Auditors' Report

The financial statements have been prepared by management in
conformity with generally accepted accounting principles in Canada.
These statements include some amounts that are based on best esti-
mates and judgments. Financial information used elsewhere in the
annual report is consistent with these financial statements.

KPMG LLP, who have been appointed as the sole auditors of the
Company by the shareholders.

To the shareholders of Canadian National Railway Company

We have audited the consolidated balance sheets of Canadian National
Railway Company as at December 31, 2004 and 2003 and the consoli-
dated statements of income, changes in shareholders’ equity and cash
flows for each of the years in the three-year period ended December 31,
2004. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with Canadian generally

On January 25, 2005, we reported separately to the Board of
Directors of the Company on consolidated financial statements for
the same period, prepared in accordance with United States generally
accepted accounting principles.

Claude Mongeau
Executive Vice-President and Chief Financial Officer

January 25, 2005

KPMG LLP
Chartered Accountants

Montreal, Canada
January 25, 2005

Serge Pharand
Vice-President and Corporate Comptroller

January 25, 2005

Canadian GAAP

Canadian National Railway Company

105

Consolidated Statement of Income

In millions, except per share data

Year ended December 31,

2004

2003

2002

Revenues

Petroleum and chemicals
Metals and minerals
Forest products
Coal

Grain and fertilizers

Intermodal
Automotive
Other items

Total revenues

Operating expenses

Labor and fringe benefits
Purchased services and material
Depreciation and amortization
Fuel
Equipment rents
Casualty and other (Note 2)

Total operating expenses

Operating income
Interest expense (Note 14)
Other income (loss) (Note 15)

Income before income taxes
Income tax expense (Note 16)

Net income

Basic earnings per share (Note 18)
Diluted earnings per share (Note 18)

$1,123
713
1,452
284
1,053
1,117
510
296

6,548

1,838
746
517
528
244
445

4,318

2,230
(282)
(20)

1,928
(631)

$1,297

$««4.55
$««4.48

$1,058
527
1,284
261
938
1,101
525
190

5,884

1,929
879
472
471
299
466

4,516

1,368
(317)
21

1,072
(338)

$÷«734

$««2.56
$««2.52

$1,102
521
1,323
326
986
1,052
591
209

6,110

2,069
908
499
459
353
724

5,012

1,098
(353)
76

821
(268)

$÷«553

$««1.85
$««1.82

See accompanying notes to consolidated financial statements.

106

Canadian National Railway Company

Canadian GAAP

Consolidated Balance Sheet

In millions

Assets

Current assets:

Cash and cash equivalents
Accounts receivable (Note 4)
Material and supplies
Deferred income taxes (Note 16)

Other

Properties (Note 5)
Intangible and other assets (Note 6)

Total assets

Liabilities and shareholders’ equity

Current liabilities:

Accounts payable and accrued charges (Note 8)
Current portion of long-term debt (Note 10)

Other

Deferred income taxes (Note 16)
Other liabilities and deferred credits (Note 9)
Long-term debt (Note 10)

Shareholders’ equity:

Common shares (Note 11)
Contributed surplus
Currency translation
Retained earnings

December 31,

2004

2003

$÷÷«147
793
127
393
194

1,654
16,688
929

$19,271

$÷÷«130
529
120
125
188

1,092
15,158
900

$17,150

$÷1,605
578
76

$÷1,421
483
73

2,259
3,591
1,488
4,586

3,587
164
(80)
3,676

7,347

1,977
3,365
1,153
4,175

3,530
166
(38)
2,822

6,480

Total liabilities and shareholders’ equity

$19,271

$17,150

On behalf of the Board:

David G.A. McLean
Director

E. Hunter Harrison
Director

See accompanying notes to consolidated financial statements.

Canadian GAAP

Canadian National Railway Company

107

Consolidated Statement of Changes in Shareholders’ Equity

Issued and
outstanding
common
shares

Issued and
outstanding
convertible
preferred
securities

In millions

Convertible

Common
shares

preferred Contributed
surplus
securities

Currency
translation

Retained
earnings

Total
shareholders’
equity

Balances December 31, 2001
Net income
Stock options exercised (Notes 11, 12)
Conversion of convertible

289.1
–
2.7

preferred securities (Note 11)
Share repurchase program (Note 11)
Currency translation
Dividends ($0.57 per share)
Dividends on convertible
preferred securities

Balances December 31, 2002
Net income
Stock options exercised

and other (Notes 11, 12)

Share repurchase program (Note 11)
Currency translation
Dividends ($0.67 per share)

Balances December 31, 2003
Net income
Stock options exercised

and other (Notes 11, 12)

Share repurchase program (Note 11)
Currency translation
Dividends ($0.78 per share)

Balances December 31, 2004

9.0
(4.5)
–
–

–

296.3
–

2.9
(15.0)
–
–

284.2
–

2.9
(4.0)
–
–

283.1

6.9
–
–

(6.9)
–
–
–

–

–
–

–
–
–
–

–
–

–
–
–
–

–

$3,209
–
93

327
(53)
–
–

–

3,576
–

136
(182)
–
–

3,530
–

107
(50)
–
–

$«327
–
–

(327)
–
–
–

–

–
–

–
–
–
–

–
–

–
–
–
–

$178
–
–

«$133
–
–

$2,514
553
–

$6,361
553
93

–
(3)
–
–

–

175
–

–
(9)
–
–

166
–

–
(2)
–
–

–
–
(1)
–

–

132
–

–
–
(170)
–

(38)
–

–
–
(42)
–

–
(147)
–
(170)

(6)

2,744
734

–
(465)
–
(191)

2,822
1,297

–
(221)
–
(222)

–
(203)
(1)
(170)

(6)

6,627
734

136
(656)
(170)
(191)

6,480
1,297

107
(273)
(42)
(222)

$3,587

$÷÷«–

$164

$«(80)

$3,676

$7,347

See accompanying notes to consolidated financial statements.

108

Canadian National Railway Company

Canadian GAAP

Consolidated Statement of Cash Flows

In millions

Operating activities
Net income

Year ended December 31,

2004

2003

2002

$«1,297

$««««734

$««««553

Adjustments to reconcile net income to net cash provided from operating activities:

Workforce reduction charge (Note 9)
Other changes in:

Accounts receivable
Material and supplies

Accounts payable and accrued charges
Other net current assets and liabilities

Other

Cash provided from operating activities

Investing activities

Net additions to properties
Acquisition of BC Rail (Note 3)
Acquisition of GLT (Note 3)

Other, net

Cash used by investing activities

Dividends paid

Financing activities

Issuance of long-term debt
Reduction of long-term debt
Issuance of common shares (Note 11)
Repurchase of common shares (Note 11)

Cash provided from (used by) financing activities

Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of year

Cash and cash equivalents, end of year

Supplemental cash flow information

Net cash receipts from customers and other
Net cash payments for:

Employee services, suppliers and other expenses
Interest (Note 14)

Workforce reductions (Note 9)

Personal injury and other claims (Note 19)
Pensions (Note 13)
Income taxes (Note 16)

Cash provided from operating activities

See accompanying notes to consolidated financial statements.

521
401
4
–
–

(233)
10
5
21
113

2,139

(1,072)
(984)
(547)
192

(2,411)

(222)

8,277
(7,579)
86
(273)

511

17
130

478
232
(17)
–
–

153
(3)
(96)
(27)
46

506
156
(33)
281
120

(80)
–
(154)
(18)
(158)

1,500

1,173

(583)
–
–
(16)

(599)

(191)

4,109
(4,141)
83
(656)

(605)

105
25

(571)
–
–
95

(476)

(179)

3,146
(3,558)
69
(203)

(546)

(28)
53

$««««147

$««««130

$««««««25

$«6,501

$«6,022

$«6,285

(3,628)
(282)
(93)
(106)
(161)
(92)

(3,736)
(327)
(155)
(126)
(92)
(86)

(4,231)
(390)
(177)
(156)
(93)
(65)

$«2,139

$«1,500

$«1,173

Canadian GAAP

Canadian National Railway Company

109

Notes to Consolidated Financial Statements

1 Summary of significant accounting policies

These consolidated financial statements are expressed in Canadian
dollars, except where otherwise indicated, and have been prepared in
accordance with accounting principles generally accepted in Canada
(Canadian GAAP). Significant differences between the accounting
principles applied in the accompanying financial statements and those
under United States generally accepted accounting principles (U.S.
GAAP) are quantified and explained in Note 21 to the financial state-
ments. 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 rev-
enues 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 personal injury and
other claims, environmental claims, depreciation, pensions and other
post-retirement benefits, and income taxes, based upon currently avail-
able information. Actual results could differ from these estimates.

C. Foreign exchange
All of the Company’s United States (U.S.) operations are self-sustain-
ing foreign entities with the U.S. dollar as their functional currency. The
Company also has an equity investment in an international affiliate based
in the United Kingdom with the British pound as its functional currency.
Accordingly, the U.S. operations’ assets and liabilities and the Company’s
foreign equity investment are translated into Canadian dollars at the rate
in effect at the balance sheet date and the revenues and expenses are
translated at average exchange rates during the year. All adjustments
resulting from the translation of the foreign operations are recorded in
Currency translation, which forms part of Shareholders’ equity.

gains and losses, from the dates of designation, on the translation
of the U.S. dollar denominated long-term debt are also included in
Currency translation.

D. Cash and cash equivalents
Cash and cash equivalents include highly liquid investments purchased
three months or less from maturity and are stated at cost, which
approximates market value.

110

Canadian National Railway Company

Canadian GAAP

Notes to Consolidated Financial Statements

Asset class

Track and roadway

Rolling stock

Buildings

Other

Annual rate

The Company follows the group method of depreciation for railroad

I. Intangible assets
Intangible assets relate to customer contracts and relationships
assumed through recent acquisitions and are being amortized on a
straight-line basis over 40 to 50 years.

J. Pensions
Pension costs are determined using actuarial methods. Net periodic
benefit cost is charged to income and includes:

(i)

the cost of pension benefits provided in exchange for employees’
services rendered during the year,

(ii)

the interest cost of pension obligations,

(iii) the amortization of the initial net transition obligation on a

straight-line basis over the expected average remaining service life
of the employee group covered by the plans,

(iv) the amortization of prior service costs and amendments over the

expected average remaining service life of the employee group cov-
ered by the plans,

(v)

the expected long-term return on pension fund assets, and

(vi) the amortization of cumulative unrecognized net actuarial gains

The pension plans are funded through contributions determined in

accordance with the projected unit credit actuarial cost method.

L. Personal injury claims
In Canada, the Company accounts for costs related to employee work-
related injuries based on actuarially developed estimates of the ulti-
mate cost associated with such injuries, including compensation, health
care and administration costs.

In the U.S., the Company accrues the expected cost for personal

N. Income taxes
The Company follows the asset and liability method of accounting
for income taxes. Under the asset and liability method, the change in
the net deferred tax asset or liability is included in the computation of
net income. Deferred tax assets and liabilities are measured using sub-
stantively enacted tax rates expected to apply to taxable income
in the years in which temporary differences are expected to be recov-
ered or settled.

O. Derivative financial instruments
The Company uses derivative financial instruments in the manage-
ment of its fuel exposure, and may use them from time to time, in the
management of its interest rate and foreign currency exposures. Gains
or losses on such instruments entered into for the purpose of hedging
financial risk exposures are deferred and amortized in the results of
operations over the life of the hedged asset or liability or over the term
of the derivative financial instrument. Income and expense related to
hedged derivative financial instruments are recorded in the same cat-
egory as that generated by the underlying asset or liability.

P. Stock-based compensation
The Company follows the fair value based approach for stock option
awards and retroactively applied this method of accounting to all
awards of employee stock options granted, modified or settled on

Canadian GAAP

Canadian National Railway Company

111

Notes to Consolidated Financial Statements

Summary of significant accounting policies (continued)

or after January 1, 2002 and restated the 2002 comparative period
to reflect this change in accounting policy, as explained in Note 2
– Accounting changes. For awards of conventional and performance-
based employee stock options granted before January 1, 2002, the
Company did not record compensation cost, and any consideration
paid by employees on the exercise of stock options was recorded as
share capital.

2 Accounting changes

2004
Property capitalization
Effective January 1, 2004, the Company changed its capitalization policy
under Canadian GAAP, on a prospective basis, to conform with the
Canadian Institute of Chartered Accountants (CICA) Handbook Section
3061, “Properties, Plant and Equipment.” The change was made in
response to the CICA Handbook Section 1100, “Generally Accepted
Accounting Principles,” issued in July 2003. This section provides new
accounting guidance as to what constitutes GAAP in Canada and its
sources, thereby codifying a GAAP hierarchy. The section also estab-
lishes that when financial statements are prepared in accordance with
regulatory or legislative requirements that are in conflict with the new
GAAP hierarchy, they cannot be described as being in accordance with
Canadian GAAP.

For the year ended December 31, 2004, net income increased by

$312 million ($464 million before tax), as a result of the change in the
capitalization policy.

2003
Stock-based compensation
Effective January 1, 2003, the Company adopted the fair value based
approach recommended by CICA Handbook Section 3870, “Stock-Based
Compensation and Other Stock-Based Payments.” The Company retro-
actively applied this method of accounting to all awards of employee
stock options granted, modified or settled on or after January 1, 2002
and restated the 2002 comparative period to reflect this change in

accounting policy. For the year ended December 31, 2002, the restate-
ment had the effect of decreasing net income by $18 million ($0.06 per
basic and diluted share), through increased labor and fringe benefits
expense. The restatement also had the effect of increasing the book
value of common shares and decreasing retained earnings by $18 mil-
lion at December 31, 2002.

In 2002, prior to the adoption of the fair value based approach, the

Company had applied the intrinsic value method of accounting to its
awards of conventional and performance-based employee stock options
granted on or after January 1, 2002 and as a result, no compensation
cost had been recognized for the year ended December 31, 2002 as no
performance-based employee stock options were granted. For awards of
conventional and performance-based employee stock options granted
before January 1, 2002, the Company did not record compensation
cost, and any consideration paid by employees on the exercise of stock
options was recorded as share capital.

The Company granted 3.0 million and 4.8 million stock options
during 2003 and 2002, respectively, which will be expensed over their
vesting period based on their estimated fair values on the date of grant,
determined using the Black-Scholes option-pricing model. For the years
ended December 31, 2003 and 2002, the Company recognized compen-
sation cost of $50 million and $18 million, respectively.

Under the actuarial-based approach, the Company accrues the
expected cost for personal injury and property damage claims and
asserted occupational disease claims, based on actuarial estimates of
their ultimate cost. The Company is unable to estimate the total cost for
unasserted occupational disease claims. However, a liability for unas-
serted occupational disease claims was accrued to the extent they were
reasonably estimable.

In 2002, the Company’s U.S. personal injury and other claims

expense, including the above-mentioned charge, was $362 million.
Had the Company continued to apply the case-by-case approach to its
U.S. personal injury and other claims liability, recognizing the effects of
the actual claims experience for existing and new claims in the fourth
quarter, these expenses would have been approximately $135 million
in 2002.

112

Canadian National Railway Company

Canadian GAAP

Notes to Consolidated Financial Statements

3 Acquisitions

On July 2, 2004, the Company reached a consent agreement with

On July 14, 2004, the Company completed its acquisition of BC
Rail and began a phased integration of the companies’ operations. The
acquisition was financed by debt and cash on hand.

The Company accounted for the acquisition using the pur-
chase method of accounting as required by Section 1581, “Business
Combinations,” and Section 3062, “Goodwill and Other Intangible
Assets,” of the CICA Handbook. As such, the accompanying consoli-
dated financial statements include the assets, liabilities and results of
operations of BC Rail as of July 14, 2004, the date of acquisition. The
Company’s cost to acquire BC Rail of $991 million includes purchase
price adjustments and transaction costs. The following table reflects
the preliminary purchase price allocation, based on the fair value of
BC Rail’s assets acquired, owned and leased, and liabilities assumed at
acquisition, which is subject to a final valuation, the impact of which is
not expected to have a material effect on the results of operations.

In millions

Current assets

Deferred income taxes

Properties

Other assets

Total assets acquired

Current liabilities

Other liabilities and deferred credits

Long-term debt

Total liabilities assumed

Net assets acquired

As of April 2004, the Company received all necessary regulatory

approvals, including the U.S. Surface Transportation Board (STB) ruling
rendered on April 9, 2004.

On May 10, 2004, the Company completed its acquisition of GLT

and began a phased integration of the companies’ operations. The
acquisition was financed by debt and cash on hand.

In millions

Current assets

Properties

Intangible and other assets

Total assets acquired

Current liabilities

Deferred income taxes

Other liabilities and deferred credits

Total liabilities assumed

Net assets acquired

4 Accounts receivable

In millions

Freight

Trade

Accrued

Non-freight

May 10, 2004

$÷÷«67

977

1,131

290

230

584

$÷«547

December 31,

2004

2003

$414
93
356
863
(70)
$793

$252

277

584

(55)

$529

July 14, 2004

Provision for doubtful accounts

$÷«202

397

620

1,222

142

231

$÷«991

The Company has an accounts receivable securitization program,
expiring in June 2006, under which it may sell, on a revolving basis, a
maximum of $450 million of eligible freight trade and other receivables
outstanding at any point in time, to an unrelated trust. The Company
has a contingent residual interest of approximately 10% of receivables
sold, which is recorded in Other current assets. The Company has
retained the responsibility for servicing, administering and collecting
freight receivables sold. Other income (loss) included $9 million in
each of 2004, 2003 and 2002, for costs related to the agreement,
which fluctuate with changes in prevailing interest rates.

At December 31, 2004, pursuant to the agreement, $445 million

had been sold compared to $448 million at December 31, 2003.

Canadian GAAP

Canadian National Railway Company

113

Notes to Consolidated Financial Statements

5 Properties

In millions

Track, roadway and land

Rolling stock

Buildings

Other

Capital leases included in properties

Track and roadway

Rolling stock

Buildings

Other

December 31, 2004

Accumulated
depreciation

$3,697

1,466

771

514

Cost

$16,105

4,059

1,915

1,057

$23,136

$6,448

$÷÷«395

1,155

110

119

$÷÷÷«7

265

$÷1,779

$÷«285

Net

$12,408
2,593
1,144
543
$16,688

$÷÷«388
890
104
112
$÷1,494

December 31, 2003

Accumulated
depreciation

$3,544

1,399

817

505

Cost

$15,094

3,658

1,773

898

Net

$11,550

2,259

956

393

$21,423

$6,265

$15,158

$÷÷÷«41

1,213

105

$÷÷÷«4

275

$÷÷÷«37

938

$÷1,380

$÷«290

$÷1,090

6 Intangible and other assets

In millions

December 31,

Prepaid benefit cost (Note 13)

Investments (A)

Deferred receivables

Intangible assets (B)

Note receivable from EWS

Unamortized debt issue costs

Other

(Cdn$141 million) in cash and a note receivable of £23.9 million
(Cdn$58 million) from EWS. The note receivable is due in 2009, carries
interest at 8% and is redeemable in whole or in part at any time by
EWS, at the principal amount together with accrued but unpaid interest
up to the date of repayment.

B. Intangible assets
Intangible assets relate to customer contracts and relationships
assumed through the GLT acquisition.

2004

$515
166
77
69
57
35
10
$929

2003

$411

367

–

$900

7 Credit facility

114

Canadian National Railway Company

Canadian GAAP

Notes to Consolidated Financial Statements

8 Accounts payable and accrued charges

(ii) Funded status

In millions

Trade payables

Income and other taxes

Payroll-related accruals

Accrued charges

Personal injury and other claims provision

Accrued interest

Workforce reduction provisions

Other

December 31,

2004

$÷«491
310
259
179
118
106
90
52
$1,605

2003

In millions

December 31,

$÷«444

Unfunded benefit obligation at end of year

270

205

131

123

Unrecognized net actuarial gain (loss)

Unrecognized prior service cost

Accrued benefit cost for post-retirement benefits

other than pensions (including current portion)

(iii) Components of net periodic benefit cost

$1,421

In millions

Year ended December 31,

9 Other liabilities and deferred credits

In millions

December 31,

2004

2003

Personal injury and other claims provision,

net of current portion

Workforce reduction provisions, net of current portion (A)

Accrual for post-retirement benefits other than pensions (B)

Accrued benefit cost for pensions (Note 13)

Environmental reserve, net of current portion

Deferred credits and other

$÷«524
149
284
156
93
282
$1,488

$÷«467

136

139

126

223

Current service cost – employer portion

Interest cost

Plan amendments

Actuarial loss (gain) on accrued benefit obligation

Cost arising in the period

Difference between cost arising in the period and
cost recognized in the period in respect of:

Actuarial loss (gain)

Plan amendments

Net periodic benefit cost

2004

$÷÷«8
17
(12)
(111)
(98)

112
15
$÷«29

2004

$319
6
(16)

2003

$«309

(112)

(33)

$309

$«164

2003

$÷«5

2002

$÷÷4

132

(22)

(5)

(92)

(15)

$«33

$÷25

$1,153

(iv) Weighted-average assumptions

B. Post-retirement benefits other than pensions

(i) Change in benefit obligation

In millions

Year ended December 31,

Benefit obligation at beginning of year

Acquisition of GLT and BC Rail

Amendments

Actuarial (gain) loss

Interest cost

Service cost

Foreign currency changes

Benefits paid

Benefit obligation at end of year

2004

$«309
151
(12)
(111)
17
8
(25)
(18)
$«319

2003

$311

–

(44)

(18)

$309

The Company uses a measurement date of September 30 for its U.S. plans and December 31
for its Canadian plans.

December 31,

2004

2003

2002

To determine benefit obligation

Discount rate

Rate of compensation increase

To determine net periodic benefit cost

Discount rate

Rate of compensation increase

5.90%
3.75%

6.00%

3.75%

6.69%

4.00%

6.00%
3.75%

6.69%

4.00%

7.14%

4.00%

A one-percentage-point change in the assumed health care cost

trend rates would have the following effect:

In millions

Effect on total service and interest costs

Effect on benefit obligation

One-percentage-point

Increase

Decrease

$÷2

$÷(2)

(24)

Canadian GAAP

Canadian National Railway Company

115

Notes to Consolidated Financial Statements

9 Other liabilities and deferred credits (continued)

prescription drug benefits provided by its health care plans to be actu-
arially equivalent to the Medicare benefit under the Act. The Company
measured the effects of the Act on the accumulated post-retirement
benefit obligation (APBO) as of January 1, 2004 and, as such, the APBO
was reduced by $49 million. Net periodic benefit cost for the year
ended December 31, 2004 was reduced by $7 million due to the effects
of the Act.

(vi) The estimated future benefit payments for each of the next five
years and the subsequent five-year period are as follows:

In millions

2005

2006

2007

2008

2009

Years 2010 to 2014

$÷20

130

10 Long-term debt

In millions

Debentures and notes: (A)

Canadian National series:

7.00% 10-year notes

6.45% Puttable Reset Securities (PURS) (B)

4.25% 5-year notes (C)

6.38% 10-year notes (C)

4.40% 10-year notes (C)

6.80% 20-year notes (C)

7.63% 30-year debentures

6.90% 30-year notes (C)

7.38% 30-year debentures (C)

6.25% 30-year notes (C)

Illinois Central series:

7.75% 10-year notes

6.98% 12-year notes

6.63% 10-year notes

5.00% 99-year income debentures

7.70% 100-year debentures

Wisconsin Central series:

6.63% 10-year notes

BC Rail series:

Currency
in which
payable

Maturity

Mar. 15, 2004

July 15, 2006

Aug. 1, 2009

Oct. 15, 2011

Mar. 15, 2013

July 15, 2018

May 15, 2023

July 15, 2028

Oct. 15, 2031

Aug. 1, 2034

May 1, 2005

July 12, 2007

June 9, 2008

Dec. 1, 2056

Sept. 15, 2096

April 15, 2008

U.S.$

Non-interest bearing 90-year subordinated notes (D)

July 14, 2094

CDN$

Total debentures and notes

Other:

Revolving credit facility (A) (Note 7)

Commercial paper (E) (Note 7)

Capital lease obligations and other (F)

Total other

Less:

Current portion of long-term debt

Net unamortized discount

U.S.$

Various

116

Canadian National Railway Company

Canadian GAAP

December 31,

2004

2003

$÷«÷÷–

$÷«344

301

361

482

241

181

572

241

602

120

151

181

4,008

843

4,851

108

254

805

1,167

6,018

578

854

1,432

324

–

518

259

194

615

259

–

129

162

194

3,617

–

3,617

233

–

822

1,055

4,672

483

497

$4,586

$4,175

Notes to Consolidated Financial Statements

A. The Company’s debentures, notes and revolving credit facility are
unsecured.

•

H. The aggregate amount of debt payable in U.S. currency as at
December 31, 2004 is U.S.$4,022 million (Cdn$4,845 million) and
U.S.$3,273 million (Cdn$4,236 million) as at December 31, 2003.

I. The Company has U.S.$200 million available under its currently effec-
tive shelf prospectus and registration statement providing for the issu-
ance of debt securities in one or more offerings.

11 Capital stock and convertible preferred securities

A. Authorized capital stock
The authorized capital stock of the Company is as follows:
•
•

D. The Company records these notes as a discounted debt of $5 million,
using an imputed interest rate of 5.75%. The discount of $838 million
is included in the net unamortized discount.

F. Interest rates for the capital leases range from approximately 2.23%
to 13.13% with maturity dates in the years 2005 through 2025. The
imputed interest on these leases amounted to $342 million as at
December 31, 2004 and $395 million as at December 31, 2003.

The capital lease obligations are secured by properties with a net
carrying amount of $1,054 million as at December 31, 2004 and $1,091
million as at December 31, 2003.

G. Long-term debt maturities, including repurchase arrangements and
capital lease repayments on debt outstanding as at December 31, 2004,
for the next five years and thereafter, are as follows:

In millions

2005

2006

2007

2008

2009

2010 and thereafter

$÷«578

376

154

230

427

3,399

In 2002, the Company issued 9.0 million common shares related to

the conversion of the Company’s convertible preferred securities.

D. Share repurchase program
On October 26, 2004, the Board of Directors of the Company approved
a share repurchase program which allows for the repurchase of up to
14.0 million common shares between November 1, 2004 and October 31,
2005 pursuant to a normal course issuer bid, at prevailing market
prices. As at December 31, 2004, 4.0 million common shares have been
repurchased for $273 million, at an average price of $68.31 per share.

Canadian GAAP

Canadian National Railway Company

117

Notes to Consolidated Financial Statements

11 Capital stock and convertible preferred securities (continued)

12 Stock plans

The Company has various stock-based incentive plans for eligible
employees. A description of the Company’s major plans is provided
below:

Stock-based plans
Compensation cost for awards under all stock-based plans was $84
million, $50 million and $18 million for the years ended December 31,
2004, 2003 and 2002, respectively.

At December 31, 2004, the total liability under the VIDP was $22

million, representing 354,745 units outstanding under the plan. For the
year ended December 31, 2004, the Company recognized an expense
of $7 million related to the plan.

118

Canadian National Railway Company

Canadian GAAP

Notes to Consolidated Financial Statements

accelerated options outstanding at December 31, 2004 were 8.9 million,
1.3 million and 2.9 million, respectively.

Changes in the Company’s stock options are as follows:

Outstanding at December 31, 2001 (1)
Granted

Canceled and expired

Exercised

Outstanding at December 31, 2002 (1)
Granted

Canceled and expired

Exercised

Outstanding at December 31, 2003 (1)
Granted

Canceled and expired

Exercised

Outstanding at December 31, 2004 (1)

Weighted-
average
exercise price

Number
of options

In millions

14.9

4.8

(0.3)

(2.7)

16.7

3.0

(0.6)

(2.9)

16.2

–

(0.2)

(2.9)

13.1

$29.08

$51.19

$37.99

$26.11

$35.67

$40.95

$45.11

$26.60

$37.16

–

$42.58

$28.70

$38.85

Stock options outstanding and exercisable as at December 31, 2004 were as follows:

(1) Includes IC and WC converted stock options translated to Canadian dollars using the

foreign exchange rate in effect at the balance sheet date.

Range of exercise prices

$ 9.00–$16.02

$18.13–$27.08

$27.31–$33.35

$37.17–$49.21

$51.05–$58.44

Balance at December 31, 2004 (1)

Options outstanding

Options exercisable

Number
of options

In millions

0.2

1.6

4.1

3.1

4.1

13.1

Weighted-
average years
to expiration

Weighted-
average
exercise price

$15.40

$23.33

$32.10

$40.98

$51.19

$38.85

Weighted-
average
exercise price

Number
of options

In millions

0.2

1.6

3.3

1.1

2.0

8.2

$15.40

$23.33

$31.82

$41.03

$51.20

$35.55

(1) Includes IC and WC converted stock options translated to Canadian dollars using the foreign exchange rate in effect at the balance sheet date.

At December 31, 2003 and 2002, the Company had 7.5 million and 7.4 million options exercisable at a weighted-average exercise price of

$31.39 and $29.34, respectively.

Compensation cost for awards of employee stock options granted,

modified or settled on or after January 1, 2002 was determined using
the fair value based approach in accordance with the CICA Handbook
Section 3870, “Stock-Based Compensation and Other Stock-Based
Payments,” as explained in Note 2 – Accounting changes. Compensation
cost recognized for stock option awards was $28 million, $43 million
and $18 million in 2004, 2003 and 2002, respectively.

Compensation cost related to stock option awards under the fair
value based approach was calculated using the Black-Scholes option-
pricing model with the following assumptions:

Year ended December 31,

2004 (1)

2003

Expected option life (years)

Risk-free interest rate

Expected stock price volatility

Average dividend per share

–
–
–
–

2002

7.0

5.0

4.12%

5.79%

30%

$÷0.67

$÷0.57

Year ended December 31,

2004 (1)

2003

2002

Weighted average fair value of options granted

$«–

$11.88

$20.65

(1) The Company did not grant any stock option awards in 2004.

Canadian GAAP

Canadian National Railway Company

119

Notes to Consolidated Financial Statements

13 Pensions

Description of Pension Plan
The Pension Plan is a contributory defined benefit pension plan that
covers the majority of CN employees. It provides for pensions based
mainly on years of service and final average pensionable earnings and
is generally applicable from the first day of employment. Indexation
of pensions is provided after retirement through a gain (loss) sharing
mechanism, subject to guaranteed minimum increases. An independent
trust company is the Trustee of the Canadian National Railways Pension
Trust Funds (CN Pension Trust Funds). As Trustee, the trust company
performs certain duties, which include holding legal title to the assets
of the CN Pension Trust Funds and ensuring that the Company, as
Administrator, complies with the provisions of the Pension Plan and
the related legislation. The Company utilizes a measurement date of
December 31 for the Pension Plan.

Plan assets by category

Equity securities

Debt securities

Real estate

Other

Target
Allocation

December 31,
2003

2004

53%
40%
4%
3%
100%

56%
34%
3%
7%
100%

56%

38%

100%

The Company follows a disciplined investment strategy, which limits

concentration of investments by asset class, foreign currency, sector
or company. The Investment Committee of the Board of Directors has
approved an investment policy that establishes long-term asset mix
targets based on a review of historical returns achieved by worldwide
investment markets. Investment managers may deviate from these
targets but their performance is evaluated in relation to the market
performance of the target mix. The Company does not anticipate the
return on plan assets to fluctuate materially from related capital market
indices. The Investment Committee reviews investments regularly with
specific approval required for major investments in illiquid securities.
The policy also permits the use of derivative financial instruments to
implement asset mix decisions or to hedge existing or anticipated expo-
sures. The Pension Plan does not invest in the securities of the Company
or its subsidiaries.

Weighted-average assumptions

December 31,

2004

2003

2002

To determine benefit obligation

Discount rate

Rate of compensation increase

To determine net periodic benefit cost

Discount rate

Rate of compensation increase

Expected return on plan assets

5.75%
3.75%

6.00%

3.75%

6.50%

4.00%

6.00%
3.75%
8.00%

6.50%

4.00%

8.00%

6.50%

4.00%

9.00%

Information about the Company’s defined benefit pension plans:

(a) Change in benefit obligation

In millions

Year ended December 31,

2004

2003

Benefit obligation at beginning of year

Acquisition of GLT and BC Rail

Interest cost

Actuarial loss

Service cost

Plan participants’ contributions

Foreign currency changes

Benefit payments and transfers

Benefit obligation at end of year

$12,020
684
733
349
124
55
(23)
(805)
$13,137

$11,376

–

720

482

103

(26)

(695)

$12,020

120

Canadian National Railway Company

Canadian GAAP

Notes to Consolidated Financial Statements

(b) Change in plan assets

(f) Estimated future benefit payments

In millions

Year ended December 31,

2004

2003

The estimated future benefit payments for each of the next five years
and the subsequent five-year period are as follows:

$11,671
611
165
55
(15)
1,371
(805)
$13,053

$11,182

–

(15)

1,049

(695)

$11,671

In millions

2005

2006

2007

2008

2009

Years 2010 to 2014

Fair value of plan assets at beginning of year

Acquisition of GLT and BC Rail

Employer contributions

Plan participants’ contributions

Foreign currency changes

Actual return on plan assets

Benefit payments and transfers

Fair value of plan assets at end of year

In millions

Deficiency of fair value of plan assets over
benefit obligation at end of year (1)

Unrecognized net actuarial loss (1)
Unrecognized prior service cost

Net amount recognized

December 31,

2004

2003

14 Interest expense

In millions

Year ended December 31,

Interest on debt and capital leases

Interest income

$«(84)
368
75
$359

$(349)

540

$«285

(1) Subject to future reduction for gain sharing under the terms of the plan.

Cash interest payments

(d) Amount recognized in the Consolidated Balance Sheet

15 Other income (loss)

In millions

December 31,

Prepaid benefit cost (Note 6)

Accrued benefit cost (Note 9)

Net amount recognized

2004

$«515
(156)
$«359

2003

$«411

(126)

$«285

The accumulated benefit obligation for all defined benefit pension
plans was $12,450 million and $11,381 million at December 31, 2004,
and 2003, respectively.

In millions

Year ended December 31,

Gain on disposal of properties

Investment income

Foreign exchange gain (loss)

Equity in earnings of English Welsh
and Scottish Railway (Note 6)

Net real estate costs

Other

$÷«957

821

845

869

893

4,760

2002

$353

–

$353

$390

2002

$«41

(15)

(13)

2003

$318

(1)

$317

$327

2003

$«56

(3)

(19)

(31)

$«21

$«76

2004

$282
–
$282

$282

2004

$«32
5
(2)

(4)
(18)
(33)
$(20)

(e) Components of net periodic benefit cost

In millions

Year ended December 31,

Current service cost – employer portion

Interest cost

Actual return on plan assets

Actuarial loss (gain) on accrued benefit obligation

Cost arising in the period

Difference between cost arising in the period

and cost recognized in the period in respect of:

Return on plan assets

Actuarial loss (gain)

Transition obligation

Plan amendments

Net periodic benefit cost

2004

$«÷«124
733
(1,371)
349
(165)

514
(346)
–
19
$÷÷÷22

2003

2002

16 Income taxes

$÷÷103

$«108

720

(1,049)

482

256

230

(478)

722

(86)

783

(913)

$÷÷÷49

$÷÷«–

The Company’s consolidated effective income tax rate differs from the
statutory Federal tax rate. The reconciliation of income tax expense is
as follows:

In millions

Year ended December 31,

Federal tax rate

Income tax expense at the statutory

Federal tax rate

Income tax (expense) recovery resulting from:

Provincial and other taxes

Deferred income tax adjustments

due to rate enactments

Gain on disposals and dividends
Adjustments to prior years’ income taxes (1)

Other

Income tax expense

Cash payments for income taxes

2004

22.1%

2003

2002

24.1%

26.1%

$÷«(426)

$÷«(258)

$÷«(219)

(272)

(144)

(97)

2
10
11
44
$÷«(631)

$÷«÷«92

(33)

–

$÷«(338)

$÷«(268)

$÷«÷«86

$÷«÷«65

(1) Adjustments relating mainly to the resolution of matters pertaining to prior years’ income

taxes.

Canadian GAAP

Canadian National Railway Company

121

Notes to Consolidated Financial Statements

16 Income taxes (continued)

17 Segmented information

The following table provides tax information for Canada and the

United States:

The Company operates in one business segment with operations in
Canada and the United States.

In millions

Year ended December 31,

2004

2003

2002

Information on geographic areas

$1,552
376
$1,928

$÷(222)
(8)
$÷(230)

$÷(279)
(122)
$÷(401)

$1,052

$1,072

$«882

(61)

$«821

$÷÷(94)

$(130)

(12)

$÷(106)

$(112)

$÷(244)

$(161)

$÷(232)

$(156)

In millions

Revenues

Canada

U.S.

In millions

Properties

Canada

U.S.

Year ended December 31,

2004

2003

2002

$4,126
2,422
$6,548

$3,707

$3,726

2,177

2,384

$5,884

$6,110

December 31,

2004

2003

$÷7,449
9,239
$16,688

$÷6,376

8,782

$15,158

Significant components of deferred income tax assets and liabilities

18 Earnings per share

December 31,

2004

2003

Basic earnings per share

Diluted earnings per share

Year ended December 31,

2004

$4.55
$4.48

2003

2002

$2.56

$2.52

$1.85

$1.82

$÷÷«86
190
115
278
669

121
3,746
3,867
$3,198

$÷«644
2,554
$3,198

$3,198
393
$3,591

$÷÷«81

252

475

102

3,613

3,715

$3,240

$÷«630

2,610

$3,240

125

$3,365

The following table provides a reconciliation between basic and

diluted earnings per share:

In millions

Net income

Year ended December 31,

Dividends on convertible preferred

securities (Note 11)

Weighted-average shares outstanding

Effect of dilutive securities and stock options

Weighted-average diluted shares outstanding

2004

$1,297

–
$1,297

285.1
4.5
289.6

2003

$734

2002

$553

–

$734

$547

286.8

3.9

290.7

295.0

9.2

304.2

For the years ended December 31, 2004, 2003 and 2002, the
weighted-average number of stock options that were not included in
the calculation of diluted earnings per share, as their inclusion would
have had an anti-dilutive impact, was 0.2 million, 6.8 million and
4.8 million, respectively. The 2003 and 2002 figures have been adjusted
for the three-for-two common stock split (see Note 11(E)).

Income before income taxes

Canada

U.S.

Current income taxes

Canada

U.S.

Deferred income taxes

Canada

U.S.

are as follows:

In millions

Deferred income tax assets

Workforce reduction provisions

Personal injury claims and other reserves

Post-retirement benefits

Losses and tax credit carryforwards

Deferred income tax liabilities

Net prepaid benefit cost for pensions

Properties and other

Total net deferred income tax liability

Canada

U.S.

Total net deferred income tax liability

Net current deferred income tax asset

Long-term deferred income tax liability

It is more likely than not that the Company will realize its deferred

income tax assets from the generation of future taxable income, as
the payments for provisions, reserves and accruals are made and losses
and tax credit carryforwards are utilized. At December 31, 2004, the
Company had $794 million of operating loss carryforwards, mainly
resulting from the BC Rail acquisition, available to reduce future taxable
income expiring between 2005 and 2023.

The Company recognized tax credits of $4 million in 2004 for
research and development expenditures ($15 million in 2003 and
$9 million in 2002) not previously recognized, which reduced the
cost of properties.

122

Canadian National Railway Company

Canadian GAAP

Notes to Consolidated Financial Statements

19 Major commitments and contingencies

In millions

2005

2006

2007

2008

2009

2010 and thereafter

Less: imputed interest on capital leases at rates

ranging from approximately 2.23% to 13.13%

Present value of minimum lease payments included in debt

Operating

Capital

$206

$÷«113

194

146

116

240

106

130

609

$992

1,103

342

$÷«761

Rent expense for operating leases was $242 million, $230 million

and $269 million for the years ended December 31, 2004, 2003 and
2002, respectively. Contingent rentals and sublease rentals were not
significant.

In Canada, employee injuries are governed by the workers’ com-

In the United States, employee work-related injuries, including
occupational disease claims, are compensated according to the provi-
sions of the Federal Employers’ Liability Act (FELA), which requires
either the finding of fault through the U.S. jury system or individual
settlements, and represent a major expense for the railroad industry.
The Company follows an actuarial-based approach and accrues the
expected cost for personal injury and property damage claims and
asserted occupational disease claims, based on actuarial estimates of
their ultimate cost. A liability for the minimum amount of unasserted
occupational disease claims is also accrued to the extent they can be
reasonably estimated. The amount recorded reflects a 25-year horizon
as the Company expects that a large majority of these cases will be
received over such period.

Although the Company considers such provisions to be adequate

Canadian GAAP

Canadian National Railway Company

123

Notes to Consolidated Financial Statements

19 Major commitments and contingencies (continued)

magnitude of such additional liabilities and the costs of complying with
environmental laws and containing or remediating contamination can-
not be reasonably estimated due to:

(i)

(ii)

the lack of specific technical information available with respect to
many sites;

the absence of any government authority, third-party orders, or
claims with respect to particular sites;

(iii) the potential for new or changed laws and regulations and for
development of new remediation technologies and uncertainty
regarding the timing of the work with respect to particular sites;

(iv) the ability to recover costs from any third parties with respect to

particular sites; and

In 2004, the Company’s expenses relating to environmental matters,

net of recoveries, were $10 million ($6 million in both 2003 and 2002)
and payments for such items were $8 million ($12 million in 2003 and
$16 million in 2002). As at December 31, 2004, the Company had aggre-
gate accruals for environmental costs of $113 million ($83 million as at
December 31, 2003). The Company anticipates that the majority of the
liability at December 31, 2004 will be paid out over the next five years.
In addition, related environmental capital expenditures were
$13 million in 2004, $23 million in 2003 and $19 million in 2002. The
Company expects to incur capital expenditures relating to environmen-
tal matters of approximately $20 million in 2005, $17 million in 2006
and $16 million in 2007.

Effective January 1, 2003, the Company is required to disclose
its obligation undertaken in issuing certain guarantees on the date
the guarantee is issued or modified. In addition, where the Company
expects to make a payment in respect of a guarantee, a liability will be
recognized to the extent that one has not yet been recognized.

Guarantee of residual values of operating leases
The Company has guaranteed a portion of the residual values of certain
of its assets under operating leases with expiry dates between 2005
and 2012, for the benefit of the lessor. If the fair value of the assets,
at the end of their respective lease term, is less than the fair value,
as estimated at the inception of the lease, then the Company must,
under certain conditions, compensate the lessor for the shortfall. At
December 31, 2004, the maximum exposure in respect of these guar-
antees was $97 million, of which $6 million has been recorded. The
Company has issued guarantees for which the fair value at December 31,
2004 was $2 million. There are no recourse provisions to recover any
amounts from third parties.

Other guarantees
The Company, including certain of its subsidiaries, has granted irrevo-
cable standby letters of credit and surety bonds, issued by highly rated
financial institutions, to third parties to indemnify them in the event
the Company does not perform its contractual obligations. As at
December 31, 2004, the maximum potential liability under these
guarantees was $439 million of which $359 million was for workers’
compensation and other employee benefits and $80 million was for
equipment under leases and other.

124

Canadian National Railway Company

Canadian GAAP

Notes to Consolidated Financial Statements

General indemnifications
In the normal course of business, the Company has provided indemnifi-
cations, customary for the type of transaction or for the railway
business, in various agreements with third parties, including indemnifi-
cation provisions where the Company would be required to indemnify
third parties and others. Indemnifications are found in various types
of contracts with third parties which include, but are not limited to,
(a) contracts granting the Company the right to use or enter upon prop-
erty owned by third parties such as leases, easements, trackage rights
and sidetrack agreements; (b) contracts granting rights to others to use
the Company’s property, such as leases, licenses and easements; (c) con-
tracts for the sale of assets and securitization of accounts receivable;
(d) contracts for the acquisition of services; (e) financing agreements;
(f) trust indentures, fiscal agency agreements, underwriting agree-
ments or similar agreements relating to debt or equity securities of the
Company and engagement agreements with financial advisors;
(g) transfer agent and registrar agreements in respect of the Company’s
securities; (h) trust agreements relating to pension plans and other
plans, including those establishing trust funds to secure payment to
certain officers and senior employees of special retirement compensa-
tion arrangements; (i) master agreements with financial institutions
governing derivative transactions; and (j) settlement agreements with
insurance companies or other third parties whereby such insurer or
third party has been indemnified for any present or future claims relat-
ing to insurance policies, incidents or events covered by the settlement
agreements. To the extent of any actual claims under these agreements,
the Company maintains provisions for such items, which it considers
to be adequate. Due to the nature of the indemnification clauses, the
maximum exposure for future payments may be material. However,
such exposure cannot be determined with certainty.

In 2004 and 2003, the Company entered into various indemnifica-
tion contracts with third parties for which the maximum exposure for
future payments cannot be determined with certainty. As a result, the
Company was unable to determine the fair value of these guarantees.
For guarantees for which the fair value was estimable, it was deter-
mined to be $1 million. There are no recourse provisions to recover any
amounts from third parties.

20 Financial instruments

(i) Credit risk
In the normal course of business, the Company monitors the financial
condition of its customers and reviews the credit history of each new
customer.

The Company is exposed to credit risk in the event of non-per-
formance by counterparties to its derivative financial instruments.
Although collateral or other security to support financial instruments
subject to credit risk is usually not obtained, counterparties are of high
credit quality and their credit standing or that of their guarantor is
regularly monitored. As a result, losses due to counterparty non-perfor-
mance are not anticipated. The total risk associated with the Company’s
counterparties was immaterial at December 31, 2004. The Company
believes there are no significant concentrations of credit risk.

As a result of fuel hedging activities, the Company had an unrealized

gain of $92 million at December 31, 2004 compared to $38 million at
December 31, 2003.

(iii) Interest rate
In the first quarter of 2004, in anticipation of future debt issuances,
the Company had entered into treasury lock transactions for a notional
amount of U.S.$380 million to fix the treasury component on these
future debt issuances. Upon expiration in June 2004, these treasury rate
locks were rolled into new contracts expiring in September 2004, at an
average locked-in rate of 5.106%. The Company settled these treasury
locks at a gain of U.S.$9 million (Cdn$12 million) upon the pricing of
the U.S.$500 million 6.25% Debentures due 2034, subsequently issued
on July 9, 2004 and recorded the gain into income, as a reduction of
interest expense.

Canadian GAAP

Canadian National Railway Company

125

Notes to Consolidated Financial Statements

20 Financial instruments (continued)

21 Reconciliation of Canadian and United States generally

For the purpose of minimizing volatility of earnings resulting from

the conversion of U.S. dollar denominated long-term debt into the
Canadian dollar, the Company designates the U.S. dollar denominated
long-term debt of the parent company as a foreign exchange hedge of
its net investment in U.S. subsidiaries. As a result, from the dates of des-
ignation, unrealized foreign exchange gains and losses on the translation
of the Company’s U.S. dollar denominated long-term debt are recorded
in Currency translation, which forms part of Shareholders’ equity.

(v) Other
The Company does not currently have any derivative instruments not
designated as hedging instruments.

In millions

December 31, 2004

December 31, 2003

Carrying
amount

Fair
value

Carrying
amount

Fair
value

accepted accounting principles

The Consolidated Financial Statements of the Company are expressed
in Canadian dollars and are prepared in accordance with Canadian
GAAP which conform, in all material respects, with U.S. GAAP except
as follows:

A. Reconciliation of net income
The application of U.S. GAAP would have the following effects on the
net income as reported:

In millions

Year ended December 31,

Net income – Canadian GAAP

Adjustments in respect of:

Property capitalization, net of depreciation

Stock-based compensation cost

Interest expense

Income tax rate enactments

Interest on convertible preferred securities

Income tax (expense) recovery on current

year U.S. GAAP adjustments

Income before cumulative effect of change

in accounting policy

Cumulative effect of change in accounting

policy (net of applicable taxes)

Net income – U.S. GAAP

2004

$1,297

2003

2002

$÷«734

$«553

(81)
19
(12)
3
–

384

–

(46)

–

363

–

(9)

(133)

(116)

1,258

966

800

–
$1,258

–

$1,014

$«800

(i) Property capitalization
Effective January 1, 2004, the Company changed its capitalization policy
under Canadian GAAP, on a prospective basis, to conform with the CICA
Handbook Section 3061, “Properties, Plant and Equipment.” The change
was made in response to the CICA Handbook Section 1100, “Generally
Accepted Accounting Principles,” issued in July 2003, as explained in
Note 2 – Accounting changes.

Financial assets

Investments

Financial liabilities

Long-term debt

(including current portion)

$÷«166

$÷«220

$÷«367

$÷«420

This change effectively harmonizes the Company’s Canadian and

$5,164

$5,857

$4,658

$5,128

126

Canadian National Railway Company

Canadian GAAP

Notes to Consolidated Financial Statements

(ii) Interest expense
In the first quarter of 2004, in anticipation of future debt issuances, the
Company had entered into treasury lock transactions for a notional
amount of U.S.$380 million to fix the treasury component on these
future debt issuances. Under U.S. GAAP, these derivatives were accounted
for as cash flow hedges whereby the cumulative change in the market
value of the derivative instruments was recorded in Other comprehen-
sive loss. On July 9, 2004, upon the pricing and subsequent issuance of
U.S.$500 million 6.25% Debentures due 2034, the Company settled
these treasury-rate locks and realized a gain of $12 million. Under U.S.
GAAP, this gain was recorded in Other comprehensive loss and will be
amortized and recorded into income, as a reduction of interest expense,
over the term of the debt based on the interest payment schedule.
Under Canadian GAAP, this gain was recorded immediately into income,
as a reduction of interest expense.

(iii) Stock-based compensation cost
As explained in Note 2, effective January 1, 2003, the Company
adopted the fair value based approach of the CICA’s Handbook Section
3870, “Stock-Based Compensation and Other Stock-Based Payments.”
The Company retroactively applied the fair value method of accounting
to all awards of employee stock options granted, modified or settled
on or after January 1, 2002 and restated the 2002 comparative period
to reflect this change in accounting policy. Under U.S. GAAP, effective
January 1, 2003, the Company voluntarily adopted the recommenda-
tions of Statement of Financial Accounting Standards (SFAS) No. 123,
“Accounting for Stock-Based Compensation,” and applied the fair value
based approach prospectively to all awards of employee stock options
granted, modified or settled on or after January 1, 2003. Compensation
cost attributable to employee stock options granted prior to January 1,
2003 continues to be a reconciling difference.

(iv) Convertible preferred securities
As explained in Note 11, the Convertible preferred securities (Securities)
were converted into common shares of the Company on July 3, 2002.
Prior to such date, the Securities were treated as equity under Canadian
GAAP, whereas under U.S. GAAP they were treated as debt. Consequently,
the interest on the Securities until July 3, 2002 was treated as a divi-
dend for Canadian GAAP but as interest expense for U.S. GAAP.

(v) Income tax expense
The provincial and federal governments enact new corporate tax rates
resulting in either lower or higher tax liabilities under both U.S. and
Canadian GAAP. The difference in the deferred income tax expense or
recovery recorded is a function of the net deferred income tax liability
position, which is larger under U.S. GAAP due essentially to the dif-
ference in the property capitalization policy prior to 2004. In addition,
under U.S. GAAP, the resulting deferred income tax expense or recovery
is recorded when the rates are enacted, whereas under Canadian GAAP,
when they are substantively enacted. In 2004, under U.S. GAAP, the
Company recorded a decrease to its net deferred income tax liability of

$5 million resulting from the enactment of lower corporate tax rates in
the province of Alberta, with the corresponding decrease of $2 million
under Canadian GAAP. In 2003, under U.S. GAAP, the Company recorded
an increase to its net deferred income tax liability resulting from the
enactment of higher corporate tax rates in the province of Ontario.
As a result, the Company recorded deferred income tax expense of
$79 million and $2 million in income and Other comprehensive loss,
respectively. For Canadian GAAP, the corresponding increase to the net
deferred income tax liability was $33 million.

(vi) Cumulative effect of change in accounting policy
In 2003, under U.S. GAAP, in accordance with SFAS No. 143, “Accounting
for Asset Retirement Obligations,” the Company changed its accounting
policy for certain track structure assets to exclude removal costs as a
component of depreciation expense where the inclusion of such costs
would result in accumulated depreciation balances exceeding the
historical cost basis of the assets. As a result, a cumulative benefit of
$75 million, or $48 million after tax, was recorded for the amount of
removal costs accrued in accumulated depreciation on certain track
structure assets at January 1, 2003. Under Canadian GAAP, the recom-
mendations of Handbook Section 3110, “Asset Retirement Obligations,”
which are similar to those under SFAS No. 143 (U.S. GAAP), were effec-
tive for the Company’s fiscal year beginning January 1, 2004 and did
not have an impact on the Canadian GAAP financial statements since
removal costs, as a component of depreciation expense, have not
resulted in accumulated depreciation balances exceeding the historical
cost basis of the assets.

B. Earnings per share
The earnings per share calculation under Canadian GAAP differs from
U.S. GAAP essentially due to differences in the earnings figures:

(i) Basic earnings per share

Year ended December 31,

2004

2003

2002

Income before cumulative effect of change

in accounting policy – U.S. GAAP

Cumulative effect of change in accounting policy

Net income – U.S. GAAP

$4.41
–
$4.41

$3.38

0.16

$3.54

$2.71

–

$2.71

Weighted-average number of common shares

outstanding (millions) – U.S. GAAP

285.1

286.8

295.0

(ii) Diluted earnings per share

Year ended December 31,

2004

2003

2002

Income before cumulative effect of change

in accounting policy – U.S. GAAP

Cumulative effect of change in accounting policy

Net income – U.S. GAAP

$4.34
–
$4.34

$3.33

0.16

$3.49

$2.65

–

$2.65

Weighted-average number of common shares

outstanding (millions) – U.S. GAAP

289.9

290.7

304.2

Canadian GAAP

Canadian National Railway Company

127

Notes to Consolidated Financial Statements

21 Reconciliation of Canadian and United States generally accepted accounting principles (continued)

C. Reconciliation of significant balance sheet items

In millions

Current assets – Canadian GAAP

Derivative instruments

Deferred income taxes related to derivative instruments

Other

Current assets – U.S. GAAP

Properties – Canadian GAAP

Property capitalization, net of depreciation

Cumulative effect of change in accounting policy

Properties – U.S. GAAP

Intangible and other assets – Canadian GAAP

Derivative instruments

Intangible and other assets – U.S. GAAP

Deferred income tax liability – Canadian GAAP

Cumulative effect of prior years’ adjustments to income

Income taxes on current year U.S. GAAP adjustments to income

Income taxes on cumulative effect of change in accounting policy

Income taxes on translation of Canadian to U.S. GAAP adjustments

Income taxes on minimum pension liability adjustment

Income taxes on derivative instruments

Income taxes on settlement of interest rate swaps recorded in Other comprehensive loss

Income tax rate enactments

Other

Deferred income tax liability – U.S. GAAP

Other liabilities and deferred credits – Canadian GAAP

Stock-based compensation

Minimum pension liability

Other

Other liabilities and deferred credits – U.S. GAAP

Common shares – Canadian GAAP

Capital reorganization

Stock-based compensation

Foreign exchange loss on convertible preferred securities

Costs related to the sale of shares

Share repurchase program

Common shares – U.S. GAAP

Contributed surplus – Canadian GAAP

Dividend in kind with respect to land transfers

Costs related to the sale of shares

Other transactions and related income tax effect

Share repurchase program

Capital reorganization

Contributed surplus – U.S. GAAP

December 31,

2004

$÷1,654
81
(29)
4
$÷1,710

$16,688
2,952
75
$19,715

$÷÷«929
11
$÷÷«940

$÷3,591
1,204
(32)
27
(28)
(7)
1
4
(41)
4
$÷4,723

$÷1,488
–
22
3
$÷1,513

$÷3,587
1,300
18
12
(33)
(178)
$÷4,706

$÷÷«164
248
33
18
26
(489)
$÷÷÷÷«–

2003

$÷«1,092

–

$÷1,127

$15,158

3,072

$18,305

$÷÷«900

$÷«÷905

$÷3,365

1,071

133

(15)

(10)

–

(38)

$÷4,550

$÷1,153

–

$÷1,203

$÷3,530

1,300

(33)

(162)

$÷4,664

$÷÷«166

248

(489)

$÷÷÷÷«–

128

Canadian National Railway Company

Canadian GAAP

Notes to Consolidated Financial Statements

In millions

Currency translation – Canadian GAAP

Unrealized foreign exchange loss on translation of Canadian to U.S. GAAP adjustments, net of applicable taxes

December 31,

Derivative instruments, net of applicable taxes

Unamortized gain on settlement of interest rate swaps, net of applicable taxes

Income tax rate enactments

Minimum pension liability adjustment, net of applicable taxes

Accumulated other comprehensive loss – U.S. GAAP

Retained earnings – Canadian GAAP

Cumulative effect of prior years’ adjustments to income

Cumulative effect of change in accounting policy

Current year adjustments to net income

Share repurchase program

Cumulative dividend on convertible preferred securities

Capital reorganization

Dividend in kind with respect to land transfers

Other transactions and related income tax effect

Retained earnings – U.S. GAAP

Under Canadian GAAP, costs related to the sale of shares have
been deducted from Contributed surplus. For U.S. GAAP purposes, these
amounts would have been deducted from Common shares.

Under Canadian GAAP, the cost resulting from the repurchase of
shares was allocated first to Common shares, then to Contributed sur-
plus and finally to Retained earnings. Under U.S. GAAP, the cost would
have been allocated to Common shares followed by Retained earnings.
For Canadian and U.S. GAAP purposes, the Company designates
the U.S. dollar denominated long-term debt of the parent company as a
foreign exchange hedge of its net investment in U.S. subsidiaries. Under
Canadian GAAP, the resulting net unrealized foreign exchange loss from
the date of designation, has been included in Currency translation.
For U.S. GAAP purposes, the resulting net unrealized foreign exchange
loss has been included as part of Accumulated other comprehensive
loss, a separate component of Shareholders’ equity, as required under
SFAS No. 130, “Reporting Comprehensive Income.”

2004

$÷÷÷(80)
(89)
62
8
(34)
(15)
$÷÷(148)

$÷3,676
1,928
48
(39)
152
38
(811)
(248)
(18)
$÷4,726

2003

$÷÷÷(38)

(63)

–

(34)

(20)

$÷÷(129)

$÷2,822

1,696

232

138

(811)

(248)

(18)

$÷3,897

(iii) Derivative instruments
Under U.S. GAAP, pursuant to SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities,” as amended by SFAS No. 138,
“Accounting for Certain Derivative Instruments and Certain Hedging
Activities,” the Company records in its balance sheet the fair value
of derivative instruments used in its hedging activities. Changes in
the market value of these derivative instruments have been recorded
in Accumulated other comprehensive loss, a separate component of
Shareholders’ equity. There are no similar requirements under Canadian
GAAP.

(iv) Convertible preferred securities
As explained in Note 11, the Convertible preferred securities (Securities)
were converted into common shares of the Company on July 3,
2002. Prior to such date, the Securities were treated as equity under
Canadian GAAP, whereas under U.S. GAAP they were treated as debt.
Consequently, the initial costs related to the issuance of the Securities,
net of amortization, which were previously deferred and amortized for
U.S. GAAP, have since been reclassified to equity.

22 Comparative figures

Certain figures, previously reported for 2003 and 2002, have been
reclassified to conform with the basis of presentation adopted in the
current year.

Canadian GAAP

Canadian National Railway Company

129

Non-GAAP Measures – unaudited

The Company makes reference to non-GAAP measures in this Annual Report that do not have any standardized meaning prescribed by U.S. GAAP
and are, therefore, not necessarily comparable to similar measures presented by other companies and, as such, should not be considered in isola-
tion. Management believes that non-GAAP measures such as adjusted net income and the resulting adjusted performance measures for such items
as operating income, operating ratio and per share data are useful measures of performance that can facilitate period-to-period comparisons as
they exclude items that do not arise as part of the normal day-to-day operations or that could potentially distort the analysis of trends in business
performance. The exclusion of specified items in the adjusted measures below does not imply that they are necessarily non-recurring. The Company
also believes free cash flow to be a useful measure of performance as it demonstrates the Company’s ability to generate cash after the payment
of capital expenditures and dividends. A reconciliation of the various non-GAAP measures presented in this Annual Report to their comparable
U.S. GAAP measures is provided herein:

Reconciliation of adjusted performance measures 2001-2002

In millions, except per share data, or unless otherwise indicated

Year ended December 31,

Revenues

Operating expenses

Operating income

Interest expense

Other income

Income before income taxes

Income tax expense

Net income

Operating ratio

Basic earnings per share

Diluted earnings per share

2001

2002

Reported Adjustments(1) Adjusted

Reported Adjustments(2) Adjusted

$«5,652

3,970

$÷÷«–

(98)

$«5,652

3,872

$«6,110

4,641

$÷÷«–

(401)

$«6,110

4,240

1,682

1,780

1,469

401

1,870

(327)

1,420

(380)

–

(2)

(158)

(327)

1,516

(538)

(361)

1,184

(384)

–

401

(149)

(361)

1,585

(533)

$1,040

$÷(62)

$÷««978

$÷««800

$«252

$«1,052

70.2%

$÷3.61

$÷3.49

68.5%

$÷«3.39
$÷«3.28

76.0%

$÷«2.71

$÷«2.65

69.4%

$÷«3.57

$÷«3.48

(1) Operating expenses include a charge of $98 million ($62 million after tax) for workforce reductions. Other income includes a gain of $101 million ($73 million after tax) from the sale

of the Company’s 50 per cent interest in the Detroit River Tunnel Company and a charge of $99 million ($71 million after tax) to write down the Company’s net investment in
360networks Inc. 2001 also includes a deferred income tax recovery of $122 million resulting from the enactment of lower corporate tax rates in Canada.

(2) Includes a fourth-quarter charge of $281 million ($173 million after tax) to increase the Company’s U.S. personal injury and other claims liability and a workforce reduction charge of

$120 million ($79 million after tax).

130

Canadian National Railway Company

Non-GAAP Measures – unaudited

Free cash flow 2000-2004

In millions

Cash provided from operating activities

Less:

Investing activities

Dividends paid

Cash provided (used) before financing activities

Adjustments:

Change in level of accounts receivable sold (1)

Acquisitions (2)

Free cash flow

2000

2001

2002

2003

2004

$1,506

$«1,621

$1,612

$«1,976

$«2,139

(981)

(136)

389

(2,173)

(150)

(702)

(924)

(170)

518

(1,075)

(191)

710

(2,411)

(222)

(494)

(3)

–

(133)

1,278

(5)

–

(132)

–

(12)

1,531

$÷«386

$«÷«443

$÷«513

$÷««578

$«1,025

(1) Changes in the level of accounts receivable sold under the Company’s accounts receivable securitization program are considered a financing activity.

(2) Significant acquisitions, WC in 2001 and BC Rail and GLT in 2004, are excluded as they are not indicative of normal day-to-day investments in the Company’s asset base.

Canadian National Railway Company

131

Corporate Governance

CN is committed to being a good corporate citizen. At CN, sound
corporate citizenship touches nearly every aspect of what we do, from
governance to business ethics, from safety to environmental protection.
Central to this comprehensive approach is our strong belief that good
corporate citizenship is simply good business.

CN has always recognized the importance of good governance.
As it evolved from a Canadian institution to a North American publicly
traded company, CN voluntarily followed certain corporate governance
requirements that, as a company based in Canada, it was not technically
compelled to follow. We continue to do so today. Since many of our
peers – and shareholders – are based in the United States, we want to
provide the same assurances of sound practices as our U.S. competitors.
Hence, we adopt and adhere to corporate governance practices

that either meet or exceed applicable Canadian and U.S. corporate
governance standards. As a Canadian reporting issuer with securi-
ties listed on the Toronto Stock Exchange and the New York Stock
Exchange (NYSE), CN complies with applicable rules adopted by the
Canadian Securities Administrators and the rules of the U.S. Securities
and Exchange Commission giving effect to the provisions of the U.S.
Sarbanes Oxley Act of 2002.

On October 29, 2004, the Canadian Securities Administrators (CSA)

published for comment proposed National Policy 58-201 “Corporate
Governance Guidelines” and proposed National Instrument 58-101
“Disclosure of Corporate Governance Practices.” Our governance prac-
tices are already substantially in compliance with the proposed CSA
guidelines. When these guidelines will be finalized, the board intends to
reassess its governance practices in order to improve them further.

As a Canadian company, we are not required to comply with many
of the NYSE corporate governance rules, and instead may comply with
Canadian governance practices. However, except as summarized on our
Web site (www.cn.ca/cngovernance), our governance practices comply
with the NYSE corporate governance rules in all significant respects.
Consistent with the belief that ethical conduct goes beyond com-
pliance and resides in a solid governance culture, the governance sec-
tion on the CN Web site contains CN’s Corporate Governance Manual
(including the charters of our Board and of our Board committees) and
CN’s Code of Business Conduct. Printed versions of these documents
are also available upon request to CN’s Corporate Secretary.

Because it is important to CN to uphold the highest standards in
corporate governance and that any potential or real wrongdoings be
reported, CN has also adopted methods allowing employees and third
parties to report accounting, auditing and other concerns, as more fully
described on our Web site.
We are proud of our corporate governance practices. For more
information on these practices, please refer to our Web site and to our
proxy circular which has been mailed to all shareholders and which is
also available on our Web site.

132

Canadian National Railway Company

2004 President’s Awards for Excellence

The accomplishments of these employees not only reinforced the five principles that are the foundation of
CN's industry-leading railroad but also won them the President’s Award for Excellence for their outstanding
contributions in 2004 in the areas of Service, Cost Control, Asset Utilization, Safety and People. These
individuals and teams were singled out for their exceptional effort, dedication and performance.

Category: Service

Winner: Rolland Miron – Saskatoon, SK

Winners: Eastern Canada Engineering Team

Steve Tselios, Montreal, QC; George Nowak, Edmonton, AB; Mario Ruel,
Montreal, QC; Rocco Cacchiotti, Montreal, QC; Denis Bourque, Charny, QC;
Roméo Morin, Montreal, QC; Alain Martineau, Charny, QC; Réjean Martel,
Montreal, QC

When disaster struck in Montmagny, Quebec, in February 2004, this team
snapped into action to minimize disruptions. With a steel railway bridge lit-
erally destroyed due to a major derailment, they wasted no time in building
a temporary rail line around the existing crossing – which had traffic moving
again in just three days. They restored full service within a mere 22 days.

Winners: Mainframe Install Team

Ron Hewitt, Ron Dubois, Bruno Michaud, John Hillier, John Ferrari,
Kevin Whelan, all from Montreal, QC

CN’s three mainframe computers had to be replaced with two newer model
mainframes, translating into $1.9 million in savings in 2004 alone. Aware
that any outages of the mainframe computers that host CN’s most critical
applications would hurt operations of the railroad, this team used care and
professionalism in tackling this complex and highly technical task on week-
ends over a five-week period, avoiding any disruptions to operations.

Category: Cost Control

Winner: Gary Petersen – Kamloops, BC

Gary’s suggestion of a new process for stocking and delivering sand needed for
locomotive traction resulted in substantial savings. With the new method, sand
is trucked to the site and elevated using the compressor on the delivery truck,
eliminating the need for a sand car. The 100-hp compressor was replaced with
a 50-hp compressor, which has resulted in additional savings of $31,000 a year.

Winner: Glen Becker – Winnipeg, MB

Glen undertook a thorough review of material purchased by CN to repair
and service its work equipment. The review of 21 items shows an annual
savings of well over $100,000 in materials, and that amount is expected
to increase significantly. Additional benefits include reduced repair times,
improved inventory management and identification of duplicate parts.

Rolland undertook a thorough review of intermodal operations in Saskatoon
and implemented important modifications. He was able to adjust the work
schedule and operations without having an impact on service, which helped
the company’s efficiency and reduced costs by about $5.00 for every lift.

Category: Safety

Winners: Alberta WCB Disability Team

Don Penney, Brian Kalin, Tom Brown, Joseph Slavin, Randy Roach, all from
Edmonton, AB

Besides promoting safety for the prevention of injuries, this team also
improved disability management for early return to work and modified
duties as well as for on-time reporting of injuries to the Workers’ Compen-
sa tion Board. Their hard work resulted in a better-than-target injury ratio
and a 50 per cent reduction in lost time days compared to 2003, in addition
to a substantial rebate to CN from the Workers’ Compensation Board.

Category: People

Winners: Mike Cater – Surrey, BC; Jim Halberg – Kamloops, BC

Alert to the possibility of bringing a new client on board, Jim referred a
friend in the propane business to Mike, who jumped at the opportunity to
explain the benefits of shipping this traffic from Edmonton to Vancouver by
CN instead of by truck. As a result, a new rail facility was built by Canwest
Propane on property adjacent to CN’s Thornton Yard, with all inbound traffic
committed to CN over a five-year period.

Winners: Susan Seebeck, Kathy McDonald and Julie O’Halloran –
Montreal, QC

In order to promote and support culture change throughout CN, these
employees created a variety of learning and tutorial materials that focused
on CN’s five principles, including the “How We Work and Why” Web site
and book, as well as the ABC Field Toolbook and Leadership and Process
Improvement Cards. The written materials have been used by employees
across the system, and the Web site has registered hundreds of thousands of
hits, helping employees better understand and implement CN’s principles.

Winner: William Moss – Brandon, MS

Special Award

Bill designed and implemented a system to remotely monitor the position
of the automatic drawbridge at Manchac, Louisiana. This not only verifies
proper bridge operation, but also increases the energy efficiency and
reliability of the bridge operating motors.

Category: Asset Utilization

Winners: Paul Zastre and Tim Schick – Winnipeg, MB

Using materials and assets they had on hand, Paul and Tim designed a pro-
totype Plate F box car – a large car that can haul up to 286,000 pounds of
paper and stands 17 feet tall from the rail. They then fabricated all the fix-
tures to duplicate the prototype. Their inventiveness resulted in the building
of 199 Plate F’s, which was accomplished at the rate of two cars a day.

Winners: Paul Kirk – Homewood, IL; James Reed – Jackson, MS;
Sam Cook – Jackson, MS

When a runaway train was speeding toward a head-on collision with their
train, this crew worked with their dispatcher to prevent disaster. Dispatcher
Paul Kirk contacted engineer James Reed and conductor Sam Cook by radio
and advised them to stop their train. After a quick discussion of options, the
dispatcher and the crew decided to attempt to intercept the runaway. Sam
got off the train and ran towards the runaway to give James an estimate of
how fast it was rolling. As the runaway got closer to him, James backed up
at a speed to match the velocity of the runaway, skillfully coupled up and
brought both trains to a stop.

Canadian National Railway Company

133

Board of Directors
(at December 31, 2004)

Committees:
1 Audit, ﬁ nance and risk
2 Corporate governance and
nominating
3 Donations
4 Environment, safety and security
5 Human resources and
compensation
6 Investment
7 Strategic planning

*denotes chairman of the committee

David G.A. McLean, O.B.C., LL.D.
Chairman of the Board
Canadian National Railway Company
Chairman of the Board and
Chief Executive Ofﬁ cer
The McLean Group
Committees: 2*, 3, 4, 5, 6, 7

E. Hunter Harrison
President and
Chief Executive Ofﬁ cer
Canadian National Railway Company
Committees: 3*, 7

Ambassador Gordon D. Gifﬁ n
Senior Partner
McKenna Long & Aldridge
Committees: 2, 5, 7

Hugh J. Bolton, F.C.A.
Chairman of the Board
EPCOR Utilities Inc.
Committees: 1, 2, 4, 7

Robert Pace
President and
Chief Executive Ofﬁ cer
The Pace Group
Committees: 1*, 2, 6, 7

Michael R. Armellino
Retired Partner
The Goldman Sachs Group
Committees: 1, 2, 4, 6, 7*

Purdy Crawford, O.C., Q.C., LL.D.
Counsel
Osler, Hoskin & Harcourt
Committees: 2, 5*, 6, 7

134

Canadian National Railway Company

J.V. Raymond Cyr, O.C., LL.D.
Chairman of the Board
Polyvalor Inc.
Committees: 1, 4*, 5, 6, 7

Gilbert H. Lamphere
Private Investor
Former Chairman of the Board
Illinois Central Corporation
Committees: 1, 4, 5, 7

V. Maureen Kempston Darkes,
O.C., D.Comm., LL.D.
Group Vice-President
General Motors Corporation
President
GM Latin America, Africa
and Middle East
Committees: 4, 6, 7

James K. Gray, O.C., A.O.E., LL.D.
Corporate Director
Former Chairman and
Chief Executive Ofﬁ cer
Canadian Hunter Exploration Ltd.
Committees: 1, 2, 4, 7

Edith E. Holiday
Corporate Director and Trustee
Former General Counsel
United States Treasury Department
Secretary of the Cabinet
The White House
Committees: 1, 6, 7

The Honorable
Edward C. Lumley, P.C., LL.D.
Vice-Chairman
BMO Nesbitt Burns
Committees: 4, 5, 6*, 7

Denis Losier
President and
Chief Executive Ofﬁ cer
Assumption Life
Committees: 1, 4, 5, 6, 7

A. Charles Baillie, LL.D.
Former Chairman and
Chief Executive Ofﬁ cer
The Toronto-Dominion Bank
Committees: 1, 2, 5, 7

Canadian National Railway Company

135

Chairman of the Board and Executive Officers of the Company

David G.A. Mc Lean
Chairman of the Board

E. Hunter Harrison
President and
Chief Executive Officer

Tullio Cedraschi
President and
Chief Executive Officer
CN Investment Division

Keith E. Creel
Senior Vice-President
Eastern Canada Region

Les Dakens
Senior Vice-President
People

Sean Finn
Senior Vice-President
Public Affairs,
Chief Legal Officer and
Corporate Secretary

James M. Foote
Executive Vice-President
Sales and Marketing

Fred R. Grigsby
Senior Vice-President and
Chief Information Officer

Edmond L. Harris
Senior Vice-President
Operations

Peter Marshall
Senior Vice-President
Western Canada Region

Claude Mongeau
Executive Vice-President and
Chief Financial Officer

Robert E. Noorigian
Vice-President
Investor Relations

Gordon T. Trafton
Senior Vice-President
United States Region

136

Canadian National Railway Company

Shareholder and investor information

Annual meeting
The annual meeting of shareholders will be held at
10:00 am (local time) on Thursday, April 21, 2005,
at Fairmont The Queen Elizabeth Hotel, Montreal, QC.

Annual information form
The annual information form may be obtained by writing to:

The Corporate Secretary
Canadian National Railway Company
935 de La Gauchetière Street West
Montreal, Quebec H3B 2M9

Stock exchanges
CN common shares are listed on the Toronto and
New York stock exchanges.

Ticker symbols:
CNR (Toronto Stock Exchange)
CNI (New York Stock Exchange)

Investor relations
Robert Noorigian
Vice-President, Investor Relations
Telephone: (514) 399-0052 or 1-800-319-9929

Transfer agent and registrar
Computershare Trust Company of Canada

Offices in:
Montreal, QC; Toronto, ON; Calgary, AB; Vancouver, BC
Telephone: 1-800-332-0095
Fax: 1-888-453-0330
www.computershare.com

Co-transfer agent and co-registrar
Computershare Trust Company of New York
88 Pine Street, 19th Floor
Wall Street Plaza, New York, NY 10005
Telephone: (212) 701-7600 or 1-800-245-7630

Dividend payment options
Shareholders wishing to receive dividends by Direct Deposit or in
U.S. dollars may obtain detailed information by communicating with:

Computershare Trust Company of Canada
Telephone: 1-800-332-0095

Shareholder services
Shareholders having inquiries concerning their shares
or wishing to obtain information about CN should contact:

Computershare Trust Company of Canada
Shareholder Services
100 University Avenue, 9th Floor
Toronto, Ontario M5J 2Y1
Telephone: 1-800-332-0095
Fax: 1-888-453-0330
Email: service@computershare.com

Head office
Canadian National Railway Company
935 de La Gauchetière Street West
Montreal, Quebec H3B 2M9

P.O. Box 8100
Montreal, Quebec H3C 3N4

Additional copies of this report are
available from:

CN Public Affairs
935 de La Gauchetière Street West
Montreal, Quebec H3B 2M9
Telephone: 1-888-888-5909
Email: contact@cn.ca

La version française du présent rapport
est disponible à l’adresse suivante :

Affaires publiques CN
935, rue de La Gauchetière Ouest
Montréal (Québec) H3B 2M9
Téléphone : 1 888 888-5909
Courriel : contact@cn.ca

This report has been printed on recycled paper.

935 de La Gauchetière Street West, Montreal, Quebec H3B 2M9