Canadian National Railway Company Annual Report 2005

← All annual reports

FY2005 Annual Report · Canadian National Railway Company

Loading PDF…

2
0
0
5
A
n
n
u
a

R
e
p
o
r
t

A great run,

a great future

935 de La Gauchetière Street West, Montreal, Quebec H3B 2M9

www.cn.ca

2005 Annual Report

59672 Covers_K.indd 1
59672 Covers_K.indd 1

2/24/06 11:33:07 AM
2/24/06 11:33:07 AM

Certain information included in this Annual Report
may be forward-looking statements within the
meaning of United States and Canadian securities
laws. Implicit in these statements is the assumption
that the positive economic trends in North America
and Asia will continue. This assumption, although
considered reasonable by the Company at the time
of preparation, may not materialize. 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, 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 speciﬁ c risks set forth in Management’s Discus-
sion and Analysis contained in this Annual Report
as well as other risks detailed from time to time
in reports ﬁ led by the Company with securities
regulators in Canada and the United States.

Shareholder and investor information

Annual meeting
The annual meeting of shareholders will be held at
9:00 am (local time) on Friday, April 21, 2006,
at The Peabody Memphis hotel, Memphis, Tennessee.

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: 1-800-564-6253
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: 1-800-564-6253

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: 1-800-564-6253
www.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

59672 Covers_K.indd 2
59672 Covers_K.indd 2

2/24/06 11:41:40 AM
2/24/06 11:41:40 AM

This report has been printed on recycled paper.

It’s been a great run. As the ﬁ rst true scheduled railroad with a string
It’s been a great run. As the ﬁ rst true scheduled railroad with a string
It’s been a great run.
As the ﬁ rst true scheduled railroad with a string
of other industry-leading initiatives – innovative service improvements, interline
of other industry-leading initiatives – innovative service improvements, interline

ce impro
ce improv
ce impro
ce improv

ents, inte
ents, inte
ents, inte
ents, inte

routing protocols, unique labor agreements and more – CN has proven in its ﬁ rst
routing protocols, unique labor agreements and more – CN has proven in its ﬁ rst
n its ﬁ rs
in its ﬁ rst
n its ﬁ rs
in its ﬁ rst

N has pro
N has prov
N has pro
N has prov

decade as a public company that unconventional thinking and relentless focus on
decade as a public company that unconventional thinking and relentless focus on
us ons ons on
us on

elentless
relentless
elentless
relentless

execution can bring unprecedented performance. We now intend to prove something
execution can bring unprecedented performance. We now intend to prove something
mething
mething
mething
mething

to prov
d to prove
to prov
d to prove

else: We really have only begun to leverage the innovative model we have created.
else: We really have only begun to leverage the innovative model we have created.
e created
e created
e created.
e created.

odel we
model we
odel we
model we

Contents

1 It’s been a great run
12 A message from E. Hunter Harrison
14 Financial summary
20 Investing to support future growth
24 SmartYard: the future of rail yard

management

28 Taking performance to the next level
32 Pursuing opportunity at Prince Rupert
36 CN at a glance
38 A message from the Chairman

39 Doing the right thing
42 Glossary of terms
43 Financial Section (U.S. GAAP)
101 Non-GAAP Measures – unaudited
102 Corporate Governance
103 2005 President’s Awards for Excellence
104 Board of Directors
106 Chairman of the Board and

Executive Ofﬁ cers of the Company
107 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).

Canadian National Railway Company

59672_Pg01-11.indd 1
59672_Pg01-11.indd 1

2/25/06 8:17:35 AM
2/25/06 8:17:35 AM

A GREAT RUN: CN 1995–2005
A GREAT RUN: CN 1995–2005
A GREAT RUN: CN 1995–2005

Operating ratio improvement
Operating ratio improvement
ementntntntnt
ement
ement

of more than 25 points
of more than 25 points

than 25 poin
than 25 poin
than 25 poin
than 25 poin
than 25 poin
than 25 poin
than 25 poin
than 25 poin

252525252522ement

2
2

Canadian National Railway Company
Canadian National Railway Company
Canadian National Railway Company

59672_Pg01-11.indd 2
59672_Pg01-11.indd 2

2/25/06 8:11:36 AM
2/25/06 8:11:36 AM

89.089.0%%

from 89.0%* to 63.8%

63.8%

* Adjusted to exclude items affecting the comparability of the results of operations. See page 101 of this report for a reconciliation of this non-GAAP measure.

Canadian National Railway Company

59672_Pg01-11.indd 3
59672_Pg01-11.indd 3

2/24/06 12:01:53 PM
2/24/06 12:01:53 PM

A GREAT RUN: CN 1995–2005
A GREAT RUN: CN 1995–2005
A GREAT RUN: CN 1995–2005

Diluted earnings per share
Diluted earnings per share

growth rate of 21%*
rate of 21%
rate of 21%
rate of 21%
h rate of 21%
h rate of 21%
h rate of 21%
growth rate of 21%*

2121h rate of 21%
21%
rate of 21%%%

* Compound annual growth rate
* Compound annual growth rate
* Compound annual growth rate

4
4
4

Canadian National Railway Company
Canadian National Railway Company
Canadian National Railway Company
Canadian National Railway Company

59672_Pg01-11.indd 4
59672_Pg01-11.indd 4

2/25/06 8:12:46 AM
2/25/06 8:12:46 AM

$$0.850.85

from $0.85* to $5.54

$5.54

* Adjusted to exclude items affecting the comparability of the results of operations. See page 101 of this report for a reconciliation of this non-GAAP measure.

Canadian National Railway Company

59672_Pg01-11.indd 5
59672_Pg01-11.indd 5

2/24/06 12:02:30 PM
2/24/06 12:02:30 PM

A GREAT RUN: CN 1995–2005
A GREAT RUN: CN 1995–2005
A GREAT RUN: CN 1995–2005

Market capitalization
Market capitalization

up more than 12-fold
up more than 12-fold

than 12-fo
than 12-fo
than 12-fo
than 12-fo
than 12-fo
than 12-fo
than 12-fo

12x12x12x1212than 12-fo

6
6

Canadian National Railway Company
Canadian National Railway Company
Canadian National Railway Company

59672_Pg01-11.indd 6
59672_Pg01-11.indd 6

2/25/06 8:13:42 AM
2/25/06 8:13:42 AM

$$2B2B

from $2 billion to $25 billion

$25B

59672_Pg01-11.indd 7
59672_Pg01-11.indd 7

2/24/06 12:03:05 PM
2/24/06 12:03:05 PM

Canadian National Railway Company

A GREAT RUN: CN 1995–2005

From negative free cash ﬂ ow*

to more than $1 billion

* See page 101 of this report for a reconciliation of this non-GAAP measure.

Canadian National Railway Company

59672_Pg01-11.indd 8
59672_Pg01-11.indd 8

2/24/06 12:03:21 PM
2/24/06 12:03:21 PM

-- $$118M118M

from -$118 million to $1.3 billion

$1.3B

59672_Pg01-11.indd 9
59672_Pg01-11.indd 9

2/24/06 12:03:39 PM
2/24/06 12:03:39 PM

Canadian National Railway Company

A GREAT RUN: CN 1995–2005
A GREAT RUN: CN 1995–2005
A GREAT RUN: CN 1995–2005

consecutive
Nine* consecutive

99999NineNineNineNineNineNineNineNineNine* consecutive

dividend increases
dividend increases
dividend increases

* In January 2006, the Company announced its tenth consecutive dividend increase.
* In January 2006, the Company announced its tenth consecutive dividend increase.
* In January 2006, the Company announced its tenth consecutive dividend increase.

10
1010

Canadian National Railway Company
Canadian National Railway Company
Canadian National Railway Company

59672_Pg01-11.indd 10
59672_Pg01-11.indd 10

2/25/06 8:14:44 AM
2/25/06 8:14:44 AM

$$0.270.27

from $0.27 to $1.00

$1.00

59672_Pg01-11.indd 11
59672_Pg01-11.indd 11

2/24/06 12:04:11 PM
2/24/06 12:04:11 PM

Canadian National Railway Company

E. Hunter Harrison

President and Chief Executive Ofﬁ cer

Canadian National Railway Company

59672_Pg12-19.indd 12
59672_Pg12-19.indd 12

23/02/2006 01:18:29
23/02/2006 01:18:29

A message from
E. Hunter Harrison

Dear fellow shareholders: What a great run. The accom-

a meeting I had with the CN account manager for one of

plishments and results that CN has been able to achieve

our largest customers. He was upset with some right-

in its ﬁ rst 10 years as a public company are nothing short

sizing and bureaucracy reductions we had made in

of spectacular. Some of the things we have done are

our marketing group. He said, “You’ve taken away my

beyond anything I have seen in my 40 years in this busi-

analyst here, you’ve taken away my sales person there,

ness. While our culture is never to be satisﬁ ed, there’s a

you’ve taken away this, you’ve taken away that. And

certain amount of pride among all of us at CN. Because

you expect me to still manage this account?” This was the

it has been anything but easy.

only account he managed. I got a little excited myself, and

I ﬁ rst came aboard CN back in 1998 with the CN-IC

I might have raised my voice a little – I said, “Excuse me.

merger. At that time, CEO Paul Tellier and his team had

Let me ask you a question. Exactly what is it that you do?”

already established a very powerful track record of doing

Long story short, that account manager became a

exactly what they said they’d do – and they were surpris-

believer. And we got one small step closer to the culture

ing a lot of people. CN was the most improved railroad

of precision and execution we were trying to build.

in North America, and driving rapid change had become

Six months later, he was proud of how signiﬁ cantly the

an integral part of its culture. My role was to accelerate

service he was able to offer his customer had improved.

the pace of change and help take the company to the

That’s what inspires me: creating believers, one person

next level.

at a time. The men and women of CN, more and more

My focus then was on the same ﬁ ve principles we

each day realizing that we are all railroaders, working

emphasize today: deliver great service, control your

hard at getting better at precision railroading every day.

costs, use your assets well, don’t get anybody hurt, and

The passion and dedication of our people are what make

develop your people. I’m a detail guy, and I pay a great

me so conﬁ dent that our great run is far from over.

deal of attention to the ﬁ rst four, but my emphasis is on

the ﬁ fth principle, our people, because that’s what drives

Another year of excellent performance CN delivered

everything else.

another solid year of ﬁ nancial performance in 2005.

And as we entered a new period of rapid, profound

Volumes, in revenue ton miles, grew by 3 per cent year-

change, people sometimes became emotional. I remem ber

over-year. Total revenues reached $7,240 million for the

59672_Pg12-19.indd 13
59672_Pg12-19.indd 13

2/18/06 7:28:57 PM
2/18/06 7:28:57 PM

Canadian National Railway Company

Financial summary

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

2005

2004(1)

2003(2)

Financial results

Revenues

Operating income

Net income

Diluted earnings per share

Dividend per share

Net capital expenditures

Financial position

Total assets

Long-term debt, including current portion

Shareholders’ equity

Financial ratios (%)

Operating ratio

Debt-to-total capitalization

$÷7,240

$÷6,548

$÷5,884

2,624

1,556

5.54

1.00

1,180

2,168

1,258

4.34

0.78

1,072

1,777

1,014

3.49

0.67

1,043

22,188

5,085

9,249

22,365

20,337

5,164

9,284

4,658

8,432

63.8

35.5

66.9

35.7

69.8

35.6

(1) 2004 includes GLT and BC Rail from May 10, 2004 and July 14, 2004, respectively.
(2) The Company’s ﬁ nancial results include items affecting the comparability of the results of operations as discussed in the Company’s Management’s Discussion and Analysis (MD&A) on page 53.

Employees (average for the year)

2003
2003

2004 (1)
22004 (1)

2005

Adjusted diluted earnings per share (dollars) (2)

2003
2003

2004 (1)
2004 (1)

2005

Operating ratio (percentage)

2003
2003

2004 (1)
2004 (1)

2005

3.60

4.34

22,012

22,470

22,246

5.54

69.8

66.9

63.8

(1) Includes GLT and BC Rail from May 10, 2004 and July 14, 2004, respectively.
(2) 2003 adjusted to exclude items affecting the comparability of the results of operations. See discussion and reconciliation of this non-GAAP adjusted performance measure in the

Company’s MD&A on page 53.

Canadian National Railway Company

59672_Pg12-19.indd 14
59672_Pg12-19.indd 14

2/24/06 3:38:47 PM
2/24/06 3:38:47 PM

We’re going to focus on improving the
execution of our model, and continue
our search for new areas to achieve
breakthrough results.

year, an 11 per cent increase over the $6,548 million we

performance in 2005 with a tight window of compliance,

reported for 2004. When you exclude the negative trans-

closing in on 90 per cent for all carload business. On a

lation impact of the stronger Canadian dollar on our

comparable year-over-year basis (excluding GLT and

U.S. dollar-denominated revenues – approximately

BC Rail), average car velocity – the number of miles

$260 million for the year – CN revenues grew 15 per

traveled per day from origin to destination – increased by

cent. At $5.54, diluted earnings per share increased by

close to 9 per cent, while locomotive ﬂ eet productivity – in

28 per cent in 2005, compared with $4.34 in 2004.

gross ton miles per horsepower – increased by 5 per cent.

We established a new record operating ratio for the

Our product and service quality have never been better,

year at 63.8 per cent, taking another 3.1 points off our

and we intend to continue our efforts to improve.

previous record of 66.9 per cent set in 2004. This perfor-

mance was made possible by our continued focus on

A sobering reminder The year 2005 would be an unmiti-

ﬁ nancial and operating discipline.

gated success for our company and our unique precision

We also continued to deliver extraordinary free cash

railroading approach if not for a number of accidents

ﬂ ow growth, generating $1,301 million in 2005, com-

that humbled us and reminded us of the risks of this

pared with $1,025 million in 2004.* Strong free cash ﬂ ow

business, including a derailment and spill in western

provides us maximum ﬂ exibility in our efforts to deliver

Canada, and accidents in Mississippi and Alberta that

long-term growth and pursue investment opportunities.

cost ﬁ ve CN employees their lives.

It also allows us to further reward our shareholders:

The derailment at Alberta’s Wabamun Lake in early

In July of 2005, CN announced its intention to repur-

August caused environmental damage. We moved

chase up to 16 million shares of stock in the ensuing

quickly after the incident to work with public authorities

12 months. This followed the successful completion of

and local residents and to begin a comprehensive pro-

a 14 million-share buyback program announced in Oc-

cess to contain and remediate the environmental impact

tober 2004. In addition, the Board approved CN’s tenth

of the spill.

consecutive dividend increase in January 2006.

We also experienced a derailment in the Squamish

A look at operating measures is equally encour -

area, which resulted in the release of caustic soda into

aging. Across our network, we delivered solid on-time

the Cheakamus River. Although the chemical was

* See page 57 of this report for a reconciliation of this non-GAAP measure.

Canadian National Railway Company

59672_Pg12-19.indd 15
59672_Pg12-19.indd 15

23/02/2006 01:25:14
23/02/2006 01:25:14

diluted and effectively neutralized within 24 hours, harm

and efﬁ ciency testing, auditing of track inspections

was done to the ﬁ sh population. We are continuing to

and computerized track inspection logs. We’ve also

work with the regulatory agencies and local stakeholders

taken steps to enhance CN’s emergency response plan

to remediate the current and long-term effects of the

including a more comprehensive community communi-

spill. Part of this work includes a $1.25 million ﬁ sh

cations plan.

re-stocking program with the Paciﬁ c Salmon Foundation.

However good a railroad’s accident or injury fre-

But what hurt most were accidents involving four

quency ratio may be, 2005 was a painful reminder that

fatalities in Mississippi and one in Alberta in 2005. I

even one accident can be devastating because of the

knew most of the men who died. They were good people

potential impact on human life. We’re more determined

with families, experienced railroaders who loved their

than ever to excel in this critical aspect of railroading.

jobs. Due to the nature and severity of the Mississippi

accident, we will likely never know exactly what caused

Getting to the next level One of the hallmarks of the

it. The loss of life we sustained in 2005 will remain with

CN culture is our focus on continuous improvement and

me for a long, long time.

innovation. Across our entire business, we are always

Over the years, CN has consistently been one of the

looking for ways to move performance to the next level –

safest railroads in North America. Safety has always

we have done this throughout our 10 years as a public

been a top priority at CN and we continue to invest

company. Our scheduled service model is a ﬁ rst in the

considerable resources in safety, technology and

history of railroading. And the list goes on…Our historic

employee education throughout our company. In the

hourly labor agreements. Our innovative Intermodal

wake of the unfortunate events of 2005, and although

Excellence (IMX) and Carload Excellence (CX) products.

the cause of the derailments remains under investigation,

Our ﬁ rst-of-its-kind customer service department. Our

we have implemented a number of speciﬁ c initiatives to

leadership in establishing routing protocols with the four

further enhance our efforts to reduce the incidence and

major U.S. Class I rail carriers.

mitigate the impact of derailments, including: increased

We are continuing to lead in the use of technology

rail testing, installation of additional Wheel Impact Load

to manage our network. A few years ago, we developed

Detectors, more extensive locomotive engineer training

TOPC (Train Operations Planning and Control), a

Canadian National Railway Company

59672_Pg12-19.indd 16
59672_Pg12-19.indd 16

2/24/06 12:10:15 PM
2/24/06 12:10:15 PM

We expanded our unique

“Hunter Camps” program,

conducting 12 sessions

across the company

in 2005.

pro prietary system that enables management to see,

number of innovative programs. Our “Railroad MBA”

in real time, every train throughout the network and its

executive training program is still going strong. And we

trip-plan status. We also designed DataCity, a computer

have expanded our “Hunter Camps,” in which I spend

scorecard updated at the end of every day – and you can

three days with small groups of employees to talk about

be sure it appears on my screen every morning – that

how we work and why.

tracks key performance measurements such as on-time

You see, what many people fail to recognize is the fact

performance overall or by train, average cost per train,

that our unique precision railroading model is still in its

bad order per car ratio, key crew information and more.

infancy. We are going to get better and better at this. We

The latest technology tool with breakthrough potential

are still in a learning curve. There are a lot of things that

is SmartYard, which uses embedded, best-practice-based

we haven’t yet thought of. We are going to continue to

rules and logic to dramatically enhance CN yardmasters’

focus intensely on discovering those things.

and terminal operators’ ability to manage the complexity

Every year I say it, and every year everyone at CN

of yard operations. The two modules, Workload Planner

works very hard to prove me right: It’s been a great run,

and SmartAnalyst, are in use on a pilot-project basis at

and I believe it is nowhere near over.

our MacMillan Yard. We expect to integrate the two

modules into a single platform and migrate this to other

Sincerely,

CN hump yards throughout 2006.

It’s still about people Technology is important, and

I believe ours leads the industry, but the systems I de-

scribed are just tools. The real drivers of future success

E. Hunter Harrison

are the passion, skills and dedication of our people.

President and Chief Executive Ofﬁ cer

But what separates companies is not what they say

about the importance of people – it’s what they do to

develop them. At CN, we have been focused for years

on developing a culture of difference-makers through a

59672_Pg12-19.indd 17
59672_Pg12-19.indd 17

2/24/06 12:10:34 PM
2/24/06 12:10:34 PM

Canadian National Railway Company

We see a great

future ahead.

Canadian National Railway Company

59672_Pg12-19.indd 18
59672_Pg12-19.indd 18

2/24/06 12:11:02 PM
2/24/06 12:11:02 PM

CN’s precision railroading model, combined with the passion of its people, is a

powerful engine for growth. We’re looking at every possible way to become better

railroaders and working to improve the quality of our service. We’re going to seek

growth in the same way we have up to this point: by providing shippers a transpor-

tation product that keeps getting better, faster, more efﬁ cient and more reliable.

59672_Pg12-19.indd 19
59672_Pg12-19.indd 19

2/24/06 12:11:20 PM
2/24/06 12:11:20 PM

Canadian National Railway Company

59672_Pg20-35.indd 20
59672_Pg20-35.indd 20

2/24/06 6:01:40 PM
2/24/06 6:01:40 PM

Investing to support
tttt
Investing to support
future growth
future growth
ththhh

upporpporppor
uppor

59672_Pg20-35.indd 21
59672_Pg20-35.indd 21

2/25/06 8:16:25 AM
2/25/06 8:16:25 AM

Canadian National Railway Company

Improving our infrastructure for
enhanced network velocity, reliability
and cost efﬁ ciency.

“Longer sidings mean fewer train

An increasing ﬂ ow of multi-commodity steamship trafﬁ c to and from

starts, reduced dispatching, mainte-

Asia; a beetle-kill in British Columbia that is expected to generate a

nance and crew costs, and increased

surge in forest product production; the oil sands project in Alberta;

network velocity – and we’ll accom-

the migration of Quebec paper from truck to rail; the resurgence of

plish this by reusing existing assets.

coal and iron ore; the rebuilding of New Orleans and the Gulf Coast –

After completion in western Canada,

we see numerous growth opportunities on the horizon for CN’s

we’ll expand the program to our

unique franchise.

network in the east.”

Throughout 2005, and in 2006 and beyond, CN invested and will

Peter Marshall,

continue to invest in its physical plant to support proﬁ table growth.

CN Senior Vice-President,

We increased reliability and fuel efﬁ ciency with the continued acquisi-

Western Canada Region

tion of new locomotives. We began the process of developing a more

versatile car ﬂ eet, reducing the number of specialized cars in favor of

more generic ones that are able to serve a wider range of customers.

In western Canada, we are moving and combining obsolete short

sidings, reusing rail, ties, switches and other materials to create

better-placed, longer sidings at the lowest possible cost.

Canadian National Railway Company

59672_Pg20-35.indd 22
59672_Pg20-35.indd 22

2/24/06 6:09:18 PM
2/24/06 6:09:18 PM

With transatlantic and transpaciﬁ c ship-
ping trafﬁ c continuing to rise, interna-
tional carriers such as Evergreen – and
their customers – beneﬁ t from CN’s
continuously improving reliability
and network capacity. Shown are
Thomas Chen, President, Evergreen
America Corporation (right) and
JC Chartrand, CN Account Manager,
reviewing a trip plan.

Canadian National Railway Company

59672_Pg20-35.indd 23
59672_Pg20-35.indd 23

2/18/06 6:41:39 PM
2/18/06 6:41:39 PM

Canadian National Railway Company

59672_Pg20-35.indd 24
59672_Pg20-35.indd 24

2/18/06 7:11:17 PM
2/18/06 7:11:17 PM

SmartYard:
the future of rail yard
management

59672_Pg20-35.indd 25
59672_Pg20-35.indd 25

2/18/06 6:48:36 PM
2/18/06 6:48:36 PM

Canadian National Railway Company

A powerful tool to reduce dwell
time, support schedule integrity and
improve yard productivity.

“SmartYard takes input from multiple

Anyone familiar with railroading knows that managing a rail yard is a

CN systems, combines the data,

highly complex and challenging task. Especially in larger classiﬁ cation

and models the optimal sequence

yards, constantly shifting trafﬁ c conditions make it extremely difﬁ cult

for cars in yard inventory – continu-

to coordinate the jobs of multiple departments – transportation, engi-

ously adjusting to the variables and

neering, mechanical, motive power – while assembling and clearing

constantly changing conditions of

trains within the demanding schedules of precision railroading.

a busy rail network.”

To drive breakthrough improvements in rail yard efﬁ ciency, CN has

Keith Creel,

developed SmartYard, a computer program that makes decision-making

CN Senior Vice-President,

easier and more effective in a highly dynamic, live environment.

Eastern Canada Region

SmartYard consists of two modules: Workload Planner, which creates,

communicates and continuously updates the car processing plan for

all users; and SmartAnalyst, which identiﬁ es and analyzes every pos-

sible combination and outcome for sequencing cars. SmartYard is

being implemented on a pilot-project basis at CN’s MacMillan Yard;

the plan is to expand it to other CN yards starting in mid-2006. Once

this is under way, the next element of SmartYard will be Dynamic

Track Assignment, which is designed to optimize classiﬁ cation-track

capacity in sync with Workload Planner and SmartAnalyst.

Canadian National Railway Company

59672_Pg20-35.indd 26
59672_Pg20-35.indd 26

2/18/06 6:49:52 PM
2/18/06 6:49:52 PM

With our ongoing efforts to perfect and
implement SmartYard across the CN system,
we expect to improve transit times and
reliability for our customers. Fausto Santos,
Trafﬁ c Coordinator at CN’s MacMillan Yard, is
already experiencing how SmartYard simpliﬁ es
management of a very complex function.

59672_Pg20-35.indd 27
59672_Pg20-35.indd 27

23/02/2006 01:27:06
23/02/2006 01:27:06

Canadian National Railway Company

59672_Pg20-35.indd 28
59672_Pg20-35.indd 28

2/18/06 6:51:42 PM
2/18/06 6:51:42 PM

Taking performance
to the next level

59672_Pg20-35.indd 29
59672_Pg20-35.indd 29

2/27/06 3:26:03 PM
2/27/06 3:26:03 PM

Canadian National Railway Company

The best-route focus of the routing protocol
agreements between CN and all four U.S.
Class I carriers is proving to be a boon for cus-
tomers like containerboard producer Norampac.
Jim Quart, General Manager, Transportation of
Norampac, Inc., reviews routing options with
Suzanne Dales, CN Account Manager.

Canadian National Railway Company

59672_Pg20-35.indd 30
59672_Pg20-35.indd 30

2/20/06 12:54:10 PM
2/20/06 12:54:10 PM

IMX, CX and the routing protocols:
making innovation work.

“The Routing Precision module of

Intermodal Excellence (IMX), CN’s application of the discipline of

CN’s proprietary DataCity technology

scheduled railroading to manage the complexity of intermodal trans-

enabled us to ensure compliance

portation, continues to deliver highly competitive transit time and

with the new routing protocols –

reliability for customers. The key to growing intermodal through IMX

it’s one thing to get the agreement,

resides in further improving velocity, expanding U.S. gateways with

quite another to get it fully imple-

other carriers, port expansions such as Prince Rupert and, in IMXtra,

mented. We are now more than

the addition of storage capacity at CN terminals to provide shippers

98 per cent there.”

with additional ﬂ exibility in managing container pick-up and drop-off.

François Hébert,

CN Vice-President,

Network Strategies

Carload Excellence (CX) is the innovative use of IMX techniques to

further improve carload performance. CN’s DataCity technology

provides key carload information on a daily basis, from average cost

and on-time performance to bad-order cars. Another critical element

of CX success resides in the routing protocol agreements completed

in 2004 and 2005 between CN and the four major U.S. Class I carriers,

in which the shortest routes and best gateways are selected for CN

trafﬁ c interchange with U.S. carriers. Routing protocols also enable

instant Web-based interline pricing, a feature that enhances rail’s

competitiveness with truck transportation.

Canadian National Railway Company

59672_Pg20-35.indd 31
59672_Pg20-35.indd 31

2/18/06 6:54:54 PM
2/18/06 6:54:54 PM

Canadian National Railway Company

59672_Pg20-35.indd 32
59672_Pg20-35.indd 32

2/18/06 6:55:39 PM
2/18/06 6:55:39 PM

Pursuing opportunity
at Prince Rupert

59672_Pg20-35.indd 33
59672_Pg20-35.indd 33

2/18/06 6:56:52 PM
2/18/06 6:56:52 PM

Canadian National Railway Company

Prince Rupert, with its new container terminal
planned for 2007, will provide much-needed
port capacity to handle rapidly increasing
international shipping trafﬁ c. Served exclusively
by the CN network, the new terminal will be
operated by Maher Terminals of Canada Corpo-
ration, one of the world’s largest independent
multi-user terminal operators.

Canadian National Railway Company

59672_Pg20-35.indd 34
59672_Pg20-35.indd 34

2/18/06 6:58:05 PM
2/18/06 6:58:05 PM

A new gateway for growth for
CN’s intermodal, coal, grain and
other backhaul businesses.

“In my travels to China, I found that

British Columbia’s Prince Rupert is 30 hours closer to Asia than any

Prince Rupert already is on the minds

other North American port. It is the west coast’s deepest port, able

of people making decisions about

to easily accommodate the world’s largest ocean vessels. It is less

the sourcing and routing of natural

congested than other ports and is ice-free all year. The port is served

resources imports. Our north line to

exclusively by a high-quality, high-capacity but underutilized CN rail

Rupert could be huge not only for

line that provides excellent access to Toronto, Chicago and other key

CN intermodal but also for our bulk

North American gateways. And in 2005, CN, the Prince Rupert Port

and merchandise businesses.”

Authority and a major container terminal operator announced plans

to open a new, state-of-the-art container terminal in 2007.

Jean-Jacques Ruest,

CN Vice-President, Marketing

For CN, Prince Rupert is more than an intermodal opportunity. We

already have a coal terminal and grain elevator there, both of which

can handle signiﬁ cant additional volumes with very little capital

investment. And we are planning a facility to put specialty grains into

containers, as well as a multi-commodity facility to handle lumber,

pulp and other products – all to maximize backhaul opportunities

for CN and the steamship lines that call at Prince Rupert.

59672_Pg20-35.indd 35
59672_Pg20-35.indd 35

2/18/06 6:59:13 PM
2/18/06 6:59:13 PM

Canadian National Railway Company

2005
19,221
4,841
342,894
179,701
22,246
403
÷«1.72

2004 (1)

19,304

4,578

332,807

174,240

22,470

391

÷«1.30

2003

17,544

4,100

313,593

162,152

22,012

374

÷«1.21

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

Freight
revenues
(millions)

$1,096

837

1,738

331

1,119

1,270

514

Revenue ton
miles (RTM)
(millions)

31,235

16,848

42,330

13,576

40,393

32,184

3,135

Freight
revenue
per RTM
(cents)

3.51

4.97

4.11

2.44

2.77

3.95

16.40

CN at a glance

Statistical summary

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.

2005 data

CN derives revenue
from a balanced
mix of goods mov-
ing over a network
of approximately
19,200 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.

Petroleum and chemicals

Metals and minerals

Forest products

Coal

Grain and fertilizers

Intermodal

Automotive

Freight revenues
2005 percentage data

16%

18%

12%

25%

16%

16% Petroleum and chemicals
12% Metals and minerals
25% Forest products
5% Coal
16% Grain and fertilizers
18% Intermodal
8% Automotive

Revenue – traffic mix
Per cent

22%

24%

33%

21%

24% Canadian domestic
21% Overseas
33% Transborder
22% U.S. domestic

Petroleum and chemicals

Metals and minerals

Forest products

Petroleum and chemicals comprises
a wide range of commodities in-
cluding chemicals, sulfur, plastics,
petroleum and gas products. Most
of CN’s petroleum and chemicals
shipments originate in Alberta, east-
ern 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 non-
ferrous base metals, iron ore, steel,
equipment and parts and construc-
tion materials. The company’s
unique rail access to major mines,
ports and smelters throughout
North America has made the com-
pany a leader in the transportation
of copper, lead, zinc concentrates,
iron ore, reﬁ ned metals and
aluminum.

CN is one of the largest carriers of
forest products in North America.
This commodity group includes
various types of lumber, panels,
wood chips, wood pulp, printing
paper, linerboard 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 Midwestern and southern U.S.
corridors with interline capabilities
to other Class I railroads.

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

Canadian National Railway Company

59672_Pg36-37.indd 36
59672_Pg36-37.indd 36

2/24/06 6:58:59 PM
2/24/06 6:58:59 PM

Fort Nelson

Prince Rupert

Prince George

Dawson Creek

Whistler

Kamloops

Vancouver

Edmonton

Saskatoon

Calgary

CN – North America’s Railroad

Regina

Winnipeg

Hearst

Moncton

Thunder Bay

Quebec

Montreal

Sault Ste. Marie

Halifax

Duluth

Minneapolis/ St. Paul

Sioux City

Omaha

Stevens
Point

Fond du Lac

Green Bay

Sarnia

Toronto

Buffalo

Detroit

Conneaut

Chicago

Pittsburgh

Springfield

St. Louis

Memphis

Jackson

Mobile

New Orleans

Baton
Rouge

CN Main Line

CN Feeder Lines

Short Line
Haulage Partners

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 fertilizers business
transports commodities from 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’s innovative IMX intermodal
service consists of two segments.
The ﬁ rst segment, domestic, is
responsible for consumer products
and manufactured goods, operating
through both retail and wholesale
channels. The second, the interna-
tional 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.

59672_Pg36-37.indd 37
59672_Pg36-37.indd 37

2/24/06 6:59:34 PM
2/24/06 6:59:34 PM

Canadian National Railway Company

A message from
the Chairman

Dear fellow shareholders: It is hard to believe 10 years
have passed since CN’s highly successful IPO. The results

meeting to better match the skills of the directors with the
mandates of the committees.

presented in the ﬁ rst few pages of this annual report express

We strengthened the independence criteria for Board

the story from various perspectives. Needless to say, it has

membership earlier in the year, and we created a clear

been a great decade by any measure!

mandate for all our committee chairs. We also continued to

The numbers are but a small part of CN’s remarkable

align our governance practices with the new best practice

story. It is a story of focus and leadership from many people

guidelines for corporate governance issued by the securities

throughout CN, burnished by a decade of experience that

regulators throughout North America. CN is consistently

still beneﬁ ts our company today.

ranked near the top by the organizations that rate corporate

The decision to acquire the Illinois Central Railroad

governance performance every year.

certainly is a key milestone, a move that brought the

Also in 2005, we approved a comprehensive communica-

railroading acumen and leadership of Hunter Harrison to

tions policy to strengthen assurance that our disclosures to

CN – Hunter has proven to be an individual that I have no

shareholders are timely, accurate and complete.

doubt will be viewed by future generations as one of this

Our Directors are very committed to CN and I thank

industry’s great leaders.

each of them for their dedication to creation of shareholder

We feel a deep sense of pride and accomplishment as we

value as they all work diligently to make CN a better com-

pause to reﬂ ect on this, our tenth year. We are proud of the

pany. I would also like to express the Board’s gratitude to

strong performance each year of CN – never content with

Gilbert H. Lamphere, who retired in 2005 from CN’s Board,

the status quo, but always striving for excellence in both

for his contribution to the company over the past seven years.

leadership and innovation.

To our shareholders, we thank you for your continued

As Chairman of the Board, I am also proud to say that

support. We are conﬁ dent as we look to CN’s future that

this tradition extends to our approach to corporate gover-

the company will continue to provide some of the best

nance. Ever since our ﬁ rst days as a public company, the

leadership in the industry. We will never be complacent –

Board has been committed to developing and continuously

there are still many mountains to climb.

improving upon best practices in governance. This commit-

ment continued in 2005 with a number of actions taken by

Sincerely,

the CN Board.

We divided the Board’s Audit, Finance and Risk

Committee into separate Audit and Finance committees.

The change allows the Audit Committee to focus on ﬁ nan-

cial reporting and account ing matters, while the Finance

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

Committee concentrates on ﬁ nancial strategy. Further, we

Chairman of the Board

realigned committee membership after the 2005 annual

Canadian National Railway Company

59672_Pg38-42.indd 38
59672_Pg38-42.indd 38

2/24/06 7:04:42 PM
2/24/06 7:04:42 PM

ALL ABOARD FOR SAFETY:2005

Doing the

right thing

59672_Pg38-42.indd 39
59672_Pg38-42.indd 39

2/20/06 1:44:07 PM
2/20/06 1:44:07 PM

During Safe Crossing Day, CN Police ofﬁ cers
like Constable Sam Masanotti showed children
how and when to cross railroad tracks safely.

Canadian National Railway Company

Doing the right thing
drives CN’s business strategies, our

internal policies and our activities

Every day, we strive to do better than we did the day before

and to make sure everyone goes home safely.

Each person who works at CN can hear the distinctive

voice of our leader, Hunter Harrison, saying, “Don’t get

anybody hurt.” Safety is a key value here, and one we all

in the community. For us, nothing

take to heart.

is more important than the safety of

All Aboard for Safety picked up speed in 2005

our employees, customers and the

people who live, work and play in

the communities along our tracks.

All Aboard for Safety is the name we created in 2004 for a pro-

gram we have run for more than 20 years to help educate

children and adults in the community about railroad safety.

As part of the program each year, CN Police ofﬁ cers talk

to more than a quarter of a million adults and children

40
40

Canadian National Railway Company
Canadian National Railway Company

59672_Pg38-42.indd 40
59672_Pg38-42.indd 40

23/02/2006 01:30:49
23/02/2006 01:30:49

(Left)
Special agent Michael Landini,
CN Police, spoke to hundreds of
motorists in a company-wide
highway/rail crossing safety blitz
during Rail Safety Week 2005.

Safe Kids Canada and CN

launched the Safe Crossing

Program in October to help

parents teach their children

how to be safe near

railroad crossings.

about the importance of safety and about the dangers of

teach their children about crossing streets safely; why not

walking and playing on or near our tracks. And of course,

railroad tracks?

no child ever forgets meeting CN’s safety train, Little Obie,

CN teamed up with Safe Kids Canada, the national injury

the reduced-scale CN locomotive with a full-scale train

prevention program, to develop the Safe Crossing Program,

horn that visits communities all over Canada and the

designed to encourage parents, educators and caregivers to

United States all year long.

teach children about safe behavior around railroad tracks.

In 2005, we raised the proﬁ le of our program by develop-

Program materials included a parent tip sheet, brochure,

ing an All Aboard for Safety logo that we use in community

poster and Web-based toolkit ﬁ lled with information, edu-

education materials and displays, at CN-sponsored events

cational activities and discussion topics for conversation.

and in our corporate advertising.

CN and Safe Kids Canada declared October 27, 2005 Safe

Our overall goal? To help reduce injuries and fatalities on

Crossing Day. To promote the program, CN Police ofﬁ cers

and near our tracks and property and to raise awareness of

visited elementary schools in 10 cities across Canada and

the importance of railroad safety.

conducted Safe Crossing activities with children.

Going the extra mile during Rail Safety Week

We don’t do it alone

Rail Safety Week is an annual event in Canada, but we know

We know the All Aboard for Safety program won’t have

safety does not stop at the border. So we made it a North

the impact we desire without help. So we work with law

American effort. Between April 25 and May 1, 2005, CN

enforcement agencies, ﬁ reﬁ ghters, emergency medical

Police ofﬁ cers conducted safety blitzes at highway/rail

service providers, hospitals and leading community safety

crossings in nearly 100 towns and cities in Canada and

organizations in Canada and the United States to help

the United States.

promote railroad safety.

The safety blitzes were aimed at increasing motorists’

In addition to Safe Kids Canada, our major partners

awareness about crossing safety and reminding pedestrians

include Operation Lifesaver, a public education program

about the dangers of trespassing on railroad property.

to promote railroad safety, Safe Communities Foundation,

an organization that helps communities implement safety

Safe Crossing Day targeted parents in 2005

programs, SMARTRISK, an injury-prevention organization,

When a Safe Kids Canada survey indicated that only 30 per

and Mothers Against Drunk Driving (MADD).

cent of parents polled had talked to their children about

Working together is a dialog of caring – and it helps make

railroad safety within the past year, we knew we had found

our communities safer places to live.

a problem that needed to be addressed. All parents try to

59672_Pg38-42.indd 41
59672_Pg38-42.indd 41

23/02/2006 01:31:17
23/02/2006 01:31:17

Canadian National Railway Company
Canadian National Railway Company

41
41

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 I 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 2004 was $289.4 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

59672_Pg38-42.indd 42
59672_Pg38-42.indd 42

2/18/06 3:39:51 PM
2/18/06 3:39:51 PM

Financial Section (U.S. GAAP)

Contents

Canadian National Railway Company

44 Selected Railroad Statistics
45 Management’s Discussion and Analysis
69 Management Report
69 Report of Independent Registered Public Accounting Firm
70 Consolidated Statement of Income
71 Consolidated Statement of Comprehensive Income
72 Consolidated Balance Sheet
73 Consolidated Statement of Changes in Shareholders’ Equity
74 Consolidated Statement of Cash Flows

Notes to Consolidated Financial Statements

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

75
77
78
79
79
80
80
80
80
82 10 Long-term debt
83 11 Capital stock
83 12 Stock plans
85 13 Pensions
87 14 Other income (loss)
87 15 Income taxes
88 16 Segmented information
89 17 Earnings per share
89 18 Major commitments and contingencies
92 19 Financial instruments
93 20 Other comprehensive income (loss)
94 21 Reconciliation of United States and Canadian generally accepted accounting principles
100 22 Subsequent event
100 23 Comparative figures

59672_Pg43.indd 43
59672_Pg43.indd 43

2/24/06 7:47:09 PM
2/24/06 7:47:09 PM

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 (%)

Freight revenue per RTM (cents)

Freight revenue per carload ($)

Operating expenses per GTM (cents)

Labor and fringe benefits expense per GTM (cents)

GTMs per average number of employees (thousands)

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

Average fuel price ($/U.S. gallon) (2)

GTMs per U.S. gallon of fuel consumed

Safety indicators

Injury frequency rate per 200,000 person hours

Accident rate per million train miles

(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.

2005

2004 (1)

2003

6,905

342,894

179,701

4,841

19,221

21,540

22,246

63.8

3.84

1,426

1.35

0.54

15,414

403

1.72

851

2.4

1.6

6,252

332,807

174,240

4,578

19,304

22,679

22,470

66.9

3.59

1,366

1.32

0.55

5,694

313,593

162,152

4,100

17,544

21,489

22,012

69.8

3.51

1,389

1.31

0.54

14,811

14,246

391

1.30

851

2.6

1.6

374

1.21

838

2.9

2.0

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

59672_Pg44-69 .indd 44
59672_Pg44-69 .indd 44

2/18/06 4:08:15 PM
2/18/06 4:08:15 PM

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 or the Company) 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 Partnership and the former BC Rail Ltd. (collectively 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). Prior to 2005, the Company also prepared consolidated financial statements in accordance with Canadian
generally accepted accounting principles (Canadian GAAP), which differed in some respects from financial statements in accordance with U.S. GAAP,
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. For 2005, pursuant to the regulations under the Canadian Business Corporations Act, the
Company has provided a reconciliation of the U.S. to Canadian GAAP financial statements in Note 21 to the Company’s Consolidated Financial
Statements. As of 2006, the Company will be reporting solely in accordance with U.S. GAAP. 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. The reader is advised to read all information
provided in the MD&A in conjunction with the Company’s 2005 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 19,200
route miles of track (at December 31, 2005) spans Canada and mid-
America, connecting three coasts: the Atlantic, the Pacific and the Gulf of
Mexico. CN’s marketing alliances, interline agreements, co-production
arrangements and routing protocols, in addition to its extensive network,
give CN customers access to all three North American Free Trade
Agreement (NAFTA) nations.

CN’s freight revenues are derived from seven commodity groups

representing a diversified and balanced portfolio of goods transported
between diverse origins and destinations. This product and geographic
diversity positions the Company well to face economic fluctuations and
enhances its potential for growth opportunities. In 2005, no individual
commodity group accounted for more than 24% of revenues. CN is equally
well diversified from a geographic standpoint. In 2005, 22% of revenues
came from U.S. domestic traffic, 33% from transborder traffic, 24% from
Canadian domestic traffic and 21% from overseas traffic. The Company
originates approximately 87% of traffic moving along its network, which
allows it both to capitalize on service advantages and build on opportu-
nities to efficiently use assets.

Corporate organization

The Company manages its rail operations in Canada and the United States
as one business segment. Financial information reported at this level, such
as revenues, operating income, operating ratio and cash flow from opera-
tions, is used by the Company’s corporate management in evaluating
financial and operational performance and allocating resources across CN’s
network. The Company’s strategic initiatives, which drive its operational
direction, are developed and managed centrally by corporate management
and are communicated to its regional activity centers (the Western Canada,
Eastern Canada and U.S. regions), whose role is to manage the day-to-day
service requirements of their territory, service small customer accounts within
their region, control direct costs incurred locally, and execute the corporate
strategy and operating plan established by corporate management.

See Note 16 – Segmented information, to the Company’s Annual

Consolidated Financial Statements for additional information on the
Company’s corporate organization, as well as selected financial infor-
mation by geographic area.

Strategy overview

CN’s goal is to remain at the forefront of the rail industry and its chal-
lenge is to be regarded as the continent’s best-performing transportation
company.

CN is committed to creating value for both its customers and share-
holders. 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 has a unique
business model, which is anchored on five core values: providing good
service, controlling costs, focusing on asset utilization, committing to
safety and developing employees.

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
principles of scheduled railroading to its intermodal business through
the Intermodal Excellence (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. In early 2005, the Company began applying the addi-
tional principles learned from IMX to its carload business, launching
Carload Excellence (CX), in order to improve asset utilization and
optimize capacity.

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 are improved transit
and cycle times for freight cars and the penetration of new markets.

U.S. GAAP

Canadian National Railway Company

59672_Pg44-69 .indd 45
59672_Pg44-69 .indd 45

2/18/06 4:08:54 PM
2/18/06 4:08:54 PM

Management’s Discussion and Analysis

The acquisition of GLT in May 2004 has permitted new efficiencies

The Company strives to offer transportation services that deliver value

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
steel industry in the United States. The purchase of BC Rail in July 2004
not only added to CN’s forest products business substantially, but also
expanded the railroad’s capacity in British Columbia.

In 2006, the Company plans to spend approximately $1,525 million
on capital programs. Of this, more than $1,000 million is targeted for rail
infrastructure integrity and safety maintenance, including rail, tie, ballast,
and other track material replacements, as well as bridges and signaling
systems upgrades. This allotment also includes strategic initiatives, such
as siding extensions in western Canada; the reconfiguration of Johnston
Yard in Memphis, Tennessee for increased network fluidity and efficiency;
and investments in the Company’s Prince Rupert, B.C. corridor, to capitalize
on the Port of Prince Rupert’s potential as an important traffic gateway
between Asia and the North American heartland.

The remaining $500 million is targeted for equipment expenditures,
including new locomotive and car purchases, plus existing fleet refurbish-
ments; as well as for facilities, information technology and other projects.
These will enable the Company to tap new growth opportunities and
improve overall efficiency.

Financial and statistical highlights

to its customers. It does so with the belief that better service benefits
customers while improving CN’s yields, operating efficiency and earnings.
The Company foresees a number of business-growth opportunities. In
the intermodal area, there is growth potential in international markets
because of increasing North American-Asian container trade, as well
as the projected 2007 opening of the Prince Rupert container terminal.
In the bulk area, western Canadian growth prospects are enhanced
by continued coal mine expansion. In merchandise, the Company sees
growth potential for a number of commodities, particularly wood prod-
ucts and metals. The Company’s business prospects are based on the
continuation of positive economic trends in North America and Asia.

The Company foresees improvements in productivity, particularly

in yards and terminals. The Company also intends to pursue further
operating efficiencies by continuing to improve labor productivity and
to focus on reducing accidents and related costs, legal claims and health
care costs. The Company partners with connecting carriers to implement
routing protocol agreements and pursues co-production initiatives to
further improve service and generally reduce costs.

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

2005

2004

2003

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

Statistical operating data and productivity measures

Employees (average during period)

Gross ton miles (GTM) per average number of employees (thousands)

GTMs per U.S. gallon of fuel consumed

$÷7,240

$÷2,624

$÷1,556

63.8%

$÷÷5.64

$÷÷5.54

$÷÷1.00

$22,188

$10,981

22,246

15,414

851

$÷6,548

$÷2,168

$÷1,258

66.9%

$÷÷4.41

$÷÷4.34

$÷÷0.78

$22,365

$10,822

22,470

14,811

851

$÷5,884

$÷1,777

$÷1,014

69.8%

$÷÷3.54

$÷÷3.49

$÷÷0.67

$20,337

$÷9,928

22,012

14,246

838

Financial results

2005 compared to 2004
In 2005, net income increased by $298 million, or 24%, to $1,556 million,
when compared to 2004, with diluted earnings per share rising 28%, to
$5.54. Revenues increased by $692 million, or 11%, to $7,240 million,
mainly due to freight rate increases, an important part of which was due
to a higher fuel surcharge as a result of increases in crude oil prices,
the inclusion of a full year of GLT and BC Rail revenues, and a return to
normal intermodal volumes following the first quarter 2004 Canadian
Auto Workers (CAW) strike. Partly offsetting these gains was the transla-
tion impact of the stronger Canadian dollar on U.S. dollar-denominated
revenues of $260 million.

Operating expenses increased by $236 million, or 5%, to
$4,616 million, primarily due to increased fuel costs, the inclusion
of a full year of GLT and BC Rail expenses, and increased purchased
services and material costs. Partly offsetting these factors was the
translation impact of the stronger Canadian dollar on U.S. dollar-
denominated expenses of $155 million, lower equipment rents, and
lower casualty and other expense.

The operating ratio, defined as operating expenses as a percentage

of revenues, was 63.8% in 2005 compared to 66.9% in 2004, a 3.1-point
betterment.

The years ended December 31, 2005 and 2004 included items
affecting the comparability of the results of operations. The Company
acquired and consolidated GLT and BC Rail effective May 10, 2004 and

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 46
59672_Pg44-69 .indd 46

2/18/06 4:09:28 PM
2/18/06 4:09:28 PM

Management’s Discussion and Analysis

July 14, 2004, respectively. Accordingly, in the discussions herein, the
Company’s results of operations for 2005 include the results of opera-
tions of both GLT and BC Rail. The Company’s results for 2004 included
the results of operations of GLT as of May 10, 2004 and BC Rail as of
July 14, 2004.

In 2005, the continued 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, resulted in a reduction
to net income of approximately $60 million.

For the year ended December 31, 2004, a first-quarter strike by the

Company’s employees represented by the CAW union negatively
impacted operating income and net income by $35 million and $24 mil-
lion, respectively.

Revenues

Year ended December 31,

Total revenues (millions)

Rail freight

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Carloads (thousands)

Revenue/carload (dollars)

2005

$7,240

2004 % Change

$6,548

11%

$6,905

179,701

3.84

4,841

1,426

$6,252

174,240

3.59

4,578

1,366

10%

Revenues for the year ended December 31, 2005 totaled $7,240 million
compared to $6,548 million in 2004. The increase of $692 million, or
11%, was mainly due to freight rate increases, an important part of
which was due to a higher fuel surcharge as a result of increases in
crude oil prices, the inclusion of a full year of GLT and BC Rail revenues,
and a return to normal intermodal volumes following the first-quarter
2004 CAW strike. Partly offsetting these gains was the translation impact
of the stronger Canadian dollar on U.S. dollar-denominated revenues.
In 2005, revenue ton miles, measuring the volume of rail freight
transported by the Company, increased by 3% relative to 2004. 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
7% for 2005 when compared to 2004, largely due to freight rate increases.

Petroleum and chemicals

Year ended December 31,

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2005

$1,096

31,235

3.51

2004 % Change

$1,059

31,421

3.37

(1%)

Petroleum and chemicals comprises a wide range of commodities, includ-
ing chemicals, sulfur, plastics, petroleum and gas products. Although
offshore markets have been growing strongly, the primary markets for
these commodities are still within North America. As such, the perfor-
mance of this commodity group is closely correlated with the North
American economy. Most of the Company’s petroleum and chemicals
shipments originate in the Louisiana petrochemical corridor between
New Orleans and Baton Rouge; in northern Alberta, which is a major
center for natural gas, feedstock, and petrochemicals and plastics
complex derivatives; and in eastern Canadian regional plants; and are
destined for customers in Canada, the United States and overseas.
For the year ended December 31, 2005, revenues for this commodity
group increased by $37 million, or 3%, from 2004. The improvement
was mainly due to freight rate increases, the inclusion of a full year of
BC Rail revenues, and an improved market position in petroleum products.
These gains were partly offset by the translation impact of the stronger
Canadian dollar, soft market conditions for plastics and liquefied petro-
leum gases, continued weakness in the U.S. molten sulfur market and
reduced shipments of U.S. petrochemicals. Freight revenue per revenue
ton mile increased by 4% as freight rate increases were partly offset by
the translation impact of the stronger Canadian dollar.

Percentage of revenues

Carloads*

In thousands

40%

4
7
4

60%

3
4
5

4
6
5

6
9
5

4
9
5

60% Petroleum and plastics
40% Chemicals

* Includes Wisconsin Central Transportation
Corporation (WC) from October 9, 2001, GLT from
May 10, 2004 and BC Rail from July 14, 2004

59672_Pg44-69 .indd 47
59672_Pg44-69 .indd 47

2/18/06 4:14:33 PM
2/18/06 4:14:33 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Metals and minerals

Forest products

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2005

$837

16,848

4.97

2004 % Change

Year ended December 31,

$714

16,352

4.37

17%

14%

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2005

$1,738

42,330

4.11

2004 % Change

$1,505

39,369

3.82

15%

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 unique 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 and
sand) and cement. The Company has access to major cement producers
and aggregate mines in Canada as well as in the U.S. Metals and minerals
traffic is sensitive to fluctuations in the economy. For the year ended
December 31, 2005, revenues for this commodity group increased by
$123 million, or 17%, from 2004. The increase was mainly due to freight
rate increases, the inclusion of a full year of GLT and BC Rail revenues,
strong shipments of construction materials, aluminum and Canadian
steel products, and an improvement in traffic mix. Partly offsetting these
gains was the translation impact of the stronger Canadian dollar.
Revenue per revenue ton mile increased by 14% in 2005, mainly due to
shorter-haul traffic, particularly related to GLT, and freight rate increases.
Partly offsetting these factors was the translation impact of the stronger
Canadian dollar.

Percentage of revenues

Carloads*

In thousands

23%

24%

53% Metals
24% Minerals
23% Iron ore

4
9
9

1
0
8

53%

7
8
2

8
8
3

6
9
3

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

The forest products commodity group includes various types of lumber,
panels, wood chips, wood pulp, printing paper, linerboard and newsprint.
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. corridors with inter-
line capabilities to other Class I railroads. The key drivers for the various
commodities are: for newsprint, advertising lineage and overall economic
conditions, primarily 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, 2005, revenues for this commodity
group increased by $233 million, or 15%, from 2004. The increase was
mainly due to freight rate increases, continued solid demand for Canadian
lumber and panels, the inclusion of a full year of BC Rail revenues,
improvements in traffic mix and an improved market position for paper.
The translation impact of the stronger Canadian dollar partly offset these
gains. Revenue per revenue ton mile increased by 8% in 2005, mainly due
to freight rate increases and a positive change in traffic mix, which were
partly offset by the translation impact of the stronger Canadian dollar.

Percentage of revenues

Carloads*

In thousands

12%

16%

33%

39% Fibers
33% Lumber
16% Paper
12% Panels

8
7
6

2
1
7

6
2
6

8
1
6

3
2
5

39%

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

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 48
59672_Pg44-69 .indd 48

2/18/06 4:15:11 PM
2/18/06 4:15:11 PM

Management’s Discussion and Analysis

Coal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2005

$331

13,576

2.44

Grain and fertilizers

2004 % Change

Year ended December 31,

$284

12,684

2.24

17%

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2005

$1,119

40,393

2.77

2004 % Change

$1,063

40,091

2.65

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 Canadian metallurgical coal, which is largely exported
to Asian steel producers. The strong global market for metallurgical coal
facilitated the opening of three mines along the Company’s network in
late 2004. The renewed strength in this market is expected to continue
as strong Asian demand for metallurgical coal drives increased Canadian
production. For the year ended December 31, 2005, revenues for this
commodity group increased by $47 million, or 17%, from 2004. The
increase was mainly due to new metallurgical coal mines in western
Canada, freight rate increases and the inclusion of a full year of GLT
and BC Rail revenues. Partly offsetting these gains was the translation
impact of the stronger Canadian dollar. The revenue per revenue ton mile
increase of 9% was mainly due to freight rate increases, which were
partly offset by the translation impact of the stronger Canadian dollar.

Percentage of revenues

Carloads*

In thousands

17%

9
5
4

5
3
4

9
2
4

8
4
4

6
0
4

83%

83% Coal
17% Petroleum coke

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 pri-
marily by weather conditions. Grain exports are volatile, reflecting the
size and quality of the crop produced, international market conditions
and foreign government policy. The majority of grain produced in west-
ern Canada and moved by CN is exported via the ports of Vancouver,
Prince Rupert and Thunder Bay. Certain of these rail movements are sub-
ject to government regulation and to a “revenue cap,” which effectively
establishes a maximum revenue entitlement that railways can earn. In
the U.S., grain grown in Illinois and Iowa is exported, as well as trans-
ported to domestic processing facilities and feed markets. The Company
also serves major producers of potash in Canada, as well as producers of
ammonium nitrate, urea and other fertilizers across Canada and the U.S.
For the year ended December 31, 2005, revenues for this commodity group
increased by $56 million, or 5%, from 2004. The increase was mainly due
to freight rate increases, higher export shipments of U.S. corn in a gener-
ally weak market, increased shipments of Canadian barley and canola
and an improvement in traffic mix. These gains were partly offset by the
translation impact of the stronger Canadian dollar and the decreased
availability of high-quality Canadian wheat for export markets via west
coast ports. Revenue per revenue ton mile increased by 5% in 2005,
largely due to freight rate increases and a positive change in traffic mix,
partly offset by the translation impact of the stronger Canadian dollar.

Percentage of revenues

Carloads*

In thousands

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

12%

27%

3
9
5

9
3
5

2
5
5

7
7
5

6
6
5

24%

25%

27% Feed grain
25% Food grain
24% Oilseeds
12% Fertilizers
12% Potash

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

59672_Pg44-69 .indd 49
59672_Pg44-69 .indd 49

2/18/06 4:15:53 PM
2/18/06 4:15:53 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Intermodal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2005

$1,270

32,184

3.95

Automotive

2004 % Change

Year ended December 31,

$1,117

31,002

3.60

14%

10%

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2005

$514

3,135

16.40

2004 % Change

$510

3,321

15.36

(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, directly serving the major 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 by North American economic and trade
conditions. For the year ended December 31, 2005, revenues for this
commodity group increased by $153 million, or 14%, from 2004. The
increase was mainly due to freight rate increases, strong imports into the
Port of Vancouver and an improvement in traffic mix. Also contributing
to the increase during the year was the return to normal traffic levels
following the first-quarter 2004 CAW strike. Partly offsetting these gains
were the translation impact of the stronger Canadian dollar and a change
in port of call for an overseas shipper. The revenue per revenue ton mile
increase of 10% in 2005 was largely due to freight rate increases and a
positive change in traffic mix, which were partly offset by the translation
impact of the stronger Canadian dollar and an increase in the average
length of haul.

Percentage of revenues

Carloads*

In thousands

7
3
2
,
1

6
7
2
,
1

2
0
2
,
1

8
4
2
,
1

1
6
0
,
1

50%

50% Domestic
50% International

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

The automotive commodity group moves both finished vehicles and parts,
originating in southern Ontario, Michigan and Mississippi, and 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, 2005, revenues for this com-
modity group increased by $4 million, or 1%, from 2004. The increase
was driven by freight rate increases, higher import vehicles via the ports
of Vancouver and Halifax, and the benefit of new finished vehicle traffic
in the southern U.S. that began in the second half of 2004. These gains
were partly offset by the translation impact of the stronger Canadian
dollar and a reduction in automotive production at CN-served facilities
in southern Ontario and Michigan. Revenue per revenue ton mile
increased 7% in 2005 largely due to freight rate increases, which were
partly offset by the translation impact of the stronger Canadian dollar.

Percentage of revenues

Carloads*

In thousands

18%

7
0
3

8
8
2

5
9
2

9
7
2

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 2005, other revenues increased by $39 million, when compared to
2004, mainly due to the inclusion of a full year of revenues from GLT’s
maritime division.

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 50
59672_Pg44-69 .indd 50

2/18/06 4:16:29 PM
2/18/06 4:16:29 PM

Management’s Discussion and Analysis

Operating expenses
Operating expenses amounted to $4,616 million in 2005 compared to $4,380 million in 2004. The increase of $236 million, or 5%, in 2005 was
mainly due to increased fuel costs, the inclusion of a full year of GLT and BC Rail expenses and increased purchased services and material costs. Partly
offsetting these factors was the translation impact of the stronger Canadian dollar on U.S. dollar-denominated expenses, lower equipment rents, and
lower casualty and other expense.

In millions

Year ended December 31,

2005

2004

Labor and fringe benefits

Purchased services and material

Depreciation and amortization

Fuel

Equipment rents

Casualty and other

Total

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. Certain incentive and stock-based compensation
plans are based on financial and market performance targets and the
related expense is recorded in the period in which there is an expecta-
tion that the targets will be attained. Labor and fringe benefits increased
by $22 million, or 1%, in 2005 as compared to 2004. The increase was
attributable to higher stock-based compensation expense, the inclusion
of a full year of GLT and BC Rail expenses, wage increases and a return
to normal wage levels following the first-quarter 2004 CAW strike.
Partly offsetting these factors was the translation impact of the stronger
Canadian dollar, the impact of a reduced workforce, and adjustments
made in 2004 to the workforce reduction provision.

Purchased services and material: Purchased services and material primarily
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 $68 million, or 9%, in 2005 as
compared to 2004. The increase was primarily due to the inclusion of a
full year of GLT and BC Rail expenses, and higher expenses for material
and maintenance on rolling stock and track repairs. These factors were
partly offset by the translation impact of the stronger Canadian dollar.

Depreciation and amortization: Depreciation and amortization relates to
the Company’s rail operations. These expenses increased by $29 million,
or 5%, in 2005 as compared to 2004. The increase was mainly due to
the impact of net capital additions and to the inclusion of a full year of
GLT and BC Rail depreciation expense, which were partly offset by the
translation impact of the stronger Canadian dollar.

Amount

% of revenue

Amount

% of revenue

$1,841

814

627

725

192

417

$4,616

25.4%
11.2%
8.7%
10.0%
2.7%
5.8%
63.8%

$1,819

746

598

528

244

445

$4,380

27.8%

11.4%

9.1%

8.1%

3.7%

6.8%

66.9%

Fuel: Fuel expense includes the cost of fuel consumed by locomotives,
intermodal equipment and other vehicles. These expenses increased by
$197 million, or 37%, in 2005 as compared to 2004. The increase was
mainly due to a 32% increase in the average price per U.S. gallon of
fuel, net of the benefits from CN’s fuel hedging program, from $1.30 in
2004 to $1.72 in 2005; higher volumes, particularly in the first quarter;
the inclusion of a full year of GLT and BC Rail fuel expense; and a sec-
ond-quarter 2004 fuel excise tax refund. Partly offsetting these factors
was the translation impact of the stronger Canadian dollar.

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 $52 mil-
lion, or 21%, in 2005 as compared to 2004. The decrease was mainly
due to lower car hire expense and higher car hire income, mainly as a
result of the integration of the BC Rail fleet, and the translation impact
of the stronger Canadian dollar. These factors were partly offset by
higher car lease expense due to an increased fleet size, higher rates
and the inclusion of a full year of BC Rail car lease expense.

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 $28 million, or 6%, in 2005 as compared to 2004.
The decrease was mainly due to a reduction to the provision for U.S. per-
sonal injuries following the 2005 actuarial valuation, a 2004 adjustment
made to the provision for personal injuries in Canada and the translation
impact of the stronger Canadian dollar. Partly offsetting these factors
were higher derailment-related expenses, in particular, $28 million related
to the incident at Wabamun Lake (See Note 18 – Major commitments and
contingencies, to the Company’s Annual Consolidated Financial Statements),
the inclusion of a full year of GLT and BC Rail expenses and higher
property taxes in the U.S.

59672_Pg44-69 .indd 51
59672_Pg44-69 .indd 51

2/18/06 4:17:12 PM
2/18/06 4:17:12 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Other
Interest expense: Interest expense increased by $5 million, or 2%, for the
year ended December 31, 2005 as compared to 2004, mainly due to the
financing related to the Company’s acquisitions in 2004 and higher interest
rates on commercial paper borrowings. Partly offsetting these factors was
the translation impact of the stronger Canadian dollar and the benefit
of the repayment of matured Notes in March 2004 and May 2005.

Other income (loss): In 2005, the Company recorded income of $12 mil-
lion compared to a loss of $20 million in 2004. The change from loss
to income in 2005 was due to improvements in real estate and other
business activities, realized foreign exchange gains and a first-quarter
2004 restructuring charge related to the Company’s investment in English
Welsh and Scottish Railway. Partly offsetting these factors were lower
investment income, lower gains on disposal of surplus properties, and
higher costs related to the securitization program.

Income tax expense: The Company recorded income tax expense of
$781 million for the year ended December 31, 2005 compared to $596 mil-
lion in 2004. The effective tax rate for the year ended December 31, 2005
was 33.4% compared to 32.1% in 2004. The increase in the effective
tax rate was mainly due to higher provincial tax rates enacted in the
current year.

2004 compared to 2003
In 2004, net income increased by $244 million, or 24%, to $1,258 million,
when compared to 2003, with diluted earnings per share rising 24%, to
$4.34. Revenues increased by $664 million, or 11%, to $6,548 million,
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%, to $4,380 mil-

lion, driven mainly by the inclusion of $228 million of GLT and BC Rail
expenses, higher labor and fringe benefits, increased fuel costs and higher
casualty 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 percentage

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 CAW 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 impacted
the conversion of the Company’s U.S. dollar-denominated revenues and
expenses, resulting in a reduction to net income of approximately
$45 million for 2004.

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
benefit of $75 million, $48 million after tax, resulting from a change in
the accounting for removal costs for certain track structure assets pursu-
ant to the requirements of Statement of Financial Accounting Standards
(SFAS) No. 143, “Accounting for Asset Retirement Obligations,” as
explained in Note 2 – Accounting changes, to the Company’s Annual
Consolidated Financial Statements. This change in policy results 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
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 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

59672_Pg44-69 .indd 52
59672_Pg44-69 .indd 52

2/18/06 4:40:46 PM
2/18/06 4:40:46 PM

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
performance. 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,

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

2004

Reported

$«6,548

4,380

2,168

(294)

(20)

1,854

(596)

1,258

–

$1,258

66.9%

$÷4.41

$÷4.34

Reported

Change in policy

Rate enactment

Adjusted

2003

$«5,884

4,107

1,777

(315)

1,483

(517)

966

$1,014

69.8%

$÷3.54

$÷3.49

$ ÷«–

$ ÷–

–

(48)

$(48)

–

$79

$«5,884

4,107

1,777

(315)

1,483

(438)

1,045

–

$1,045

69.8%

$÷3.65

$÷3.60

Year ended December 31,

2004

2003 % Change

Total revenues (millions)

$6,548

$5,884

11%

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.

Rail freight

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Carloads (thousands)

Revenue/carload (dollars)

$6,252

$5,694

174,240

162,152

3.59

4,578

1,366

3.51

4,100

1,389

10%

12%

(2%)

Petroleum and chemicals

Year ended December 31,

2004

2003 % Change

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

$1,059

31,421

3.37

$1,013

29,693

3.41

(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 of $351 mil-
lion, strong merchandise revenue, an improved Canadian grain crop,
and a higher fuel surcharge. Partly offsetting these gains was the trans-
lation impact of the stronger Canadian dollar on U.S. dollar-denominated
revenues. Revenue ton miles, measuring the volume of freight transported
by the Company, increased by 7% relative to 2003. Freight revenue per
revenue ton mile increased by 2% when compared to 2003. In 2004,
freight revenue per revenue ton mile was positively affected by freight

Revenues for the year ended December 31, 2004 increased by $46 million,
or 5%, from 2003. The increase was due to freight rate improvements in
several key segments, particularly in the first half of 2004, 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 partly
offset by the translation impact of the stronger Canadian dollar. Freight
revenue per revenue ton mile decreased by 1% due to the translation
impact of the stronger Canadian dollar, partly offset by freight rate
improvements and a decrease in the average length of haul.

59672_Pg44-69 .indd 53
59672_Pg44-69 .indd 53

2/18/06 4:18:20 PM
2/18/06 4:18:20 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Metals and minerals

Grain and fertilizers

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2004

$714

16,352

4.37

2003 % Change

Year ended December 31,

2004

2003 % Change

$527

13,873

3.80

35%

18%

15%

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

$1,063

40,091

2.65

$947

35,666

2.66

12%

–

Revenues for the year ended December 31, 2004 increased by $187 mil-
lion, 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. Partly offsetting these gains was the trans-
lation impact of the stronger Canadian dollar. Revenue per revenue ton
mile increased by 15% in 2004, mainly due to GLT shorter-haul traffic,
which was partly offset by the translation impact of the stronger
Canadian dollar.

Forest products

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2004

2003 % Change

$1,505

39,369

3.82

$1,320

35,483

3.72

14%

11%

Revenues for the year ended December 31, 2004 increased by $185 mil-
lion, or 14%, from 2003. The increase was largely due to the inclusion of
$85 million of BC Rail revenues (mainly lumber and panels), continued
solid demand for lumber, freight rate improvements and a higher fuel
surcharge. The translation impact of the stronger Canadian dollar partly
offset these gains. Revenue per revenue ton mile increased by 3% in
2004 as the benefit of freight rate improvements and a positive change
in traffic mix were partly offset by the translation impact of the stronger
Canadian dollar.

Revenues for the year ended December 31, 2004 increased by $116 mil-
lion, or 12%, from 2003. The increase reflects higher Canadian wheat and
barley exports, which were partly offset by weak shipments of U.S. soy-
beans 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.

Intermodal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2004

2003 % Change

$1,117

31,002

3.60

$1,101

31,168

3.53

(1%)

Revenues for the year ended December 31, 2004 increased by $16 mil-
lion, 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 2004 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.

Year ended December 31,

Coal

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

2004

$284

12,684

2.24

2003 % Change

Automotive

$261

13,044

2.00

(3%)

12%

Revenues (millions)

RTMs (millions)

Revenue/RTM (cents)

Year ended December 31,

2004

$510

3,321

15.36

2003 % Change

$525

3,225

16.28

(3%)

(6%)

Revenues for the year ended December 31, 2004 increased by $23 mil-
lion, 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 mil-
lion, 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 12% 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.

Revenues for the year ended December 31, 2004 decreased by $15 mil-
lion, or 3%, from 2003. The decrease was due to the translation impact
of the stronger Canadian dollar that was partly 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.

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

59672_Pg44-69 .indd 54
59672_Pg44-69 .indd 54

2/18/06 4:18:59 PM
2/18/06 4:18:59 PM

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-denomi-
nated 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

Labor and fringe benefits: Labor and fringe benefits in 2004 increased by
$121 million, or 7%, 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
expenses in 2004 increased by $43 million, or 6%, 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 expenses
in 2004 increased by $44 million, or 8%, 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, partly offset by
the translation impact of the stronger Canadian dollar.

Fuel: Fuel expense in 2004 increased by $59 million, or 13%, as com-
pared to 2003. The increase was mainly due to a higher average price
per U.S. gallon, net of the benefits from CN’s fuel 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 productivity and a fuel excise
tax refund in the second quarter of 2004.

Amount

% of revenue

Amount

% of revenue

$1,819

746

598

528

244

445

$4,380

27.8%

11.4%

9.1%

8.1%

3.7%

6.8%

66.9%

$1,698

703

554

469

293

390

$4,107

28.9%

11.9%

9.4%

8.0%

5.0%

6.6%

69.8%

Equipment rents: Equipment rents in 2004 decreased by $49 million,
or 17%, 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 expenses in 2004 increased by
$55 million, or 14%, 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 favor-
able adjustments to U.S. property taxes in 2003. Partly 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 acquisitions in 2004.

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 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 pertaining to prior years’ income taxes.

59672_Pg44-69 .indd 55
59672_Pg44-69 .indd 55

2/18/06 4:19:43 PM
2/18/06 4:19:43 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

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

Fourth

$1,886

$÷«720

$÷«430

$÷1.59

$÷1.56

2005 Quarters

Third

Second

$1,810

$÷«665

$÷«411

$÷1.50

$÷1.47

$1,838

$÷«713

$÷«416

$÷1.50

$÷1.47

First

$1,706

$÷«526

$÷«299

$÷1.06

$÷1.04

$0.250

Fourth

$1,736

$÷«607

$÷«376

$÷1.32

$÷1.29

$0.195

2004 Quarters

Third

Second

$1,709

$÷«591

$÷«346

$÷1.21

$÷1.19

$0.195

$1,665

$÷«575

$÷«326

$÷1.14

$÷1.13

$0.195

First

$1,438

$÷«395

$÷«210

$÷0.74

$÷0.73

$0.195

Revenues generated by the Company during the year are 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 included 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. The continued appreciation in the
Canadian dollar relative to the U.S. dollar has impacted the conversion of the Company’s U.S. dollar-denominated revenues and expenses and resulted
in varying reductions in net income in the rolling eight quarters presented above.

Liquidity and capital resources

The Company’s principal source of liquidity is cash generated from oper-
ations. The Company also has the ability to fund liquidity requirements
through its revolving credit facility, the issuance of debt and/or equity,
and the sale of a portion of its accounts receivable through a securitiza-
tion 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 $2,705 mil-
lion for the year ended December 31, 2005 compared to $2,139 million
for 2004. Net cash receipts from customers and other were $7,375 mil-
lion for the year ended December 31, 2005 compared to $6,501 million
in 2004. In 2005, payments for employee services, suppliers and other
expenses were $3,872 million, an increase of $244 million when com-
pared to 2004. Also consuming cash in 2005 were payments for interest,
workforce reductions and personal injury and other claims of $306 mil-
lion, $87 million and $92 million, respectively, compared to $282 million,
$93 million and $106 million, respectively, in 2004. In 2005, pension
contributions and payments for income taxes were $127 million and
$186 million, respectively, compared to $161 million and $92 million,
respectively, in 2004. The Company increased the level of accounts
receivable sold under its accounts receivable securitization program
by $54 million in 2005 and $12 million in 2004. Payments in 2006 for
workforce reductions are expected to be $49 million, while pension
contributions are expected to be approximately $100 million.

As at December 31, 2005, the Company had outstanding informa-

tion technology service contracts of $18 million.

Investing activities: Cash used by investing activities in 2005 amounted
to $1,075 million compared to $2,411 million in 2004. The Company’s
investing activities in 2005 included net proceeds of £26 million
(Cdn$61 million) related to the Company’s 8% note receivable from
EWS. The Company’s investing activities in 2004 included $984 million
related to the acquisition 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,
2005 amounted to $1,180 million, an increase of $108 million over 2004.
The following table details capital expenditures for 2005 and 2004:

In millions

Year ended December 31,

Track and roadway

Rolling stock

Buildings

Other

Capital expenditures

Less: capital leases

2005

$÷«868

338

125

1,402

222

2004

$÷«769

253

132

1,232

160

Net capital expenditures

$1,180

$1,072

The Company expects to spend approximately $1,525 million on
capital expenditures in 2006 due to increased expenditures required for
ongoing renewal of the basic plant, the acquisition of rolling stock and
other acquisitions and investments required to improve the Company’s
operating efficiency and customer service.

As at December 31, 2005, the Company had commitments to acquire

railroad ties, rail, freight cars, locomotives and other equipment at an
aggregate cost of $578 million ($194 million at December 31, 2004).

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 56
59672_Pg44-69 .indd 56

2/18/06 4:20:24 PM
2/18/06 4:20:24 PM

Management’s Discussion and Analysis

Dividends: During 2005, the Company paid dividends totaling $275 mil-
lion to its shareholders at the quarterly rate of $0.25 per share compared
to $222 million at the quarterly rate of $0.195 per share, in 2004.

repurchase program, which was completed by the second quarter of
2005. In 2004, the Company used $273 million to repurchase 4.0 million
common shares under its 14.0 million share repurchase program.

Free cash flow
The Company generated $1,301 million of free cash flow for the year
ended December 31, 2005, compared to $1,025 million in 2004. 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,

2005

2004

CN’s debt-to-total capitalization ratio was 35.5% at December 31,
2005, compared to 35.7% at December 31, 2004. As at December 31,
2005, the adjusted debt-to-total capitalization ratio was 41.1% com-
pared to 40.9% at December 31, 2004. Management believes that
adjusted debt-to-total capitalization is a useful measure of performance
and aims to show the true leverage of the Company. However, since this
adjusted measure does not have any standardized meaning prescribed
by GAAP, it may not be comparable to similar measures presented by
other companies and, as such, should not be considered in isolation.

Debt-to-total capitalization ratio (a)

Add:

December 31,

2005

35.5%

2004

35.7%

Present value of operating lease commitments

and securitization financing (b)

Adjusted debt-to-total capitalization ratio (c)

5.6%

41.1%

5.2%

40.9%

$«2,705

$«2,139

(a) Debt-to-total capitalization is calculated as total long-term debt plus current portion of

long-term debt divided by the sum of total debt plus total shareholders’ equity.

Cash provided from operating activities

Less:

Investing activities

Dividends paid

Cash provided (used) before financing activities

Adjustments:

Change in accounts receivable sold

Acquisition of BC Rail

Acquisition of GLT

Free cash flow

(1,075)

(275)

1,355

(54)

–

(2,411)

(222)

(494)

(12)

984

547

$«1,301

$«1,025

Financing activities: Cash used by financing activities totaled $1,440 mil-
lion for the year ended December 31, 2005 compared to cash provided
from financing activities of $511 million in 2004. In May 2005, the
Company repaid U.S.$100 million (Cdn$125 million) of 7.75% 10-year
Notes with cash on hand. In July 2004, the Company issued U.S.$300 mil-
lion (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 2005 and 2004, issuances and repay-
ments of long-term debt related principally to the Company’s commercial
paper program.

During 2005, the Company recorded $222 million in assets it
acquired through equipment leases ($160 million in 2004), for which
an equivalent amount was recorded in debt.

In 2005, the Company repurchased 18.0 million common shares under

its share repurchase programs; 8.0 million common shares for $670 mil-
lion (average price of $83.81 per share) under its new 16.0 million share
repurchase program and 10.0 million common shares for $748 million
(average price of $74.78 per share) under its previous 14.0 million share

(b) The operating lease commitments have been discounted using the Company’s implicit

interest rate for each of the years presented.

debt, plus current portion of long-term debt, plus the present value of operating lease
commitments, plus securitization financing) divided by the sum of adjusted debt plus
total shareholders’ equity.

The Company has access to various financing arrangements:

Revolving credit facility
In March 2005, the Company refinanced, by way of amendment, its
U.S.$1,000 million revolving credit facility, which was scheduled to
mature in December 2005, for a five-year period to March 2010. The
credit facility is available for general corporate purposes, including
back-stopping the Company’s commercial paper program, and 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 amended
credit facility agreement retained one financial covenant, the customary
limitation on debt as a percentage of total capitalization, with which the
Company has been in compliance. The Company’s borrowings under its
previous revolving credit facility of U.S.$90 million (Cdn$108 million)
outstanding at December 31, 2004 (average interest rate of 2.77%)
were entirely repaid in the first quarter of 2005. At December 31, 2005,
the Company had borrowings under its revolving credit facility of
U.S.$15 million (Cdn$17 million) at an interest rate of 4.66% and letters
of credit drawn of $316 million.

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, or

59672_Pg44-69 .indd 57
59672_Pg44-69 .indd 57

2/18/06 4:21:04 PM
2/18/06 4:21:04 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

the U.S. dollar equivalent. Commercial paper debt is due within one year
but is classified as long-term debt, reflecting the Company’s intent and
contractual ability to refinance the short-term borrowings through subse-
quent issuances of commercial paper or drawing down on the long-term
revolving credit facility. As at December 31, 2005, the Company had
U.S.$367 million (Cdn$427 million) of commercial paper outstanding at
an average interest rate of 4.40%, and U.S.$211 million (Cdn$254 mil-
lion) at an average interest rate of 2.37%, as at December 31, 2004.

Shelf prospectus and registration statement
On October 29, 2005, the Company’s shelf prospectus and registration
statement filed in October 2003 expired with an unused balance of
U.S.$200 million.

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, 2005:

In millions

Long-term debt obligations (a)

Interest on long-term debt obligations

Capital lease obligations (b)

Operating lease obligations

Purchase obligations (c)

Other long-term liabilities reflected on the balance sheet (d)

Total obligations

Total

$÷4,214

4,399

1,231

1,058

596

1,083

$12,581

2006

$÷««296

253

159

238

446

103
$1,495

2007

$÷«58

234

154

196

72
$768

2008

$«203

224

165

59
$771

2009

$«351

217

113

136

51
$897

2010

$«444

188

103

44
$851

2011 &
thereafter

$«2,862

3,283

680

220

–

754
$7,799

(a) Presented net of unamortized discounts, of which $836 million relates to non-interest bearing Notes due in 2094 assumed as part of the BC Rail acquisition and excludes

capital lease obligations of $1,231 million which are included in “Capital lease obligations.”

(b) Includes $360 million of imputed interest on capital leases at rates ranging from approximately 3.00% to 13.13%.

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

(d) Includes expected payments for workers’ compensation, workforce reductions, post-retirement benefits and environmental liabilities that have been classified as contractual

settlement agreements.

For 2006 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

Investment in English Welsh and Scottish Railway (EWS)

The Company completed its acquisitions of GLT and BC Rail on May 10,
2004 and July 14, 2004, respectively.

The Company accounted for the acquisitions 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 GLT and
BC Rail as of the dates of acquisition, May 10, 2004 and July 14, 2004,
respectively. The Company’s GLT acquisition cost of U.S.$395 million
(Cdn$547 million) and BC Rail acquisition cost of $991 million, included
purchase price adjustments and transaction costs.

The Company had estimated, on a preliminary basis, the fair value
of GLT’s and BC Rail’s assets acquired, owned and leased, and liabilities
assumed at acquisition based on then current available information.
The Company has since finalized the allocations of the GLT and BC Rail
purchase price and has not made any significant adjustments to the
preliminary purchase price allocations. See Note 3 – Acquisitions, to the
Company’s Annual Consolidated Financial Statements for the final fair
values of BC Rail’s and GLT’s assets acquired, owned and leased, and
liabilities assumed at acquisition.

In January 2004, EWS shareholders had 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 in
exchange for 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) com-
pared 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 an 8%
note receivable due 2009 of £23.9 million (Cdn$58 million) from EWS.
In April 2005, EWS fully redeemed the Company’s note receivable. The
Company received £26 million (Cdn$61 million), which included principal
and accrued but unpaid interest to the date of redemption.

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, eligible freight
trade and other receivables outstanding at any point in time, to an unre-
lated trust. The Company has a contingent residual interest of approxi-
mately 10% of receivables sold, which is recorded in Other current assets.

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 58
59672_Pg44-69 .indd 58

2/18/06 4:21:41 PM
2/18/06 4:21:41 PM

Management’s Discussion and Analysis

In February 2005, the Company amended the agreement to increase
the maximum amount it may sell from $450 million to $500 million and
modified certain reporting requirements.

the Company’s remaining hedge positions covered approximately 17%
of the estimated 2006 fuel consumption, representing approximately
69 million U.S. gallons at an average price of U.S.$0.89 per U.S. gallon.

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 use. 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, 2005, pursuant to the agreement, $489 million

had been sold compared to $445 million at December 31, 2004.

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 may
extend beyond the term of the agreement. These include, but are not
limited to, residual value guarantees on operating leases, standby letters
of credit and surety and other bonds, and indemnifications that are
customary for the type of transaction or for the railway business.

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 18 – Major commitments and contingencies, to 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 hedging program which
calls for 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, with an increased application of fuel surcharge on revenues, no
additional swap positions were entered into since September 2004 and
the Company has now suspended this program. At December 31, 2005,

Realized gains from the Company’s fuel hedging activities
were $177 million, $112 million, and $49 million for the years ended
December 31, 2005, 2004, and 2003, respectively.

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. 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 cumu-
lative change in the market value of the derivative instruments was
recorded in Other comprehensive loss. The realized gain of $12 million
accumulated in other comprehensive income (loss) is being recorded
into income, as a reduction of interest expense, over the term of the
debt based on the interest payment schedule.

At December 31, 2005, Accumulated other comprehensive loss

included an unamortized gain of $12 million, $8 million after tax
($12 million, $8 million after tax at December 31, 2004).

Recent accounting pronouncement

In December 2004, the Financial Accounting Standards Board (FASB)
issued SFAS No. 123(R), “Share-Based Payment,” which requires expens-
ing of all options issued, modified or settled based on the grant-date fair
value, 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. In April 2005, the U.S. Securities and Exchange Commission
extended the effective application date of this standard from interim
or annual reporting periods beginning after June 15, 2005 to annual
reporting periods beginning after December 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. The Company does not expect this standard to
have a significant impact on its results of operations.

Common stock

Share repurchase programs
In July 2005, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 16.0 mil-
lion common shares between July 25, 2005 and July 24, 2006 pursuant
to a normal course issuer bid, at prevailing market prices. As at
December 31, 2005, 8.0 million common shares had been repurchased
for $670 million, at an average price of $83.81 per share.

U.S. GAAP

Canadian National Railway Company

59672_Pg44-69 .indd 59
59672_Pg44-69 .indd 59

2/18/06 4:22:21 PM
2/18/06 4:22:21 PM

Management’s Discussion and Analysis

The Company’s previous share repurchase program, initiated in
2004, allowed 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. By the second quarter of
2005, the Company had completed this share repurchase program,
repurchasing 14.0 million common shares for $1,021 million, at an aver-
age price of $72.94 per share (10.0 million and 4.0 million in 2005 and
2004, respectively).

Outstanding share data
As at January 24, 2006, the Company had 268.4 million common shares
outstanding.

Common stock split
On January 24, 2006, the Board of Directors of the Company approved
a two-for-one common stock split which is to be effected in the form of
a stock dividend of one additional common share of CN for each share
outstanding, payable on February 28, 2006, to shareholders of record on
February 22, 2006. All equity-based benefit plans and the current share
repurchase program will be adjusted to reflect the issuance of additional
shares or options due to the declaration of the stock split. All share and
per share data for future periods will reflect the stock split.

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 discusses the development and selection of the
Company’s critical accounting estimates with the Audit Committee
of the Company’s Board of Directors and the Audit Committee has
reviewed the Company’s related disclosures.

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.

At December 31, 2005, 2004, and 2003, the Company’s provision

for personal injury and other claims in Canada was as follows:

In millions

Balance January 1

Accruals and other

Payments

Balance December 31

2005

$204

(45)

$205

2004

$169

(29)

$204

2003

$183

(39)

$169

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 significantly
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 occupa-
tional disease claims, are compensated according to the provisions of the
Federal Employers’ Liability Act (FELA), which requires either the finding
of fault through the U.S. jury system or individual settlements, and repre-
sent a major liability 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 and unasserted occupa-
tional disease claims, based on actuarial estimates of their ultimate cost.
Prior to 2005, the Company’s provisions for unasserted occupational dis-
ease claims constituted the minimum amount that could be reasonably
estimated, reflecting a 25-year horizon as the Company expected that a
large majority of the cases would be received over such period. In 2005,
changes in the legislative and judicial environment, as well as in the
methodology used by the courts and the Company to diagnose claims,
enabled the Company to actuarially determine a best estimate for unas-
serted occupational disease claims, thereby increasing the expected
number of claims to be received. These changes have also rendered the
recent claim experience to be more representative of future anticipated
settlements for asserted occupational disease claims, thereby reducing
the average cost per claim. Accordingly, the Company recorded an
increase in the provision for unasserted occupational disease claims,
which was substantially offset by a reduction in the provision for
asserted occupational disease claims.

Due to the inherent uncertainty involved in projecting future events

related to occupational diseases, which include but are not limited to,
the number of expected claims, the average cost per claim and the legis-
lative and judicial environment, the Company’s future obligations may
differ from current amounts recorded.

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 60
59672_Pg44-69 .indd 60

2/18/06 4:22:56 PM
2/18/06 4:22:56 PM

Management’s Discussion and Analysis

At December 31, 2005, 2004, and 2003, the Company’s provision

for U.S. personal injury and other claims was as follows:

In millions

Balance January 1

Accruals and other

Payments

Balance December 31

2005

$438

(47)

$452

2004

$421

(77)

$438

2003

$481

(87)

$421

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 severity would have the effect
of changing the provision by approximately $30 million and the annual
expense by approximately $5 million.

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
current operations are expensed unless they relate to an improvement
to the property. Expenditures that relate to an existing condition caused
by past operations and which are not expected to contribute to current
or future operations are expensed.

Known existing environmental concerns
The Company is subject to environmental clean-up and enforcement
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 approxi-
mately 17 sites governed by Superfund (and other similar federal and
state laws) 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 techniques, 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 occur 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 avail-
able, the Company considers its provisions to be adequate.

In the third quarter of 2005, the Company recorded an expense of

$28 million, of which $25 million was for environmental matters, related
to the derailment at Wabamun Lake, Alberta, as explained in Note 18 –
Major commitments and contingencies, to the Company’s Annual
Consolidated Financial Statements. This amount represents the Company’s
retention under its insurance policies and other uninsured costs. The ulti-
mate liability for clean-up costs could differ from the current amount
recorded, but such a change is expected to be offset by a corresponding
change in the insurance receivable.

At December 31, 2005, 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.
The final assessment stage can span multiple years. 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)

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

(ii) 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 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

59672_Pg44-69 .indd 61
59672_Pg44-69 .indd 61

2/18/06 4:23:35 PM
2/18/06 4:23:35 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

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.

In 2005, the Company’s expenses relating to environmental matters,
net of recoveries, were $34 million ($10 million in 2004 and $6 million
in 2003). Payments for such matters were $24 million, net of potential
insurance recoveries for 2005 ($8 million in 2004 and $12 million in
2003). As at December 31, 2005, the Company had aggregate accruals
for environmental costs of $124 million ($113 million as at December 31,
2004). The Company anticipates that the majority of the liability at
December 31, 2005 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 business, is charged
to accumulated depreciation.

Assessing the reasonableness of the estimated useful lives of prop-

erties requires judgment and is based on currently available information,
including periodic depreciation studies conducted by the Company. The
Company’s U.S. properties are subject to comprehensive depreciation
studies conducted by external consultants as required by the Surface
Transportation Board (STB). Depreciation studies for Canadian properties
are not required by regulation 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 $13 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 certain
U.S. rolling stock and equipment. The study did not have a significant
impact on depreciation expense. In 2006, the Company expects to com-
plete a depreciation study for certain U.S. rolling stock and equipment.

In 2005, the Company recorded total depreciation and amortization

expense of $630 million ($602 million in 2004 and $560 million in
2003). At December 31, 2005, the Company had Properties of $20,078
million, net of accumulated depreciation of $9,347 million ($19,715 mil-
lion in 2004, net of accumulated depreciation of $9,232 million).

Pensions and other post-retirement benefits
The Company has several pension plans with measurement dates
of December 31 for the Canadian plans, and September 30 for the
U.S. plans. The descriptions in the following paragraphs pertaining to
pensions relate generally to the Company’s main pension plan, the
CN Pension Plan (the Plan), unless otherwise specified.

The Company accounts for pensions and other post-retirement ben-
efits 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 fund performance over the expected average remaining
service life of the employee group covered by the plans.

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, termi-
nations and 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 remain-
ing 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 the corridor threshold, which is calculated as 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 demographic experience, economic
conditions and investment performance. Recent demographic experience
has revealed no material net gains or losses on termination, retirement,
disability and mortality. Experience with respect to economic conditions
and investment performance is further discussed herein.

The Company’s discount rate assumption, which is set annually at the

end of each year, is used to determine the projected benefit obligation at
the end of the year and the net periodic benefit cost for the following
year. The discount rate is used to measure the single amount that, if
invested at the measurement date in a portfolio of high-quality debt
instruments with a rating of AA or better, would provide the necessary
cash flows to pay for pension benefits as they become due. The discount
rate is determined by management with the aid of third-party actuaries.
The Company’s methodology for determining the discount rate is based
on a zero-coupon bond yield curve, which is derived from a semi-annual
bond yield curve provided by a leading Canadian financial institution.

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 62
59672_Pg44-69 .indd 62

2/18/06 4:24:14 PM
2/18/06 4:24:14 PM

Management’s Discussion and Analysis

The portfolio of hypothetical zero-coupon bonds is expected to generate
cash flows that match the estimated future benefit payments of the plans
as the bond rate for each maturity year is applied to the plans’ corre-
sponding expected benefit payments of that year. A discount rate of
5.0%, based on bond yields prevailing at December 31, 2005 (5.75%
at December 31, 2004), was considered appropriate by the Company to
match the approximately 12-year average duration of estimated future
benefit payments. As a result, in 2006, the Company’s net periodic bene-
fit cost for all plans is expected to increase by approximately $60 million,
since the cumulative unrecognized actuarial loss of $2,145 million, mainly
resulting from a decrease in the level of interest rates, was in excess of
the plans’ corridor threshold as at December 31, 2005. The current estimate
for the expected average remaining service life of the employee group
covered by the plans is approximately nine years.

For the year ended December 31, 2005, a one-percentage-point
decrease in the 5.75% discount rate used to determine net periodic
benefit cost at January 1, 2005 would have resulted in an increase of
approximately $131 million in net periodic benefit cost, whereas a one-
percentage-point increase would not have caused a material change to
net periodic benefit cost, given that 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 the corridor threshold.

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 com-
position 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 appre-
ciation/depreciation in the value of the investments are recognized over
a period of five years, while investment income is recognized immediately.
If the Company had elected to use the market value of assets, which at
December 31, 2005 exceeded the market-related value of Plan assets by
approximately $2,300 million, net periodic benefit cost would decrease
by approximately $50 million for 2005, assuming all other assumptions
remained constant. The Company follows a disciplined investment strat-
egy, 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 imple-
ment asset mix decisions or to hedge existing or anticipated exposures.

The Plan does not invest in the securities of the Company or its subsid-
iaries. During the last 10 years ended December 31, 2005, the Plan
earned an annual average rate of return of 10.6%. The actual and mar-
ket-related value rates of return on plan assets for the last five years
were as follows:

Rates of return

Actual

Market-related value

2005

20.5%
8.6%

2004

11.7%

6.3%

2003

9.6%

7.0%

2002

2001

(0.3)%

7.4%

(1.4)%

10.2%

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 annual net
periodic benefit cost by approximately $55 million for all years presented.
Based on the fair value of the assets held as at December 31, 2005,
the Plan assets are comprised of 56% in Canadian and foreign equities,
32% in debt securities, 2% in real estate assets and 10% in other assets.
The long-term asset allocation percentages are not expected to differ
materially from the current composition.

The rate of compensation increase of 3.75%, used to determine
both the benefit obligation and the net periodic benefit cost, is another
significant 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 for prescription drugs was 14% in the current
year, and it is assumed that the rate will decrease gradually to 6% in 2013
and remain at that level thereafter. For the year ended December 31, 2005,
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, the Company has conducted actuarial
valuations on an annual basis to account for pensions. The latest actuar-
ial valuation of the CN Pension Plan was conducted as at December 31,
2004 and indicated a funding excess. Total contributions for all of the
Company’s pension plans are expected to be approximately $100 million
in each of 2006, 2007, and 2008 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 enti-
tled to receive upon termination of employment. This new standard will

59672_Pg44-69 .indd 63
59672_Pg44-69 .indd 63

2/18/06 4:25:04 PM
2/18/06 4:25:04 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

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 funding position of the Company’s
Canadian pension plans. The standard, which was effective February
2005, will apply to future actuarial valuations and may significantly
impact future funding requirements.

The Company recorded consolidated net periodic benefit cost for

pensions of $17 million, $22 million and $49 million in 2005, 2004,
and 2003, respectively. Consolidated net periodic benefit cost for other
post-retirement benefits was $24 million, $29 million, and $33 million
in 2005, 2004, and 2003, respectively. At December 31, 2005, the
Company’s accrued benefit cost for post-retirement benefits other than
pensions was $313 million ($309 million at December 31, 2004). In addi-
tion, at December 31, 2005, the Company’s consolidated pension benefit
obligation and accumulated post-retirement benefit obligation (APBO)
were $14,346 million and $300 million, respectively ($13,137 million
and $319 million at December 31, 2004).

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 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 pro-
vides 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 2005

Employee contributions in 2005

December 31, 2005

CN
Pension Plan

BC Rail Ltd
Pension Plan

U.S. and
other plans

$÷7,814

4,514

321

1,420

$14,069

$13,404

$÷÷÷«77

$÷÷÷«55

$300

194

$596

$546

$÷20

$÷««3

$131

–

$209

$396

$÷30

$÷««–

Total

$÷8,245

4,770

335

1,524

$14,874

$14,346

$÷÷«127

$÷÷÷«58

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 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 pro-
jections, a valuation allowance is recorded. As at December 31, 2005,

the Company expects that its deferred income tax assets will be recov-
ered from future taxable income and therefore, has not set up a valua-
tion 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-retirement
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 differences
related to properties and net 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

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 64
59672_Pg44-69 .indd 64

2/18/06 4:27:57 PM
2/18/06 4:27:57 PM

Management’s Discussion and Analysis

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 $23 million in 2005.

In 2005, the Company recorded a deferred income tax expense of

$14 million and a corresponding increase to its net deferred income tax
liability resulting from the net impact of higher enacted corporate tax rates
in certain Canadian provinces. 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 million was recorded in income
and $2 million was recorded in Other comprehensive loss.

For the year ended December 31, 2005, the Company recorded
total income tax expense of $781 million ($596 million in 2004 and
$517 million in 2003) of which $547 million was for deferred income
taxes ($366 million in 2004 and $411 million in 2003). The Company’s
net deferred income tax liability at December 31, 2005 was $4,752 mil-
lion ($4,359 million at December 31, 2004).

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 and under Canadian securities laws.
Implicit in these statements, particularly in respect of growth opportuni-
ties, is the assumption that the positive economic trends in North
America and Asia will continue. This assumption, although considered
reasonable by the Company at the time of preparation, may not materi-
alize. Such forward-looking statements are not guarantees of future per-
formance 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 specific risks set forth below as well as other risks detailed
from time to time in reports filed by the Company with securities regula-
tors in Canada and the United States.

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 carriers’

equipment. Competition is particularly intense in eastern Canada
where an extensive highway network and population centers, located
relatively close to one another, have encouraged significant competition
from trucking companies. In addition, much of the freight carried by the
Company consists of commodity goods that are available from other
sources in competitive markets. Factors affecting the competitive position
of suppliers of these commodities, including exchange rates, could
materially adversely affect the demand for goods supplied by the sources
served by the Company and, therefore, the Company’s volumes, revenues
and profit margins.

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 services
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. There can be
no assurance that the Company will be able to compete effectively
against current and future competitors in the railroad industry and that
further consolidation within the railroad industry will not adversely
affect the Company’s competitive position. No assurance can be given
that competitive pressures will not lead to reduced revenues, profit
margins or both.

Environmental matters
The Company’s operations are subject to numerous federal, provincial,
state, municipal and local environmental laws and regulations in
Canada and the United States concerning, among other things, emissions
into the air; discharges into waters; the generation, handling, storage,
transportation, treatment and disposal of waste, hazardous substances
and other materials; decommissioning of underground and aboveground
storage tanks; and soil and groundwater contamination. A risk of envi-
ronmental liability is inherent in railroad and related transportation
operations; real estate ownership, operation or control; and other com-
mercial 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 regu-
latory compliance and clean-up requirements in its railroad operations
and relating to its past and present ownership, operation or control of
real property.

59672_Pg44-69 .indd 65
59672_Pg44-69 .indd 65

2/18/06 4:28:40 PM
2/18/06 4:28:40 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

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.

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. In addition, the Company
is also exposed to liability risk, faced by the railroad industry generally,
in connection with the transportation of toxic-by-inhalation hazardous
materials such as chlorine and anhydrous ammonia, commodities that
are essential to the public health and welfare and that, as a common
carrier, the Company has a duty to transport. As a result, the Company
may incur costs in the future, which may be material, to address any
such harm, including costs relating to the performance of clean-ups,
natural resource damages and compensatory or punitive damages
relating to harm to individuals or property.

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 techniques, 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 environmen-
tal 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 opera-
tions 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, 2005, 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.

Labor negotiations
Canadian workforce
As of December 31, 2005, CN employed a total of 14,979 employees in
Canada, of which 11,987 were unionized employees.

As of January 2006, the Company had in place labor agreements

covering its entire Canadian unionized workforce. In 2006, CN will
begin bargaining with two national unions whose agreements expire
December 31, 2006. These agreements will remain in effect until bar-
gaining and legal processes have been concluded.

Following the acquisition of BC Rail, the Company reached imple-

menting agreements in December 2004 for BC Rail employees with the
Council of Trade Unions and its members, representing all unions, regard-
ing the integration of the various collective agreements. In March 2005,
under Section 18 of the Canada Labour Code, the Company filed a
request with the Canada Industrial Relations Board (CIRB) to amend the
current bargaining agent certificates at BC Rail to correspond with those
agents representing the same employee groups at CN. On October 13,
2005, the CIRB granted the Company’s request but retained jurisdiction
on any issues that might remain in contention.

There can be no assurance that the Company will be able to renew

and have ratified its collective agreements without any strikes or lockouts.

U.S. workforce
As of December 31, 2005, CN employed a total of 6,561 employees in
the United States, of which 5,676 were unionized employees.

As of January 2006, the Company had in place agreements with

bargaining units representing the entire unionized workforce at Grand
Trunk Western Railroad Incorporated (GTW); Duluth, Winnipeg and
Pacific (DWP); ICRR; CCP Holdings, Inc. (CCP); Duluth, Missabe & Iron
Range Railroad (DMIR); Bessemer & Lake Erie (BLE); and Pittsburgh &
Conneaut Dock Company (PCD); and 93% of the unionized workforce
at Wisconsin Central Transportation Corporation (WC). Agreements in
place have various moratorium provisions, ranging from the end of
2004 to the end of 2009, which preserve the status quo in respect of
given areas during the terms of such moratoriums. Several of these
agreements are currently under renegotiation.

The general approach to labor negotiations by U.S. Class I railroads

is to bargain on a collective national basis. GTW, DWP, ICRR, CCP, WC,
DMIR, BLE and PCD have bargained on a local basis rather than holding
national, industry-wide negotiations because they believe it results in
agreements that better address both the employees’ concerns and
preferences, and the railways’ actual operating environment. However,
local negotiations may not generate federal intervention in a strike or
lockout situation, since a dispute may be localized. The Company believes
the potential mutual benefits of local bargaining outweigh the risks.

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 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
(the CTA), and (ii) safety by the federal Minister of Transport under the
Railway Safety Act and certain other statutes. The Company’s U.S. rail

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 66
59672_Pg44-69 .indd 66

2/18/06 4:29:20 PM
2/18/06 4:29:20 PM

Management’s Discussion and Analysis

operations are subject to regulation as to (i) economic regulation by the
STB and (ii) safety by the Federal Railroad Administration. As such, vari-
ous 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 regula-
tions, all of which can affect its competitive position and profitability.
With respect to safety, rail safety regulation in Canada is the
responsibility of Transport Canada, which administers the Canadian
Railway Safety Act, as well as the rail portions of other safety-related
statutes. In the U.S., rail safety regulation is the responsibility of the
Federal Railroad Administration, which administers the Federal Rail Safety
Act, as well as the rail portions of other safety statutes. In addition, safety
matters related to security are overseen by the Transportation Security
Administration, which is part of the U.S. Department of Homeland Security.
The federal government carries out a review of Canadian trans-
portation legislation periodically. The latest review resulted in a report
to the Minister of Transport, released to the public on July 18, 2001,
which 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. On March 24,
2005, the Minister of Transport tabled Bill C-44 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-44 was terminated when Parliament was dissolved
on November 29, 2005. No assurance can be given that any future
legislative action by the federal government or other future government
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
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 requirements include
advance electronic transmission of cargo information for U.S.-bound
traffic and cargo screening (including gamma ray and radiation screen-
ing), as well as U.S. government-imposed restrictions on the transporta-
tion 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 requiring advance

notification by all modes for certain food imports into the United States.
CBSA is also working on implementation of advance notification require-
ments for Canadian-bound traffic. The Company has also worked with
the Association of American Railroads to develop and put in place an
extensive industry-wide security plan to address terrorism and security-
driven efforts by state and local governments seeking to restrict the
routings of certain hazardous materials. If such state and local routing
restrictions were to go into force, they would be likely to add to security
concerns by foreclosing the Company’s most optimal and secure trans-
portation routes, leading to increased yard handling, longer hauls, and
the transfer of traffic to lines less suitable for moving hazardous materi-
als, while also infringing upon the exclusive and uniform federal over-
sight over railroad security matters. 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.,
Canadian, provincial, state, or local governments on homeland security
matters, or joint decisions by the industry in response to threats to the
North American rail network, 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 Trade Partnership
Against Terrorism (C-TPAT). C-TPAT is a joint government-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 regulate 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 governing 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 legisla-
tion 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. Subsequent to the
enactment of this legislation, on April 13, 2005, the Coast Guard and
Maritime Administration withdrew their proposed rulemaking, and plan
to publish a new notice of proposed rulemaking in the future to address
the legislation’s provisions. 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 competi-
tive and financial position.

59672_Pg44-69 .indd 67
59672_Pg44-69 .indd 67

2/18/06 4:30:03 PM
2/18/06 4:30:03 PM

U.S. GAAP

Canadian National Railway Company

Management’s Discussion and Analysis

Business prospects and other risks
In any given year, the Company, like other railroads, is susceptible to
changes in the economic conditions of the industries and geographic
areas that produce and consume the freight it transports or the supplies
it requires to operate. In addition, many of the goods and commodities
carried by the Company experience cyclicality in demand. Many of the bulk
commodities the Company transports move offshore and are affected
more by global rather than North American economic conditions. The
Company’s results of operations can be expected to reflect these condi-
tions because of the significant fixed costs inherent in railroad operations.

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.

The Company, like other railroads, is susceptible to the volatility of
fuel prices due to changes in the economy or supply disruptions. Rising
fuel prices could materially adversely affect the Company’s expenses. As
such, CN has implemented a fuel surcharge program to help mitigate the
impact of rising fuel prices. No assurance can be given that continued
increases in fuel prices or supply disruptions will not materially adversely
affect the Company’s operations or its financial position.

Overall return in the capital market, and the level of interest rates,
affect the funded status of the Company’s pension plans as well as the
Company’s results of operations. Adverse changes with respect to pension
plan returns and the level of interest rates from the date of the last actuar-
ial valuation may increase future pension contributions and could have a
material adverse effect on the Company’s results of operations. The fund-
ing requirements as well as the impact on the results of operations will be
determined following the completion of future actuarial valuations.

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.

Although the Company conducts its business and receives revenues
primarily in Canadian dollars, a growing portion of its revenues, expenses,
assets and debt is 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 approximately $10 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
further 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. In recent years, 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 cumula-
tive 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

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, 2005, have concluded that the Company’s
disclosure controls and procedures were adequate and effective 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, 2005, 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.

The Company is undergoing a comprehensive effort in preparation
for compliance with Section 404 of the Sarbanes-Oxley Act for the year
ending December 31, 2006. This effort includes, among other things,
evaluating the adequacy of the Company’s documentation of controls,
assessing the effectiveness of control design, and testing the operation
of the controls as designed.

In the course of its evaluation, management has identified certain
deficiencies in its internal control over financial reporting. These deficien-
cies are being addressed through a detailed remediation program. The
Company does not believe that any of the deficiencies identified to date,
individually or in the aggregate, result in a material weakness to its
internal control over financial reporting.

Additional information, including the Company’s 2004 Annual
Information Form (AIF) and Form 40-F, may be found on SEDAR at
www.sedar.com and on EDGAR at www.sec.gov/edgar.shtml, respec-
tively. The 2005 AIF and Form 40-F will become available on or prior
to March 31, 2006.

Montreal, Canada
January 24, 2006

Canadian National Railway Company

U.S. GAAP

59672_Pg44-69 .indd 68
59672_Pg44-69 .indd 68

2/18/06 4:30:38 PM
2/18/06 4:30:38 PM

Management Report

Report of Independent Registered Public Accounting Firm

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 extensive
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 Committee,
consisting solely of outside directors. The Audit Committee reviews
the Company’s consolidated financial statements and management’s
discussion and analysis and recommends their approval by the Board
of Directors. Also, the Audit Committee meets regularly 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 and to the Shareholders of
Canadian National Railway Company

We have audited the consolidated balance sheets of Canadian National
Railway Company as at December 31, 2005 and 2004 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, 2005. 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 misstatement.
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, 2005 and 2004, and the results of its operations
and its cash flows for each of the years in the three-year period ended
December 31, 2005, in accordance with generally accepted accounting
principles in the United States.

Claude Mongeau
Executive Vice-President and Chief Financial Officer

January 24, 2006

KPMG LLP
Chartered Accountants

Montreal, Canada
January 24, 2006

Serge Pharand
Vice-President and Corporate Comptroller

January 24, 2006

59672_Pg44-69 .indd 69
59672_Pg44-69 .indd 69

2/18/06 4:31:19 PM
2/18/06 4:31:19 PM

U.S. GAAP

Canadian National Railway Company

Consolidated Statement of Income

In millions, except per share data

Year ended December 31,

2005

2004

2003

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

Total operating expenses

Operating income

Interest expense

Other income (loss) (Note 14)

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

Income tax expense (Note 15)

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 17)

Income before cumulative effect of change in accounting policy

Net income

Diluted earnings per share (Note 17)

Income before cumulative effect of change in accounting policy

Net income

$1,096

$1,059

$1,013

837

1,738

331

1,119

1,270

514

335

7,240

714

527

1,505

1,320

284

261

1,063

947

1,117

1,101

510

525

296

190

6,548

5,884

1,841

1,819

1,698

814

627

725

192

417

4,616

2,624

(299)

2,337

(781)

1,556

–

$1,556

$÷5.64

$÷5.54

746

703

598

554

528

469

244

293

445

390

4,380

4,107

2,168

1,777

(294)

(20)

(315)

1,854

1,483

(596)

(517)

1,258

966

–

$1,258

$1,014

$÷4.41

$÷4.34

$÷3.38

$÷3.54

$÷3.33

$÷3.49

See accompanying notes to consolidated financial statements.

Canadian National Railway Company

U.S. GAAP

59672_Pg70-74.indd 70
59672_Pg70-74.indd 70

2/18/06 4:35:26 PM
2/18/06 4:35:26 PM

Consolidated Statement of Comprehensive Income

In millions

Net income

Year ended December 31,

2005

2004

2003

$1,556

$1,258

$«1,014

Other comprehensive income (loss) (Note 20):

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

Increase (decrease) in unrealized holding gains on fuel derivative instruments (Note 19)

Realized gain on settlement of interest rate swaps (Note 19)

Minimum pension liability adjustment (Note 13)

Other comprehensive loss before income taxes

Income tax recovery on other comprehensive loss

Other comprehensive loss

Comprehensive income

152

(233)

(35)

–

(112)

(74)

326

754

(428)

(28)

(1,101)

–

(332)

106

(19)

(226)

$1,482

$1,239

$÷÷788

See accompanying notes to consolidated financial statements.

U.S. GAAP

Canadian National Railway Company

59672_Pg70-74.indd 71
59672_Pg70-74.indd 71

2/18/06 4:36:03 PM
2/18/06 4:36:03 PM

Consolidated Balance Sheet

In millions

Assets

Current assets:

Cash and cash equivalents

Accounts receivable (Note 4)

Material and supplies

Deferred income taxes (Note 15)

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 15)

Other liabilities and deferred credits (Note 9)

Long-term debt (Note 10)

Shareholders’ equity:

Common shares (Note 11)

Accumulated other comprehensive loss (Note 20)

Retained earnings

Total liabilities and shareholders’ equity

Subsequent event (Note 22)

On behalf of the Board:

David G.A. McLean
Director

E. Hunter Harrison
Director

December 31,

2005

2004

$÷÷÷«62

623

151

248

1,149

20,078

961

$22,188

$÷1,478

408

1,958

4,817

1,487

4,677

4,580

(222)

4,891

9,249

$÷÷«147

793

127

364

279

1,710

19,715

940

$22,365

$÷1,605

578

2,259

4,723

1,513

4,586

4,706

(148)

4,726

9,284

$22,188

$22,365

See accompanying notes to consolidated financial statements.

Canadian National Railway Company

U.S. GAAP

59672_Pg70-74.indd 72
59672_Pg70-74.indd 72

2/25/06 1:01:32 AM
2/25/06 1:01:32 AM

Consolidated Statement of Changes in Shareholders' Equity

In millions

Balances December 31, 2002

Net income

Stock options exercised and other (Notes 11, 12)

Share repurchase program (Note 11)

Other comprehensive loss (Note 20)

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 20)

Dividends ($0.78 per share)

Balances December 31, 2004

Net income

Stock options exercised and other (Notes 11, 12)

Share repurchase programs (Note 11)

Other comprehensive loss (Note 20)

Dividends ($1.00 per share)

Balances December 31, 2005

Issued and
outstanding
common
shares

Accumulated
other
comprehensive
income (loss)

Common
shares

Retained
earnings

Total
shareholders’
equity

296.3

$«4,785

$÷÷97

$«3,487

$«8,369

–

2.9

(15.0)

–

122

(243)

–

1,014

–

122

(413)

(656)

– (226)

–

(226)

–

(191)

284.2

4,664

(129)

3,897

8,432

–

2.9

(4.0)

–

108

(66)

–

1,258

–

108

(207)

(273)

– (19)

–

(19)

–

(222)

283.1

4,706

(148)

4,726

9,284

–

3.3

(18.0)

–

176

(302)

–

1,556

–

176

(1,116)

(1,418)

– (74)

–

(74)

–

(275)

268.4

$4,580

$(222)

$4,891

$9,249

See accompanying notes to consolidated financial statements.

U.S. GAAP

Canadian National Railway Company

59672_Pg70-74.indd 73
59672_Pg70-74.indd 73

2/18/06 4:37:17 PM
2/18/06 4:37:17 PM

Year ended December 31,

2005

2004

2003

Consolidated Statement of Cash Flows

In millions

Operating activities

Net income

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

Depreciation and amortization

Deferred income taxes (Note 15)

Equity in earnings of English Welsh and Scottish Railway (Note 14)

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

Workforce reductions (Note 9)

Personal injury and other claims (Note 18)

Pensions (Note 13)

Income taxes (Note 15)

Cash provided from operating activities

$«1,556

$«1,258

$«1,014

630

547

(4)

–

142

(25)

(156)

602

366

–

560

411

(17)

(48)

(233)

153

(3)

(96)

(29)

106

2,705

2,139

1,976

(1,180)

–

105

(1,075)

(275)

2,728

(2,865)

115

(1,418)

(1,440)

(85)

147

(1,072)

(984)

(547)

(1,043)

–

192

(32)

(2,411)

(1,075)

(222)

(191)

8,277

(7,579)

4,109

(4,141)

(273)

(656)

511

(605)

105

130

$÷÷÷62

$÷÷147

$÷÷130

$«7,375

$«6,501

$«6,022

(3,872)

(306)

(87)

(92)

(127)

(186)

(3,628)

(282)

(93)

(106)

(161)

(92)

(3,262)

(325)

(155)

(126)

(92)

(86)

$«2,705

$«2,139

$«1,976

See accompanying notes to consolidated financial statements.

Canadian National Railway Company

U.S. GAAP

59672_Pg70-74.indd 74
59672_Pg70-74.indd 74

2/18/06 4:37:53 PM
2/18/06 4:37:53 PM

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 prin-
ciples applied in the accompanying financial statements and those under
Canadian generally accepted accounting principles (Canadian GAAP)
are quantified and explained in Note 21 to the financial statements.
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.

A. Principles of consolidation
These consolidated financial statements include the accounts of all subsid-
iaries, 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-sustaining
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 Other comprehensive income (loss) (Note 20).

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 approx-
imates market value.

E. Accounts receivable
Accounts receivable are recorded at cost net of the provision for doubtful
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 discounted 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
second-hand, 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. Major overhauls and large refur-
bishments are also capitalized when they result in an extension to the
useful life or increase the functionality of the asset. Included in property
additions 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 carrying
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.

59672_Pg75-101.indd 75
59672_Pg75-101.indd 75

2/18/06 4:46:17 PM
2/18/06 4:46:17 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

1 Summary of significant accounting policies (continued)
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 significant
line abandonments are recognized in income when the asset ceases to
be used. Gains are recognized in income when they are realized.

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 properties
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 and occupational disease claims, based on actuarial estimates
of their ultimate cost.

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 operations and which are
not expected to contribute to current or future operations are expensed.
Liabilities are recorded when environmental assessments occur 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.

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 76
59672_Pg75-101.indd 76

2/18/06 4:46:55 PM
2/18/06 4:46:55 PM

Notes to Consolidated Financial Statements

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.

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 interpretations.
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,

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

2005

$1,556

2004

2003

$1,258

$1,014

–

(110)

$1,532

$÷5.64

$÷5.55

$÷5.54

$÷5.45

(78)

$1,227

$÷4.41

$÷4.30

$÷4.34

$÷4.23

(53)

$÷«984

$÷3.54

$÷3.43

$÷3.49

$÷3.39

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,

Expected option life (years)

Risk-free interest rate

Expected stock price volatility

Average dividend per share

Year ended December 31,

Weighted average fair value of options granted

2005

5.2
3.50%
25%
$1.00

2005

$18.38

2004 (1)

2003

–

5.0

4.12%

30%

$0.67

2004 (1)

2003

$–

$11.88

(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, 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. In April 2005,
the U.S. Securities and Exchange Commission extended the effective
application date of this standard from interim or annual reporting periods
beginning after June 15, 2005 to annual reporting periods beginning after
December 15, 2005. The Company has elected to apply the modified pro-
spective approach, which requires compensation cost to be recognized
for unvested awards based on their grant-date fair value. The Company
does not expect this standard to have a significant impact on its results
of operations.

2 Accounting changes

2005
Conditional asset retirement obligations
Effective December 31, 2005, the Company adopted the recommenda-
tions of FASB Interpretation No. 47, “Accounting for Conditional Asset
Retirement Obligations – an interpretation of FASB Statement No. 143.”
The Interpretation clarifies that an obligation to perform an asset retire-
ment activity exists, even if there may be uncertainty about the timing
and/or method of settlement. Accordingly, an entity is required to
recognize a liability for the fair value of a conditional asset retirement
obligation when incurred, generally upon acquisition, construction, or
development and/or through the normal operation of the asset, if the
fair value of the liability can be reasonably estimated. This standard
had no impact on the Company’s financial statements.

2003
Asset retirement obligations
Effective January 1, 2003, the Company adopted the recommendations
of 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 obli-
gation exists for substantially all of its asset classes that have removal
programs. 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 results 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).

59672_Pg75-101.indd 77
59672_Pg75-101.indd 77

2/18/06 4:47:38 PM
2/18/06 4:47:38 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

2 Accounting changes (continued)
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 compensation 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.

3 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, to acquire all the issued and out-
standing shares of the former BC Rail Ltd. and all the partnership 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 purchase price
of $1 billion.

On July 2, 2004, the Company reached a consent agreement with
Canada’s Competition Bureau, allowing for the closing of the transaction,
whereby the Company reaffirmed its commitment to share merger effi-
ciencies with BC Rail shippers and assure them competitive transporta-
tion 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 acqui-
sition 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 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
transaction costs.

The Company had estimated, on a preliminary basis, the fair value
of BC Rail’s assets acquired, owned and leased, and liabilities assumed
at acquisition based on then current available information. The Company
has since finalized the allocation of the purchase price and has not
made any significant adjustments. The following table reflects the fair
values of BC Rail’s assets acquired, owned and leased, and liabilities
assumed at acquisition:

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

$÷«200

399

597

1,199

119

208

$÷«991

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.

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 financial
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 Company had estimated, on a preliminary basis, the fair value

of GLT’s assets acquired and liabilities assumed at acquisition based
on then current available information. The Company has since finalized
the allocation of the purchase price and has not made any significant
adjustments. The following table reflects the fair values of GLT’s assets
acquired and liabilities assumed at acquisition:

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

$÷÷«67

980

1,134

286

237

587

$÷«547

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 78
59672_Pg75-101.indd 78

2/18/06 4:48:18 PM
2/18/06 4:48:18 PM

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 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, basic and diluted earnings
per share for the years ended December 31, 2004 and 2003 would
have been as follows:

In millions, except per share data

Year ended December 31,

2004

2003

4 Accounts receivable

In millions

Freight

Trade

Accrued

Non-freight

Provision for doubtful accounts

December 31,

2005

2004

$330

347

703

(80)

$623

$414

356

863

(70)

$793

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

$6,773

$6,428

$1,272

$1,026

$1,077

$÷4.46

$÷3.58

$÷3.76

$÷4.39

$÷3.53

$÷3.70

The pro forma figures for both BC Rail and GLT do not reflect syner-
gies, and accordingly, do not account for any potential increases in oper-
ating 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 $500 million ($450 million prior to February 2005) of eligi-
ble 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 $16 million in 2005 and $9 million in each of 2004 and 2003,
for costs related to the agreement, which fluctuate with changes in
prevailing interest rates.

At December 31, 2005, pursuant to the agreement, $489 million

had been sold compared to $445 million at December 31, 2004.

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, 2005

Cost

$21,792

4,581

1,878

1,174

Accumulated
depreciation

$6,388

1,642

724

593

Net

$15,404

2,939

1,154

581

December 31, 2004

Accumulated
depreciation

$6,300

1,549

877

506

Cost

$21,524

4,336

2,009

1,078

Net

$15,224

2,787

1,132

572

$29,425

$9,347

$20,078

$28,947

$9,232

$19,715

$÷÷«451

1,348

144

$÷÷«16

279

$÷÷«435

1,069

120

$÷÷«395

1,155

113

119

$÷÷÷«5

241

$÷÷«390

914

106

110

$÷2,000

$÷«327

$÷1,673

$÷1,782

$÷«262

$÷1,520

59672_Pg75-101.indd 79
59672_Pg75-101.indd 79

2/18/06 4:49:02 PM
2/18/06 4:49:02 PM

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

2005

$621

132

102

–

2004

$515

166

$961

$940

A. Investments
As at December 31, 2005, the Company had $124 million ($157 million
at December 31, 2004) of investments accounted for under the equity
method and $8 million ($9 million at December 31, 2004) of investments
accounted for under the cost method.

Investment in English Welsh and Scottish Railway (EWS)
As at December 31, 2005, the Company owned approximately 32% of
the outstanding shares of EWS, a company that 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, 2005, 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.

In January 2004, EWS shareholders had 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 in
exchange for 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 approxi-
mately 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 an 8% note receivable due
2009 of £23.9 million (Cdn$58 million) from EWS. In April 2005, EWS
fully redeemed the Company’s note receivable. The Company received
£26 million (Cdn$61 million), which included principal and accrued but
unpaid interest to the date of redemption.

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

In March 2005, the Company refinanced, by way of amendment, its
U.S.$1,000 million revolving credit facility, which was scheduled to
mature in December 2005, for a five-year period to March 2010. The
credit facility is available for general corporate purposes, including back-
stopping the Company’s commercial paper program, and 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 amended
credit facility agreement retained one financial covenant, the customary
limitation on debt as a percentage of total capitalization, with which
the Company has been in compliance. The Company’s borrowings under
its previous revolving credit facility of U.S.$90 million (Cdn$108 million)
outstanding at December 31, 2004 (average interest rate of 2.77%) were
entirely repaid in the first quarter of 2005. At December 31, 2005, the
Company had borrowings under its revolving credit facility of U.S.$15 mil-
lion (Cdn$17 million) at an interest rate of 4.66% and letters of credit
drawn of $316 million.

The Company’s commercial paper program is backed by a portion
of its revolving credit facility. As at December 31, 2005, the Company
had U.S.$367 million (Cdn$427 million) of commercial paper outstanding
at an average interest rate of 4.40%, and U.S.$211 million (Cdn$254 mil-
lion) at an average interest rate of 2.37%, as at December 31, 2004.

8 Accounts payable and accrued charges

In millions

Trade payables

Income and other taxes

Accrued charges

Payroll-related accruals

Personal injury and other claims provision

Accrued interest

Workforce reduction provisions

Other

December 31,

2005

2004

$÷«475

$÷«491

261

226

207

115

101

310

179

259

118

106

$1,478

$1,605

9 Other liabilities and deferred credits

In millions

December 31,

2005

2004

Personal injury and other claims provision,

net of current portion

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

Accrued benefit cost for pensions (Note 13)

Environmental reserve, net of current portion

Workforce reduction provisions, net of current portion (B)

Additional minimum pension liability (Note 13)

Deferred credits and other

$÷«542

$÷«524

289

150

296

284

156

149

285

$1,487

$1,513

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 80
59672_Pg75-101.indd 80

2/18/06 4:49:43 PM
2/18/06 4:49:43 PM

Notes to Consolidated Financial Statements

A. Post-retirement benefits other than pensions
(i) Change in benefit obligation

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

trend rates would have the following effect:

2004

In millions

Effect on total service and interest costs

Effect on benefit obligation

One-percentage-point

Increase

Decrease

$÷2

$÷(2)

(22)

In millions

Year ended December 31,

Benefit obligation at beginning of year

Acquisition of GLT and BC Rail

Amendments

Transfer from other plan

Actuarial gain

Interest cost

Service cost

Foreign currency changes

Benefits paid

Benefit obligation at end of year

2005

$319

–

(4)

(20)

(8)

(19)

$«309

151

(12)

–

(111)

(25)

(18)

$300

$«319

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

Unrecognized prior service cost

Accrued benefit cost for post-retirement benefits other than

pensions (including current portion)

(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 (gain) loss

Net periodic benefit cost

(iv) Weighted-average assumptions

2005

$19

(1)

$24

2005

$300

(11)

$313

2004

$17

2004

$319

(16)

$309

2003

$18

$29

$33

December 31,

2005

2004

2003

To determine benefit obligation

Discount rate

Rate of compensation increase

To determine net periodic benefit cost

Discount rate

Rate of compensation increase

5.30%
3.75%

5.90%
3.75%

5.90%

3.75%

6.00%

3.75%

6.00%

3.75%

6.69%

4.00%

(v) For measurement purposes, increases in the per capita cost of covered
health care benefits were assumed to be 13% for 2006 and 14% for
2005. It is assumed that the rate will decrease gradually to 6% in 2013
and remain at that level thereafter.

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 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

2006

2007

2008

2009

2010

Years 2011 to 2015

$÷16

110

B. 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 2005, net charges and adjustments decreased the provi-
sions by $10 million. In 2004, liabilities assumed through acquisitions
and other charges and adjustments had increased the provisions by
$107 million. Payments have reduced the provisions by $87 million
for the year ended December 31, 2005 ($93 million for the year ended
December 31, 2004). As at December 31, 2005, the aggregate provisions,
including the current portion, amounted to $142 million ($239 million
as at December 31, 2004).

59672_Pg75-101.indd 81
59672_Pg75-101.indd 81

2/18/06 4:50:30 PM
2/18/06 4:50:30 PM

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:

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:

Maturity

Currency
in which
payable

December 31,

2005

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

U.S.$

April 15, 2008

U.S.$

$÷«291

$÷«301

349

465

233

174

552

233

582

–

145

174

3,753

842

4,595

427

897

1,341

5,936

408

851

1,259

$4,677

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

$4,586

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

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 exercised,
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 addi-
tional 30-year term ending July 15, 2036. The new coupon rate will be
determined according to a pre-set mechanism based on market condi-
tions 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.

D. The Company records these notes as a discounted debt of $6 million,
using an imputed interest rate of 5.75%. The discount of $836 million is
included in the net unamortized discount.

E. 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,
or the U.S. dollar equivalent. Commercial paper debt is due within one
year but is classified as long-term debt, reflecting the Company’s intent
and contractual ability to refinance the short-term borrowing through

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 82
59672_Pg75-101.indd 82

2/18/06 4:51:11 PM
2/18/06 4:51:11 PM

Notes to Consolidated Financial Statements

subsequent issuances of commercial paper or drawing down on the
revolving credit facility. At December 31, 2004, the amounts outstanding
under both the revolving credit facility and the commercial paper pro-
gram were presented as short-term debt given the anticipated maturity
in December 2005 of the revolving credit facility. In March 2005, the
Company refinanced by way of amendment, its revolving credit facility,
for a five-year period to March 2010.

C. Share repurchase programs
In July 2005, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 16.0 million
common shares between July 25, 2005 and July 24, 2006 pursuant to a
normal course issuer bid, at prevailing market prices. As at December 31,
2005, 8.0 million common shares had been repurchased for $670 million,
at an average price of $83.81 per share.

F. Interest rates for capital leases range from approximately 3.00% to
13.13% with maturity dates in the years 2006 through 2025. The imputed
interest on these leases amounted to $360 million as at December 31,
2005 and $342 million as at December 31, 2004.

The capital lease obligations are secured by properties with a net

carrying amount of $1,243 million as at December 31, 2005 and
$1,080 million as at December 31, 2004.

During 2005, the Company recorded $222 million in assets it ac-

quired through equipment leases ($160 million in 2004), for which
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, 2005,
for the next five years and thereafter, are as follows:

In millions

2006

2007

2008

2009

2010

2011 and thereafter

$÷«408

169

238

429

467

3,374

H. The aggregate amount of debt payable in U.S. currency as at
December 31, 2005 was U.S.$4,169 million (Cdn$4,849 million) and
U.S.$4,022 million (Cdn$4,845 million) as at December 31, 2004.

11 Capital stock

A. Authorized capital stock
The authorized capital stock of the Company is as follows:
(cid:127) Unlimited number of Common Shares, without par value
(cid:127) Unlimited number of Class A Preferred Shares, without par value

issuable in series

(cid:127) Unlimited number of Class B Preferred Shares, without par value

issuable in series

B. Issued and outstanding common shares
During 2005, the Company issued 3.3 million shares (2.9 million shares
in both 2004 and 2003) related to stock options exercised. The total
number of common shares issued and outstanding was 268.4 million
as at December 31, 2005.

The Company’s previous share repurchase program, initiated in
2004, allowed 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. By the second quarter
of 2005, the Company had completed this share repurchase program,
repurchasing 14.0 million common shares for $1,021 million, at an
average price of $72.94 per share (10.0 million and 4.0 million in 2005
and 2004, respectively).

By October 2003, the Company had completed its 19.5 million share
repurchase program at a total cost of $859 million, and an average price
of $44.04 per share (15.0 million and 4.5 million shares in 2003 and
2002, respectively).

12 Stock plans

The Company has various stock-based incentive plans for eligible employ-
ees. 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,
2005 was 11,010 employees (10,073 at December 31, 2004 and 8,894
at December 31, 2003). The total number of ESIP shares purchased on
behalf of employees, including the Company’s contributions, was 0.8 mil-
lion in 2005, 0.7 million in 2004 and 0.9 million in 2003, resulting in a
pre-tax charge to income of $12 million, $11 million, and $8 million for
the years ended December 31, 2005, 2004, and 2003, respectively.

Stock-based plans
Compensation cost for awards under all stock-based plans was $120 mil-
lion, $65 million and $23 million for the years ended December 31, 2005,
2004, and 2003, respectively.

59672_Pg75-101.indd 83
59672_Pg75-101.indd 83

23/02/2006 01:39:32
23/02/2006 01:39:32

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

12 Stock plans (continued)
A. Restricted share units
The Company has granted restricted share units (RSUs), 0.4 million in
2005 and 1.2 million in 2004, 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, 2007 for the
2005 grant and December 31, 2006 for the 2004 grant. The 2004 grant
was subject to accelerated payout if specified targets related to the
Company’s 20-day average share price were attained during the period
ending December 31, 2005. Given that these targets were met, vesting
of the 2004 grant was accelerated and increased to its maximum allow-
able amount under the plan, resulting in a payout of $105 million. Of
this amount, $41 million was converted into deferred share units (see
section C) at December 31, 2005, and the remaining payout of $64 million
will be paid in cash in January 2006. For the years ended December 31,
2005 and 2004, the Company recorded compensation cost of $89 mil-
lion and $36 million, respectively, for RSUs. As at December 31, 2005,
the Company had approximately 0.6 million RSUs outstanding.

B. Mid-term incentive share unit plan
The 2001 mid-term incentive share unit plan 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.

C. Voluntary Incentive Deferral Plan
The Company has a Voluntary Incentive Deferral Plan (VIDP), providing
eligible senior management employees the opportunity to elect to receive
their annual incentive bonus payments and other eligible incentive pay-
ments in deferred share units (DSUs). A DSU is equivalent to a common
share of the Company and also earns dividends when normal cash divi-
dends are paid on common shares. The number of DSUs received by each
participant is established using the average closing price for the 20 trad-
ing days prior to and including the date of the incentive payment. For
each participant, the Company will grant a further 25% of the amount
elected in DSUs, which will vest over a period of four years. The election
to receive eligible incentive payments in DSUs is no longer available to a
participant when the value of the participant’s vested DSUs is sufficient

to meet the Company’s stock ownership guidelines. The value of
each participant’s DSUs is payable in cash at the time of cessation
of employment.

At December 31, 2005, the total liability under the VIDP was $83 mil-
lion ($22 million at December 31, 2004), representing 1.0 million units
outstanding (0.4 million units in 2004) under the plan, which includes
the deferred share units related to the 2004 RSU grant as discussed
herein. For the years ended December 31, 2005 and 2004, the Company
recognized an expense of $13 million and $7 million, respectively,
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 exer-
cise options generally accrues over a period of four years of continuous
employment. Options are not generally exercisable during the first 12
months after the date of grant. At December 31, 2005, 8.1 million com-
mon 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 unle-
vered return on investment; and performance-accelerated options, which
vest on or prior to the sixth anniversary of the grant if certain Company
targets relating to return on investment and revenues are attained. The
total conventional, performance, and performance-accelerated options
outstanding at December 31, 2005 were 7.4 million, 0.5 million, and
2.6 million, respectively.

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

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)

Granted

Canceled and expired

Exercised
Outstanding at December 31, 2005 (1)

Weighted-
average
exercise price

Number of
options

In millions

16.7

3.0

(0.6)

(2.9)

16.2

–

(0.2)

(2.9)

13.1

0.7

–

(3.3)
10.5

$35.67

$40.95

$45.11

$26.60

$37.16

–

$42.58

$28.70

$38.85

$69.84

–

$35.14
$41.91

(1) Stock options with a U.S. dollar exercise price have been translated to Canadian dollars

using the foreign exchange rate in effect at the balance sheet date.

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 84
59672_Pg75-101.indd 84

2/18/06 4:52:31 PM
2/18/06 4:52:31 PM

Notes to Consolidated Financial Statements

Stock options outstanding and exercisable as at December 31, 2005 were as follows:

Range of exercise prices

$12.35–$23.34

$23.69–$29.51

$30.23–$39.67

$40.54–$49.21

$51.05–$56.41

$67.88–$94.25
Balance at December 31, 2005 (1)

Options outstanding

Options exercisable

Number of
options

In millions

1.0

0.7

1.9

2.7

3.5

0.7
10.5

Weighted-
average years
to expiration

Weighted-
average
exercise price

9
6

$21.43

$26.05

$33.17

$41.00

$51.19

$69.83
$41.91

Weighted-
average
exercise price

Number of
options

In millions

1.0

0.7

1.9

1.8

2.4

–
7.8

$21.43

$26.05

$33.17

$41.03

$51.20

–
$38.35

(1) Stock options with a U.S. dollar exercise price have been translated to Canadian dollars using the foreign exchange rate in effect at the balance sheet date.

At December 31, 2004 and 2003, the Company had 8.2 million and 7.5 million options exercisable at a weighted-average exercise price of

$35.55 and $31.39, 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 $18 million, $9 million and $16 million
in 2005, 2004, and 2003, 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 compen-
sation cost related to stock option awards are presented in Note 1 –
Summary of significant accounting policies.

E. Vision 2008 Share Unit Plan
In the first quarter of 2005, the Board of Directors of the Company
approved a special share unit plan with a four-year term to December 31,
2008, entitling designated senior management employees to receive cash
payout in January 2009. The Company granted 0.4 million share units
which vest conditionally upon the attainment of targets relating to the
Company’s share price during the six-month period ending December 31,
2008. Payout is conditional upon the attainment of targets relating to
return on invested capital over the four-year period and to the Company’s
share price during the 20-day period ending on December 31, 2008.

The award payout will be equal to the number of share units vested on
December 31, 2008 multiplied by the Company’s 20-day average share
price ending on such date. Due to the nature of the vesting conditions,
no compensation cost was recorded for the year ended December 31,
2005. As at December 31, 2005, 0.1 million share units remained autho-
rized for future issuance under this plan.

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 contribu-
tions. 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 Plan), unless otherwise specified.

Description of the Plan
The 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, sub-
ject 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 Plan and the related legislation. The Company
utilizes a measurement date of December 31 for the Plan.

59672_Pg75-101.indd 85
59672_Pg75-101.indd 85

2/18/06 4:53:13 PM
2/18/06 4:53:13 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

13 Pensions (continued)
Funding policy
Employee contributions to the Plan are determined by the plan rules.
Company contributions are in accordance with the requirements of the
Government of Canada legislation, The Pension Benefits Standards Act,
1985, and are determined by actuarial valuations conducted at least on
a triennial basis. These valuations are made in accordance with legislative
requirements and with the recommendations of the Canadian Institute
of Actuaries for the valuation of pension plans. The latest actuarial valua-
tion of the Plan was conducted as at December 31, 2004 and indicated
a funding excess. Total contributions for all of the Company’s pension
plans are expected to be approximately $100 million in each of 2006,
2007, and 2008 based on the plans’ current positions. All of the
Company’s contributions are expected to be in the form of cash.

Description of fund assets
The assets of the Plan are accounted for separately in the CN Pension
Trust Funds and consist of cash and short-term investments, bonds, mort-
gages, Canadian and foreign equities, real estate, and oil and gas assets.
The assets of the Plan have a fair market value of $14,069 million as at
December 31, 2005 ($12,256 million at December 31, 2004). The Plan’s
target percentage allocation and weighted-average asset allocations as
at December 31, 2005 and 2004, by asset category are as follows:

Weighted-average assumptions

December 31,

2005

2004

2003

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

5.00%
3.75%

5.75%
3.75%
8.00%

5.75%

3.75%

6.00%

3.75%

6.00%

3.75%

8.00%

6.50%

4.00%

8.00%

Information about the Company’s defined benefit pension plans:

(a) Change in benefit obligation

In millions

Year ended December 31,

2005

2004

Benefit obligation at beginning of year

$13,137

$12,020

Plan assets by category

Equity securities

Debt securities

Real estate

Other

Target
Allocation

53%
40%
4%
3%
100%

December 31,

2005

56%
32%
2%
10%
100%

2004

56%

34%

Amendments

Acquisition of GLT and BC Rail

Interest cost

Actuarial loss

Service cost

100%

Plan participants’ contributions

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 per-
formance 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 exposures. The
Plan does not invest in the securities of the Company or its subsidiaries.

Foreign currency changes

Benefit payments and transfers

Benefit obligation at end of year

(b) Change in plan assets

In millions

Year ended December 31,

2005

2004

Fair value of plan assets at beginning of year

$13,053

$11,671

Acquisition of GLT and BC Rail

Employer contributions

Plan participants’ contributions

Foreign currency changes

Actual return on plan assets

Benefit payments and transfers

–

127

(8)

2,593

(949)

611

165

(15)

1,371

(805)

Fair value of plan assets at end of year

$14,874

$13,053

(3)

–

742

1,234

138

(11)

(949)

–

684

733

349

124

(23)

(805)

$14,346

$13,137

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 86
59672_Pg75-101.indd 86

2/18/06 4:53:54 PM
2/18/06 4:53:54 PM

Notes to Consolidated Financial Statements

14 Other income (loss)

In millions

December 31,

2005

2004

In millions

Year ended December 31,

In millions

Year ended December 31,

2005

2004

2003

Federal tax rate

Gain on disposal of properties

Equity in earnings of EWS (Note 6)

Investment income

Foreign exchange gain (loss)

Net real estate costs

Other

2005

$«26

(12)

(21)

$«12

2004

$«32

(4)

(2)

(18)

(33)

$(20)

2003

$«56

(3)

(19)

(31)

$«21

15 Income taxes

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

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

2005

22.1%

$(516)

2004

2003

22.1%

24.1%

$(410)

$(358)

(331)

(263)

(199)

(14)

$(781)

$«186

$(596)

$÷«92

(79)

$(517)

$÷«86

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

income taxes.

The following table provides tax information for Canada and the

United States:

In millions

Year ended December 31,

2005

2004

2003

Income before income taxes (1)

Canada

U.S.

Current income taxes

Canada

U.S.

Deferred income taxes

Canada

U.S.

$1,769

568

$2,337

$««««(95)

(139)

$««(234)

$««(488)

(59)

$««(547)

$1,501

$1,322

353

161

$1,854

$1,483

$««(222)

$««««(94)

(8)

(12)

$««(230)

$««(106)

$««(244)

(122)

$««(366)

$««(377)

(34)

$««(411)

(1) Before cumulative effect of change in accounting policy for 2003.

Excess (deficiency) of fair value of plan assets over

benefit obligation at end of year (1)
Unrecognized net actuarial (gain) loss (1)

Unrecognized prior service cost

Net amount recognized

$«528

(111)

$«471

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

(d) Amount recognized in the Consolidated Balance Sheet

In millions

December 31,

Prepaid benefit cost (Note 6)

Accrued benefit cost (Note 9)

Additional minimum pension liability (Note 9)

Accumulated other comprehensive loss (Note 20)

Net amount recognized

(e) Additional information

2005

$«621

(150)

(18)

$«471

$«(84)

368

$359

2004

$«515

(156)

(22)

$«359

Adjustment to minimum pension liability

as a component of Other comprehensive
income (loss)

The accumulated benefit obligation for all defined benefit pension
plans was $13,584 million and $12,450 million at December 31, 2005
and 2004, respectively. The projected benefit obligation, accumulated
benefit obligation, and fair value of plan assets for the pension plan
with an accumulated benefit obligation in excess of plan assets were
$104 million, $96 million, and $87 million, respectively, as at December 31,
2005; and $98 million, $93 million, and $86 million, respectively, as at
December 31, 2004.

(f) Components of net periodic benefit cost

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

2005

$«138

742

–

(884)

$÷«17

2004

$«124

733

–

(857)

$÷«22

2003

$«103

720

(819)

$÷«49

(g) Estimated future benefit payments

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

In millions

2006

2007

2008

2009

2010

Years 2011 to 2015

$÷«821

844

868

893

916

4,918

59672_Pg75-101.indd 87
59672_Pg75-101.indd 87

2/18/06 4:54:37 PM
2/18/06 4:54:37 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

15 Income taxes (continued)

Significant components of deferred income tax assets and liabilities

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

December 31,

2005

2004

$÷÷«51

$÷÷«86

234

117

411

168

4,995

5,163

$4,752

$1,802

2,950

$4,752

$4,817

197

115

278

676

121

4,914

5,035

$4,359

$1,349

3,010

$4,359

364

$4,723

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, 2005, the Company
had no operating loss carryforwards available for future use ($794 mil-
lion of operating loss carryforwards at December 31, 2004).

The Company recognized tax credits of $4 million in 2005 for eligi-

ble research and development expenditures ($4 million in 2004 and
$15 million in 2003) not previously recognized, which reduced the cost
of properties.

16 Segmented information

The Company manages its rail operations as one business segment over
a single network that spans vast geographic distances and territories,
with operations in Canada and the United States. Financial information
reported at this level, such as revenues, operating income, operating
ratio and cash flow from operations, is used by corporate management,
including the Company’s chief operating decision-maker, in evaluating
financial and operational performance and allocating resources across
CN’s network.

The Company’s strategic initiatives, which drive its operational
direction, are developed and managed centrally by corporate manage-
ment and are communicated to its regional activity centers (the Western
Canada, Eastern Canada and U.S. regions). Corporate management is
responsible for, among others, CN’s marketing strategy, the management

of large customer accounts, overall planning and control of infrastructure
and rolling stock, the allocation of resources, and other functions such
as financial planning, accounting and treasury.

The role of each region is to manage the day-to-day service

requirements within its territory, service small customer accounts within
its region, and control direct costs incurred locally. Such cost control is
required to ensure that pre-established efficiency standards set at the
corporate level are met. The regions execute the overall corporate strat-
egy and operating plan established by corporate management, as their
management of throughput and control of direct costs does not serve as
the platform for the Company’s decision-making process. Approximately
85% of the Company’s freight revenues are from national accounts for
which freight traffic spans North America and touches various commod-
ity groups. As a result, the Company does not manage revenues on a
regional basis since a large number of the movements originate in one
region and pass through and/or terminate in another region.

The regions also demonstrate common characteristics in each of

the following areas:

(i) each region’s sole business activity is the transportation of freight

over the Company’s extensive rail network;

(ii) the regions service national accounts that extend over the

Company’s various commodity groups and across its rail network;

(iii) the services offered by the Company stem predominantly from

the transportation of freight by rail with the goal of optimizing the
rail network as a whole;

(iv) the Company and its subsidiaries, not its regions, are subject to one

regulatory regime in both Canada and the U.S.

For the reasons mentioned herein, the Company reports as one

operating segment.

The following tables provide information by geographic area:

In millions

Year ended December 31,

2005

2004

2003

Revenues

Canada

U.S.

$4,660

2,580

$7,240

$4,126

2,422

$6,548

$3,707

2,177

$5,884

In millions

Year ended December 31,

2005

2004

2003

Net income

Canada

U.S.

In millions

Properties

Canada

U.S.

$1,186

370

$1,556

$1,035

$÷«888

223

126

$1,258

$1,014

December 31,

2005

2004

$10,457

9,621

$20,078

$÷9,945

9,770

$19,715

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 88
59672_Pg75-101.indd 88

2/18/06 4:55:19 PM
2/18/06 4:55:19 PM

Notes to Consolidated Financial Statements

17 Earnings per share

Year ended December 31,

2005

2004

2003

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

Rent expense for operating leases was $233 million, $242 million
and $230 million for the years ended December 31, 2005, 2004, and 2003,
respectively. Contingent rentals and sublease rentals were not significant.

$5.64

–

$5.64

$5.54

–

$5.54

$4.41

$3.38

–

$4.41

0.16

$3.54

$4.34

$3.33

–

$4.34

0.16

$3.49

B. Other commitments
As at December 31, 2005, the Company had commitments to acquire
railroad ties, rail, freight cars, locomotives and other equipment at an
aggregate cost of $578 million. Furthermore, as at December 31, 2005,
the Company had outstanding information technology service contracts
of $18 million and agreements with fuel suppliers to purchase approxi-
mately 57% of its anticipated 2006 volume and 12% of its anticipated
2007 volume at market prices prevailing on the date of the purchase.

The following table provides a reconciliation between basic and

diluted earnings per share:

In millions

Year ended December 31,

Net income

Weighted-average shares outstanding

Effect of stock options

Weighted-average diluted shares outstanding

2005

$1,556

275.8

5.3

281.1

2004

2003

$1,258

$1,014

285.1

4.8

289.9

286.8

3.9

290.7

For the year ended December 31, 2003, 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 6.0 million.

18 Major commitments and contingencies

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, 2005, the Company’s commitments under operating
and capital leases were $1,058 million and $1,231 million, respectively.
Minimum lease payments in each of the next five years and thereafter
are as follows:

In millions

2006

2007

2008

2009

2010

2011 and thereafter

Less: imputed interest on capital leases at rates

ranging from approximately 3.00% to 13.13%

Present value of minimum lease payments included in debt

Operating

Capital

$÷«238

$÷«159

196

165

136

103

220

154

113

680

$1,058

1,231

360

$÷«871

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’ compensa-
tion 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.
At December 31, 2005, 2004, and 2003, the Company’s provision for

personal injury and other claims in Canada was as follows:

In millions

Balance January 1

Accruals and other

Payments

Balance December 31

2005

$204

(45)

$205

2004

$169

(29)

$204

2003

$183

(39)

$169

59672_Pg75-101.indd 89
59672_Pg75-101.indd 89

2/18/06 4:56:05 PM
2/18/06 4:56:05 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

18 Major commitments and contingencies (continued)
In 2005, changes in the legislative and judicial environment, as well as
in the methodology used by the courts and the Company to diagnose
claims, enabled the Company to actuarially determine a best estimate
for unasserted occupational disease claims, thereby increasing the
expected number of claims to be received. These changes have also ren-
dered the recent claim experience to be more representative of future
anticipated settlements for asserted occupational disease claims, thereby
reducing the average cost per claim. Accordingly, the Company recorded
an increase in the provision for unasserted occupational disease claims,
which was substantially offset by a reduction in the provision for
asserted occupational disease claims.

Due to the inherent uncertainty involved in projecting future events

At December 31, 2005, 2004, and 2003, the Company’s provision

for U.S. personal injury and other claims was as follows:

In millions

Balance January 1

Accruals and other

Payments

Balance December 31

2005

$438

(47)

$452

2004

$421

(77)

$438

2003

$481

(87)

$421

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, 2005, 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 numerous federal, provincial,
state, municipal and local environmental laws and regulations in Canada
and the United States concerning, among other things, emissions into
the air; discharges into waters; the generation, handling, storage, trans-
portation, 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 envi-
ronmental 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 opera-
tions and relating to its past and present ownership, operation or
control of real property.

(i)

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

(ii) 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 operating 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 com-
petitive position. Costs related to any future remediation will be accrued
in the year in which they become known.

In 2005, the Company recorded a liability related to a derailment
at Wabamun Lake, Alberta. The liability, which is mostly short-term, is
based on current facts and circumstances and represents clean-up
costs for the shoreline, fronting residences and First Nations Land. The
Company’s insurance policies are expected to cover substantially all
expenses related to the derailment above the self-insured retention.
Accordingly, the Company has recorded a receivable for estimated
recoveries from the Company’s insurance carriers. Third quarter expenses
included approximately $28 million, of which $25 million was for envi-
ronmental matters, related to this derailment, which represents the
Company’s retention under its insurance policies and other uninsured
costs. The ultimate liability for clean-up costs could differ from the cur-
rent amount recorded, but such a change is expected to be offset by a
corresponding change in the insurance receivable. The Company expects
its insurance coverage to be adequate to cover any additional clean-up
costs related to the derailment above its self-insured retention.

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 90
59672_Pg75-101.indd 90

2/18/06 4:56:44 PM
2/18/06 4:56:44 PM

Notes to Consolidated Financial Statements

In 2005, the Company’s expenses relating to environmental matters,
net of recoveries, were $34 million ($10 million in 2004 and $6 million
in 2003). Payments for such matters were $24 million, net of potential
insurance recoveries for 2005 ($8 million in 2004 and $12 million in 2003).
As at December 31, 2005, the Company had aggregate accruals for envi-
ronmental costs of $124 million ($113 million as at December 31, 2004).
The Company anticipates that the majority of the liability at December 31,
2005 will be paid out over the next five years.

In addition, related environmental capital expenditures were $11 mil-
lion in 2005, $13 million in 2004, and $23 million in 2003. The Company
expects to incur capital expenditures relating to environmental matters
of approximately $18 million in 2006, $13 million in 2007, and $12 mil-
lion in 2008.

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 may
extend beyond the term of the agreement. These include, but are not
limited to, residual value guarantees on operating leases, standby letters
of credit and surety and other 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. In addition,
where the Company expects to make a payment in respect of a guaran-
tee, 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
2006 and 2012, for the benefit of the lessor. If the fair value of the
assets, at the end of their respective lease terms, 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, 2005, the maximum exposure in respect of these
guarantees was $93 million, of which $9 million has been recorded.
Of that amount, $7 million represents the expected cash outlay for such
guarantees, while the remaining $2 million represents the Company’s
obligation 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 irrevoca-
ble standby letters of credit and surety and other 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, 2005, the maximum potential liability under these guaran-
tees was $467 million of which $375 million was for workers’ compensa-
tion and other employee benefits and $92 million was for equipment
under leases and other. During 2005, the Company granted guarantees
for which no liability has been recorded, as they relate to the Company’s
future performance.

As at December 31, 2005, 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 2006 and 2010.

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 respec-
tive 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 agree-
ments and trust deeds, including in respect of their reliance on autho-
rized 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, 2005, the Company
had not recorded a liability associated with these indemnifications, as
the Company does not expect to make any payments pertaining to these
indemnifications.

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 indemnification provi-
sions 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 agree-
ments; (b) contracts granting rights to others to use the Company’s
property, such as leases, licenses and easements; (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 and other
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 compensation arrangements; (i) pension
transfer agreements; (j) master agreements with financial institutions
governing derivative transactions; and (k) settlement agreements with
insurance companies or other third parties whereby such insurer or third
party has been indemnified for any present or future claims relating to
insurance policies, incidents or events covered by the settlement agree-
ments. 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 maxi-
mum exposure for future payments may be material. However, such
exposure cannot be determined with certainty.

59672_Pg75-101.indd 91
59672_Pg75-101.indd 91

2/18/06 8:55:26 PM
2/18/06 8:55:26 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

18 Major commitments and contingencies (continued)

The Company has entered into various indemnification 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, 2005, the carrying value
for guarantees for which the Company was able to determine the fair
value, was $1 million. There are no recourse provisions to recover any
amounts from third parties.

19 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.

The Company is exposed to credit risk in the event of non-perfor-
mance 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 qual-
ity and their credit standing or that of their guarantor is regularly moni-
tored. As a result, losses due to counterparty non-performance are not
anticipated. The total risk associated with the Company’s counterparties
was immaterial at December 31, 2005. 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 hedging program which
calls for 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, with an increased application of fuel surcharge on
revenues, no additional swap positions were entered into since
September 2004 and the Company has now suspended this program.
At December 31, 2005, the Company’s remaining hedge positions cov-
ered approximately 17% of the estimated 2006 fuel consumption,
representing approximately 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
correlated 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 $177 million, $112 million, and
$49 million for the years ended December 31, 2005, 2004, and 2003,
respectively.

At December 31, 2005, Accumulated other comprehensive loss
included unrealized gains of $57 million, $39 million after tax ($92 mil-
lion, $62 million after tax at December 31, 2004), which relate to deriva-
tive 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 2005, 2004, and 2003 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. 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. The realized gain of $12 mil-
lion accumulated in other comprehensive income (loss) is being recorded
into income, as a reduction of interest expense, over the term of the
debt based on the interest payment schedule.

At December 31, 2005, Accumulated other comprehensive loss

included an unamortized gain of $12 million, $8 million after tax
($12 million, $8 million after tax at December 31, 2004).

(iv) Foreign currency
Although the Company conducts its business and receives revenues
primarily in Canadian dollars, a growing portion of its revenues, expenses,
assets and debt is 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 further affect the Company’s revenues and expenses.

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 92
59672_Pg75-101.indd 92

2/18/06 5:35:02 PM
2/18/06 5:35:02 PM

Notes to Consolidated Financial Statements

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 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 following 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.

The following table presents the carrying amounts and estimated fair
values of the Company’s financial instruments as at December 31, 2005
and 2004 for which the carrying values on the Consolidated Balance
Sheet are different from their fair values:

In millions

December 31, 2005

December 31, 2004

Financial assets

Investments

Financial liabilities

Long-term debt

(including current portion)

Carrying
amount

Fair
value

Carrying
amount

Fair
value

$÷«132

$÷«185

$÷«166

$÷«220

$5,085

$5,751

$5,164

$5,857

20 Other comprehensive income (loss)

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

In millions

Year ended December 31, 2005

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

Decrease in unrealized holding gains on fuel

derivative instruments (Note 19)

Minimum pension liability adjustment (Note 13)

$«152

$(52)

$«100

(233)

(35)

(1)

(154)

(23)

Other comprehensive loss

$(112)

$«38

$÷(74)

In millions

Year ended December 31, 2004

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 gains on fuel derivative

instruments (Note 19)

Realized gain on settlement of interest rate

swaps (Note 19)

Minimum pension liability adjustment (Note 13)

$«326

$(106)

$«220

(428)

140

(18)

(4)

(3)

(288)

Other comprehensive loss

$÷(28)

$÷÷«9

$÷(19)

In millions

Year ended December 31, 2003

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 gains on fuel derivative

instruments (Note 19)

Minimum pension liability adjustment (Note 13)

Deferred income tax (DIT) rate enactment

$÷÷754

$(245)

$«509

(1,101)

358

(743)

–

(2)

(3)

(2)

Other comprehensive loss

$÷«(332)

$«106

$(226)

59672_Pg75-101.indd 93
59672_Pg75-101.indd 93

2/18/06 5:35:53 PM
2/18/06 5:35:53 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

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

In millions

Balance at December 31, 2002

Period change

Balance at December 31, 2003

Period change

Balance at December 31, 2004

Period change

Balance at December 31, 2005

Foreign
exchange –
Net investment
in foreign
operations

Increase
(decrease) in
unrealized
holding gains on
fuel derivative
instruments

Foreign
exchange –
U.S.$ debt

$(187)

509

322

220

542

100
$«642

$«320

(743)

(423)

(288)

(711)

(154)
$(865)

$«20

(23)
$«39

Realized gain
on settlement of
interest
rate swaps

Minimum
pension liability
adjustment

Accumulated
other
comprehensive
income (loss)

DIT rate
enactment

$–

–

–
$8

$(24)

(20)

(15)

3
$(12)

$(32)

(2)

(34)

–

(34)

–
$(34)

$÷«97

(226)

(129)

(19)

(148)

(74)
$(222)

21 Reconciliation of United States and Canadian generally accepted accounting principles

The Consolidated Financial Statements of the Company prepared in accordance with Canadian GAAP are provided below along with a tabular
reconciliation and discussion of the significant differences between U.S. and Canadian GAAP.

A. Canadian GAAP financial statements

Consolidated Statement of Income – Canadian GAAP

In millions, except per share data

Revenues

Operating expenses

Labor and fringe benefits

Purchased services and material

Depreciation and amortization

Fuel

Equipment rents

Casualty and other

Total operating expenses

Operating income

Interest expense

Other income (loss)

Income before income taxes

Income tax expense

Net income

Earnings per share

Basic

Diluted

Weighted-average number of shares

Basic

Diluted

Year ended December 31,

2005

$7,240

2004

$6,548

2003

$5,884

1,873

814

510

725

192

417

4,531

2,709

(299)

2,422

(819)

1,838

1,929

746

517

528

244

445

4,318

2,230

(282)

(20)

1,928

(631)

879

472

471

299

466

4,516

1,368

(317)

1,072

(338)

$1,603

$1,297

$÷«734

$÷5.81

$÷5.71

275.8

280.9

$÷4.55

$÷4.48

285.1

289.6

$÷2.56

$÷2.52

286.8

290.7

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 94
59672_Pg75-101.indd 94

2/25/06 11:55:56 AM
2/25/06 11:55:56 AM

Notes to Consolidated Financial Statements

Consolidated Balance Sheet – Canadian GAAP

In millions

Assets

Current assets:

Cash and cash equivalents

Accounts receivable

Material and supplies

Deferred income taxes

Other

Properties

Intangible and other assets

Total assets

Liabilities and shareholders’ equity

Current liabilities:

Accounts payable and accrued charges

Current portion of long-term debt

Other

Deferred income taxes

Other liabilities and deferred credits

Long-term debt

Shareholders’ equity:

Common shares

Contributed surplus

Currency translation

Retained earnings

December 31,

2005

2004

$÷÷÷«62

$÷÷«147

623

151

188

1,109

17,187

961

$19,257

793

127

393

194

1,654

16,688

929

$19,271

$÷1,478

$÷1,605

408

1,958

3,731

1,466

4,677

3,562

154

(120)

3,829

7,425

578

2,259

3,591

1,488

4,586

3,587

164

(80)

3,676

7,347

Total liabilities and shareholders’ equity

$19,257

$19,271

59672_Pg75-101.indd 95
59672_Pg75-101.indd 95

2/18/06 5:37:19 PM
2/18/06 5:37:19 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

21 Reconciliation of United States and Canadian generally accepted accounting principles (continued)
Consolidated Statement of Cash Flows – Canadian GAAP

Year ended December 31,

2005

2004

2003

$«1,603

$«1,297

$÷÷734

In millions

Operating activities

Net income

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

Depreciation and amortization

Deferred income taxes

Equity in earnings of English Welsh and Scottish Railway

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

Acquisition of GLT

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

Repurchase of common shares

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

B. Reconciliation and discussion of significant differences between U.S. and Canadian GAAP
(i) Reconciliation of net income
The application of Canadian GAAP would have the following effects on the net income as reported:

Year ended December 31,

In millions

Net income – U.S. GAAP

Adjustments in respect of:

Depreciation and amortization on difference in properties

Stock-based compensation cost

Interest expense

Income tax rate enactments

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

513

585

(4)

142

(25)

(156)

2,705

(1,180)

–

105

(1,075)

(275)

2,728

(2,865)

115

(1,418)

(1,440)

(85)

147

521

401

(233)

113

2,139

(1,072)

(984)

(547)

192

(2,411)

(222)

8,277

(7,579)

(273)

511

130

478

232

(17)

153

(3)

(96)

(27)

1,500

(583)

–

(16)

(599)

(191)

4,109

(4,141)

(656)

(605)

105

$÷÷÷62

$÷÷147

$÷÷130

2005

$1,556

117

(32)

–

(40)

1,603

–

$1,603

2004

$1,258

(19)

(3)

(32)

1,297

–

$1,297

2003

$1,014

(384)

(27)

–

133

782

(48)

$÷«734

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 96
59672_Pg75-101.indd 96

2/18/06 5:37:57 PM
2/18/06 5:37:57 PM

December 31,

Notes to Consolidated Financial Statements

(ii) Reconciliation of significant balance sheet items
The application of Canadian GAAP would have the following effects on the balance sheet as reported:

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 Accumulated other comprehensive loss

Income tax rate enactments

Other

Deferred income tax liability – Canadian GAAP

Other liabilities and deferred credits – U.S. GAAP

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 programs

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 programs

Capital reorganization

Contributed surplus – Canadian GAAP

2005

$÷1,149

(57)

(1)

$÷1,109

$20,078

(2,816)

(75)

$17,187

$÷÷«961

–

$÷÷«961

$÷4,817

(1,172)

(27)

–

(4)

(1)

$÷3,731

$÷1,487

(18)

(3)

$÷1,466

$÷4,580

(1,300)

(12)

247

$÷3,562

$÷÷÷÷«–

(248)

(33)

(18)

(36)

489

2004

$÷1,710

(81)

(4)

$÷1,654

$19,715

(2,952)

(75)

$16,688

$÷÷«940

(11)

$÷÷«929

$÷4,723

(1,204)

(27)

(1)

(4)

$÷3,591

$÷1,513

(22)

(3)

$÷1,488

$÷4,706

(1,300)

(18)

(12)

178

$÷3,587

$÷÷÷÷«–

(248)

(33)

(18)

(26)

489

$÷÷«154

$÷÷«164

59672_Pg75-101.indd 97
59672_Pg75-101.indd 97

2/18/06 5:38:41 PM
2/18/06 5:38:41 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

21 Reconciliation of United States and Canadian generally accepted accounting principles (continued)

In millions

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 programs

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,

2005

2004

$÷÷(222)

$÷÷(148)

103

(39)

(8)

$÷÷(120)

$÷4,891

(1,889)

(48)

(211)

(38)

811

248

(62)

(8)

$÷÷÷(80)

$÷4,726

(1,928)

(48)

(152)

(38)

811

248

$÷3,829

$÷3,676

(iii) Reconciliation of cash flow items
For the years ended December 31, 2005 and 2004, cash provided from
(used by) operating, investing and financing activities presented under
U.S. and Canadian GAAP were the same.

For the year ended December 31, 2003, cash provided from operat-

ing activities and cash used by investing activities under Canadian GAAP,
would decrease by the same amount, $476 million, when compared to
U.S. GAAP, due to the difference in the Company’s property capitalization
policies that existed prior to January 1, 2004 as discussed herein. Cash
used by financing activities presented under U.S. and Canadian GAAP
was the same.

(iv) Discussion of the significant differences between U.S. and
Canadian GAAP
Property capitalization
Effective January 1, 2004, the Company changed its capitalization
policy under Canadian GAAP, on a prospective basis, to conform to 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 accordance with the

CICA Handbook Section 3061, “Properties, Plant and Equipment,” the
Company now capitalizes the costs of labor, material and related over-
head 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.
This change effectively harmonizes the Company’s Canadian and

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 amounts capitalized under Canadian and U.S. GAAP as at
January 1, 2004.

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 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 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.

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 98
59672_Pg75-101.indd 98

2/18/06 5:39:20 PM
2/18/06 5:39:20 PM

Notes to Consolidated Financial Statements

Income taxes
The provincial, federal and state 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 differ-
ence 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 2005, under U.S. GAAP, the
Company recorded an increase to its net deferred income tax liability of
$14 million resulting from the net impact of higher enacted corporate
tax rates in certain Canadian provinces, with the corresponding increase
of $12 million under Canadian GAAP. 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 mil-
lion 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.

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 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. Compensation
cost attributable to employee stock options granted prior to January 1,
2003 continues to be a reconciling difference.

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. Effective for the Company’s fiscal year beginning after October 1,
2006, Canadian GAAP will conform to the U.S. GAAP standard.

Minimum pension liability adjustment
Under U.S. GAAP 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, this would give rise to an additional minimum pen-
sion liability. As a result, an intangible asset is recognized to the extent
of the unrecognized prior service cost and the difference is recorded
in Accumulated other comprehensive loss, a separate component of
Shareholders’ equity. There are no requirements under Canadian GAAP
to record a minimum pension liability adjustment.

Convertible preferred securities
In July 2002, the Convertible preferred securities (Securities) of the
Company were converted into common shares. 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. Also, the interest on the Securities until July 2002
was treated as a dividend for Canadian GAAP but as interest expense
for U.S. GAAP.

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

Under U.S. GAAP, the dividend in kind declared in 1995 (with respect

to land transfers) and other capital transactions were deducted from
Retained earnings. For Canadian GAAP purposes, these amounts have
been deducted from Contributed surplus.

Under U.S. GAAP, costs related to the sale of shares were deducted

from Common shares. For Canadian GAAP purposes, these amounts have
been deducted from Contributed surplus.

Under U.S. GAAP, the cost resulting from the repurchase of shares
has been allocated to Common shares followed by Retained earnings.
Under Canadian GAAP, the cost was allocated first to Common shares,
then to Contributed surplus and finally to Retained earnings.

59672_Pg75-101.indd 99
59672_Pg75-101.indd 99

2/18/06 5:40:03 PM
2/18/06 5:40:03 PM

U.S. GAAP

Canadian National Railway Company

Notes to Consolidated Financial Statements

21 Reconciliation of United States and Canadian generally

accepted accounting principles (continued)

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
U.S. GAAP, 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.” For Canadian GAAP purposes,
the resulting net unrealized foreign exchange loss from the date of des-
ignation, has been included in Currency translation. Effective for the
Company’s fiscal year beginning after October 1, 2006, Canadian GAAP
will conform to the U.S. GAAP standard.

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 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 histori-
cal cost basis of the assets. As a result, a cumulative benefit of $75 mil-
lion, 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 recommendations
of the CICA 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, had not resulted in
accumulated depreciation balances exceeding the historical cost basis
of the assets.

22 Subsequent event

23 Comparative figures

Certain figures, previously reported for 2004 and 2003, have been
reclassified to conform with the basis of presentation adopted in the
current year.

100

Canadian National Railway Company

U.S. GAAP

59672_Pg75-101.indd 100
59672_Pg75-101.indd 100

2/18/06 5:40:46 PM
2/18/06 5:40:46 PM

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 isolation.
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 perfor-
mance. 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 – 1995

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

Year ended December 31,

Revenues

Operating expenses

Operating income (loss)

Interest expense

Other income

Income (loss) from continuing operations before income taxes

Income tax recovery (expense)

Income (loss) from continuing operations

Operating ratio

Diluted earnings (loss) per share from continuing operations

Reported

Adjustments (1)

Adjusted

Adjustment (2)

Adjusted for
normalized taxes

1995

$«÷÷÷÷–

(1,415)

1,415

–

1,415

–

$«1,415

$÷3,862

4,852

(990)

(194)

148

(1,036)

$(1,017)

125.6%
$÷(4.21)

$«3,862

3,437

425

(194)

148

379

$÷«398

89.0%
$÷1.65

$÷÷÷–

–

(194)

$(194)

$«3,862

3,437

425

(194)

148

379

(175)

$÷«204

89.0%
$÷0.85

(1) Operating expenses include $1,300 million for an asset impairment write-down of rail properties, $88 million for future environmental costs, a $14 million write-down for material

and supplies and $13 million for the provision for legal actions.

(2) Adjustment to reflect a normalized effective tax rate.

Free cash flow – 1995 and 2005

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)

Free cash flow

Year ended December 31,

1995

$÷«24

(142)

–
(118)

2005

$«2,705

(1,075)

(275)
1,355

–
$(118)

(54)
$«1,301

(1) Changes in the level of accounts receivable sold under the Company’s accounts receivable securitization program are considered a financing activity.

59672_Pg75-101.indd 101
59672_Pg75-101.indd 101

2/25/06 11:57:16 AM
2/25/06 11:57:16 AM

Canadian National Railway Company

101

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.

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, as well as
to our proxy circular – mailed to our shareholders and also available on
our Web site.

102

Canadian National Railway Company

59672_Pg102-103.indd 102
59672_Pg102-103.indd 102

23/02/2006 01:43:02
23/02/2006 01:43:02

2005 President’s Awards for Excellence

These employees' accomplishments reinforced the five principles that are the foundation of CN's industry-
leading railroad, and also won them the President’s Award for Excellence for their outstanding contributions
in 2005 in the areas of Service, Cost Control, Asset Utilization, Safety and People.

Category: Service

Winner: Martita Mullen – Memphis, Tennessee

Winner: Rheissie Ballard Jr. – Geismar, Louisiana

When Hurricane Katrina disrupted communication and power in the Geismar
area where Rheissie Ballard Jr. works as a conductor, he went above and
beyond the call of duty by taking the initiative on his own time to personally
ensure each customer was receiving the cars needed for operations.

Martita’s expert skill and original thinking were put to good use when she
took over full responsibility for contractor management during construction
of the Memphis Intermodal Terminal. Martita assured timely completion of
the project thanks to her innovative solutions to keep construction going
during unseasonably wet weather.

Winners: Savage Service Integrity Team

Category: Safety

Lee Aitchison, David James – Edson, Alberta; Brian Kalin, Robert Leblanc,
Kerry Morris, Nick Nielsen, Joseph Slavin, Graham Wood – Edmonton,
Alberta

Winners: Graf and Krane Team

Eric Graf, Charles Krane – Harvey, Illinois

This team solved a servicing problem to the Grande Cache coal mine and, at
the same time, greatly increased efficiency. Working with the shortline carrier,
the team members designed and adopted a new operating plan that involved
intervening and handling the traffic on the shortline.

Category: Cost Control

Winners: Champlain Division 2P71 Undercutter Gang Team

Serge Allard, John Barrette, Sylvain Fafard – Charny, Quebec; Sylvain Duff –
Montreal, Quebec

This gang achieved a remarkable 3,491 feet a day in undercutting on the Lac
St-Jean Subdivision. The process, which involves multiple tasks, got off to a
slow start. But the dedicated team quickly adapted and turned up the pace of
the operation with exemplary results.

Winner: David Lilley – Edmonton, Alberta

David designed and implemented a test to document the potential cost
savings of a new approach to rail lubrication, known as wayside top-of-rail
lubrication; his was the first test of its kind in the world. When preliminary
results suggested an extension of asset life in the range of 50 to 100 per
cent, David started implementing top-of-rail lubrication on 140 miles of the
B.C. South corridor: an initiative that would significantly reduce CN’s costs
over the long term.

Eric and Charles made extraordinary efforts, including going through high
school yearbooks, to find five young people in Des Plaines who had been
photographed trespassing at or near the Des Plaines Avenue crossing.
They scheduled meetings with the parents and the offenders to discuss the
trespassing incident. They also worked jointly with the Des Plaines Police
department in an attempt to curtail any more trespassing in the area.

Winners: Balanced Load Distribution Team

William Blevins – Montreal, Quebec; Vic Jaseckas, David Livingstone,
Gerry Weber – Edmonton, Alberta; Lonny Kubas – Winnipeg, Manitoba

This team uncovered a contributing factor to the derailment of a bulk
commodities train in British Columbia and helped the customer reduce the
risk of future problems. Using wheel impact load detectors, they reviewed
how the car was loaded, discovering that the loading had been done
unevenly. The team helped the shipper review different ways of improving
load distribution.

Winner: Laura Soutar – Toronto, Ontario

Among other duties, conductor Laura Soutar trains newly hired members
of the United Transportation Union (UTU) in the Greater Toronto Area. Her
passion for safety is a daily focus that comes as second nature to her. She
combines this unwavering commitment with her training expertise and
team spirit to instil safety values in class participants.

Winner: Josée Danis – Montreal, Quebec

Category: People

Josée spearheaded a multi-departmental project to review CN’s agreements
with other companies with whom it co-owns facilities. Her thorough audit
of existing agreements identified significant opportunities to recover funds
from other companies.

Category: Asset Utilization

Winners: Custom Building Logs Team

Vincent Gauthier – Montreal, Quebec; Kevin Foley – Edmonton, Alberta;
Greg Kendall – Winnipeg, Manitoba; Jim Newton – Saskatoon, Saskatchewan;
Mitch Romano – Thunder Bay, Ontario

Custom Building Logs (CBL) presented CN with an opportunity to substan-
tially increase its business with the logging company, provided CN could
respond to increased demand. Among other improvements, the team members
succeeded in reducing the complexity of switching and reducing car cycle
times, and were rewarded with a 67 per cent increase in volume of cars.

Winner: Barry Malmquist – Winnipeg, Manitoba

Barry is recognized in his community for donating his personal time to
organized activities. In September 2005, he made an even greater donation
when he gave one of his kidneys to a friend who is also a CN employee.
Barry is a deeply compassionate person and an inspiration to others.

Winner: Tim Maltais – Winnipeg, Manitoba

Thanks to Tim’s approach to the repair process and his initiative and his
ability to motivate his team, productivity is way up and bad order numbers
are way down in the Symington Yard Mechanical department, which is
saving time for Transportation and ensuring serviceable assets are delivered
to customers in a much more timely fashion.

Special Award

Winners: Gulf Team Hurricane Katrina, New Orleans

A dedicated team of some 700 CN employees from the Gulf Coast zone
worked tirelessly to overcome the devastation created by Hurricane Katrina.
With foresight and planning, teamwork and an unwavering commitment
to service and safety, the team overcame multiple logistical challenges to
re-establish rail service in astounding time.

Canadian National Railway Company

103

59672_Pg102-103.indd 103
59672_Pg102-103.indd 103

23/02/2006 01:43:18
23/02/2006 01:43:18

104
104

Canadian National Railway Company
Canadian National Railway Company

59672_Pg104-105.indd 104
59672_Pg104-105.indd 104

23/02/2006 01:41:18
23/02/2006 01:41:18

Board of Directors (As of December 31, 2005)

Fourth row, left to right:

Robert Pace
President and

Chief Executive Ofﬁ cer

The Pace Group

The Honourable

Edward C. Lumley, P.C., LL.D.
Vice-Chairman

BMO Nesbitt Burns

Hugh J. Bolton, F.C.A.
Chairman of the Board

EPCOR Utilities Inc.

Committees: 1, 3, 6, 7

Committees: 1*, 3, 6, 7, 8

Committees: 2, 5, 6, 7, 8*

Third row, left to right:

Ambassador Gordon D. Gifﬁ n
Senior Partner

J.V. Raymond Cyr, O.C., LL.D.
Chairman of the Board

James K. Gray, O.C., A.O.E., LL.D.
Corporate Director

Denis Losier
President and

McKenna Long & Aldridge

Polyvalor Inc.

Committees: 2, 5, 6, 7

Committees: 2, 5*, 7, 8

Former Chairman and

Chief Executive Ofﬁ cer

Assumption Life

Canadian Hunter Exploration Ltd.

Committees: 1, 2*, 7, 8

Committees: 3, 5, 6, 7

Second row, left to right:

Edith E. Holiday
Corporate Director and Trustee

Former General Counsel

A. Charles Baillie, LL.D.
Former Chairman and

Chief Executive Ofﬁ cer

Purdy Crawford, O.C., Q.C., LL.D.
Counsel

Osler, Hoskin & Harcourt

United States Treasury Department

The Toronto-Dominion Bank

Committees: 1, 3, 6*, 7, 8

Secretary of the Cabinet

Committees: 1, 3, 6, 7

The White House

Committees: 3, 5, 6, 7, 8

First row, left to right:

David G.A. McLean, O.B.C., LL.D.
Chairman of the Board

E. Hunter Harrison
President and

Michael R. Armellino
Retired Partner

Canadian National Railway Company

Chief Executive Ofﬁ cer

The Goldman Sachs Group

V. Maureen Kempston Darkes,

O.C., D.Comm., LL.D.

Group Vice-President

Chairman of the Board and

Canadian National Railway Company

Committees: 1, 2, 7*, 8

General Motors Corporation

Chief Executive Ofﬁ cer

The McLean Group

Committees: 3*, 4, 5, 6, 7, 8

Committees: 4*, 7

President

GM Latin America, Africa

and Middle East

Committees: 2, 5, 7, 8

Committees:
1 Audit

2 Finance
3 Corporate governance and

nominating

4 Donations

5 Environment, safety and security

6 Human resources and compensation
7 Strategic planning

8 Investment

*denotes chairman of the committee

59672_Pg104-105.indd 105
59672_Pg104-105.indd 105

2/20/06 2:10:08 PM
2/20/06 2:10:08 PM

Canadian National Railway Company

105

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
Executive 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

106

Canadian National Railway Company

59672_Pg106-.indd 106
59672_Pg106-.indd 106

2/20/06 2:17:14 PM
2/20/06 2:17:14 PM