2006 Annual Report
Proving it.
935 de La Gauchetière Street West, Montreal, Quebec H3B 2M9
www.cn.ca
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Shareholder and investor information
Annual meeting
Stock exchanges
The annual meeting of shareholders will be held at
CN common shares are listed on the Toronto and
10:00 am (local time) on April 24, 2007 at the Delta Beausejour,
New York stock exchanges.
in Moncton, New Brunswick, Canada.
Nothing proves an idea like results.
CNR (Toronto Stock Exchange)
Ticker symbols:
CNI (New York Stock Exchange)
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
Investor relations
Robert Noorigian
Vice-President, Investor Relations
Co-transfer agent and co-registrar
Telephone: 1-800-564-6253
of business. You have to prove it every day.
17 State Street, 28th Floor
New York, NY 10004
Computershare Trust Company of New York
www.computershare.com
Telephone: 212-805-7000 or 1-800-245-7630
Head office
Dividend payment options
Shareholders wishing to receive dividends by Direct Deposit or in
Canadian National Railway Company
935 de La Gauchetière Street West
Montreal, Quebec H3B 2M9
P.O. Box 8100
CN has developed a uni que model for railroading, characterized by
Telephone: 514-399-0052 or 1-800-319-9929
Transfer agent and registrar
balance, precision and discipline. The
improvements in the numbers we’ve posted
or wishing to obtain information about CN should contact:
Shareholders having inquiries concerning their shares
Montreal, QC; Toronto, ON; Calgary, AB; Vancouver, BC
Offices in:
Computershare Trust Company of Canada
Shareholder services
over the past decade have been excepti onal, but we know nothing stays the same.
100 University Avenue, 9th Floor
Toronto, Ontario M5J 2Y1
Telephone: 1-800-564-6253
www.computershare.com
Computershare Trust Company of Canada
Shareholder Services
It’s the nature
That’s w hat we’re doing. We’re proving CN’s model
and resolve by conti nuing to deliver industry-leading reliability.
Computershare Trust Company of Canada
U.S. dollars may obtain detailed information by communicating with:
Telephone: 1-800-564-6253
Montreal, Quebec H3C 3N4
And by continuing to define new horizons for profitable growth.
est disponible à l’adresse suivante :
Affaires publiques CN
CN Public Affairs
available from:
Additional copies of this report are
La version française du présent rapport
By continuing to drive change.
Certain information included in this Annual Report
may be forward-looking statements within the mean-
ing of United States and Canadian securities laws.
Implicit in these statements is the assumption that
while the Company expects a moderate slowdown
in the North American economy in the near term, its
business prospects assume positive economic condi-
tions in North America and globally. This assumption,
although considered reasonable by the Company
at the time of preparation, may not materialize.
Such forward-looking statements are not guaran-
tees of future performance and involve known and
unknown risks, uncertainties and other factors which
may cause the actual results or performance of the
Company or the rail industry to be materially different
from the outlook or any future results or performance
implied by such statements. Such factors include the
specific risks set forth in Management’s Discussion
and Analysis contained in this Annual Report as well
as other risks detailed from time to time in reports
filed by the Company with securities regulators in
Canada and the United States.
935 de La Gauchetière Street West
Montreal, Quebec H3B 2M9
Telephone: 1-888-888-5909
Email: contact@cn.ca
Contents
935, rue de La Gauchetière Ouest
Montréal (Québec) H3B 2M9
Téléphone : 1 888 888-5909
Courriel : contact@cn.ca
2 Financial and operational highlights
29 Financial Section (U.S. GAAP)
4 A message from E. Hunter Harrison
85 Non-GAAP Measures – unaudited
10 Delivering reliability
14 Driving change
86 Corporate Governance
87 2006 President’s Awards for Excellence
ment is expressed in Canadian
18 Defining new growth horizons
88 Board of Directors
22 CN at a glance
90 Chairman of the Board and
24 A message from the Chairman
Executive Officers of the Company
25 Pulling together for communities
91 Shareholder and investor information
principles (U.S. GAAP).
28 Glossary of terms
Except where otherwise
indicated, all financial infor-
mation reflected in this docu-
dollars and determined
on the basis of United States
generally accepted accounting
This report has been printed on recycled paper.
Canadian National Railway Company
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2/23/07 3:48:14 PM
Nothing proves an idea like results.
balance, precision and discipline. The
CN has developed a uni que model for railroading, characterized by
improvements in the numbers we’ve posted
over the past decade have been excepti onal, but we know nothing stays the same.
of business. You have to prove it every day.
It’s the nature
That’s w hat we’re doing. We’re proving CN’s model
and resolve by conti nuing to deliver industry-leading reliability.
By continuing to drive change.
And by continuing to define new horizons for profitable growth.
Contents
2 Financial and operational highlights
4 A message from E. Hunter Harrison
10 Delivering reliability
14 Driving change
18 Defining new growth horizons
22 CN at a glance
24 A message from the Chairman
25 Pulling together for communities
28 Glossary of terms
29 Financial Section (U.S. GAAP)
85 Non-GAAP Measures – unaudited
86 Corporate Governance
87 2006 President’s Awards for Excellence
88 Board of Directors
90 Chairman of the Board and
Executive Officers of the Company
91 Shareholder and investor information
Except where otherwise
indicated, all financial infor-
mation reflected in this docu-
ment is expressed in Canadian
dollars and determined
on the basis of United States
generally accepted accounting
principles (U.S. GAAP).
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Canadian National Railway Company
1
Financial and operational highlights
Financial summary
$ in millions, except per share data, or unless otherwise indicated
2006 (1)
2005
2004 (2)
Financial results
Revenues
Operating income
Net income
Diluted earnings per share (3)
Dividend per share (3)
Net capital expenditures
Financial position
Total assets
Long-term debt, including current portion
Shareholders’ equity
Financial ratios (%)
Operating ratio
Debt-to-total capitalization
$÷7,716
$÷7,240
$÷6,548
3,030
2,087
3.91
0.65
1,298
24,004
5,604
9,824
2,624
1,556
2.77
0.50
1,180
2,168
1,258
2.17
0.39
1,072
22,188
22,365
5,085
9,249
5,164
9,284
60.7
36.3
63.8
35.5
66.9
35.7
(1) The Company’s financial results include an item affecting the comparability of the results of operations as discussed on pages 32–33 of this report.
(2) Includes the former Great Lakes Transportation LLC’s railroads and related holdings (GLT) and the former BC Rail (BC Rail) from May 10, 2004 and July 14, 2004, respectively.
(3) Reflects the two-for-one stock split effective February 28, 2006.
Employees (average for the year)
2004 (1)
2005
2006
Adjusted diluted earnings per share (dollars) (2) (3)
2004 (1)
2005
2006
Operating ratio (percentage)
2004 (1)
2005
2006
22,470
22,246
21,685
3.40
66.9
2.17
2.77
63.8
60.7
(1) Includes GLT and BC Rail from May 10, 2004 and July 14, 2004, respectively.
(2) 2006 adjusted to exclude an item affecting the comparability of the results of operations. See discussion and reconciliation of this non-GAAP adjusted performance measure
on page 85 of this report.
(3) Reflects the two-for-one stock split effective February 28, 2006.
Canadian National Railway Company
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Revenue ton miles
In millions
Adjusted diluted earnings per share
Freight revenues
2006 percentage data
Revenue – traffic mix
Per cent
0
1
6
,
5
8
1
1
0
7
,
9
7
1
0
4
2
,
4
7
1
04
05
06
23%
Percentage increase from 2005.
7%
16%
19%
17%
5%
12%
24%
22%
24%
33%
21%
16% Petroleum and chemicals
12% Metals and minerals
24% Forest products
5% Coal
17% Grain and fertilizers
19% Intermodal
7% Automotive
24% Canadian domestic
21% Overseas
33% Transborder
22% U.S. domestic
Operating ratio
Gross ton miles per average
number of employees
In thousands
7
7
2
,
6
1
4
1
4
,
5
1
05
06
60.7%
Operating ratio in 2006 vs. 63.8% in 2005.
1
1
8
4
1
,
04
Revenue – traffic mix
Dividend per share
22%
23%
32%
23%
23% Canadian domestic
23% Overseas
32% Transborder
22% U.S. domestic
BCN USE ONLY
2,277 = 90 pts.
90 divide 2,277=0.0395256
14,811 x 0.0395256= 585.41 pts
14,000 x 0.0395256= 553.35 pts
30%
585.41 - 553.35pts=32.06pts (ht of bar)
Percentage increase from 2005.
Average car velocity
Car miles per day
Revenue ton miles
2006 percentage data
7
4
1
5
5
1
1
7
1
2%
18%
18%
10%
22%
04
9%
05
06
Percentage increase from 2005.
7%
24%
18% Petroleum and chemicals
9% Metals and minerals
24% Forest products
7% Coal
Gross ton miles per U.S. gallon of
fuel consumed
22% Grain and fertilizers
18% Intermodal
2% Automotive
BCN USE ONLY
96pt(8picas) divided by 175=0.5485714
Number x 0.5485714= height of bar
0
8
8
1
5
8
1
5
8
04
05
06
2004 data includes GLT and BC Rail from May 10 and July 14, respectively.
BCN USE ONLY
880-800=80
80 (numeral)=80pts (height of bar)
51 (numeral)=51pts (height of bar)
Canadian National Railway Company
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E. Hunter Harrison,
CN President and Chief Executive Officer,
talking with “Hunter Camp” participants,
December 2006.
We’re going to
stay focused on
the basics, work
on continuing
to drive change
that benefits
all stakeholders
and expand
new horizons
for profitable
growth.
Canadian National Railway Company
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A message from E. Hunter Harrison
Dear fellow shareholders There’s one thing we’ve been driven to do at CN for as long as I’ve been here. In fact, it’s
something we’ve always been driven to do. It’s something we’ve heard from outsiders and within our walls, time and
time again, starting with CN’s historic IPO:
Prove it.
That’s the imperative of the innovator. When you have a bold idea, a better way to do something, a new vision or
strategy, that’s only the beginning. You have to execute. You have to prove it.
Over the past 10-plus years, we’ve proven that we’re capable of seeing things differently, of going beyond the
conventions of railroading to deliver breakthrough results. It’s a powerful track record that I’m very proud of.
But this is a world of “what have you done for me lately?” Shareholders are that way. Customers are that way.
Ask any CN employee – I’m that way, too. It’s a healthy attitude that drives progress. You can never prove anything
once and for all. You have to go out there and prove it all over again, every day.
We can keep improving. We can keep growing. We’re going to prove it.
Proof in 2006 financial and operating performance We had another outstanding year in 2006. We grew
revenue ton miles by 3 per cent year-over-year. Total revenues were $7,716 million, up 7 per cent over $7,240 million
in 2005. We achieved diluted earnings per share growth as well in 2006, reaching $3.40 on an adjusted basis, a 23 per
cent improvement over the $2.77 per share we reported in 2005.
Our operating ratio performance for the year continued to prove our model, falling to 60.7 per cent. This was yet
another new record and a 3.1-point improvement over the 63.8 per cent we achieved in 2005.
Free cash flow was again a highlight of CN’s financial performance. We generated $1,343 million in 2006, slightly
above our record 2005 free cash flow results, which continues to put us in a strong position to build our business for the
long term. We also put our cash to work to provide more immediate return for our shareholders. In July 2006, the CN
Board authorized the purchase for cancellation of up to 28 million shares of CN stock by July 2007. More recently,
in January 2007, the Board also approved CN’s 11th consecutive dividend increase.
63830_ang_001_023.indd 5
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Canadian National Railway Company
We delivered excellent results for our shareholders and our customers with solid operating performance in 2006.
On-time performance in our carload business, which we measure against a very tight compliance window, reached close
to 90 per cent across the network in spite of harsh weather conditions in western Canada late in the year. Average car
velocity (the number of miles travelled per day from origin to destination) improved by approximately 10 per cent com-
pared with 2005. This is part of our ongoing and concerted effort to increase the fluidity of our network.
Perhaps the most important measure of performance, one that affects our customers, our employees and the com-
munities in which we operate, is safety. Even though CN has over the years consistently been one of the industry’s safest
carriers, 2005 was a tough year for us. We spent 2006 continuing to work with regulatory authorities, making process
improvements and investments in equipment and technology to help further ensure the safe operation of the railroad.
We were encouraged by the decrease in main-track derailments in 2006, but safety is one area of performance
where we can never be satisfied. Every accident or injury is one too many. We’ll continue to strive for excellence and
improvement in this critical area of our business.
Investing in safety, operational excellence and growth In 2006, we spent more than $1.5 billion – representing
20 per cent of our revenues – on capital programs designed to maintain the safety and integrity of our rail infrastructure,
improve the fluidity of our network and support growth initiatives.
We spent approximately $1 billion for the replacement of rail, ties, ballast and other track material, for bridge and
signalling system upgrades, and for network productivity and strategic projects, including siding extensions in western
Canada, investments in our Prince Rupert corridor and improvements in CN’s Johnston Yard in Memphis, Tennessee.
We spent approximately $350 million for new equipment and the rejuvenation of our locomotive and railcar fleets, and
approximately $200 million on facilities, information technology and other projects to support efficiency improvements
and growth initiatives.
In November 2006, we renewed our commitment to running a safe, efficient and productive railroad with the
announcement of our intention to increase 2007 capital spending to $1.6 billion. The allocations will be similar
Canadian National Railway Company
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We see a number of promising
opportunities to leverage the CN
precision operating model.
to our 2006 capital budget – significant investments to maintain a safe railway, improve the efficiency and fluidity
of our network, and support key growth initiatives in Canada and the United States.
Development of the port facility at Prince Rupert continued as planned in 2006, with terminal and rail-related
construction on schedule for a fall 2007 opening. This is an exciting opportunity, and we’re investing across our
network to take full advantage, not just of anticipated Asian container traffic bound for destinations in North America,
but also of backhaul opportunities across a wide range of containerizable commodities. Prince Rupert will be a strong
addition to CN’s gateway strategy, joining Vancouver on the West Coast, Halifax on the East Coast and New Orleans
and Mobile, Alabama, on the Gulf, positioning us to benefit from growing global trade.
Where from here Ten years ago, CN set out with a goal that many thought grandiose: to become North America’s
best railroad. Today, many people would agree that we’ve achieved that goal: service reliability that consistently ranks
in the top of independent surveys; an operating ratio that leads the industry by a wide margin; a strong culture of
innovation developed over the years, from our precision railroading model to our unique hourly labour agreements;
solid, consistent, profitable performance through a number of ups and downs in the economy.
We’ve proven a lot, no question. But, as I say every year, there’s much more to prove. We can continue to get
better at leveraging our business model to improve customer service, safety performance and shareholder value. But
that’s a given. That’s always the goal.
Now we’re setting our sights on new directions for CN. Something we can strive for over the next decade. North
America’s best railroad, why stop there? Why not strive to become one of the world’s best transportation companies?
We’re a company that differentiates itself from others by continuously defining new horizons for profitable
growth. A good example is CN WorldWide, our international freight forwarding service subsidiary, launched in Europe
two years ago to leverage CN’s extensive North American route knowledge for trans-Atlantic shippers. In October 2006,
CN WorldWide started operations in China with offices in Shanghai, Beijing and Shenzhen. While it’s still early in
the development process, CN WorldWide has begun to prove that it can deliver an excellent product by applying the
CN precision approach beyond rail.
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Canadian National Railway Company
In 2007, we’ll continue to gradually ramp up our efforts to offer more integrated transportation services within
North America, extending CN precision and reliability across the logistics chain to include warehousing and distribution,
ground transportation and other services. Why not? We already have much of the know-how, and we can integrate these
services under CN management. This is a promising opportunity to help our customers realize the benefit of improved
speed and door-to-door reliability for their shipments across North America.
Defining new growth horizons, striving to become the best transportation company in the world. A new vision?
I don’t know if I’d call it that yet. Call it a dream. But I see no reason why we can’t do it, without losing any of our
passion for efficient railroading. We still have some ways to go to chart the detailed roadmap. But from there on in,
we’ll do what we do best.
We’re going to prove it to the world.
Sincerely,
Signed by
E. Hunter Harrison
President and Chief Executive Officer
Canadian National Railway Company
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What we’re doing to prove it.
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Canadian National Railway Company
10
10
Canadian National Railway Company
Canadian National Railway Company
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2/22/07 10:20:47 AM
Delivering reliability.
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2/22/07 12:58:37 PM
Canadian National Railway Company
11
What’s behind CN’s industry leadership
changes, CN’s focus on the basics, captured
those commitments, we do what it takes to
and consistent performance? Our balanced
in five guiding principles, will never change.
meet them. That’s what service is all about.
franchise – a diverse mix of commodities,
Reliability.
carried on a highly efficient rail network
The fundamentals got us here
Managing costs and maximizing the pro-
spanning North America’s three coasts.
Five principles guide CN: deliver great
ductivity of our assets are possible only with
That, along with the unique CN operating
customer service, tightly manage costs,
finely tuned processes that are continuously
model, characterized by a precise, scheduled
maximize the use of the company’s assets,
being refined. Always looking for ways
approach to railroading, and the people who
do it safely, and keep on developing and
to work more efficiently; doing things right
make it work, every day, day in and day out.
rewarding people.
the first time. That builds reliability and
CN people question everything they
Everything begins with the customer.
efficiency simultaneously.
do, which drives innovation. We are never
The essence of service is doing what you
Safety is critical. We work to deliver great
satisfied with our performance, which drives
say you’ll do. We’re in business to help our
service, manage costs and maximize the use
improvement. And we never lose sight of the
customers compete. We’re also in business
of our assets without anyone getting hurt
fundamentals, which keeps us on course as
to deliver a return for our shareholders.
and without damaging the environment. A
we innovate and improve. As we continue
We make commitments to our customers
safe operation is indeed the most important
to evolve, as the world around us constantly
only when we can do both. Once we make
kind of reliability.
Do what you
say you’ll do.
That’s the
first thing.
CN people are the key. Never
satisfied, always looking to
improve. Innovative thinkers.
Passionate about service ex-
cellence. In a highly complex
business, our focus is simple:
delivering the highest-quality
transportation services avail-
able in the marketplace.
12
Canadian National Railway Company
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At the end of the day, the first four fun-
people, that’s what will move us forward. We
damentals can’t take shape without the right
can improve the reliability of our rail service
people. CN people like to be challenged and
and work to grow the business across all
have a passion to excel. And they continue
commodity groups, including markets that
to prove it every day. Many are railroading
have been favouring trucks because of reli-
veterans, but for those from other back-
ability concerns with the rail industry.
grounds, we turn them into railroaders.
We can also start extending the reliabil-
That’s the idea behind our unique “Hunter
ity of our rail service further out the logistics
Camp” and “Railroad MBA” programs. At
chain. There’s potential to improve reliability
CN, we’re all railroaders, striving for quality
across the chain if we reduce the number
performance and reliability.
of interfaces between service providers and
The fundamentals will take us
Defining new growth horizons to leverage
forward
our franchise. That’s how we plan to add to
Better service, tight cost and asset manage-
our success going forward.
drive our business model from door to door.
ment, safe operations conducted by solid
Safety is a critical funda-
mental and a top priority
at CN. Each year we invest
a significant percentage of
revenues in equipment and
infrastructure, and we’re
always refining our processes
and procedures, to improve
our safety performance. Here
again, people are key. Safety
is a responsibility and com-
mitment that each of
us shares.
Reliability is the linchpin of
CN success. We are proud of
our accomplishments, but
there’s plenty of room to
improve. A key area of focus
is smooth yard operation, and
we’re working on new tech-
nology like CN’s SmartYard
to drive continuous improve-
ment across the network.
63830_ang_001_023.indd 13
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Canadian National Railway Company
13
14
Canadian National Railway Company
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Driving change.
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2/22/07 1:14:56 PM
Canadian National Railway Company
15
Precision railroading
changed everything. While
it wasn’t easy for us or our
customers to implement, the
service plan opened up a
whole new world. It brought
unprecedented asset prod-
uctivity, reliability and
competitiveness to rail. That
has given shippers more
choice than ever.
Launched a few years ago,
Intermodal Excellence (IMX)
was an entirely new ap-
proach to operating our most
complex business, applying
the discipline of precision
railroading to reduce transit
times and improve reliability.
It required a different mindset
to implement – at CN and,
more important, among
CN customers – but today IMX
has definitively improved the
speed and the reliability of
CN’s intermodal service.
We’ve always believed that change – not
extra time. This is true within CN; it’s equally
just reacting to it, but embracing and driv-
true with our customers.
ing it – is the key to our continued success.
Never being satisfied, not accepting the
Positive change benefits all
status quo, always looking for a better way
We believe that people never discover what
to do things, and once we find a better way,
they’re really capable of until they’re forced
having the courage to make it happen.
out of their comfort zone. That’s why we’ve
Change is never easy
always been aggressive in implementing
change, both within our organization and
It’s always much easier to continue doing
with customers. We’ve excelled at making
things the way they’ve always been done.
change happen in record time. Where we
Change is highly disruptive. It takes extra
have fallen short is in helping our custom-
effort to implement. Change in one process
ers understand the reasons for change and
affects other processes. People have to learn
providing them with adequate lead time
new procedures, do things they never had
to assimilate it.
to do before, which in the short term adds
time in an environment where there is little
16
Canadian National Railway Company
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2/17/07 5:05:22 AM
“In times of rapid change,
experience could be your worst enemy.”
–J. Paul Getty
We believe we’ve only
scratched the surface of the
potential of the CN operat-
ing model. We’re going to
keep working with customers
to implement change that
improves performance and
benefits all.
We’re going
to continue
to change for
the better.
Intermodal Excellence, IMX, our inter-
We’re going to keep driving change
modal service offering, is a good example.
Change is embedded in our culture. We’re
When we first introduced the product, it was
going to keep changing to improve the value
difficult for customers. It meant they had to
of what we deliver to customers. We’re
change how they managed things on their
going to keep changing to improve our cost
end, and in hindsight we didn’t do enough
structure and asset utilization.
to communicate and help them adjust. As a
We’re going to keep finding new ways
result, we faced a great deal of resistance.
to improve safety performance. We’re going
Today, our customers are starting to under-
to keep encouraging our people to embrace
stand what we’re trying to achieve. Transit
and drive change in every aspect of our
times are faster and more consistent. The
business.
process is smoother, with less waste.
In the future, we’re committed to work-
ing more closely with our customers when
we implement change that benefits all.
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Canadian National Railway Company
17
18
Canadian National Railway Company
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2/22/07 1:22:19 PM
Defining new growth horizons.
63830_ang_001_023.indd 19
2/22/07 1:24:13 PM
Canadian National Railway Company
19
Leveraging a great rail franchise
business. With reliable and efficient service,
production and trade. Prince Rupert rep-
Our network is well positioned to take
we offer a superior transportation product to
resents a strategic CN opportunity in such
advantage of increasing global demand for
a range of shippers who have traditionally
an economy. A new port on the West Coast
resources. This is particularly true for
turned to trucking. Shippers can also take
exclusively served by CN rail lines. A state-
northern Alberta’s oil sands, a huge oppor-
advantage of rail’s greater fuel efficiency,
of-the-art container terminal, connected to
tunity that the oil and gas industry is ex-
especially as we continue to rejuvenate our
major Canadian and U.S. markets by fast and
pected to spend billions of dollars over
locomotive fleet with state-of-the-art power
highly reliable intermodal service. Growing
the next 10–15 years to develop. Our net-
units. Railroads have been dreaming of get-
volumes of Asian goods coming to North
work, enhanced by the recent acquisition
ting their hands back on traffic lost to truck-
America, and significant export opportuni-
of MacKenzie Northern Railway and the
ing over the years. At CN we think the dream
ties for the backhaul of goods to Asia. We’ve
Savage Alberta Railway, Inc. and by new
can come true with the right operating
been investing in key points of our network
transload centres in Edmonton, uniquely
model and a clear focus on service quality.
to tap Prince Rupert’s potential: extended
positions CN to be a highly efficient, single-
sidings and double-stack clearances in
line provider for the oil sands.
Opening gateways to serve
British Columbia; a new intermodal terminal
Our franchise also gives us the ability to
North America
in Memphis, a critical hub for the eastern
seize other opportunities in the merchandise
Continued globalization is generating
and southern United States. The Prince
significant change in the patterns of world
We’re taking
advantage of
our strengths to
develop new
opportunities.
The expansion of global
trade represents an excellent
opportunity for CN’s unique
franchise – a precision
operating model, a balanced
mix of commodities and a
highly efficient network
that connects three North
American coasts.
20
Canadian National Railway Company
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2/22/07 1:27:55 PM
We’re taking
advantage of
our strengths to
develop new
opportunities.
Rupert terminal is scheduled to come on line
Broadening our scope, extending
shippers. Through CN WorldWide, we manage
in the fall of 2007.
the model
rail, trucking, ocean vessels, port handling,
Prince Rupert will be an important
Our passion for railroading and our model
warehousing and customs, with one point of
building block in CN’s gateway strategy.
to run the business can be pushed to other
contact, one rate and one bill of lading. With
It complements our access to Vancouver,
parts of the supply chain as we gradually
full control of rail, one of the most complex
Halifax, New Orleans and Mobile, Alabama.
expand our efforts to offer more integrated
links in the chain, we can make a difference
Given volume prospects on all global trade
transportation services in North America.
and deliver significant improvements in
routes, we can set our sights on new traffic
This includes warehousing and distribution,
speed, reliability and shipment visibility.
in and out of the North American market via
ground transport, transportation manage-
With a global scope and integrated offering,
all CN gateways. In each case, the ingredi-
ment and customs brokerage, all areas
CN WorldWide is a good example of what
ents for success are the same: fast, reliable
where CN can add value by streamlining
lies on CN’s growth horizon for the future.
rail service, reaching into key consumer
the supply chain.
markets and production centres, to and from
CN WorldWide, our international freight
uncongested ports and terminal facilities.
forwarding subsidiary, is all about offering
That is precisely what CN has to offer with
such seamless, single-source transportation
a unique three-coast network.
services for trans-Pacific and trans-Atlantic
Launched two years ago,
CN WorldWide, CN’s global
freight forwarding business,
is starting to prove itself
among an increasing number
of international shippers.
CN WorldWide offers seamless,
door-to-door service across the
Atlantic and Pacific – including
rail, trucking and vessels; port
handling, warehousing,
customs and billing – with
one point of contact.
CN now is extending its oper-
ating model across the North
American supply chain with
more integrated transporta-
tion services that include
warehousing and distribu-
tion, trucking, transportation
management and more.
63830_ang_001_023.indd 21
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Canadian National Railway Company
21
CN at a glance
With a highly effi-
cient network that
connects major ports
on three coasts to
important North
American markets,
CN is well positioned
in an increasingly
global marketplace.
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)
2006
20,264
4,824
352,972
185,610
21,685
401
÷«2.13
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
(1) Includes GLT and BC Rail from May 10, 2004 and July 14, 2004, respectively.
(2) Includes the impact of the Company’s fuel hedging program.
Prince Rupert
Certain statistical data are based on estimated data available at such time and are subject to
change as more complete information becomes available.
Kitimat
Prince George
Edmonton
Saskatoon
Vancouver
Calgary
Thunder Bay
Winnipeg
Duluth
Superior
Escanaba
Sault Ste. Marie
Minneapolis/St. Paul
Sioux City
Omaha
Green Bay
Neenah
Sarnia
Arcadia
Toronto
Buffalo
Detroit
Conneaut
Chicago
East St. Louis
Pittsburgh
Cincinnati
Quebec
Montreal
Moncton
Saint John
Halifax
Ports served by CN
Ports served by CN,
with Intermodal service
Cities with CN
Intermodal terminals
Memphis
Jackson
Baton Rouge
New Orleans
Mobile
Pascagoula
Gulfport
Petroleum and chemicals
Metals and minerals
Forest products
Petroleum and chemicals comprises
a wide range of commodities in-
cluding chemicals, sulfur, plastics,
petroleum and natural gas products.
Most of CN’s petroleum and chemicals
shipments originate in Alberta, eastern
Canada and the Gulf of Mexico, and
are destined for customers in Canada,
the United States and overseas.
CN’s metals and minerals commodity
group consists primarily of nonferrous
base metals, iron ore, steel, equipment
and parts and construction materials.
The company’s unique rail access to
major mines, ports and smelters
throughout North America has made
the company a leader in the
transportation of copper, lead, zinc
concentrates, iron ore, refined 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 fibre-pro-
ducing regions. In the United States,
CN is strategically located to serve
both the midwestern and southern
U.S. corridors with interline capabili-
ties to other Class I railroads.
We believe the
balance of our
commodity mix
positions us well
to face economic
fluctuations and
enhances our
potential to grow
revenues.
22
Canadian National Railway Company
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Prince Rupert
Kitimat
Prince George
Edmonton
Saskatoon
2006 data
Petroleum and chemicals
Metals and minerals
Forest products
Coal
Grain and fertilizers
Intermodal
Automotive
Freight
revenues
(millions)
$1,173
885
1,745
375
1,259
1,420
514
Revenue ton
miles (RTM)(1)
(millions)
Freight revenue
per RTM(1)
(cents)
31,868
17,467
42,488
13,727
44,096
32,922
3,042
3.68
5.07
4.11
2.73
2.86
4.31
16.90
(1) Such statistical data and related productivity measure are based on estimated data available at such time and are subject to change as more complete
information becomes available.
Vancouver
Calgary
Thunder Bay
Winnipeg
Duluth
Superior
Escanaba
Sault Ste. Marie
Minneapolis/St. Paul
Sioux City
Omaha
Green Bay
Neenah
Sarnia
Arcadia
Toronto
Buffalo
Detroit
Conneaut
Chicago
Quebec
Montreal
Moncton
Saint John
Halifax
Ports served by CN
Ports served by CN,
with Intermodal service
Cities with CN
Intermodal terminals
East St. Louis
Pittsburgh
Cincinnati
Memphis
Jackson
Baton Rouge
New Orleans
Mobile
Pascagoula
Gulfport
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 south-
eastern United States. CN also moves
metallurgical 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 ser-
vice handles two segments. The first
segment, domestic, is responsible for
consumer products and manufac-
tured goods, operating through both
retail and wholesale channels within
domestic Canada, domestic United
States, Mexico and transborder. The
second, the international segment,
handles import and export container
traffic, serving the ports of Vancouver,
Montreal, Halifax and New Orleans.
CN is a leading carrier of automotive
products originating in southwestern
Ontario, Michigan and Mississippi.
This commodity group moves both
finished vehicles and parts within the
United States, Canada and Mexico. CN
also serves shippers of import vehicles
via the ports of Halifax and Vancouver,
and through interchange with other
railroads.
Canadian National Railway Company
23
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2/22/07 2:35:56 PM
A message from the Chairman
Dear fellow shareholders 2006 was another extraordi-
narily successful year for CN. The management team and CN
employees continue to prove the strength of the franchise
and business model with industry-leading performance.
One of the hallmarks of the CN corporate culture is
never being satisfied. This has been true of CN since its first
year as a public company in 1995; it’s just as true today.
This attitude drives a philosophy of continuous improvement.
We have been refining and deepening our corporate
governance policies and procedures on an ongoing basis for a
long time. Our efforts have gained recognition from a number
of prestigious organizations, most recently including a num-
ber-two position in the 2006 ranking of Canada’s best boards from Canadian Business magazine and the highest rating, AAA+,
from the Rotman School of Management (Clarkson Centre) – Board Shareholder Confidence Index in 2006.
Such recognition, while encouraging, is not the goal. Our mandate is to continuously improve our performance as
responsible stewards of our shareholders’ best interests – to be independent, engaged, proactive, transparent, well aligned and
well informed; to seek always and on an ongoing basis to strengthen those attributes. This is what we have done, and this is
what we are continuing to do, most recently with enhanced compensation disclosure, increased share ownership requirements
for directors and guidelines on the number of other boards on which CN directors may serve.
In late 2006, the Board was delighted to announce a one-year extension of Hunter Harrison’s contract through
December 31, 2009. Hunter is a unique leader, a central figure in CN’s becoming one of North America’s most innovative and
best-performing railroads. We were also pleased to welcome Robert H. Lee to our Board, who brings a broad business back-
ground that includes extensive experience in Asia that I know will serve CN well.
One of our most distinguished directors, Purdy Crawford, reached mandatory retirement age and will step down from the
Board effective with the CN Annual Meeting in 2007. Mr. Crawford has been an invaluable member of our Board since 1995;
he has served as chair of the Human Resources and Compensation Committee, and as a member of a number of important
committees, during his tenure. His wisdom and talent will be greatly missed. To recognize his extraordinary contributions, the
Board created the Director Emeritus designation, an honourary title that will be awarded to him and one other valued CN
director who retired a few years ago: Cedric Ritchie.
As chairman of the CN Board of Directors, I have never been more confident in the quality of our Board, the strength
of our management team and the direction of the company. I believe the future of CN is bright indeed.
Sincerely,
Signed by
David McLean, O.B.C., LL.D.
Chairman of the Board
24
90
Canadian National Railway Company
Canadian National Railway Company
63830_ang_024_029.indd 24
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Pulling together for communities.
63830_ang_024_029.indd 25
2/17/07 12:16:34 AM
Canadian National Railway Company
25
The spirit
of CN:
committed
to building
safer,
stronger
communities.
Le Bonheur Children’s Medical Center, Memphis, Tennessee
When E. Hunter Harrison presented CN’s
Community investment program
Part of the strength of our All Aboard
U.S. $1 million cheque to Le Bonheur
Our community investment program, Pulling
for Safety program is the collaborative
Children’s Medical Center in Memphis,
Together, symbolizes CN’s commitment to
relationship we share with law enforcement
Tennessee, to fund its new facility last April,
help build safer, stronger communities. While
agencies, firefighters, emergency medical
he aptly demonstrated the spirit of caring
community safety is the primary focus of
service providers and our community safety
that animates CN’s people. An important part
our program, we also support projects that
partners, which include Operation Lifesaver,
of this donation went towards the creation
further educational opportunities, conserva-
Safe Kids Worldwide, Safe Kids Canada,
of a Safety Street program for elementary
tion and awareness of our heritage. We focus
SMARTRISK and Safe Communities Canada.
school students throughout western
particularly on initiatives that align with
We all share a common goal: to help prevent
Tennessee. This gift to Le Bonheur is just
our business. In 2006, we created the
injuries and save lives. With Safe Kids
one example of many initiatives designed
CN Rail Studies Fund at the University of
Canada, we launched Safe Crossing Week,
to promote the safety, health and overall
Wisconsin-Superior and established a new
October 23–29, 2006. During the week,
betterment of the people who live, work
lecturer position in railway engineering
teachers in almost 300 elementary schools
and play in the communities we serve across
at the University of Illinois at Urbana-
and CN Police officers talked to about
Canada and the United States.
Champaign.
As an Imagine Caring Company, CN
50,000 children about the importance of
crossing tracks safely. In 2007, we plan to
is committed to contributing about 1 per
All Aboard for Safety
extend Safe Crossing Week into schools and
cent of our pre-tax profit to non-profit
Our ongoing All Aboard for Safety commu-
cities in the United States.
organizations.
nity education program encompasses a wide
To promote incident-free transporta-
range of initiatives, including safety presen-
tion of regulated products, we grant Safe
tations to more than 300,000 children and
Handling awards to customers who meet the
adults, mock train-car collisions, a website
strict standards for handling and shipping
for kids and our safety train, Little Obie.
26
Canadian National Railway Company
63830_ang_024_029.indd 26
2/22/07 10:26:51 AM
CN employees pull a locomotive to raise funds for Special Olympics
E. Hunter Harrison presents a cheque to Debbie Comuzzi, president and CEO,
Children’s Health Foundation, London, Ontario
Passion at CN Future Links
these goods. Close to 100 customers earned
world-class event to something important
wear the All Aboard for Safety logo on
awards in 2006, the program’s 15th year.
to the community: Children’s Hospital of
their t-shirts and absorb the rail safety
Our commitment to spreading the safety
Western Ontario. CN’s $250,000 donation
message that is part of so many of our
message also extends beyond our rail lines.
was supplemented by $100,000 from the
community initiatives.
In 2006, we donated $500,000 to establish
tournament’s net proceeds and $63,000
It’s all in the spirit of caring – pulling
the Agricultural Injury Control Program at
raised in the community through the CN
together for our communities.
the University of Saskatchewan’s Centre
Miracle Match challenge to produce a total
for Health and Safety in Agriculture. Aimed
of $413,000 for the hospital. Little Obie was
at preventing agriculture-related injuries
on hand throughout the tournament, bring-
and deaths, the program involves research
ing the safety message and plenty of excite-
as well as educating farm families and
ment to the young patients and their parents
agricultural workers about air, food and
who came to the event from the hospital.
water contamination and unsafe working
We look forward to the 2007 CN Canadian
conditions.
Women’s Open in Edmonton, Alberta, and
another opportunity to benefit a community.
Promoting safer, stronger
At CN, we have learned that being
communities through sports
passionate about what you do can take you
CN knows there’s a clear link between
a long way. That’s why we became a sponsor
sports, safe and healthy living, and a strong
of the Canada-wide CN Future Links junior
community spirit. In 2006, we became the
golf program. It’s a program that is much
title sponsor of one of the top LPGA tourna-
more than teaching kids how to play golf.
ments, the CN Canadian Women’s Open,
It’s also about helping them discover a
held in London, Ontario. CN is proud that
passion. In the process, the young golfers
the Open gave us the opportunity to link this
63830_ang_024_029.indd 27
2/22/07 10:28:17 AM
Canadian National Railway Company
27
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.
Rolling stock – Transportation equipment on wheels, especially
locomotives and freight cars.
Carload – A one-car shipment of freight from one consignor to one
consignee.
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.
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 2005 was $319.3 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.
Intermodal service – In railroad transportation, the movement of
trailers or containers on railroad freight cars.
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.
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.
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 specific customer location, day of week and time of release.
Unit train – A train with a fixed, 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.
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 defined limits, designed for switching
services.
Yard dwell – Yard dwell is the average duration, expressed in hours,
that cars spend in a specific operating terminal.
28
Canadian National Railway Company
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Financial Section (U.S. GAAP)
Contents
Canadian National Railway Company
30 Selected Railroad Statistics
31 Management’s Discussion and Analysis
58 Management’s Report on Internal Control over Financial Reporting
58 Report of Independent Registered Public Accounting Firm
59 Report of Independent Registered Public Accounting Firm
60 Consolidated Statement of Income
61 Consolidated Statement of Comprehensive Income
62 Consolidated Balance Sheet
63 Consolidated Statement of Changes in Shareholders’ Equity
64 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
65
67
68
68
69
69
69
69
70
71 10 Long-term debt
72 11 Capital stock
73 12 Stock plans
76 13 Pensions
78 14 Other income (loss)
78 15 Income taxes
79 16 Segmented information
80 17 Earnings per share
80 18 Major commitments and contingencies
83 19 Financial instruments
84 20 Accumulated other comprehensive loss
84 21 Comparative figures
63830_ang_024_029.indd 29
2/17/07 12:33:21 AM
U.S. GAAP
Canadian National Railway Company
29
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 year)
Employees (average for the year)
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 (3)
Accident rate per million train miles (3)
(1) Includes GLT and BC Rail from May 10, 2004 and July 14, 2004, respectively.
(2) Includes the impact of the Company’s fuel hedging program.
(3) Based on Federal Railroad Administration (FRA) reporting criteria.
2006
2005
2004 (1)
7,371
352,972
185,610
4,824
20,264
21,811
21,685
60.7
3.97
1,528
1.33
0.51
16,277
401
2.13
880
2.1
2.2
6,905
342,894
179,701
4,841
19,221
21,540
22,246
63.8
3.84
1,426
1.35
0.54
6,252
332,807
174,240
4,578
19,304
22,679
22,470
66.9
3.59
1,366
1.32
0.55
15,414
14,811
403
1.72
851
2.4
1.8
391
1.30
851
2.6
1.6
Certain statistical data and related productivity measures are based on estimated data available at such time and are subject to change as more complete information becomes available.
30
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 30
2/16/07 9:22:22 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,
together with its wholly-owned subsidiaries, collectively “CN” or “the Company.” Canadian National Railway Company’s common shares are
listed on the Toronto and New York stock exchanges. Except where otherwise indicated, all financial information reflected herein is expressed in
Canadian dollars and determined on the basis of United States generally accepted accounting principles (U.S. GAAP). The Company’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 2006 Annual Consolidated Financial Statements and
Notes thereto.
Business profile
Strategy overview
CN is engaged in the rail and related transportation business. CN’s
network of approximately 20,300 route miles of track spans Canada and
mid-America, connecting three coasts: the Atlantic, the Pacific and the
Gulf of Mexico. CN’s extensive network, in addition to co-production
arrangements, routing protocols, marketing alliances, and interline
agreements, provide 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 a wide range of origins and destinations. This product and
geographic diversity positions the Company well to face economic fluc-
tuations and enhances its potential for growth opportunities. In 2006,
no individual commodity group accounted for more than 23% of reve-
nues. From a geographic standpoint, 22% of revenues came from United
States (U.S.) domestic traffic, 32% from transborder traffic, 23% from
Canadian domestic traffic and 23% 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 and cash flow from operations,
is used by the Company’s corporate management in evaluating financial
and operational performance and allocating resources across CN’s net-
work. 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
Region, Eastern Region and Southern Region), whose role is to manage
the day-to-day service requirements within their respective territories,
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.
CN’s focus is on running a safe and efficient railroad. While remaining
at the forefront of the rail industry, CN’s goal is to be internationally
regarded as one of the best-performing transportation companies.
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. By striving for sustainable financial perfor-
mance through profitable growth, solid free cash flow and a high return
on investment, CN seeks to deliver increased shareholder value.
CN has a unique business model, which is anchored on five prin-
ciples: providing quality service, controlling costs, focusing on asset
utilization, committing to safety, and developing people. “Precision rail-
roading” is at the core of CN’s business model. It is a highly disciplined
process whereby CN handles individual rail shipments according to a
specific trip plan and manages all aspects of railroad operations to meet
customer commitments efficiently and profitably.
Precision railroading demands discipline to execute the trip plan,
the relentless measurement of results, and the use of such results to
generate further execution improvements. Precision railroading increases
velocity, improves reliability, lowers costs, enhances asset utilization and,
ultimately, helps the Company to grow the top line. It has been a key
contributor to CN’s continued earnings growth and improved return.
The Company sees further significant opportunities to grow the
business and improve productivity. While the recent slowdown in the
economy has affected CN in specific markets such as key forest prod-
ucts, construction materials and automotive products, there are several
opportunities that extend beyond business-cycle considerations. In
Intermodal, the opening of the Prince Rupert Intermodal Terminal in the
fourth quarter of 2007 will allow CN to leverage the potential of the
growing container trade between Asia and North America. In Bulk, the
Company expects to continue to benefit from increased resource
demand, particularly as it relates to the recent coal mine expansion.
In Merchandise, the Company sees growth potential for a number of
commodities, particularly pipes, machinery and equipment, condensate
and other commodities associated with oil and gas development in
western Canada. In Automotive, manufacturers continue to invest in
CN-served plants in Michigan and Ontario. In general, while the
Company expects a moderate slowdown in the North American econ-
omy in the near term, its business prospects assume positive economic
conditions in North America and globally.
63830_ang_030_059.indd 31
2/16/07 9:22:26 PM
U.S. GAAP
Canadian National Railway Company
31
Management’s Discussion and Analysis
The opportunities to further improve productivity extend across all
functions in the organization. In Transportation, the Company is aiming
to continue to increase productivity on the track and in the yards. Yard
throughput is being improved through SmartYard, an innovative use of
real-time traffic information to sequence cars effectively and get them
out on the line more quickly in the face of constantly changing condi-
tions. In Engineering, the Company is working to increase the productiv-
ity of its field forces, again through better use of traffic information and,
as a result, better management of its engineering forces on the track.
The Company also intends to maintain a solid focus on reducing acci-
dents and related costs, and also costs for legal claims and health care.
CN’s capital programs support the Company’s commitment to the
five principles and its ability to grow the business profitably. In 2007,
CN plans to spend $1.6 billion on capital programs. Of this, more than
$1 billion is targeted towards track infrastructure to maintain a safe rail-
way and to improve the productivity and fluidity of the network, and
includes the replacement of rail, ties, and other track materials, as well
as the improvement of bridges. This amount also includes funds for
strategic initiatives, such as siding extensions to accommodate container
traffic from the Prince Rupert Intermodal Terminal, the addition of new
siding capacity between Winnipeg and Chicago, the upgrade of the
Company’s freight car classification yard in Memphis, Tennessee, and
additional enhancements to the track infrastructure in western Canada
to take advantage of growth prospects in North American trade with
Asia and the boom in the west.
CN’s equipment spending, targeted to reach approximately $350
million, is intended to tap growth opportunities and to improve the qual-
ity of the fleet to meet customer requirements. This expenditure includes
the acquisition of new fuel-efficient locomotives and freight cars, as
well as improvements to the existing fleet. CN also expects to spend
approximately $200 million on facilities to grow the business, including
transloads and distribution centers, on information technology to
improve service and operating efficiency, and on other projects to
increase productivity.
Financial and statistical highlights
The Company’s commitment to safety is reflected in the wide range
of initiatives that CN is pursuing and the size of its capital programs.
Comprehensive plans are in place addressing the issues of safety, secu-
rity, employee well-being and environmental management. CN’s
Integrated Safety Plan is the framework for putting safety at the center
of its day-to-day operations. This proactive plan is designed to minimize
risk and drive continuous improvement in the reduction of injuries and
accidents, is fully supported by senior management, and engages
employees at all levels of the organization. CN also insists that its opera-
tions be conducted in compliance with all applicable regulations to
maintain a safe, secure and healthy workplace.
Environmental protection is also an integral part of CN’s day-to-day
activities. A combination of key resource people, training, policies, moni-
toring and environmental assessments helps to ensure that the Company’s
operations comply with CN’s Environmental Policy, a copy of which is
available on CN’s website.
CN’s ability to develop the best railroaders in the industry has been
a key contributor to the Company’s success. CN recognizes that without
the right people – no matter how good a service plan or business model
a company may have – it will not be able to fully execute. The Company
is focused on recruiting the right people, developing employees with the
right skills, motivating them to do the right thing, and training them to
be the future leaders of the Company.
The forward-looking statements provided in the above section and in
other parts of this MD&A are subject to risks and uncertainties that
could cause actual results or performance to differ materially from those
expressed or implied in such statements and are based on certain factors
and assumptions which the Company considers reasonable, about
events, developments, prospects and opportunities that may not materi-
alize or that may be offset entirely or partially by other events and
developments. See the Business risks section of this MD&A for assump-
tions and risk factors affecting such forward-looking statements.
$ in millions, except per share data, or unless otherwise indicated
2006
2005
2004
Financial results
Revenues
Operating income
Net income (a)
Operating ratio
Basic earnings per share (a)
Diluted earnings per share (a)
Dividend declared per share
Financial position
Total assets
Total long-term financial liabilities
Statistical operating data and productivity measures
Employees (average for the year)
Gross ton miles (GTM) per average number of employees (thousands)
GTMs per U.S. gallon of fuel consumed
$÷7,716
$÷3,030
$÷2,087
60.7%
$÷÷3.97
$÷÷3.91
$÷÷0.65
$24,004
$12,066
21,685
16,277
880
$÷7,240
$÷2,624
$÷1,556
63.8%
$÷÷2.82
$÷÷2.77
$÷÷0.50
$22,188
$10,981
22,246
15,414
851
$÷6,548
$÷2,168
$÷1,258
66.9%
$÷÷2.21
$÷÷2.17
$÷÷0.39
$22,365
$10,822
22,470
14,811
851
(a) The 2006 figures included a deferred income tax recovery of $277 million ($0.53 per basic share or $0.51 per diluted share), resulting from the enactment of lower federal and provincial
corporate tax rates in Canada and the resolution of matters pertaining to prior years’ income taxes.
32
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 32
2/22/07 10:31:02 AM
Management’s Discussion and Analysis
Financial results
Petroleum and chemicals
2006 compared to 2005
In 2006, net income increased by $531 million, or 34%, to $2,087 mil-
lion, when compared to 2005, with diluted earnings per share rising
41%, to $3.91. Included in the 2006 figures was a deferred income tax
recovery of $277 million ($0.53 per basic share or $0.51 per diluted
share), resulting from the enactment of lower federal and provincial
corporate tax rates in Canada and the resolution of matters pertaining
to prior years’ income taxes.
Revenues increased by $476 million, or 7%, to $7,716 million,
mainly due to freight rate increases and volume growth, particularly for
grain, intermodal and metals and minerals, which were partly offset by
the translation impact of the stronger Canadian dollar on U.S. dollar-
denominated revenues.
Operating expenses increased by $70 million, or 2%, to $4,686 mil-
lion, mainly due to increased fuel costs, purchased services and material
expense and depreciation. Partly offsetting these factors was the transla-
tion impact of the stronger Canadian dollar on U.S. dollar-denominated
expenses and lower casualty and other expense.
The operating ratio, defined as operating expenses as a percentage
of revenues, was 60.7% in 2006 compared to 63.8% in 2005, a 3.1-
point betterment.
Foreign exchange fluctuations have had an impact on the compara-
bility of the results of operations. In 2006, the continued appreciation in
the Canadian dollar relative to the U.S. dollar, which has affected the con-
version of the Company’s U.S. dollar-denominated revenues and expenses,
has resulted in a reduction to net income of approximately $60 million.
Revenues
Year ended December 31,
2006
2005 % Change
Total revenues (millions)
$7,716
$7,240
7%
Rail freight:
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Carloads (thousands)
Revenue/carload (dollars)
$7,371
$6,905
185,610
179,701
3.97
4,824
1,528
3.84
4,841
1,426
7%
3%
3%
–
7%
Revenues for the year ended December 31, 2006 totaled $7,716 million
compared to $7,240 million in 2005. The increase of $476 million, or 7%,
was mainly due to freight rate increases of approximately $500 million,
of which approximately 40% was due to a higher fuel surcharge that
mainly resulted from increases in crude oil prices; and volume growth,
particularly for grain, intermodal and metals and minerals. Partly offset-
ting these gains was the $255 million translation impact of the stronger
Canadian dollar on U.S. dollar-denominated revenues.
In 2006, revenue ton miles (RTMs), measuring the relative weight
and distance of rail freight transported by the Company, increased by
3% relative to 2005. Freight revenue per revenue ton mile, a measure-
ment of yield defined as revenue earned on the movement of a ton of
freight over one mile, increased by 3% in 2006 when compared to 2005,
largely due to freight rate increases that were partly offset by the trans-
lation impact of the stronger Canadian dollar on U.S. dollar-denominated
revenues and an increase in the average length of haul.
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Year ended December 31,
2006
$1,173
31,868
3.68
2005 % Change
$1,096
31,235
3.51
7%
2%
5%
Petroleum and chemicals comprises a wide range of commodities,
including chemicals, sulfur, plastics, petroleum and natural gas products.
Although offshore markets continue to grow strongly, the primary mar-
kets for these commodities are still within North America. As such, the
performance of this commodity group is closely correlated with the
North American economy. Most of the Company’s petroleum and chemi-
cals 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 world scale petrochemicals and
plastics complex derivatives; and in eastern Canadian regional plants.
These shipments are destined for customers in Canada, the United States
and overseas. For the year ended December 31, 2006, revenues for this
commodity group increased by $77 million, or 7%, from 2005. The
improvement in this commodity group was mainly due to freight rate
increases and increased shipments of condensate for oil sands-related
development, and plastics and petrochemicals. These gains were partly
offset by the translation impact of the stronger Canadian dollar; lower
petroleum products shipments in the second quarter of 2006 due to a
temporary refinery shutdown; reduced spot shipments of heavy fuel oils
in eastern Canada; lower liquefied petroleum gas shipments on account
of warmer weather conditions; and a reduction in sulfur shipments in
western Canada, particularly in the fourth quarter due to inclement
weather. Revenue per revenue ton mile increased by 5% in 2006, largely
due to freight rate increases that 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
3
4
5
4
6
5
6
9
5
4
9
5
0
9
5
40%
60%
60% Petroleum and plastics
40% Chemicals
02
03
04
05
06
* Includes the former Great Lakes Transportation
LLC’s railroads and related holdings (GLT) from
May 10, 2004 and the former BC Rail (BC Rail)
from July 14, 2004
BCN USE ONLY
Scale: 1 = .12pt
63830_ang_030_059.indd 33
2/22/07 1:56:51 PM
U.S. GAAP
Canadian National Railway Company
33
Management’s Discussion and Analysis
Metals and minerals
Forest products
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Year ended December 31,
2006
$885
17,467
5.07
2005 % Change
Year ended December 31,
$837
16,848
4.97
6%
4%
2%
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
2006
$1,745
42,488
4.11
2005 % Change
$1,738
42,330
4.11
–
–
–
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 leader in
the transportation 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, 2006, revenues for this commodity group
increased by $48 million, or 6%, from 2005. The improvement in this
commodity group was mainly due to freight rate increases; strong ship-
ments of Canadian long steel products, primarily pipes for oil sands-
related development; increased volumes of U.S. iron ore and raw
materials for steel production due to higher demand, despite temporary
fourth-quarter 2006 production issues at a customer plant; and strong
machinery and dimensional loads traffic also for oil sands-related
development. Partly offsetting these gains was the translation impact of
the stronger Canadian dollar and reduced construction material ship-
ments, particularly in the fourth quarter of 2006 due to softening
demand. Revenue per revenue ton mile increased by 2% in 2006, mainly
due to freight rate increases that 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
20%
25%
55% Metals
25% Minerals
20% Iron ore
4
9
9
1
8
9
1
0
8
55%
8
8
3
6
9
3
02
03
04
05
06
* Includes GLT from May 10, 2004 and BC Rail from
July 14, 2004
BCN USE ONLY
Scale: 1 = .072pt
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 stra-
tegically located to serve both the Midwest and southern U.S. corridors
with interline 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 lum-
ber 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,
2006, revenues for this commodity group increased by $7 million,
remaining relatively flat when compared to 2005. The improvement in
this commodity group was mainly due to freight rate increases and
increased lumber shipments originating from western Canada in the first
half of the year. Largely offsetting these gains was the translation impact
of the stronger Canadian dollar; a reduction in pulp and paper shipments
due to continued weak market conditions and related mill closures; and
lower lumber shipments originating from eastern Canada, particularly
driven by mill closures in the fourth quarter of 2006. Revenue per reve-
nue ton mile was flat in 2006 when compared to 2005, mainly due to
freight rate increases that were 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
13%
6
2
6
8
1
6
34%
8
7
6
2
1
7
7
6
6
22%
31%
34% Lumber
31% Fibers
22% Paper
13% Panels
BCN USE ONLY
Scale: 1 = .102pt
02
03
04
05
06
* Includes GLT from May 10, 2004 and BC Rail from
July 14, 2004
34
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 34
2/22/07 2:03:10 PM
Management’s Discussion and Analysis
Coal
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Grain and fertilizers
Year ended December 31,
2006
2005 % Change
Year ended December 31,
2006
2005 % Change
$375
13,727
2.73
$331
13,576
2.44
13%
Revenues (millions)
1%
RTMs (millions)
12%
Revenue/RTM (cents)
$1,259
44,096
2.86
$1,119
40,393
2.77
13%
9%
3%
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. For the year ended December 31, 2006, revenues
for this commodity group increased by $44 million, or 13%, from 2005.
The improvement in this commodity group was mainly due to the expan-
sion of metallurgical coal mines in western Canada and freight rate
increases. Partly offsetting these gains was a decline in CN shipments
originating from U.S. coal mines; the translation impact of the stronger
Canadian dollar; and the loss of export shipments of petroleum coke due
to adverse market conditions. The revenue per revenue ton mile increase
of 12% in 2006 was mainly due to freight rate increases, 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
14%
5
3
4
6
0
4
9
2
4
8
4
4
1
1
4
86%
86% Coal
14% Petroleum coke
02
03
04
05
06
* Includes GLT from May 10, 2004 and BC Rail from
July 14, 2004
BCN USE ONLY
Scale: 1 = .16pt
The grain and fertilizers commodity group depends primarily on crops
grown and fertilizers processed in western Canada and the U.S. Midwest.
The grain segment consists of three primary commodities: food grains,
mainly wheat; oilseeds and oilseed products, primarily canola seed, oil
and meal; and feed grains, including feed barley, feed wheat and corn.
Production of grain varies considerably from year to year, affected
primarily by weather conditions. Grain exports are sensitive to the size
and quality of the crop produced, international market conditions and
foreign government policy. The majority of grain produced in western
Canada and moved by CN is exported via the ports of Vancouver, Prince
Rupert and Thunder Bay. Certain of these rail movements are subject to
government regulation and to a “revenue cap,” which effectively estab-
lishes a maximum revenue entitlement that railways can earn. In the
U.S., grain grown in Illinois and Iowa is exported, as well as transported
to domestic processing facilities and feed markets. The Company also
serves 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, 2006, revenues for this commodity
group increased by $140 million, or 13%, from 2005. The improvement
in this commodity group was mainly due to freight rate increases; higher
shipments of U.S. corn mainly due to a larger harvest; stronger volumes
of Canadian wheat due to a high quality crop; and increased shipments
of canola. These gains were partly offset by the translation impact of
the stronger Canadian dollar; decreased shipments of potash and other
fertilizers due in part to soft North American market conditions; and
decreased Canadian barley shipments. Revenue per revenue ton mile
increased by 3% in 2006, largely due to freight rate increases that 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
8%
10%
28%
9
3
5
2
5
5
7
7
5
6
6
5
4
9
5
27%
27%
28% Food grain
27% Feed grain
27% Oilseeds
10% Fertilizers
8% Potash
02
03
04
05
06
* Includes GLT from May 10, 2004 and BC Rail from
July 14, 2004
BCN USE ONLY
Scale: 1 = .12pt
63830_ang_030_059.indd 35
2/22/07 2:05:12 PM
U.S. GAAP
Canadian National Railway Company
35
Management’s Discussion and Analysis
Intermodal
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Year ended December 31,
2006
2005 % Change
Year ended December 31,
Automotive
$1,420
32,922
4.31
$1,270
32,184
3.95
12%
Revenues (millions)
2%
9%
RTMs (millions)
Revenue/RTM (cents)
2006
$514
3,042
16.90
2005 % Change
$514
3,135
16.40
–
(3%)
3%
The intermodal commodity group is comprised of two segments: domestic
and international. The domestic segment transports consumer products
and manufactured goods, operating through both retail and wholesale
channels, within domestic Canada, domestic U.S., Mexico and transbor-
der, while the international segment handles import and export con-
tainer 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, 2006, revenues for this commodity group
increased by $150 million, or 12%, from 2005. The improvement in this
commodity group was mainly due to freight rate increases; growth in
international container traffic, primarily from Asia; and increased domes-
tic movements, particularly to transborder markets and western Canada.
Partly offsetting these gains was the translation impact of the stronger
Canadian dollar. The revenue per revenue ton mile increase of 9% in
2006 was largely due to freight rate increases and a decrease in the
average length of haul, which were partly offset by the translation
impact of the stronger Canadian dollar.
Percentage of revenues
Carloads*
In thousands
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, 2006,
revenues for this commodity group remained unchanged from 2005. The
benefit of freight rate increases and higher shipments of import vehicles
via CN-served ports was offset by the translation impact of the stronger
Canadian dollar and reduced shipments from domestic producers,
primarily driven by production slowdowns. Revenue per revenue ton mile
increased by 3% in 2006, largely due to freight rate increases that 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
6
2
3
,
1
15%
7
0
3
8
8
2
5
9
2
9
7
2
5
5
2
85%
48%
52%
52% International
48% Domestic
02
03
04
05
06
* Includes GLT from May 10, 2004 and BC Rail from
July 14, 2004
BCN USE ONLY
Scale: 1 = .06pt
85% Finished vehicles
15% Auto parts
02
03
04
05
06
* Includes GLT from May 10, 2004 and BC Rail from
July 14, 2004
Other
BCN USE ONLY
In 2006, other revenues increased by $10 million, when compared to
2005, mainly due to increased interswitching, rental and vessel revenues.
Scale: 1 = .24pt
36
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 36
2/22/07 2:06:12 PM
Management’s Discussion and Analysis
Operating expenses
Operating expenses amounted to $4,686 million in 2006 compared to $4,616 million in 2005. The increase of $70 million, or 2%, in 2006 was
mainly due to increased fuel costs, purchased services and material expense and depreciation. Partly offsetting these factors were the $150 million
translation impact of the stronger Canadian dollar on U.S. dollar-denominated expenses and lower casualty and other expense.
In millions
Year ended December 31,
2006
2005
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 expense includes
wages, payroll taxes, and employee benefits such as incentive compensa-
tion, stock-based compensation, health and welfare, pensions and other
post-employment benefits. Certain incentive and stock-based compensa-
tion plans are based on financial and market performance targets and
the related expense is recorded in relation to the attainment of such
targets. Labor and fringe benefits expense decreased by $41 million, or
2%, in 2006 as compared to 2005. The decrease was mainly due to
lower stock-based compensation expense, largely due to an acceleration
of a grant payout in 2005; the translation impact of the stronger
Canadian dollar; the impact of a reduced workforce and ongoing produc-
tivity improvements; and an increase in the first quarter of 2005 to the
workforce reduction provision mainly for increased health care costs.
Partly offsetting these factors were annual wage increases and an
increase in net periodic benefit cost for pensions, mainly as a result of a
decrease in the Company’s discount rate used in 2006 relative to 2005.
Purchased services and material: Purchased services and material
expense 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
$31 million, or 4%, in 2006 as compared to 2005. The increase was
mainly due to higher expenses for various services, particularly for the
Company’s maritime activities, higher expenses for locomotive mainte-
nance, lower income from joint facilities, and costs related to the
upgrading of track shared with another railroad. Partly offsetting these
factors was the translation impact of the stronger Canadian dollar.
Depreciation and amortization: Depreciation and amortization expense
relates to the Company’s rail operations. These expenses increased by
$23 million, or 4%, in 2006 as compared to 2005. The increase was
mainly due to the impact of net capital additions and higher deprecia-
tion rates for the information technology asset class, which were partly
offset by the translation impact of the stronger Canadian dollar.
Amount
% of revenue
Amount
% of revenue
$1,800
845
650
890
198
303
$4,686
23.3%
11.0%
8.4%
11.5%
2.6%
3.9%
60.7%
$1,841
814
627
725
192
417
$4,616
25.4%
11.2%
8.7%
10.0%
2.7%
5.8%
63.8%
Fuel: Fuel expense includes the cost of fuel consumed by locomotives,
intermodal equipment and other vehicles. These expenses increased by
$165 million, or 23%, in 2006 as compared to 2005. The increase was
mainly due to a 24% increase in the average price per U.S. gallon of fuel,
net of the benefits from CN’s fuel hedging program, from $1.72 in 2005
to $2.13 in 2006, and higher freight volumes. Partly offsetting these
factors were the translation impact of the stronger Canadian dollar and
productivity improvements.
Equipment rents: Equipment rents expense 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 increased by
$6 million, or 3%, in 2006 as compared to 2005. The increase was due
to lower car hire income, mainly due to shorter routes and offline cycles,
that was partly offset by lower lease and car hire expense, and the
translation impact of the stronger Canadian dollar.
Casualty and other: Casualty and other expense 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 $114 million, or 27%, in 2006 as compared
to 2005. The decrease was largely due to a net reduction to the provision
for U.S. personal injuries following the 2006 actuarial studies; a lower
expense for occupational disease claims; and lower derailment-related
expenses, mainly due to costs that were incurred for the incident at
Wabamun Lake in 2005 (see the Critical accounting policies section of
this MD&A). Partly offsetting these items were higher operating taxes
and increased environmental expenses for ongoing site restoration.
Other
Interest expense: Interest expense increased by $13 million, or 4%, for
the year ended December 31, 2006 as compared to 2005, mainly due
to interest on 2006 debt issuances and higher capital lease obligations
that were partly offset by the translation impact of the stronger
Canadian dollar.
63830_ang_030_059.indd 37
2/16/07 9:22:53 PM
U.S. GAAP
Canadian National Railway Company
37
Management’s Discussion and Analysis
Other income (loss): In 2006, the Company recorded other income of
$11 million compared to $12 million in 2005. The decrease was mainly due
to lower investment income, which was largely offset by higher foreign
exchange gains and lower costs related to the securitization program.
Income tax expense: The Company recorded income tax expense of
$642 million for the year ended December 31, 2006 compared to
$781 million in 2005. Included in the 2006 income tax expense was a
deferred income tax recovery of $277 million, resulting from the
enactment of lower tax rates in Canada and the resolution of matters
pertaining to prior years’ income taxes. Excluding this tax recovery, the
effective tax rate for the year ended December 31, 2006 was 33.7%
compared to 33.4% in 2005.
2005 compared to 2004
In 2005, net income increased by $298 million, or 24%, to $1,556 mil-
lion, when compared to 2004, with diluted earnings per share rising
28%, to $2.77.
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 translation impact of the stronger Canadian dollar on U.S. dollar-
denominated revenues.
Operating expenses increased by $236 million, or 5%, to $4,616 mil-
lion, primarily due to increased fuel costs, the inclusion of a full year of
GLT and BC Rail expenses, and increased purchased services and mate-
rial costs. Partly offsetting these factors were the translation impact of
the stronger Canadian dollar on U.S. dollar-denominated expenses, 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
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 affected 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 affected
operating income and net income by $35 million and $24 million,
respectively.
Revenues
Year ended December 31,
2005
2004 % Change
Total revenues (millions)
$7,240
$6,548
11%
Rail freight:
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Carloads (thousands)
Revenue/carload (dollars)
$6,905
$6,252
10%
179,701
174,240
3.84
4,841
1,426
3.59
4,578
1,366
3%
7%
6%
4%
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 of approximately $500 mil-
lion, of which approximately 55% 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 $260 million translation impact of the stronger Canadian
dollar on U.S. dollar-denominated revenues. In 2005, revenue ton miles
increased by 3% relative to 2004. Freight revenue per revenue ton mile
increased by 7% for 2005 when compared to 2004, largely due to freight
rate increases.
Petroleum and chemicals
Year ended December 31,
2005
2004 % Change
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
$1,096
31,235
3.51
$1,059
31,421
3.37
3%
(1%)
4%
Revenues for the year ended December 31, 2005 increased by $37 mil-
lion, 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 petroleum gases, continued
weakness in the U.S. molten sulfur market and reduced shipments of
U.S. petrochemicals. Revenue per revenue ton mile increased by 4% as
freight rate increases were partly offset by the translation impact of
the stronger Canadian dollar.
Metals and minerals
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Year ended December 31,
2005
$837
2004 % Change
$714
16,848
16,352
4.97
4.37
17%
3%
14%
Revenues for the year ended December 31, 2005 increased by $123 mil-
lion, 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
38
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 38
2/16/07 9:22:57 PM
Management’s Discussion and Analysis
shipments of construction materials, aluminum and Canadian steel prod-
ucts, and an improvement in traffic mix. Partly offsetting these gains was
the translation impact of the stronger Canadian dollar. Revenue per reve-
nue 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.
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.
Forest products
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Year ended December 31,
2005
2004 % Change
$1,738
$1,505
42,330
39,369
4.11
3.82
15%
8%
8%
Revenues for the year ended December 31, 2005 increased by $233 mil-
lion, 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.
Intermodal
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Year ended December 31,
2005
2004 % Change
$1,270
32,184
3.95
$1,117
31,002
3.60
14%
4%
10%
Revenues for the year ended December 31, 2005 increased by $153 mil-
lion, 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 in 2005 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.
Coal
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
Year ended December 31,
2005
$331
2004 % Change
Automotive
$284
13,576
12,684
2.44
2.24
Year ended December 31,
17%
7%
9%
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
2005
$514
3,135
16.40
2004 % Change
$510
3,321
15.36
1%
(6%)
7%
Revenues for the year ended December 31, 2005 increased by $47 mil-
lion, 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.
Grain and fertilizers
Year ended December 31,
2005
2004 % Change
Revenues (millions)
RTMs (millions)
Revenue/RTM (cents)
$1,119
40,393
2.77
$1,063
40,091
2.65
5%
1%
5%
Revenues for the year ended December 31, 2005 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 generally 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
Revenues for the year ended December 31, 2005 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.
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 the
Company’s maritime activities.
63830_ang_030_059.indd 39
2/16/07 9:23:01 PM
U.S. GAAP
Canadian National Railway Company
39
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 offset-
ting these factors were the $155 million 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 expense in 2005
increased by $22 million, or 1%, 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 were 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
expense in 2005 increased by $68 million, or 9%, 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 expense
in 2005 increased by $29 million, or 5%, 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.
Fuel: Fuel expense in 2005 increased by $197 million, or 37%, as com-
pared 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 second-quarter 2004 fuel excise tax refund.
Partly offsetting these factors was the translation impact of the stronger
Canadian dollar.
Equipment rents: Equipment rents expense in 2005 decreased by
$52 million, or 21%, 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.
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%
Casualty and other: Casualty and other expense in 2005 decreased by
$28 million, or 6%, as compared to 2004. The decrease was mainly due
to a reduction to the provision for U.S. personal 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 the Critical accounting policies section of this
MD&A), the inclusion of a full year of GLT and BC Rail expenses and
higher property taxes in the U.S.
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 were 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 busi-
ness 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 2005.
40
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 40
2/16/07 9:23:05 PM
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
2006 Quarters
2005 Quarters
Fourth
Third
Second
First
Fourth
Third
Second
First
$÷1,942
$÷÷«756
$÷÷«499
$÷÷0.97
$÷÷0.95
$÷1,981
$÷÷«844
$÷÷«497
$÷÷0.95
$÷÷0.94
$÷1,946
$÷÷«805
$÷÷«729
$÷÷1.38
$÷÷1.35
$÷1,847
$÷÷«625
$÷÷«362
$÷÷0.68
$÷÷0.66
$÷1,886
$÷÷«720
$÷÷«430
$÷÷0.80
$÷÷0.78
$÷1,810
$÷÷«665
$÷÷«411
$÷÷0.75
$÷÷0.74
$÷1,838
$÷÷«713
$÷÷«416
$÷÷0.75
$÷÷0.73
$÷1,706
$÷÷«526
$÷÷«299
$÷÷0.53
$÷÷0.52
$0.1625
$0.1625
$0.1625
$0.1625
$0.1250
$0.1250
$0.1250
$0.1250
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 impacted the quarter-over-quarter comparability of the results of operations: the second
quarter of 2006 included a deferred income tax recovery of $250 million ($0.48 per basic share or $0.46 per diluted share), primarily resulting from
the enactment of lower tax rates in Canada; the fourth quarter of 2006 included a deferred income tax recovery of $27 million ($0.05 per basic or
diluted share), relating mainly to the resolution of matters pertaining to prior years’ income taxes; and the continued appreciation in the Canadian
dollar relative to the U.S. dollar has affected 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
operations. The Company also has the ability to fund liquidity require-
ments through its revolving credit facility, the issuance of debt and/or
equity, and the sale of a portion of its accounts receivable through a
securitization program. In addition, from time to time, the Company’s
liquidity requirements can be supplemented by the disposal of surplus
properties and the monetization of assets.
Operating activities: Cash provided from operating activities was
$2,950 million for the year ended December 31, 2006 compared to
$2,705 million for 2005. Net cash receipts from customers and other
were $7,733 million for the year ended December 31, 2006, an increase
of $358 million when compared to 2005, mainly due to higher revenues
from operations that were partly offset by a decrease in the proceeds
received under the Company’s accounts receivable securitization pro-
gram. In 2006, payments for employee services, suppliers and other
expenses were $3,918 million, an increase of $46 million when com-
pared to 2005. Also consuming cash in 2006 were payments for interest,
workforce reductions and personal injury and other claims of $294 mil-
lion, $45 million and $107 million, respectively, compared to $306 mil-
lion, $87 million and $92 million, respectively, in 2005. In 2006, pension
contributions were $112 million, compared to $127 million in 2005.
Payments for income taxes in 2006 were $307 million, an increase of
$121 million when compared to 2005, mainly due to the Company now
being cash tax payable (see the Income taxes section of this MD&A).
Payments in 2007 for workforce reductions are expected to be
$23 million, pension contributions are expected to be approximately
$100 million and payments for income taxes are expected to be approxi-
mately $1,000 million (see the Income taxes section of this MD&A).
There are currently no specific or unusual requirements relating to work-
ing capital other than the items disclosed.
Investing activities: Cash used by investing activities in 2006 amounted
to $1,349 million compared to $1,075 million in 2005. The Company’s
investing activities in 2006 included property additions of $1,298 million,
an increase of $118 million when compared to 2005; and $84 million
related to three acquisitions. The following table details property addi-
tions for 2006 and 2005:
In millions
Year ended December 31,
2006
2005
Track and roadway
Rolling stock
Buildings
Information technology
Other
Gross property additions
Less: capital leases
Property additions
$1,012
349
$÷«868
338
35
81
82
1,559
261
44
81
71
1,402
222
$1,298
$1,180
The Company expects to spend approximately $1,600 million on
capital programs in 2007 due to increased expenditures required for the
ongoing renewal of the basic plant, the acquisition of rolling stock and
other acquisitions and investments required to improve the Company’s
productivity and the fluidity of the network.
Free cash flow
The Company generated $1,343 million of free cash flow for the year
ended December 31, 2006, compared to $1,301 million in 2005. 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 accounts receivable securitization
63830_ang_030_059.indd 41
2/16/07 9:23:09 PM
U.S. GAAP
Canadian National Railway Company
41
Management’s Discussion and Analysis
program, less investing activities and after the payment of dividends,
calculated as follows:
In millions
Year ended December 31,
2006
2005
Cash provided from operating activities
$«2,950
$«2,705
that 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.
Less:
Investing activities
Cash provided before financing activities
Adjustments:
Change in accounts receivable securitization (a)
Dividends paid
Free cash flow
(1,349)
1,601
(1,075)
1,630
82
(340)
(54)
(275)
$«1,343
$«1,301
(a) Changes in the Company’s accounts receivable securitization program are considered
a financing activity.
Financing activities: Cash used by financing activities totaled $1,484 mil-
lion for the year ended December 31, 2006 compared to $1,715 million
in 2005. On May 31, 2006, the Company issued U.S.$250 million
(Cdn$275 million) of 5.80% Notes due 2016 and U.S.$450 million
(Cdn$495 million) of 6.20% Debentures due 2036. The Company had
used the net proceeds of U.S.$692 million to reduce the Company’s
accounts receivable securitization program and to repay a portion of
its outstanding commercial paper. In May 2005, the Company repaid
U.S.$100 million (Cdn$125 million) of 7.75% 10-year Notes with cash
on hand. In 2006 and 2005, issuances and repayments of long-term
debt related principally to the Company’s commercial paper borrowings.
During 2006, the Company recorded $264 million ($222 million in
2005) in assets it acquired through equipment leases, including $3 mil-
lion for assets held for sale, for which an equivalent amount was
recorded in debt.
Cash received from options exercised during 2006 and 2005 was
$101 million and $115 million, respectively, and the related tax benefits
realized upon exercise were $19 million and $21 million, respectively.
In 2006, the Company repurchased 29.5 million common shares for
$1,483 million under its share repurchase programs; 15.5 million com-
mon shares for $766 million (average price of $49.43 per share) under
its new 28.0 million share repurchase program and 14.0 million common
shares for $717 million (average price of $51.24 per share) under its pre-
vious 32.0 million share repurchase program which was ended in June
2006. In 2005, the Company used $1,418 million to repurchase 36.0 mil-
lion common shares under its previous share repurchase programs.
During 2006, the Company paid dividends totaling $340 million
to its shareholders at the quarterly rate of $0.1625 per share compared
to $275 million at the quarterly rate of $0.1250 per share, in 2005.
CN’s debt-to-total capitalization ratio was 36.3% at December 31,
2006 compared to 35.5% at December 31, 2005. As at December 31,
2006, the adjusted debt-to-total capitalization ratio was 40.4% com-
pared to 41.1% at December 31, 2005. Management believes that
adjusted debt-to-total capitalization is a useful measure of performance
Debt-to-total capitalization ratio (a)
Add:
December 31,
2006
36.3%
2005
35.5%
Present value of operating lease commitments plus
securitization financing (b)
Adjusted debt-to-total capitalization ratio (c)
4.1%
40.4%
5.6%
41.1%
(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.
(b) The operating lease commitments have been discounted using the Company’s implicit
interest rate for each of the years presented.
(c) Adjusted debt-to-total capitalization is calculated as adjusted debt (total long-term debt,
plus current portion of long-term debt, plus the present value of operating lease commit-
ments, plus securitization financing) divided by the sum of adjusted debt plus total
shareholders’ equity.
The Company has access to various financing arrangements:
Shelf prospectus and registration statement
On May 9, 2006, the Company filed a shelf prospectus and registration
statement providing for the issuance, from time to time, of up to
U.S.$1,500 million of debt securities in one or more offerings expiring
in June 2008. Pursuant to the filing, on May 31, 2006, the Company
issued U.S.$250 million (Cdn$275 million) of 5.80% Notes due 2016
and U.S.$450 million (Cdn$495 million) of 6.20% Debentures due 2036.
The Company used the net proceeds of U.S.$692 million to reduce its
accounts receivable securitization program and to repay a portion of
its outstanding commercial paper.
On July 15, 2006, the interest rate on the Company’s U.S.$250 million
Puttable Reset Securities PURSSM (PURS) was reset at a new rate of
6.71% for the remaining 30-year term ending July 15, 2036. The PURS
were originally issued in July 1998 at the rate of 6.45% with an option
to call the securities on July 15, 2006 (the reset date). The call option
holder exercised the call option, which resulted in the remarketing of
the original PURS. The new interest rate was determined according to a
pre-set mechanism based on prevailing market conditions. The Company
did not receive any cash proceeds from the remarketing.
The remarketing did not trigger an extinguishment of debt, as
the provisions for the reset of the interest rate were set forth in the orig-
inal PURS. As such, the original PURS remain outstanding but accrue
interest at the new rate until July 2036. Under securities laws, the remar-
keting required utilization of the Company’s shelf prospectus and regis-
tration statement.
Following the issuance and remarketing of debt as explained herein, the
amount available under the shelf prospectus and registration statement
has been reduced to U.S.$550 million.
42
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 42
2/22/07 10:31:29 AM
Management’s Discussion and Analysis
Revolving credit facility
In October 2006, the Company amended its U.S.$1,000 million revolving
credit facility, improving the pricing parameters and extending the
maturity from March 2010 to October 2011. Other terms of the facility
remained substantially the same. The credit facility is available for
general corporate purposes, including back-stopping the Company’s
commercial paper program, and provides for borrowings at various inter-
est rates, including the Canadian prime rate, bankers’ acceptance rates,
the U.S. federal funds effective rate and the London Interbank Offer Rate,
plus applicable margins. The credit facility agreement has 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 of U.S.$15 million (Cdn$17 million) outstanding
at December 31, 2005 (average interest rate of 4.66%) were entirely
repaid in the first quarter of 2006. As at December 31, 2006, the
Company had no outstanding borrowings under its revolving credit facil-
ity and had letters of credit drawn of $308 million ($316 million as at
December 31, 2005).
Commercial paper
The Company’s commercial paper program 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 classi-
fied as long-term debt, reflecting the Company’s intent and contractual
ability to refinance the short-term borrowings through subsequent issu-
ances of commercial paper or drawing down on the long-term revolving
credit facility. As at December 31, 2006, the Company had no commer-
cial paper outstanding, and U.S.$367 million (Cdn$427 million) outstand-
ing at an average interest rate of 4.40%, as at December 31, 2005.
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.
All forward-looking information provided in this section is subject to
risks and uncertainties and is based on assumptions about events and
developments that may not materialize or that may be offset entirely or
partially by other events and developments. See the Business risks
section of this MD&A for a discussion of assumptions and risk factors
affecting such forward-looking statements.
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, 2006:
In millions
Long-term debt obligations (a)
Interest on long-term debt obligations
Capital lease obligations (b)
Operating lease obligations (c)
Purchase obligations (d)
Other long-term liabilities reflected on
the balance sheet (e)
Total obligations
Total
$÷4,583
5,794
1,405
740
773
1,036
$14,331
2007
$÷÷«60
284
216
184
541
82
$1,367
2008
$ 203
274
119
144
124
71
$935
2009
$ 351
267
138
116
53
54
$979
2010
$ ÷ –
252
79
95
47
48
$521
2011
$ 465
252
147
69
8
44
$985
2012 &
thereafter
$ 3,504
4,465
706
132
–
737
$9,544
(a) Presented net of unamortized discounts, of which $836 million relates to non-interest bearing Notes due in 2094, and excludes capital lease obligations of $1,021 million which are
included in “Capital lease obligations.”
(b) Includes $1,021 million of minimum lease payments and $384 million of imputed interest at rates ranging from approximately 3.0% to 7.9%.
(c) Includes minimum rental payments for operating leases having initial non-cancelable lease terms of one year or more. The Company also has operating lease agreements for its automotive
fleet with minimum one-year non-cancelable terms for which its practice is to renew monthly thereafter. The estimated annual rental payments for such leases are approximately
$30 million and generally extend over five years.
(d) Includes commitments for railroad ties, rail, freight cars, locomotives and other equipment and services, and outstanding information technology service contracts and licenses.
(e) Includes expected payments for workers’ compensation, workforce reductions, postretirement benefits other than pensions and environmental liabilities that have been classified as
contractual settlement agreements.
For 2007 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. The Company is not aware of any trends, events or
conditions or expected fluctuations in liquidity that would create any deficiencies. See the Business risks section of this MD&A for a discussion
of assumptions and risk factors affecting such forward-looking statement.
63830_ang_030_059.indd 43
2/22/07 10:31:55 AM
U.S. GAAP
Canadian National Railway Company
43
Management’s Discussion and Analysis
Off balance sheet arrangements
Accounts receivable securitization
The Company has a five-year agreement, expiring in May 2011, to sell
an undivided co-ownership interest of up to a maximum of $600 million
in a revolving pool of freight receivables to an unrelated trust. Pursuant
to the agreement, the Company sells an interest in its receivables and
receives proceeds net of the required reserves as stipulated in the agree-
ment. This program replaced the Company’s previous accounts receivable
securitization program that was set to expire in June 2006.
The Company has retained the responsibility for servicing, admin-
istering and collecting the receivables sold. At December 31, 2006, the
servicing asset and liability were not significant. Subject to customary
indemnifications, the trust’s recourse is generally limited to the receivables.
The Company accounted for the securitization programs as sales,
because control over the transferred accounts receivable was relin-
quished. Due to the relatively short collection period and the high quality
of the receivables sold, the fair value of the undivided interest trans-
ferred to the trust approximated the book value thereof.
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 the reporting requirements and is currently not aware
of 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, 2006, the Company had sold receivables that
resulted in proceeds of $393 million under the new accounts receivable
securitization program ($489 million at December 31, 2005 under the
previous program), and recorded the retained interest, which represents
the required reserves, of approximately 10% of this amount in Other
current assets (retained interest of approximately 10% recorded at
December 31, 2005).
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. In addition, where the Company expects
to make a payment in respect of a guarantee, a liability will be recog-
nized 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.
Stock-based compensation plans
On January 1, 2006, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 123(R), “Share-Based Payment,” which
requires the 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.
The Company adopted SFAS No. 123(R) using the modified prospec-
tive approach, which requires application of the standard to all awards
granted, modified, repurchased or cancelled on or after January 1, 2006,
and to all awards for which the requisite service had not been rendered
as at such date. Since January 1, 2003, the Company has been following
the fair value based approach prescribed by SFAS No. 123, “Accounting
for Stock-Based Compensation,” as amended by SFAS No. 148,
“Accounting for Stock-Based Compensation – Transition and Disclosure,”
for stock option awards granted, modified or settled on or after such
date, while cash settled awards were measured at their intrinsic value at
each reporting period until December 31, 2005. As such, the application
of SFAS No. 123(R) on January 1, 2006 to all awards granted prior to its
adoption did not have a significant impact on the financial statements.
In accordance with the modified prospective approach, prior period
financial statements have not been restated to reflect the impact of
SFAS No. 123(R).
For the year ended December 31, 2006, the application of SFAS No.
123(R) had the effect of increasing stock-based compensation expense
and decreasing net income by $16 million and $12 million, respectively,
or $0.02 per basic and diluted earnings per share.
The Company has various stock-based incentive plans for eligible
employees. A description of the plans is provided in Note 12 – Stock
plans, to the Company’s Annual Consolidated Financial Statements.
Compensation cost for awards under all stock-based compensation plans
was $79 million, $120 million and $65 million for the years ended
December 31, 2006, 2005 and 2004, respectively. The total tax benefit
recognized in income in relation to stock-based compensation expense
for the years ended December 31, 2006, 2005 and 2004 was $22 million,
$34 million and $18 million, respectively. Additional disclosures required
under SFAS No. 123(R) and Staff Accounting Bulletin (SAB) No. 107 are
provided herein.
44
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 44
2/16/07 9:23:21 PM
Management’s Discussion and Analysis
The following table provides additional disclosures as required by SFAS No. 123(R) and SAB No. 107 pertaining to all awards:
In millions, unless otherwise indicated
RSUs (a)
Vision (a)
VIDP (b) Mid-term (b)
Year of grant
2006 (d)
2005
2004
2005
2003
onwards
2001
2006 (d)
2005
Prior to
2005
Cash settled awards
Stock option awards (c)
Stock-based compensation expense
recognized over vesting period
Year ended December 31, 2006
Year ended December 31, 2005
Year ended December 31, 2004
Liability outstanding
December 31, 2006
December 31, 2005
Fair value per unit
At period-end ($)
At grant date ($)
Fair value of awards vested during period
Year ended December 31, 2006
Year ended December 31, 2005
Year ended December 31, 2004
Nonvested awards at December 31, 2006
$«÷÷21
N/A
N/A
$«÷÷19
$«÷÷15
N/A
$«÷÷÷6
$«÷÷74
$«÷÷36
$«÷÷21
N/A
$«÷÷34
$«÷÷15
$«÷÷÷8
$«÷÷66
$36.32
$49.36
$50.07
N/A
N/A
N/A
$÷÷÷«–
N/A
N/A
$÷÷÷«–
$÷÷÷«–
N/A
$«÷÷÷4
$«÷105
$«÷÷÷3
Unrecognized compensation cost
$«÷÷15
$«÷÷17
$«÷÷÷8
Remaining recognition period (years)
2.0
1.0
2.0
$«÷÷÷8
$÷÷÷«–
N/A
$«÷÷÷8
$÷÷÷«–
$19.98
N/A
$÷÷÷«–
$÷÷÷«–
N/A
$«÷÷÷8
2.0
$«÷÷11
$«÷÷13
$«÷÷÷7
$«÷÷99
$«÷÷83
$50.07
N/A
$«÷÷÷5
$«÷÷÷2
$÷÷÷«–
$«÷÷13
3.0
Assumptions (e)
Stock price ($)
Expected stock price volatility (f)
Expected term (years) (g)
Risk-free interest rate (h)
Dividend rate ($) (i)
$50.07
$50.07
$50.07
$50.07
$50.07
19%
2.0
4.02%
$÷0.65
18%
1.0
4.16%
$÷0.65
N/A
N/A
N/A
N/A
20%
2.0
4.47%
$÷0.65
N/A
N/A
N/A
N/A
N/A
N/A
$«÷÷13
$«÷÷÷8
N/A
N/A
$«÷÷÷3
$«÷÷÷2
N/A
$«÷÷÷3
$«÷÷16
$«÷÷÷9
N/A
N/A
N/A
N/A
N/A
N/A
$«÷÷20
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
$13.80
$÷9.19
$÷8.61
$÷÷÷«–
N/A
N/A
$«÷÷÷3
$÷÷÷«–
N/A
$«÷÷34
$«÷÷34
$«÷÷35
$«÷÷÷6
$«÷÷÷6
$÷÷÷«–
3.1
2.1
–
$51.51
$36.33
$23.59
25%
5.17
4.04%
$÷0.65
25%
5.20
3.50%
$÷0.50
30%
6.22
5.13%
$÷0.30
(a) Beginning in 2006, compensation cost was based on the fair value of the awards at period-end using the lattice-based valuation model that uses the assumptions as presented herein,
except for time-vested RSUs. In 2005 and 2004, compensation cost was measured using intrinsic value for all awards.
(b) Compensation cost for all periods presented was based on intrinsic value.
(c) Compensation cost for all periods presented was based on the grant date fair value using the Black-Scholes option-pricing model that uses the assumptions presented herein.
(d) Includes the accelerated recognition of awards granted to retirement-eligible employees. For these individuals, compensation cost is recognized over the period from the grant date to the
date the requisite service period has been achieved.
(e) Assumptions used to determine fair value are at period-end for cash settled awards and at grant date for stock option awards.
(f) Based on the historical volatility of the Company’s stock over a period commensurate with the expected term of the award.
(g) Represents the remaining period of time that awards are expected to be outstanding. For option awards only, the Company uses historical data to estimate option exercise and employee
termination, and groups of employees that have similar historical exercise behavior are considered separately.
(h) Based on the implied yield available on zero-coupon government issues with an equivalent term commensurate with the expected term of the awards.
(i) Based on the annualized dividend rate.
Financial instruments
The Company has limited involvement with derivative financial instruments
and does not use them for trading purposes. At December 31, 2006, the
Company did not have any derivative financial instruments outstanding.
Fuel
To mitigate the effects of fuel price changes on its operating margins and
overall profitability, the Company had a hedging program which called 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.
As such, the Company terminated this program in late 2006.
Since the changes in the fair value of the swap positions were
highly correlated to changes in the price of fuel, the fuel hedges were
being accounted for as cash flow hedges, whereby the effective portion
of the cumulative change in the market value of the derivative instru-
ments had been recorded in Accumulated other comprehensive loss.
During 2006, the Company’s remaining swap positions matured and
were settled. As a result, the related unrealized gains previously recorded
in Accumulated other comprehensive loss were reclassified into income
as realized gains (unrealized gains of $57 million, $39 million after tax
at December 31, 2005). At December 31, 2006, the Company is no longer
hedged through financial markets.
Realized gains from the Company’s fuel hedging activities, which are
recorded in fuel expense, were $64 million, $177 million and $112 million
for the years ended December 31, 2006, 2005 and 2004, respectively.
63830_ang_030_059.indd 45
2/22/07 11:44:29 AM
U.S. GAAP
Canadian National Railway Company
45
Management’s Discussion and Analysis
The Company did not recognize any material gains or losses in each
of 2006, 2005 and 2004 due to hedge ineffectiveness as the Company’s
derivative instruments were highly effective in hedging the changes in
cash flows associated with forecasted purchases of diesel fuel.
Interest rate
In 2004, the Company realized a gain of $12 million upon settlement of
treasury lock transactions that was recorded in Accumulated other com-
prehensive loss. This gain is being recorded into income, as a reduction
of interest expense, over the term of the related debt (30-year term)
based on the interest payment schedule. At December 31, 2006,
Accumulated other comprehensive loss included an unamortized gain of
$12 million, $8 million after tax ($12 million, $8 million after tax at
December 31, 2005).
Income taxes
Cash tax payments
In 2005, the Company utilized its then remaining tax loss carryforwards
and is now cash tax payable in both Canada and the U.S. Accordingly,
the Company makes scheduled installment payments as prescribed by
the tax authorities. In the U.S., tax installments are based on the fore-
casted income taxes payable for the current fiscal year. Payments made
in 2006 were $177 million and are expected to remain at the same level
for 2007. In Canada, tax installments for the current year were based
on the 2005 taxes payable, which were net of the loss carryforwards
claimed. Consequently, payments in 2006 were $130 million and the
expected amount payable in the first quarter of 2007 for Canadian
income taxes in respect of the current fiscal year amounts to approxi-
mately $350 million. For the 2007 fiscal year, the Company expects to
pay approximately $440 million of taxes in Canada based on the 2006
taxes payable.
See the Business risks section of this MD&A for a discussion of
assumptions and risk factors affecting such forward-looking statements.
Future rate enactments
In 2006, the Manitoba government announced reductions to the provin-
cial corporate income tax rates as part of its Provincial Budget, which
will be phased in through to July 1, 2008. As a result, the Company’s net
deferred income tax liability will be reduced when the new income tax
rates are enacted into law.
Common stock
Share repurchase programs
In July 2006, the Board of Directors of the Company approved a new
share repurchase program which allows for the repurchase of up to 28.0
million common shares between July 25, 2006 and July 24, 2007 pursu-
ant to a normal course issuer bid, at prevailing market prices. As at
December 31, 2006, under this current share repurchase program, 15.5
million common shares have been repurchased for $766 million, at an
average price of $49.43 per share.
The Company’s previous share repurchase program, initiated in 2005,
allowed for the repurchase of up to 32.0 million common shares
between July 25, 2005 and July 24, 2006 pursuant to a normal course
issuer bid, at prevailing market prices. In June 2006, the Company ended
this share repurchase program, repurchasing a total of 30.0 million
common shares for $1,388 million, at an average price of $46.26 per
share. Of this amount, 14.0 million common shares were repurchased in
2006 for $717 million (average price per share of $51.24) and 16.0 mil-
lion common shares in 2005 for $670 million (average price per share
of $41.90).
Common stock split
On January 24, 2006, the Board of Directors of the Company approved
a two-for-one common stock split which was effected in the form of a
stock dividend of one additional common share of CN payable for each
share held. The stock dividend was paid on February 28, 2006, to share-
holders of record on February 22, 2006. All equity-based benefit plans
and the previous share repurchase program were adjusted to reflect the
issuance of additional shares or options due to the stock split. All share
and per share data have been adjusted to reflect the stock split.
Outstanding share data
As at February 12, 2007, the Company had 511.5 million common
shares outstanding.
Recent accounting pronouncements
In September 2006, the Financial Accounting Standards Board
(FASB) issued SFAS No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, an amendment of
FASB Statements No. 87, 88, 106, and 132(R),” which requires an
employer to measure the defined benefit plan assets and the pro-
jected benefit obligation as of the date of the employer’s fiscal year-
end statement of financial position. The requirement is effective for
fiscal years ending after December 15, 2008. Pursuant to the Statement,
this requirement will be applied prospectively. Although the Company
uses a measurement date of September 30 for its U.S. pension and other
postretirement plans, the Company does not expect this standard to
have a significant impact on its financial statements. SFAS No. 158 also
requires the recognition of the funded status of a benefit plan as well
as other disclosure requirements, which were adopted on December 31,
2006. See the Critical accounting policies section of this MD&A and
Note 2 – Accounting changes, to the Company’s Annual Consolidated
Financial Statements.
In September 2006, the U.S. Securities and Exchange Commission (SEC)
issued SAB No. 108 to address diversity in practice in quantifying finan-
cial statement misstatements. SAB No. 108 requires consideration of the
effects of prior year misstatements in quantifying current year misstate-
ments for the purpose of a materiality assessment. SAB No. 108 did not
have an impact on the Company’s financial statements.
46
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 46
2/16/07 9:23:30 PM
Management’s Discussion and Analysis
In July 2006, the FASB issued FASB Interpretation (FIN) No. 48,
“Accounting for Uncertainty in Income Taxes,” which prescribes a recog-
nition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be
taken in a tax return. This Interpretation also provides guidance on
derecognition, classification, interest and penalties, disclosure and transi-
tion, and is effective for fiscal years beginning after December 15, 2006.
Based on the Company’s preliminary assessment of the impact of FIN
No. 48, the adoption of this Interpretation on January 1, 2007 is expected
to decrease the net deferred income tax liability and increase Retained
earnings by approximately $100 million.
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 based upon currently available information. Actual results
could differ from these estimates. The Company’s policies for personal
injury and other claims, environmental claims, depreciation, pensions and
other postretirement benefits, and income taxes, require management’s
more significant judgments and estimates in the preparation of the
Company’s consolidated financial statements and, as such, are consid-
ered to be critical. The following information should be read in conjunc-
tion 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.
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, occu-
pational disease and damage to property.
Canada
Employee injuries are governed by the workers’ compensation 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 compensa-
tion, health care and third-party 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, 2006, 2005 and 2004, 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
2006
$205
60
(70)
$195
2005
$204
46
(45)
2004
$169
64
(29)
$205
$204
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 the specifics of the case, trends and judgment.
United States
Employee work-related injuries, including occupational 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 represent 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 occupational disease claims,
based on actuarial estimates of their ultimate cost. Prior to 2005, the
Company’s provisions for unasserted occupational disease claims consti-
tuted the minimum amount that could be reasonably estimated, reflect-
ing 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 unasserted occu-
pational disease claims, thereby increasing the expected number of
claims to be received. These changes 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, in 2005, 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 occupa-
tional disease claims.
In 2006, the Company recorded a net reduction to its provision for
U.S. personal injury and other claims pursuant to the 2006 external actu-
arial studies. The reduction was mainly attributable to a decrease in the
Company’s claims inventory as a result of its ongoing risk mitigation
strategy focused on prevention, mitigation of claims and containment of
injuries and lower settlements for existing 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.
63830_ang_030_059.indd 47
2/16/07 9:23:34 PM
U.S. GAAP
Canadian National Railway Company
47
Management’s Discussion and Analysis
At December 31, 2006, 2005 and 2004, 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
2006
$452
(8)
(37)
2005
$438
61
(47)
2004
$421
94
(77)
$407
$452
$438
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 probability level for the number of claims or severity
would have the effect of changing the provision by approximately $35 mil-
lion and the annual expense by approximately $6 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 cur-
rent operations are expensed unless they relate to an improvement to
the property. Expenditures that relate to an existing condition caused by
past operations and which are not expected to contribute to current or
future operations are expensed.
Known 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 23 sites governed by the Superfund law (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 environ-
mental 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 2005, the Company recorded a liability related to a derailment at
Wabamun Lake, Alberta, representing clean-up costs for the shoreline,
fronting residences and First Nations Land, as explained in Note 18 –
Major commitments and contingencies, to the Company’s Annual
Consolidated Financial Statements. In 2006, this liability was adjusted for
additional environmental and legal claims and reduced by payments
made pursuant to the clean-up performed. At December 31, 2006, the
Company has a receivable for the remaining estimated recoveries from
the Company’s insurance carriers since the Company’s insurance policies
are expected to cover substantially all expenses related to the derail-
ment above the self-insured retention. Operating expenses in 2005
included approximately $28 million, of which $25 million was for envi-
ronmental matters, related to this derailment, which represented the
Company’s retention under its insurance policies and other uninsured
costs. The ultimate liability for clean-up costs is not expected to materi-
ally differ from the current amount recorded, but any additional costs are
expected to be offset by a corresponding change in the insurance receiv-
able. 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.
At December 31, 2006, 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.
48
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 48
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Management’s Discussion and Analysis
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 the costs of complying with environmental laws
and containing or remediating contamination 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
such harm, including costs relating to the performance of clean-ups, nat-
ural resource damages and compensatory or punitive damages relating
to harm to individuals or property.
In 2006, the Company’s expenses relating to specific environmental
sites and remediation, net of recoveries, were $17 million ($37 million
in 2005). Payments for such matters were $10 million, net of potential
insurance recoveries, in 2006 ($24 million in 2005 and $8 million in
2004). As at December 31, 2006, the Company had aggregate accruals
for such environmental costs of $131 million ($124 million as at
December 31, 2005). The Company anticipates that the majority of the
liability at December 31, 2006 will be paid out over the next five years.
The Company also incurs expenses related to environmental regulatory
compliance and clean-up requirements. Such expenses amounted to
$10 million in 2006 ($9 million in 2005 and $10 million in 2004).
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 value, 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 $14 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 2007, the Company
expects to finalize a comprehensive depreciation study of its U.S. rolling
stock and equipment and to complete a depreciation study for its Canadian
properties, plant and equipment and its U.S. track and roadway assets.
In 2006, the Company recorded total depreciation and amortization
expense of $653 million ($630 million in 2005 and $602 million in 2004).
At December 31, 2006, the Company had Properties of $21,053 million,
net of accumulated depreciation of $9,458 million ($20,078 million in
2005, net of accumulated depreciation of $9,347 million).
Pensions and other postretirement 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.
Recognition of the funded status of benefit plans
On December 31, 2006, the Company adopted SFAS No. 158, “Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans,
an amendment of FASB Statements No. 87, 88, 106, and 132(R),” which
requires the Company to recognize the over- or underfunded status of
its various benefit plans in its Consolidated Balance Sheet. As such, on
December 31, 2006, the Company increased its pension asset by
$599 million, to $1,275 million, and decreased its pension and other
postretirement benefits liability by $7 million, to $481 million. The
Company will recognize changes in the funded status in the year in
which the changes occur, through Other comprehensive income (loss).
63830_ang_030_059.indd 49
2/16/07 9:23:42 PM
U.S. GAAP
Canadian National Railway Company
49
Management’s Discussion and Analysis
The actuarial gains/losses and prior service costs/credits that arise during
the period but are not recognized as components of net periodic benefit
cost will be recognized as a component of Other comprehensive income
(loss), net of tax. These amounts recognized in Accumulated other com-
prehensive loss will be adjusted as they are subsequently recognized as
components of net periodic benefit cost. Prior to December 31, 2006,
actuarial gains/losses and prior service costs/credits were deferred in
their recognition, and amortized into net periodic benefit cost over the
expected average remaining service life of the employee group covered
by the plans. The adoption of SFAS No. 158 had no impact on years prior
to 2006 as retrospective application was not allowed. This standard had
no effect on the 2006 computation of net periodic benefit cost for pen-
sions and other postretirement benefits. See Note 9 – Other liabilities
and deferred credits and Note 13 – Pensions, to the Company’s Annual
Consolidated Financial Statements, for the prospective application of
SFAS No. 158 to the Company’s benefit plans.
The following table illustrates the incremental effect of applying SFAS No. 158 on individual line items in the Company’s Consolidated Balance
Sheet at December 31, 2006:
In millions
Pension
Total
Other
postretirement
benefits
Pension (a)
Net deferred
income tax
Total
Accumulated other
comprehensive loss
Total
Assets
Liabilities
Shareholders’ equity
Balance at December 31, 2006 before
application of SFAS No. 158
Adjustments
Balance at December 31, 2006 after
application of SFAS No. 158
$«÷676
$23,405
599
599
$313
(27)
$175
20
$4,939
$13,995
192
185
$(458)
414
$9,410
414
$1,275
$24,004
$286
$195
$5,131
$14,180
$÷(44)
$9,824
(a) On December 31, 2006, just prior to the adoption of SFAS No. 158, the Company had a minimum pension liability recorded of $17 million, with the offsetting amount recorded in
Accumulated other comprehensive loss ($11 million after tax).
At December 31, 2006 and 2005, the pension benefit obligation,
accumulated postretirement benefit obligation (APBO), and other postre-
tirement benefits liability were as follows:
In millions
December 31,
2006
2005
Pension benefit obligation
Accumulated postretirement benefit obligation
Other postretirement benefits liability
$14,545
$14,346
286
286
300
313
Calculation of net periodic benefit cost
The Company accounts for net periodic benefit cost for pensions and
other postretirement benefits as required by SFAS No. 87, “Employers’
Accounting for Pensions,” and SFAS No. 106, “Employers’ Accounting for
Postretirement Benefits Other Than Pensions,” respectively. Under these
standards, assumptions are made regarding the valuation of benefit obli-
gations and performance of plan assets. In the calculation of net periodic
benefit cost, these standards allow 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.
In accounting for pensions and other postretirement 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, terminations and disability. Changes in these assumptions
result in actuarial gains or losses, which pursuant to SFAS No. 158, will be
recognized in Other comprehensive income (loss) effective December 31,
2006. In accordance with SFAS No. 87 and SFAS No. 106, the Company
has elected to amortize these gains or losses into net periodic benefit
cost over the expected average remaining service life of the employee
group covered by the plans only to the extent that the unrecognized net
actuarial gains and losses are in excess of 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 Company’s net periodic benefit cost for future periods is dependent
on demographic experience, economic conditions and investment perfor-
mance. 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 perfor-
mance is further discussed herein.
The Company recorded consolidated net periodic benefit cost for
pensions of $66 million, $17 million and $22 million in 2006, 2005 and
2004, respectively. Consolidated net periodic benefit cost for other post-
retirement benefits was $17 million, $24 million and $29 million in 2006,
2005 and 2004, respectively.
50
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 50
2/22/07 10:32:49 AM
Management’s Discussion and Analysis
Discount rate assumption
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.
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’
corresponding expected benefit payments of that year. A discount rate of
5.12%, based on bond yields prevailing at December 31, 2006 (5.0% at
December 31, 2005), was considered appropriate by the Company to
match the approximately 12-year average duration of estimated future
benefit payments. As a result, in 2007, the Company’s net periodic bene-
fit cost for all plans is expected to decrease by approximately $35 mil-
lion, since the cumulative unrecognized actuarial loss has decreased to
$1,804 million at December 31, 2006 from $2,145 million at December 31,
2005, mainly resulting from an increase in the level of interest rates.
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, 2006, a one-percentage-point
decrease in the 5.0% discount rate used to determine net periodic
benefit cost at January 1, 2006 would have resulted in an increase
of approximately $150 million in net periodic benefit cost, whereas a
one-percentage-point increase would have resulted in a decrease of
approximately $90 million, 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.
Expected long-term rate of return assumption
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 composi-
tion 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, 2006 exceeded the market-related value of Plan assets by
$2,465 million, net periodic benefit cost would decrease by approxi-
mately $260 million for 2006, assuming all other assumptions remained
constant. The Company follows a disciplined investment strategy, which
limits concentration of investments by asset class, foreign currency,
sector or company. The Investment Committee of the Board of Directors
has approved an investment policy that establishes long-term asset mix
targets based on a review of historical returns achieved by worldwide
investment markets. Investment managers may deviate from these targets
but their performance is evaluated in relation to the market performance
of the target mix. The Company does not anticipate the return on plan
assets to fluctuate materially from related capital market indices. The
Investment Committee reviews investments regularly with specific
approval required for major investments in illiquid securities. The policy
also permits the use of derivative financial instruments to implement
asset mix decisions or to hedge existing or anticipated exposures. The
Plan does not invest in the securities of the Company or its subsidiaries.
During the last 10 years ended December 31, 2006, the Plan earned an
annual average rate of return of 10.0%. The actual, market-related value,
and expected rates of return on plan assets for the last five years were
as follows:
Rates of return
Actual
Market-related value
Expected
2006
10.7%
11.4%
8.0%
2005
2004
20.5%
11.7%
8.6%
8.0%
6.3%
8.0%
2003
9.6%
7.0%
8.0%
2002
(0.3)%
7.4%
9.0%
The Company’s expected long-term rate of return on plan assets reflects
management’s view of long-term investment returns and the effect of a
1% variation in such rate of return would result in a change to the net
periodic benefit cost of approximately $60 million.
Plan asset allocation
Based on the fair value of the assets held as at December 31, 2006,
the Plan assets are comprised of 52% in Canadian and foreign equities,
38% in debt securities, 2% in real estate assets and 8% in other assets.
The long-term asset allocation percentages are not expected to differ
materially from the current composition.
Rate of compensation increase and health care cost trend rate
Another significant assumption in the actuarial model for pension
accounting is the rate of compensation increase, which is determined
by the Company based upon its long-term plans for such increases.
For 2006, a rate of compensation increase of 3.50% was used to deter-
mine the benefit obligation and 3.75% for the net periodic benefit cost.
For postretirement benefits other than pensions, 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
assumed to be 13% in 2006, 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, 2006, 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 postretirement benefits.
63830_ang_030_059.indd 51
2/16/07 9:23:50 PM
U.S. GAAP
Canadian National Railway Company
51
Management’s Discussion and Analysis
Funding of pension plans
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 actuarial
valuation of the CN Pension Plan was conducted as at December 31,
2005 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 2007, 2008 and 2009 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. In 2005,
the Canadian Institute of Actuaries (CIA) adopted a new standard to
be used to calculate the values that pension plan members are entitled
to receive upon termination of employment. This standard impacts the
calculation of the pension plan liabilities under a solvency or wind-up
scenario when the Company conducts an actuarial valuation for pur-
poses of determining the funding position of the Company’s Canadian
pension plans. This standard applies to current and future actuarial valu-
ations and may significantly impact future funding requirements.
Information disclosed by major pension plan
The following table provides the Company’s plan assets by category, benefit obligation at end of year, and Company and employee contributions by
major pension plan:
In millions
Plan assets by category
Equity securities
Debt securities
Real estate
Other
Total
Benefit obligation at end of year
Company contributions in 2006
Employee contributions in 2006
December 31, 2006
CN
Pension Plan
BC Rail Ltd
Pension Plan
U.S. and
other plans
$÷7,672
5,708
236
1,196
$14,812
$13,590
$«÷÷÷85
$«÷÷÷55
$289
255
9
44
$597
$556
$÷÷6
$ ÷–
$128
68
1
19
$216
$399
$÷21
$ ÷–
Total
$÷8,089
6,031
246
1,259
$15,625
$14,545
$«÷÷112
$«÷÷÷55
Income taxes
The Company follows the asset and liability method of accounting for
income taxes. Under the asset and liability method, the change in the
net deferred income tax asset or liability is included in the computation
of net income. Deferred income tax assets and liabilities are measured
using enacted income tax rates expected to apply to taxable income in
the years in which temporary differences are expected to be recovered or
settled. As a result, a projection of taxable income is required for those
years, as well as an assumption of the ultimate recovery/settlement
period for temporary differences. The projection of future taxable income
is based on management’s best estimate and may vary from actual tax-
able income. On an annual basis, the Company assesses its need to
establish a valuation allowance for its deferred income tax assets, and if
it is deemed more likely than not that its deferred income tax assets will
not be realized based on its taxable income projections, a valuation
allowance is recorded. As at December 31, 2006, the Company expects
that its deferred income tax assets will be recovered from future taxable
income and therefore, has not set up a valuation allowance. In addition,
Canadian and U.S. tax rules and regulations are subject to interpretation
and require judgment by the Company that may be challenged by the
taxation authorities upon audit of the filed income tax returns. In 2006,
the taxation authorities completed their assessments of income tax
returns filed for the years 1998 to 2001. Accordingly, the Company has
made adjustments to its provision for income taxes in 2006. The
Company believes that its provisions for income taxes at December 31,
2006 are adequate pertaining to any future assessments from the taxa-
tion authorities.
The Company’s deferred income tax assets are mainly composed of
temporary differences related to accruals for workforce reductions, per-
sonal injury and other claims, environmental and other postretirement
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 differ-
ences related to properties and the net pension asset. The reversal of
temporary differences is expected at future-enacted income tax rates
which could change due to fiscal budget changes and/or changes in
income tax laws. As a result, a change in the timing and/or the income
tax rate at which the components will reverse, could materially affect
deferred income tax expense as recorded in the Company’s results of
operations. A one-percentage-point change in the Company’s reported
effective income tax rate would have the effect of changing the income
tax expense by $27 million in 2006.
52
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 52
2/16/07 9:23:54 PM
Management’s Discussion and Analysis
From time to time, the federal, provincial, and state governments
enact new corporate tax rates resulting in either lower or higher tax lia-
bilities. Such enactments occurred in each of 2006, 2005 and 2004 and
resulted in a deferred income tax recovery of $228 million, a deferred
income tax expense of $14 million and a deferred income tax recovery
of $5 million, respectively, with corresponding adjustments to the
Company’s net deferred income tax liability.
In 2006, for certain items reported in Accumulated other compre-
hensive loss (a separate component of Shareholders’ equity), the
Company adjusted its deferred income tax liability for changes in income
tax rates applied to certain temporary differences and also for the
income tax effect on the currency translation amount resulting from the
difference between the accounting and tax basis of its net investment in
foreign subsidiaries. As a result, the Company recorded a $180 million net
charge for deferred income taxes in Other comprehensive income (loss).
For the year ended December 31, 2006, the Company recorded total
income tax expense of $642 million ($781 million in 2005 and $596 mil-
lion in 2004) of which $3 million was for deferred income taxes, includ-
ing the deferred income tax recovery of $277 million, resulting from the
enactment of lower federal and provincial corporate tax rates in Canada
and the resolution of matters pertaining to prior years’ income taxes
($547 million in 2005 and $366 million in 2004). The Company’s net
deferred income tax liability at December 31, 2006 was $5,131 million
($4,752 million at December 31, 2005).
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 although a moderate slowdown in the North
American economy is expected in the near term, the positive economic
conditions in North America and globally are expected to continue. This
assumption, although considered reasonable by the Company at the
time of preparation, may not materialize. Such forward-looking state-
ments are not guarantees of future performance and involve known and
unknown risks, uncertainties and other factors which may cause the
actual results or performance of the Company or the rail industry to be
materially different from the outlook or any future results or perfor-
mance 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 regulators 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
companies; and in many markets, major U.S. railroads and other
Canadian and U.S. railroads. Competition is generally based on the
quality and reliability of services provided, price, and the condition and
suitability of carriers’ equipment. Competition is particularly intense in
eastern Canada where an extensive highway network and population
centers, located relatively close to one another, have encouraged signifi-
cant 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 mar-
gins 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, 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 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.
63830_ang_030_059.indd 53
2/16/07 9:23:58 PM
U.S. GAAP
Canadian National Railway Company
53
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 definitively
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 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 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, occu-
pational disease and damage to property. The Company maintains provi-
sions 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, 2006, 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.
Labor negotiations
Canadian workforce
As at December 31, 2006, CN employed a total of 15,232 employees in
Canada, of which 12,183 were unionized employees.
As of February 2007, the Company had in place labor agreements
covering its entire Canadian unionized workforce. In September 2006,
the Company began bargaining with the two unions whose agreements
were to expire on December 31, 2006; namely the United Transportation
Union (UTU), which represents conductors and yard coordinators, and
the National Automobile Aerospace Transportation and General Workers
Union of Canada (Canadian Auto Workers or CAW), which represents
clerical and intermodal employees in one bargaining unit, shopcraft
employees in a separate bargaining unit, as well as owner-operator truck
drivers in a third bargaining unit. On January 14, 2007, the Company
and the CAW reached tentative agreements covering all three bargaining
units. The CAW completed its ratification process on January 29, 2007,
and as a result, the collective agreements have been renewed for a four-
year period ending December 31, 2010.
With respect to the UTU negotiations, on November 20, 2006, the
Minister of Labour (Canada) appointed two conciliation officers to assist
with negotiations pursuant to a request from the UTU, which CN had
opposed as being premature. Following a conciliation process and the
completion of required legislated processes, the union claimed it was in
a legal strike position, and the Company would have been legally per-
mitted to lockout the members of the UTU bargaining unit or promulgate
work rule changes unilaterally on February 9, 2007. On February 6, 2007,
the UTU served a 72-hour advance strike notice to the Company and
they commenced work stoppage on February 10, 2007. The Company is
seeking to have the UTU work stoppage declared illegal. The UTU had
also advised the Company that because the UTU-represented employees
of the former BC Rail were legally members of its CN bargaining unit, it
intended to bargain terms and conditions for those employees in concili-
ation along with its demands covering all its other members at CN. The
Company intends to maintain its operations notwithstanding the work
stoppage by the UTU-represented employees. Although there can be no
assurance to such effect, the Company remains optimistic that a resolu-
tion can be reached quickly and that its operations will return to normal
with minimal adverse effects on the Company’s financial position or
results of operations. The Company also has an agreement with the UTU
for its Northern Quebec line, which is set to expire on December 15, 2007.
Following the acquisition of BC Rail, the Company reached imple-
menting agreements in December 2004 for former BC Rail employees
with the Council of Trade Unions and its members, representing all
unions, regarding the integration of the various collective agreements. In
March 2005, under Section 18 of the Canada Labour Code, the Company
had 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
March 9, 2006, the CIRB issued its final decision and granted the
Company’s request to integrate the former BC Rail employees into CN’s
bargaining unit structures. Subsequently, the CAW union requested that
the CIRB reconsider its decision. On April 20, 2006, the CIRB rejected the
CAW’s application and advised that its decision was final.
In 2007, CN will begin bargaining with two other national unions
whose agreements expire December 31, 2007. These agreements will
remain in effect until bargaining and legal processes have been concluded.
There can be no assurance that the Company will be able to renew
and have ratified its collective agreements without any strikes or lockouts
54
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 54
2/16/07 9:24:02 PM
Management’s Discussion and Analysis
or that the resolution of these collective bargaining negotiations will not
have a material adverse effect on the Company’s financial position or
results of operations.
U.S. workforce
As at December 31, 2006, CN employed a total of 6,579 employees in
the United States, of which 5,732 were unionized employees.
As of February 2007, 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 98% of the unionized workforce at Wisconsin
Central Transportation Corporation (WC). Agreements in place have vari-
ous moratorium provisions, ranging from 2004 to 2011, which preserve
the status quo in respect of given areas during the terms of such morato-
riums. 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 pref-
erences, 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 generally
continue to apply. On July 19, 2006, one of the unions representing
250 GTW employees took a one-day strike action during the mediation
process. However, a U.S. District Court subsequently determined that the
strike action was improper and enjoined employees from further action.
The employees returned to work and the Company continues to be in
mediation with that union. There can be no assurance that there will
not be any work action by any of the bargaining units with which the
Company is currently in negotiations or 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 (i) regulation
as to rate setting, level of service and network rationalization by the
Canadian Transportation Agency (the Agency) under the Canada
Transportation Act (the CTA), and (ii) safety regulation by the federal
Minister of Transport under the Railway Safety Act and certain other
statutes. The Company’s U.S. rail operations are subject to (i) economic
regulation by the Surface Transportation Board (STB) and (ii) safety
regulation by the Federal Railroad Administration (FRA). As such, various
Company business transactions must gain prior regulatory approval, with
attendant risks and uncertainties, and the Company is subject to govern-
ment oversight with respect to rate and service issues. In particular, the
STB completed a proceeding on January 26, 2007 in which it reviewed
the practice of rail carriers, including the Company and the majority of
other large railroads operating within the U.S., of assessing a fuel sur-
charge computed as a percentage of the base rate for service. Following
its review, the STB directed carriers to change that practice and adjust
their fuel surcharge programs within 90 days on a basis more closely
related to the amount of fuel consumed on individual movements. The
Company is evaluating the impact of the STB’s decision. The Company is
also subject to a variety of health, safety, security, labor, environmental
and other regulations, all of which can affect its competitive position
and profitability.
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. While recent Congressional legislation and
Coast Guard rulemakings have not adversely affected CN’s ownership
of these vessels, no assurance can be given that any future legislative or
regulatory initiatives by the U.S. federal government will not materially
adversely affect the Company’s operations or its competitive and finan-
cial position.
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
FRA, 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
(TSA), which is part of the U.S. Department of Homeland Security and
the Pipeline and Hazardous Materials Safety Administration (PHMSA),
which, like the FRA, is part of the U.S. Department of Transportation.
The federal government carries out a review of Canadian transpor-
tation 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 the 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 and has since been replaced by two separate pieces
of legislation: Bill C-3 entitled International Bridges and Tunnels Act,
tabled on April 24, 2006 and Bill C-11 entitled Transportation
Amendment Act, tabled on May 4, 2006, relating to passenger service
providers, noise, mergers and other issues. Also, the federal government
63830_ang_030_059.indd 55
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U.S. GAAP
Canadian National Railway Company
55
Management’s Discussion and Analysis
is currently engaged in a consultative process relating to shipper-railway
relationships. On December 14, 2006, the federal government announced
a full review of the Railway Safety Act. Members of the panel to conduct
the review are expected to be appointed in early 2007 and are expected
to submit their report in the fall of 2007. 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, and additional legislation was intro-
duced in 2006. 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 initiatives by the U.S. federal
government will not materially adversely affect the Company’s opera-
tions, 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. These also include
participation in CBP’s Customs-Trade Partnership Against Terrorism
(C-TPAT) program and designation as a low-risk carrier under CBSA’s
Customs Self-Assessment (CSA) program. 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 requirements for
Canadian-bound traffic. Recently, the U.S. Department of Agriculture
(USDA) issued a proposed interim rule, which would remove the current
exemption from inspection for imported fruits and vegetables grown in
Canada and the exemptions for all transport modes from the agricultural
quarantine and inspection (AQI) user fee for traffic entering the U.S.
from Canada. The rule was originally scheduled to take effect on
November 24, 2006, but the USDA deferred implementation for surface
modes until March 1, 2007.
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 mate-
rials. 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 transportation routes, leading to
increased yard handling, longer hauls, and the transfer of traffic to lines
less suitable for moving hazardous materials, while also infringing upon
the exclusive and uniform federal oversight over railroad security mat-
ters. In addition to recommended security action items for the rail trans-
portation of toxic inhalation hazard (TIH) materials jointly announced by
the TSA and the FRA on June 23, 2006 and November 21, 2006, the TSA
and the PHMSA also separately issued, on December 21, 2006, related
notices of proposed rulemakings. Among other things, the TSA’s regula-
tions would require rail carriers operating within the U.S. to provide
upon request, within one hour, location and shipping information on
cars on their networks containing TIH materials and certain radioactive
or explosive materials, and ensure the secure, attended transfer of all
such cars to and from shippers, receivers and other carriers. The PHMSA’s
regulations would require carriers to report annually the volume and
route-specific data for cars containing these commodities; conduct a
safety and security risk analysis for each used route; identify a commer-
cially practicable alternative route for each used route; and select for
use the practical route posing the least safety and security risk.
While the Company will continue to work closely with the CBSA,
CBP, and other Canadian and U.S. agencies, as described above, no
assurance can be given that these and future decisions by the U.S.,
Canadian, provincial, state, or local governments on homeland security
matters, legislation on security matters enacted by the U.S. Congress,
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.
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 condi-
tions. The Company’s results of operations can be expected to reflect
these conditions because of the significant fixed costs inherent in rail-
road operations.
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.
As part of the Security and Prosperity Partnership entered into in
2005 by the Presidents of the United States and Mexico and the Prime
Minister of Canada, as a trilateral effort to increase security and enhance
prosperity among Canada, the U.S. and Mexico, a North American
Competitiveness Council has been created. The Council is intended to
engage the private sector as partners with the governments of the three
countries in finding solutions to North American trade and security
issues in the context of the Security and Prosperity Partnership. The
Prime Minister has designated the Company’s President and Chief
Executive Officer as a member of the Council, and CN will be active in
the Council’s activities.
56
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 56
2/16/07 9:24:10 PM
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, 2006, 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 con-
solidated subsidiaries would have been made known to them.
During the fourth quarter ending December 31, 2006, 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.
During 2006, in the course of its evaluation, management had
identified certain deficiencies in its internal control over financial report-
ing which the Company does not believe, either individually or in the
aggregate, resulted in a material weakness to its internal control over
financial reporting.
As of December 31, 2006, management has assessed the effective-
ness of the Company’s internal control over financial reporting using the
criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in Internal Control – Integrated
Framework. Based on this assessment, management has determined that
the Company’s internal control over financial reporting was effective as
of December 31, 2006, and issued Management’s Report on Internal
Control over Financial Reporting dated February 12, 2007 to that effect.
Additional information, including the Company’s 2006 Annual
Information Form (AIF) and Form 40-F, may be found on SEDAR at
www.sedar.com and on EDGAR at www.sec.gov, respectively.
Montreal, Canada
February 12, 2007
Management’s Discussion and Analysis
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 markets, 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 actuarial valuation may increase future pension contributions
and could have a material adverse effect on the Company’s results of
operations. The funding 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.
The Company conducts its business in both Canada and the U.S.
and as a result, is affected by currency fluctuations. 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 $11 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 significant economic slowdown or recession occur in
North America or other key markets, or should major industrial restruc-
turing take place, the volume of rail shipments carried by the Company
may 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
cumulative effect of inflation, which has significantly increased asset
replacement costs for capital-intensive companies such as CN, is not
reflected in operating expenses. Depreciation charges on an inflation-
adjusted basis, assuming that all operating assets are replaced at
current price levels, would be substantially greater than historically
reported amounts.
63830_ang_030_059.indd 57
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U.S. GAAP
Canadian National Railway Company
57
Management’s Report on Internal Control
over Financial Reporting
Report of Independent Registered Public Accounting Firm
Management is responsible for establishing and maintaining adequate
internal control over financial reporting. Internal control over financial
reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles. Because of its inherent limitations, internal control
over financial reporting may not prevent or detect misstatements.
Management has assessed the effectiveness of the Company’s
internal control over financial reporting as of December 31, 2006 using
the criteria set forth by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) in Internal Control – Integrated
Framework. Based on this assessment, management has determined that
the Company’s internal control over financial reporting was effective as
of December 31, 2006.
KPMG llP, an independent registered public accounting firm, has
issued an unqualified audit report on management’s assessment of the
effectiveness of the Company’s internal control over financial reporting
as of December 31, 2006 and has also expressed an unqualified opinion
on the Company’s 2006 consolidated financial statements as stated in
their Reports of Independent Registered Public Accounting Firm dated
February 12, 2007.
Signed by
E. Hunter Harrison
President and Chief Executive Officer
February 12, 2007
Signed by
Claude Mongeau
Executive Vice-President and Chief Financial Officer
February 12, 2007
To the Board of Directors and Shareholders of the
Canadian National Railway Company:
We have audited the accompanying consolidated balance sheets of the
Canadian National Railway Company (the “Company”) as of December 31,
2006 and 2005, and the related consolidated statements of income,
comprehensive income, changes in shareholders’ equity and cash flows
for each of the years in the three-year period ended December 31, 2006.
These consolidated financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion
on these consolidated 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 the audit to obtain reasonable
assurance about 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 estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
the Company as of December 31, 2006 and 2005, and the results of its
operations and its cash flows for each of the years in the three-year
period ended December 31, 2006, in conformity with generally accepted
accounting principles in the United States.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of the Company’s internal control over financial reporting
as of December 31, 2006, based on criteria established in Internal
Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”), and our report
dated February 12, 2007 expressed an unqualified opinion on manage-
ment’s assessment of, and the effective operation of, internal control
over financial reporting.
Signed by
KPMG llP
Chartered Accountants
Montreal, Canada
February 12, 2007
58
Canadian National Railway Company
U.S. GAAP
63830_ang_030_059.indd 58
2/28/07 6:06:31 PM
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of the
Canadian National Railway Company:
We have audited management’s assessment, included in the accompany-
ing management report on internal control over financial reporting, that
the Canadian National Railway Company (the “Company”) maintained
effective internal control over financial reporting as of December 31, 2006,
based on criteria established in Internal Control – Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”). The Company’s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial report-
ing. Our responsibility is to express an opinion on management’s assess-
ment and an opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reason-
able assurance about whether effective internal control over financial
reporting was maintained in all material respects. Our audit included
obtaining an understanding of internal control over financial reporting,
evaluating management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles in
the United States. A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.
In our opinion, management’s assessment that the Company main-
tained effective internal control over financial reporting as of December 31,
2006, is fairly stated, in all material respects, based on criteria established
in Internal Control – Integrated Framework issued by the COSO. Also, in
our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2006, based
on criteria established in Internal Control – Integrated Framework
issued by the COSO.
We also have audited, in accordance with Canadian generally
accepted auditing standards and with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated
balance sheets of the Company as of December 31, 2006 and 2005, and
the related consolidated statements of income, comprehensive income,
changes in shareholders’ equity and cash flows for each of the years in
the three-year period ended December 31, 2006, and our report dated
February 12, 2007 expressed an unqualified opinion on those consoli-
dated financial statements.
Signed by
KPMG llP
Chartered Accountants
Montreal, Canada
February 12, 2007
63830_ang_030_059.indd 59
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U.S. GAAP
Canadian National Railway Company
59
Consolidated Statement of Income
In millions, except per share data
Year ended December 31,
2006
2005
2004
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
Income tax expense (Note 15)
Net income
Earnings per share (Note 17)
Basic
Diluted
$1,173
$1,096
$1,059
885
1,745
375
1,259
1,420
514
345
7,716
837
1,738
331
1,119
1,270
514
335
714
1,505
284
1,063
1,117
510
296
7,240
6,548
1,800
1,841
1,819
845
650
890
198
303
4,686
3,030
(312)
11
2,729
(642)
814
627
725
192
417
746
598
528
244
445
4,616
4,380
2,624
(299)
12
2,337
(781)
2,168
(294)
(20)
1,854
(596)
$2,087
$1,556
$1,258
$÷3.97
$÷3.91
$÷2.82
$÷2.77
$÷2.21
$÷2.17
See accompanying notes to consolidated financial statements.
60
Canadian National Railway Company
U.S. GAAP
63830_ang_060_064.indd 60
2/16/07 9:49:01 PM
Consolidated Statement of Comprehensive Income
In millions
Net income
Year ended December 31,
2006
2005
2004
$2,087
$1,556
$1,258
Other comprehensive income (loss) (Note 20) :
Unrealized foreign exchange gain (loss) on:
Translation of the net investment in foreign operations
Translation of U.S. dollar-denominated long-term debt designated as a
hedge of the net investment in U.S. subsidiaries
Pension and other postretirement benefit plans adjustment:
Minimum pension liability adjustment (Note 13)
Derivative instruments (Note 19) :
Increase (decrease) in unrealized holding gains on fuel derivative instruments
Realized gain on settlement of interest rate swaps
Other comprehensive loss before income taxes
Income tax recovery (expense) on other comprehensive loss
Other comprehensive loss
Comprehensive income
32
(33)
1
(57)
–
(57)
(179)
(236)
(233)
152
4
(35)
–
(112)
38
(74)
(428)
326
8
54
12
(28)
9
(19)
$1,851
$1,482
$1,239
See accompanying notes to consolidated financial statements.
U.S. GAAP
Canadian National Railway Company
61
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2/16/07 9:49:05 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
December 31,
2006
2005
$÷ 179
692
189
84
192
1,336
21,053
1,615
$÷÷÷«62
623
151
65
248
1,149
20,078
961
$24,004
$22,188
$÷1,823
$÷1,478
218
73
2,114
5,215
1,465
5,386
4,459
(44)
5,409
9,824
408
72
1,958
4,817
1,487
4,677
4,580
(222)
4,891
9,249
Total liabilities and shareholders’ equity
$24,004
$22,188
On behalf of the Board:
David G.A. McLean
Director
E. Hunter Harrison
Director
See accompanying notes to consolidated financial statements.
62
Canadian National Railway Company
U.S. GAAP
63830_ang_060_064.indd 62
2/22/07 11:25:49 AM
Consolidated Statement of Changes in Shareholders' Equity
In millions
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 ($0.39 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 ($0.50 per share)
Balances December 31, 2005
Net income
Stock options exercised and other (Notes 11, 12)
Share repurchase programs (Note 11)
Other comprehensive loss (Note 20)
Adjustment to Accumulated other comprehensive loss
(Notes 2, 9, 13, 20)
Dividends ($0.65 per share)
Balances December 31, 2006
Issued and
outstanding
common
shares
Accumulated
other
comprehensive
loss
Common
shares
568.4
$ 4,664
$(129)
–
5.8
(8.0)
–
–
566.2
–
6.6
(36.0)
–
–
536.8
–
5.1
(29.5)
–
–
–
–
108
(66)
–
–
4,706
–
176
(302)
–
–
4,580
–
133
(254)
–
–
–
512.4
$4,459
–
–
–
(19)
–
(148)
–
–
–
(74)
–
(222)
–
–
–
(236)
414
–
$ (44)
Retained
earnings
$«3,897
1,258
–
(207)
–
(222)
4,726
1,556
–
(1,116)
–
(275)
4,891
2,087
–
(1,229)
–
–
(340)
$ 5,409
Total
shareholders’
equity
$«8,432
1,258
108
(273)
(19)
(222)
9,284
1,556
176
(1,418)
(74)
(275)
9,249
2,087
133
(1,483)
(236)
414
(340)
$ 9,824
See accompanying notes to consolidated financial statements.
U.S. GAAP
Canadian National Railway Company
63
63830_ang_060_064.indd 63
2/16/07 9:49:13 PM
Year ended December 31,
2006
2005
2004
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)
Other changes in:
Accounts receivable (Note 4)
Material and supplies
Accounts payable and accrued charges
Other net current assets and liabilities
Other
Cash provided from operating activities
Investing activities
Property additions
Acquisitions, net of cash acquired (Note 3)
Other, net
Cash used by investing activities
Financing activities
Issuance of long-term debt
Reduction of long-term debt
Issuance of common shares due to exercise of stock options and
related excess tax benefits realized (Note 12)
Repurchase of common shares (Note 11)
Dividends paid
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)
$«2,087
$«1,556
$«1,258
653
3
(17)
(36)
197
58
5
630
547
142
(25)
(156)
8
3
602
366
(233)
10
5
21
110
2,950
2,705
2,139
(1,298)
(84)
33
(1,349)
3,308
(3,089)
120
(1,483)
(340)
(1,484)
117
62
(1,180)
(1,072)
–
105
(1,531)
192
(1,075)
(2,411)
2,728
(2,865)
8,277
(7,579)
115
86
(1,418)
(275)
(1,715)
(85)
147
(273)
(222)
289
17
130
$÷÷179
$÷÷÷62
$÷÷147
$«7,733
$«7,375
$«6,501
(3,918)
(294)
(45)
(107)
(112)
(307)
(3,872)
(306)
(87)
(92)
(127)
(186)
(3,628)
(282)
(93)
(106)
(161)
(92)
Cash provided from operating activities
$«2,950
$«2,705
$«2,139
See accompanying notes to consolidated financial statements.
64
Canadian National Railway Company
U.S. GAAP
63830_ang_060_064.indd 64
2/16/07 9:49:17 PM
Notes to Consolidated Financial Statements
Canadian National Railway Company, together with its wholly-owned subsidiaries, collectively “CN” or “the Company,” 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.
Summary of significant accounting policies
1
These consolidated financial statements are expressed in Canadian
dollars, except where otherwise indicated, and have been prepared in
accordance with United States generally accepted accounting principles
(U.S. GAAP). The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of revenues
and expenses during the period, the reported amounts of assets and
liabilities, and the disclosure of contingent assets and liabilities at the
date of the financial statements. On an ongoing basis, management
reviews its estimates, including those related to personal injury and
other claims, environmental claims, depreciation, pensions and other
postretirement 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
subsidiaries, including Great Lakes Transportation LLC’s railroads and
related holdings (GLT) and the former 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 signifi-
cant 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 using the percentage of completed
service method based on the transit time of freight as it moves from origin
to destination. Costs associated with movements are recognized as the
service is performed. Revenues are presented net of taxes collected from
customers and remitted to governmental authorities.
C. Foreign exchange
All of the Company’s United States (U.S.) operations are self-contained
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 billing adjustments and
an allowance for doubtful accounts. The allowance for doubtful accounts
is based on expected collectibility and considers historical experience as
well as known trends or uncertainties related to account 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. Costs related to the sale of
accounts receivable are recognized in earnings in the period incurred.
F. Material and supplies
Material and supplies, which consist mainly of rail, ties, and other items
for construction and maintenance of property and equipment, as well as
diesel fuel, are valued at weighted-average cost.
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.
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
63830_ang_065_085.indd 65
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U.S. GAAP
Canadian National Railway Company
65
Notes to Consolidated Financial Statements
Summary of significant accounting policies (continued)
1
classification as held for sale whereas losses resulting from significant line
abandonments are recognized in the statement of income when the asset
ceases to be used. Gains are recognized in income when they are realized.
The Company amortizes the cumulative 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.
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
Information technology
Other
Annual rate
2%
3%
3%
12%
5%
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 expected long-term return on pension fund assets,
(iv) the amortization of prior service costs and amendments over the
expected average remaining service life of the employee group
covered by the plans, and
(v) the amortization of cumulative 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. Postretirement benefits other than pensions
The Company accrues the cost of postretirement 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.
L. Personal injury and other 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 third-party administration costs.
In the U.S., the Company accrues the expected cost for personal
injury, property damage and occupational disease claims, based on
actuarial estimates of their ultimate cost.
For all other legal actions in Canada and the U.S., the Company main-
tains, 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.
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 from time to
time in the management of its fuel, interest rate and foreign currency
exposures. Derivative instruments are recorded on the balance sheet
at fair value and the changes in fair value are recorded in earnings
or Other comprehensive income (loss) depending on the nature and
effectiveness of the hedge transaction. Income and expense related
to hedged derivative financial instruments are recorded in the same
category as that generated by the underlying asset or liability.
P. Stock-based compensation
The Company follows the fair value based approach for stock option
awards based on the grant-date fair value using the Black-Scholes option-
pricing model. The Company expenses the fair value of its stock option
awards over the period during which an employee is required to provide
service (vesting period). The Company also follows the fair value based
approach for cash settled awards and has prospectively applied this method
of accounting to all cash settled awards granted, modified or settled on
66
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 66
2/16/07 10:12:52 PM
Notes to Consolidated Financial Statements
or after January 1, 2006, as explained in Note 2 – Accounting changes.
Compensation cost for cash settled awards is based on the fair value of
the awards at period-end. See Note 12 – Stock plans, for the assump-
tions used to determine fair value and for other required disclosures.
Q. Recent accounting pronouncements
In September 2006, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other Post-
retirement Plans, an amendment of FASB Statements No. 87, 88, 106,
and 132(R),” which requires an employer to measure the defined benefit
plan assets and the projected benefit obligation as of the date of the
employer’s fiscal year-end statement of financial position. The requirement
is effective for fiscal years ending after December 15, 2008. Pursuant to
the Statement, this requirement will be applied prospectively. Although
the Company uses a measurement date of September 30 for its U.S. pen-
sion and other postretirement plans, the Company does not expect this
standard to have a significant impact on its financial statements. SFAS
No. 158 also requires the recognition of the funded status of a benefit
plan as well as other disclosure requirements, which were adopted on
December 31, 2006. See Note 2 – Accounting changes.
In September 2006, the U.S. Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin (SAB) No. 108 to address diversity in
practice in quantifying financial statement misstatements. SAB No. 108
requires consideration of the effects of prior year misstatements in
quantifying current year misstatements for the purpose of a materiality
assessment. SAB No. 108 did not have an impact on the Company’s
financial statements.
In July 2006, the FASB issued FASB Interpretation (FIN) No. 48,
“Accounting for Uncertainty in Income Taxes,” which prescribes a
recognition threshold and measurement attribute for the financial state-
ment recognition and measurement of a tax position taken or expected
to be taken in a tax return. This Interpretation also provides guidance
on derecognition, classification, interest and penalties, disclosure and
transition, and is effective for fiscal years beginning after December 15,
2006. Based on the Company’s preliminary assessment of the impact
of FIN No. 48, the adoption of this Interpretation on January 1, 2007 is
expected to decrease the net deferred income tax liability and increase
Retained earnings by approximately $100 million.
Accounting changes
2
2006
Stock-based compensation
On January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based
Payment,” which requires the 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.
The Company adopted SFAS No. 123(R) using the modified prospec-
tive approach, which requires application of the standard to all awards
granted, modified, repurchased or cancelled on or after January 1, 2006,
and to all awards for which the requisite service had not been rendered
as at such date. Since January 1, 2003, the Company has been following
the fair value based approach prescribed by SFAS No. 123, “Accounting for
Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting
for Stock-Based Compensation – Transition and Disclosure,” for stock
option awards granted, modified or settled on or after such date, while
cash settled awards were measured at their intrinsic value at each
reporting period until December 31, 2005. As such, the application of
SFAS No. 123(R) on January 1, 2006 to all awards granted prior to its
adoption did not have a significant impact on the financial statements.
In accordance with the modified prospective approach, prior period
financial statements have not been restated to reflect the impact of
SFAS No. 123(R).
For the year ended December 31, 2006, the application of SFAS
No. 123(R) had the effect of increasing stock-based compensation expense
and decreasing net income by $16 million and $12 million, respectively,
or $0.02 per basic and diluted earnings per share. Disclosures prescribed
by SFAS No. 123(R) for the Company’s various stock-based compensation
plans are presented in Note 12 – Stock plans.
Pension and other postretirement plans
On December 31, 2006, the Company adopted SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other Post-
retirement Plans, an amendment of FASB Statements No. 87, 88, 106,
and 132(R),” which requires the Company to recognize the over- or
underfunded status of its various benefit plans in its Consolidated
Balance Sheet. As such, on December 31, 2006, the Company increased
its pension asset by $599 million, to $1,275 million, and decreased its
pension and other postretirement benefits liability by $7 million, to
$481 million. The Company will recognize changes in the funded status
in the year in which the changes occur, through Other comprehensive
income (loss). The actuarial gains/losses and prior service costs/credits
that arise during the period but are not recognized as components of
net periodic benefit cost will be recognized as a component of Other
comprehensive income (loss), net of tax. These amounts recognized in
Accumulated other comprehensive loss will be adjusted as they are
subsequently recognized as components of net periodic benefit cost.
Prior to December 31, 2006, actuarial gains/losses and prior service
costs/credits were deferred in their recognition, and amortized into
net periodic benefit cost over the expected average remaining service
life of the employee group covered by the plans. The adoption of
SFAS No. 158 had no impact on years prior to 2006 as retrospective
application was not allowed. This standard had no effect on the
2006 computation of net periodic benefit cost for pensions and other
postretirement benefits. See Note 9 – Other liabilities and deferred
credits and Note 13 – Pensions, for the prospective application of
SFAS No. 158 to the Company’s benefit plans.
63830_ang_065_085.indd 67
2/16/07 10:12:56 PM
U.S. GAAP
Canadian National Railway Company
67
Notes to Consolidated Financial Statements
2
Accounting changes (continued)
The following table illustrates the incremental effect of applying SFAS No. 158 on individual line items in the Company’s Consolidated Balance
Sheet at December 31, 2006:
In millions
Pension
Total
Other
postretirement
benefits
Pension (1)
Net deferred
income tax
Total
Accumulated other
comprehensive loss
Total
Assets
Liabilities
Shareholders’ equity
Balance at December 31, 2006 before
application of SFAS No. 158
Adjustments
Balance at December 31, 2006 after
application of SFAS No. 158
$«÷676
$23,405
599
599
$313
(27)
$175
20
$4,939
$13,995
192
185
$(458)
414
$9,410
414
$1,275
$24,004
$286
$195
$5,131
$14,180
$÷(44)
$9,824
(1) On December 31, 2006, just prior to the adoption of SFAS No. 158, the Company had a minimum pension liability recorded of $17 million, with the offsetting amount recorded in
Accumulated other comprehensive loss ($11 million after tax).
2005
Conditional asset retirement obligations
Effective December 31, 2005, the Company adopted the recommenda-
tions of FIN 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 retirement
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.
Acquisitions
3
In 2006, the Company acquired the following three entities for a total
acquisition cost of $84 million, paid in cash:
(i) Alberta short-line railways, composed of the 600-mile Mackenzie
Northern Railway, the 118-mile Lakeland & Waterways Railway
and the 21-mile Central Western Railway,
(ii) Savage Alberta Railway, Inc., a 345-mile short-line railway, and
(iii) the remaining 51% of SLX Canada Inc., a company engaged in
equipment leasing in which the Company previously had a 49%
interest that had been consolidated.
In 2004, the Company acquired the following entities for a total acquisi-
tion cost of $1,538 million, financed by debt and cash on hand:
(i) BC Rail, acquired on July 14, 2004 for an acquisition cost of
$991 million, which included purchase price adjustments and
transaction costs, and
(ii) Great Lakes Transportation LLC’s railroads and related hold-
ings, acquired on May 10, 2004, for an acquisition cost of
U.S.$395 million (Cdn$547 million), which included purchase
price adjustments and transaction costs.
All acquisitions were accounted for using the purchase method of
accounting. As such, the Company’s consolidated financial statements
include the assets, liabilities and results of operations of the acquired
entities from the dates of acquisition.
Accounts receivable
4
In millions
December 31,
Freight
Non-freight
Allowance for doubtful accounts
2006
$398
313
711
(19)
$692
2005
$330
314
644
(21)
$623
The Company has a five-year agreement, expiring in May 2011, to sell
an undivided co-ownership interest of up to a maximum of $600 million
in a revolving pool of freight receivables to an unrelated trust. Pursuant
to the agreement, the Company sells an interest in its receivables and
receives proceeds net of the required reserves as stipulated in the agree-
ment. This program replaced the Company’s previous accounts receivable
securitization program that was set to expire in June 2006.
The Company has retained the responsibility for servicing, administer-
ing and collecting the receivables sold. At December 31, 2006, the servicing
asset and liability were not significant. Subject to customary indemnifica-
tions, the trust’s recourse is generally limited to the receivables.
The Company accounted for the securitization programs as sales,
because control over the transferred accounts receivable was relinquished.
Due to the relatively short collection period and the high quality of the
receivables sold, the fair value of the undivided interest transferred to
the trust approximated the book value thereof.
At December 31, 2006, the Company had sold receivables that
resulted in proceeds of $393 million under the new accounts receivable
securitization program ($489 million at December 31, 2005 under the
previous program), and recorded the retained interest, which represents
the required reserves, of approximately 10% of this amount in Other
current assets (retained interest of approximately 10% recorded at
December 31, 2005).
Other income (loss) included $12 million in 2006, $16 million in
2005 and $9 million in 2004, for costs related to the agreement, which
fluctuate with changes in prevailing interest rates.
68
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 68
2/16/07 10:13:00 PM
Notes to Consolidated Financial Statements
Properties
5
In millions
Track and roadway (1)
Rolling stock
Buildings
Information technology
Other
Capital leases included in properties
Track and roadway (1)
Rolling stock
Buildings
Information technology
Other
December 31, 2006
Accumulated
depreciation
$6,445
1,676
609
101
627
Cost
$22,579
4,833
1,251
622
1,226
Net
$16,134
3,157
642
521
599
December 31, 2005
Accumulated
depreciation
$6,388
1,642
591
133
593
Cost
$21,792
4,581
1,232
646
1,174
Net
$15,404
2,939
641
513
581
$30,511
$9,458
$21,053
$29,425
$9,347
$20,078
$÷÷«450
1,442
38
20
188
$÷÷«25
275
3
6
41
$÷÷«425
1,167
35
14
147
$÷÷«451
1,348
38
19
144
$÷÷«16
279
4
4
24
$÷÷«435
1,069
34
15
120
$÷2,138
$÷«350
$÷1,788
$÷2,000
$÷«327
$÷1,673
(1) Includes the cost of land of $1,746 million and $1,732 million as at December 31, 2006 and 2005, respectively, of which $108 million was for right-of-way access and was recorded
as a capital lease in both years.
Intangible and other assets
6
In millions
December 31,
2006
Pension asset (previously Prepaid benefit cost) (Notes 2, 13)
Investments (A)
Other receivables
Intangible assets (B)
Unamortized debt issue costs
Other
$1,275
142
95
65
32
6
2005
$621
132
102
66
31
9
$1,615
$961
A. Investments
As at December 31, 2006, the Company had $134 million ($124 million
at December 31, 2005) of investments accounted for under the equity
method and $8 million ($8 million at December 31, 2005) of investments
accounted for under the cost method. Included in investments is the
Company’s 32% ownership in English Welsh and Scottish Railway (EWS),
a company that provides most of the rail freight services in Great Britain
and operates freight trains through the English Channel tunnel. The
Company’s ownership in EWS is accounted for using the equity method.
At December 31, 2006, 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.
B. Intangible assets
Intangible assets relate to customer contracts and relationships assumed
through acquisitions.
Credit facility
7
In October 2006, the Company amended its U.S.$1,000 million revolving
credit facility, improving the pricing parameters and extending the
maturity from March 2010 to October 2011. Other terms of the facility
remained substantially the same. 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 credit facility agreement has 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 of U.S.$15 million (Cdn$17 million) out-
standing at December 31, 2005 (average interest rate of 4.66%) were
entirely repaid in the first quarter of 2006. As at December 31, 2006,
the Company had no outstanding borrowings under its revolving credit
facility and had letters of credit drawn of $308 million ($316 million
as at December 31, 2005).
The Company’s commercial paper program is backed by a
portion of its revolving credit facility. As at December 31, 2006, the
Company had no commercial paper outstanding, and U.S.$367 million
(Cdn$427 million) outstanding at an average interest rate of 4.40%,
as at December 31, 2005.
Accounts payable and accrued charges
8
In millions
Income and other taxes
Trade payables
Payroll-related accruals
Accrued charges
Accrued interest
Personal injury and other claims provision
Workforce reduction provisions
Other
December 31,
2006
2005
$÷«566
$÷«261
529
232
184
124
115
23
50
475
207
226
101
115
49
44
$1,823
$1,478
63830_ang_065_085.indd 69
2/16/07 10:13:04 PM
U.S. GAAP
Canadian National Railway Company
69
Notes to Consolidated Financial Statements
9
In millions
Other liabilities and deferred credits
(iv) Components of net periodic benefit cost
December 31,
2006
2005
In millions
Year ended December 31,
$÷«487
$÷«542
Service cost
Interest cost
Amortization of prior service cost
Recognized net actuarial (gain) loss
Net periodic benefit cost
2006
$÷4
16
2
(5)
$17
2005
$÷5
19
1
(1)
$24
2004
$÷8
17
3
1
$29
Personal injury and other claims provision,
net of current portion
Other postretirement benefits liability, net of current portion
(previously Accrual for postretirement benefits other
than pensions) (A)
Pension liability (previously Accrued benefit cost for
pensions) (Note 13)
Environmental reserve, net of current portion
Workforce reduction provisions, net of current portion (B)
Minimum pension liability (Note 13)
Deferred credits and other
269
195
106
74
–
334
$1,465
289
150
99
93
18
296
$1,487
A. Other postretirement benefits liability
On December 31, 2006, the Company adopted SFAS No. 158, “Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans,
an amendment of FASB Statements No. 87, 88, 106, and 132(R),” as
explained in Note 2 – Accounting changes. The following disclosures in
relation to the Company’s other postretirement benefit plans are made
pursuant to SFAS No. 158 requirements.
(i) Obligations and funded status
In millions
Year ended December 31,
2006
2005
Change in benefit obligation
Benefit obligation at beginning of year
$300
$319
Amendments
Transfer from other plan
Actuarial gain
Interest cost
Service cost
Foreign currency changes
Benefits paid
Benefit obligation at end of year
Unfunded status
2
–
(19)
16
4
–
(17)
$286
$286
(4)
8
(20)
19
5
(8)
(19)
$300
$300
The estimated prior service cost and net actuarial gain for other
postretirement benefits that will be amortized from Accumulated other
comprehensive loss into net periodic benefit cost over the next fiscal
year are $1 million and $3 million, respectively.
(v) Weighted-average assumptions
The following assumptions are used in accounting for other postretire-
ment benefits:
December 31,
2006
2005
2004
To determine benefit obligation
Discount rate
Rate of compensation increase
To determine net periodic benefit cost
Discount rate
Rate of compensation increase
5.44%
3.50%
5.30%
3.75%
5.30%
3.75%
5.90%
3.75%
5.90%
3.75%
6.00%
3.75%
(vi) Health care cost trend rate
For measurement purposes, increases in the per capita cost of covered
health care benefits were assumed to be 12% for 2007 and 13% for
2006. It is assumed that the rate will decrease gradually to 6% in 2013
and remain at that level thereafter.
A one-percentage-point change in the assumed health care cost
trend rates would have the following effect:
In millions
One-percentage-point
Increase
Decrease
$÷2
24
$÷(2)
(20)
The Company uses a measurement date of September 30 for its U.S. plans and December 31
for its Canadian plans.
Effect on total service and interest costs
Effect on benefit obligation
(ii) Amount recognized in the Consolidated Balance Sheet
In millions
Current liabilities
Noncurrent liabilities
Total amount recognized (1)
December 31,
2006
$÷17
269
$286
2005
$÷24
289
$313
(1) At December 31, 2005, the amount recognized in the Consolidated Balance Sheet of
$313 million differs from the unfunded status of $300 million given the prospective
application of SFAS No. 158. The difference of $13 million represents the unrecognized
net actuarial gain of $24 million, offset by the unrecognized prior service cost of
$11 million existing at December 31, 2005.
(iii) Amounts recognized in Accumulated other comprehensive
loss (Note 20) (1)
In millions
Net actuarial gain
Prior service cost
(1) Recognized on December 31, 2006 pursuant to SFAS No. 158.
December 31,
2006
$34
(7)
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 postretire-
ment 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.
70
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 70
2/16/07 10:13:08 PM
Notes to Consolidated Financial Statements
(vii) 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:
$÷17
17
19
19
19
107
In millions
2007
2008
2009
2010
2011
Years 2012 to 2016
10
Long-term debt
In millions
Debentures and notes: (A)
Canadian National series:
4.25% 5-year notes (B)
6.38% 10-year notes (B)
4.40% 10-year notes (B)
5.80% 10-year notes (B)
6.80% 20-year notes (B)
7.63% 30-year debentures
6.90% 30-year notes (B)
7.38% 30-year debentures (B)
6.25% 30-year notes (B)
6.20% 30-year notes (B)
6.71% Puttable Reset Securities PURSSM (B)(C)
6.45% Puttable Reset Securities PURSSM (C)
Illinois Central series:
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:
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 retire-
ment, the majority of which will be disbursed within the next five years.
In 2006, net charges and adjustments did not have any effect on the
provisions and decreased the provisions by $10 million for the year
ended December 31, 2005. Payments have reduced the provisions by
$45 million for the year ended December 31, 2006 ($87 million for
the year ended December 31, 2005). As at December 31, 2006, the
aggregate provisions, including the current portion, amounted to
$97 million ($142 million as at December 31, 2005).
Maturity
Currency
in which
payable
December 31,
2006
2005
Aug. 1, 2009
Oct. 15, 2011
Mar. 15, 2013
May 31, 2016
July 15, 2018
May 15, 2023
July 15, 2028
Oct. 15, 2031
Aug. 1, 2034
May 31, 2036
July 15, 2036
July 15, 2006
July 12, 2007
June 9, 2008
Dec. 1, 2056
Sept. 15, 2096
April 15, 2008
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
U.S.$
$÷«350
$÷«349
466
466
291
233
175
554
233
583
524
291
–
58
23
9
146
175
4,577
842
5,419
–
–
1,038
1,038
6,457
218
853
1,071
$5,386
465
465
–
233
174
552
233
582
–
–
291
58
23
9
145
174
3,753
842
4,595
17
427
897
1,341
5,936
408
851
1,259
$4,677
Non-interest bearing 90-year subordinated notes (D)
July 14, 2094
CDN$
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.$
U.S.$
Various
A. The Company’s debentures, notes and revolving credit facility are unsecured.
B. 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.
U.S. GAAP
Canadian National Railway Company
71
63830_ang_065_085.indd 71
2/16/07 10:13:13 PM
Notes to Consolidated Financial Statements
Long-term debt (continued)
10
C. On July 15, 2006, the interest rate on the Company’s U.S.$250 million
Puttable Reset Securities PURSSM (PURS) was reset at a new rate of
6.71% for the remaining 30-year term ending July 15, 2036. The PURS
were originally issued in July 1998 at the rate of 6.45% with an option
to call the securities on July 15, 2006 (the reset date). The call option
holder exercised the call option, which resulted in the remarketing of the
original PURS. The new interest rate was determined according to a pre-
set mechanism based on prevailing market conditions. The Company did
not receive any cash proceeds from the remarketing.
The remarketing did not trigger an extinguishment of debt, as the
provisions for the reset of the interest rate were set forth in the original
PURS. As such, the original PURS remain outstanding but accrue interest
at the new rate until July 2036. Under securities laws, the remarketing
required utilization of the Company’s shelf prospectus and registration
statement.
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 borrowings through
subsequent issuances of commercial paper or drawing down on the
long-term revolving credit facility.
F. During 2006, the Company recorded $264 million ($222 million in 2005)
in assets it acquired through equipment leases, including $3 million for
assets held for sale, for which an equivalent amount was recorded in debt.
Interest rates for capital lease obligations range from approximately
3.0% to 7.9% with maturity dates in the years 2007 through 2025.
The imputed interest on these leases amounted to $384 million as at
December 31, 2006 and $360 million as at December 31, 2005.
The capital lease obligations are secured by properties with a
net carrying amount of $1,368 million as at December 31, 2006 and
$1,243 million as at December 31, 2005.
G. Long-term debt maturities, including repurchase arrangements and
capital lease repayments on debt outstanding as at December 31, 2006,
for the next five years and thereafter, are as follows:
In millions
2007
2008
2009
2010
2011
2012 and thereafter
$÷«218
274
446
40
571
4,055
H. The aggregate amount of debt payable in U.S. currency as at
December 31, 2006 was U.S.$4,636 million (Cdn$5,403 million) and
U.S.$4,169 million (Cdn$4,849 million) as at December 31, 2005.
I. The Company has U.S.$550 million available under its currently effec-
tive shelf prospectus and registration statement, expiring in June 2008,
providing for the issuance of debt securities in one or more offerings.
Capital stock
11
A. Authorized capital stock
The authorized capital stock of the Company is as follows:
• Unlimited number of Common Shares, without par value
• Unlimited number of Class A Preferred Shares, without par value,
issuable in series
• Unlimited number of Class B Preferred Shares, without par value,
issuable in series
B. Issued and outstanding common shares
During 2006, the Company issued 5.1 million shares (6.6 million shares
in 2005 and 5.8 million shares in 2004) related to stock options exer-
cised. The total number of common shares issued and outstanding was
512.4 million as at December 31, 2006.
C. Share repurchase programs
In July 2006, the Board of Directors of the Company approved a new
share repurchase program which allows for the repurchase of up to
28.0 million common shares between July 25, 2006 and July 24, 2007
pursuant to a normal course issuer bid, at prevailing market prices. As
at December 31, 2006, under this current share repurchase program,
15.5 million common shares have been repurchased for $766 million,
at an average price of $49.43 per share.
72
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 72
2/16/07 10:13:17 PM
Notes to Consolidated Financial Statements
In June 2006, the Company ended its previous 32.0 million share
repurchase program, which began July 25, 2005, repurchasing a total
of 30.0 million common shares for $1,388 million, at an average price
of $46.26 per share. Of this amount, 14.0 million common shares
were repurchased in 2006 for $717 million, at an average price of
$51.24 per share.
D. Common stock split
On January 24, 2006, the Board of Directors of the Company approved
a two-for-one common stock split which was effected in the form of a
stock dividend of one additional common share of CN payable for each
share held. The stock dividend was paid on February 28, 2006, to share-
holders of record on February 22, 2006. All equity-based benefit plans
and the previous share repurchase program were adjusted to reflect the
issuance of additional shares or options due to the stock split. All share
and per share data have been adjusted to reflect the stock split.
Stock plans
12
The Company has various stock-based incentive plans for eligible
employees. A description of the Company’s major plans is provided
below:
A. Employee Share Investment Plan
The Company has an Employee Share Investment Plan (ESIP) giving
eligible employees the opportunity to subscribe for up to 10% 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, 2006 was 12,590 employees (11,010
at December 31, 2005 and 10,073 at December 31, 2004). The total
number of ESIP shares purchased on behalf of employees, including the
Company’s contributions, was 1.3 million in 2006, 1.6 million in 2005 and
1.4 million in 2004, resulting in a pre-tax charge to income of $15 million,
$12 million and $11 million for the years ended December 31, 2006,
2005 and 2004, respectively.
B. Stock-based compensation plans
Compensation cost for awards under all stock-based compensation
plans was $79 million, $120 million and $65 million for the years ended
December 31, 2006, 2005 and 2004, respectively. The total tax benefit
recognized in income in relation to stock-based compensation expense
for the years ended December 31, 2006, 2005 and 2004 was $22 million,
$34 million and $18 million, respectively.
(i) Cash settled awards
Restricted share units
The Company has granted restricted share units (RSUs), 0.8 million in
2006, 0.9 million in 2005, and 2.3 million in 2004, to designated man-
agement 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
relating to the Company’s share price during the three-month period
ending December 31, 2008 for the 2006 grant and December 31, 2007
for the 2005 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 allowable amount under the plan, resulting in
a payout of $105 million. Of this amount, $41 million was converted into
deferred share units at December 31, 2005, and the remaining payout of
$64 million was paid in cash in January 2006. As at December 31, 2006,
a minimal amount of RSUs remained authorized for future issuance
under this plan.
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 0.8 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 aver-
age share price ending on such date. As at December 31, 2006, 0.2 mil-
lion share units remained authorized for future issuance under this plan.
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 payment and other eligible incentive
payments in deferred share units (DSUs). A DSU is equivalent to a com-
mon share of the Company and also earns dividends when normal cash
dividends are paid on common shares. The number of DSUs received by
each participant is established using the average closing price for the
20 trading days prior to and including the date of the incentive pay-
ment. For each participant, the Company will grant a further 25% of
63830_ang_065_085.indd 73
2/16/07 10:13:21 PM
U.S. GAAP
Canadian National Railway Company
73
Notes to Consolidated Financial Statements
Stock plans (continued)
12
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. The Company’s liability for DSUs is marked-to-
market at each period-end based on the Company’s closing stock price.
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.
The following table provides the 2006 activity for all cash settled awards:
In millions
Outstanding at December 31, 2005
Granted
Forfeited
Vested during period
Conversion into VIDP
Outstanding at December 31, 2006
RSUs
Vision
VIDP
Nonvested
Vested
Nonvested
Vested
Nonvested
Vested
1.2
0.8
–
–
–
2.0
–
–
–
–
–
–
0.8
–
–
–
–
0.8
–
–
–
–
–
–
0.4
–
–
(0.1)
–
0.3
1.7
–
–
0.1
0.1
1.9
Additional disclosures required under SFAS No. 123(R) for cash settled awards are provided in tabular format herein.
(ii) Stock option awards
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, 2006, 15.2 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 the sixth anniversary of the grant or prior if certain Company
targets relating to return on investment and revenues are attained.
As at December 31, 2006, the Company’s performance and performance-
accelerated stock options were fully vested.
For 2006 and 2005, the Company granted approximately 1.1 million
and 1.3 million, respectively, of conventional stock options to designated
senior management employees that vest over a period of four years of
continuous employment.
The total number of options outstanding at December 31, 2006,
for conventional, performance and performance-accelerated options was
12.1 million, 0.8 million and 4.0 million, respectively.
74
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 74
2/22/07 10:34:57 AM
Notes to Consolidated Financial Statements
The following table provides the activity of stock option awards during 2006, and for options outstanding and exercisable at December 31, 2006,
the weighted-average exercise price, the weighted-average years to expiration and the aggregate intrinsic value. The aggregate intrinsic value repre-
sents the total pre-tax intrinsic value, based on the Company’s closing stock price at December 31, 2006 of $50.07, which would have been received
by option holders had they exercised their options on such date.
Outstanding at December 31, 2005 (1)
Granted
Forfeited
Exercised
Vested
Outstanding at December 31, 2006 (1)
Exercisable at December 31, 2006 (1)
Options outstanding
Weighted-
average
exercise price
Weighted-
average years
to expiration
Aggregate
intrinsic value
In millions
$20.95
$51.51
$34.78
$19.69
N/A
$23.29
$20.44
5.1
4.7
$452
$439
Number of
options
In millions
21.0
1.1
(0.1)
(5.1)
N/A
16.9
14.8
Nonvested options
Weighted-
average grant
date fair value
Number of
options
In millions
5.4
1.1
N/A
N/A
(4.4)
2.1
N/A
$÷8.47
$13.80
N/A
N/A
$÷8.30
$11.61
N/A
(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.
As at December 31, 2006, stock options outstanding and exercisable by range of exercise prices were as follows:
Range of exercise prices
$9.07–$12.61
$13.54–$19.83
$20.27–$28.26
$34.01–$40.55
$45.18–$55.57
Balance at December 31, 2006 (1)
Options outstanding
Options exercisable
Number of
options
In millions
1.9
3.2
9.4
1.3
1.1
16.9
Weighted-
average years
to expiration
Weighted-
average
exercise price
2.1
3.4
5.5
8.1
9.1
5.1
$ 11.53
$ 16.06
$ 23.30
$ 34.93
$ 51.97
$23.29
Weighted-
average
exercise price
Number of
options
In millions
1.9
3.2
9.4
0.3
–
14.8
$ 11.53
$ 16.06
$ 23.30
$ 34.92
N/A
$20.44
(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.
The following table provides information related to options exer-
cised during the years ended December 31, 2006, 2005 and 2004:
In millions
Year ended December 31,
Total intrinsic value
Cash received upon exercise of options
Related tax benefits realized
2006
$156
101
÷19
2005
$139
115
÷21
2004
$91
86
12
Prior to January 1, 2006, the Company followed 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, and measured cash settled awards at their intrin-
sic value at period-end. For the years ended December 31, 2005 and
2004, 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:
In millions, except per share data Year ended December 31,
2005
2004
Net income, as reported
$1,556
$1,258
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
Basic earnings per share, as reported
Basic earnings per share, pro forma
Diluted earnings per share, as reported
Diluted earnings per share, pro forma
86
–
(110)
38
9
(78)
$1,532
$1,227
$÷2.82
$÷2.78
$÷2.77
$÷2.73
$÷2.21
$÷2.15
$÷2.17
$÷2.12
2006 data is not provided since net income and pro forma net income would be
the same given the application of SFAS No. 123(R).
Additional disclosures required under SFAS No. 123(R) for stock
option awards are provided in tabular format herein.
63830_ang_065_085.indd 75
2/22/07 10:35:19 AM
U.S. GAAP
Canadian National Railway Company
75
Notes to Consolidated Financial Statements
Stock plans (continued)
12
(iii) Additional disclosures required under SFAS No. 123(R) pertaining to all awards
In millions, unless otherwise indicated
RSUs (1)
Vision (1)
VIDP (2) Mid-term (2)
Year of grant
2006 (4)
2005
2004
2005
2003
onwards
2001
2006 (4)
2005
Prior to
2005
Cash settled awards
Stock option awards (3)
Stock-based compensation expense
recognized over vesting period
Year ended December 31, 2006
Year ended December 31, 2005
Year ended December 31, 2004
Liability outstanding
December 31, 2006
December 31, 2005
Fair value per unit
At period-end ($)
At grant date ($)
Fair value of awards vested during period
Year ended December 31, 2006
Year ended December 31, 2005
Year ended December 31, 2004
Nonvested awards at December 31, 2006
$«÷÷21
N/A
N/A
$«÷÷19
$«÷÷15
N/A
$«÷÷÷6
$«÷÷74
$«÷÷36
$«÷÷21
N/A
$«÷÷34
$«÷÷15
$«÷÷÷8
$«÷÷66
$36.32
$49.36
$50.07
N/A
N/A
N/A
$÷÷÷«–
N/A
N/A
$÷÷÷«–
$÷÷÷«–
N/A
$«÷÷÷4
$«÷105
$«÷÷÷3
Unrecognized compensation cost
$«÷÷15
$«÷÷17
$«÷÷÷8
Remaining recognition period (years)
2.0
1.0
2.0
$«÷÷÷8
$÷÷÷«–
N/A
$«÷÷÷8
$÷÷÷«–
$19.98
N/A
$÷÷÷«–
$÷÷÷«–
N/A
$«÷÷÷8
2.0
$«÷÷11
$«÷÷13
$«÷÷÷7
$«÷÷99
$«÷÷83
$50.07
N/A
$«÷÷÷5
$«÷÷÷2
$÷÷÷«–
$«÷÷13
3.0
Assumptions (5)
Stock price ($)
Expected stock price volatility (6)
Expected term (years) (7)
Risk-free interest rate (8)
Dividend rate ($) (9)
$50.07
$50.07
$50.07
$50.07
$50.07
19%
2.0
4.02%
$÷0.65
18%
1.0
4.16%
$÷0.65
N/A
N/A
N/A
N/A
20%
2.0
4.47%
$÷0.65
N/A
N/A
N/A
N/A
N/A
N/A
$«÷÷13
$«÷÷÷8
N/A
N/A
$«÷÷÷3
$«÷÷÷2
N/A
$«÷÷÷3
$«÷÷16
$«÷÷÷9
N/A
N/A
N/A
N/A
N/A
N/A
$«÷÷20
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
$13.80
$÷9.19
$÷8.61
$÷÷÷«–
N/A
N/A
$«÷÷÷3
$÷÷÷«–
N/A
$«÷÷34
$«÷÷34
$«÷÷35
$«÷÷÷6
$«÷÷÷6
$÷÷÷«–
3.1
2.1
–
$51.51
$36.33
$23.59
25%
5.17
4.04%
$÷0.65
25%
5.20
3.50%
$÷0.50
30%
6.22
5.13%
$÷0.30
(1) Beginning in 2006, compensation cost was based on the fair value of the awards at period-end using the lattice-based valuation model that uses the assumptions as presented herein,
except for time-vested RSUs. In 2005 and 2004, compensation cost was measured using intrinsic value for all awards.
(2) Compensation cost for all periods presented was based on intrinsic value.
(3) Compensation cost for all periods presented was based on the grant date fair value using the Black-Scholes option-pricing model that uses the assumptions presented herein.
(4) Includes the accelerated recognition of awards granted to retirement-eligible employees. For these individuals, compensation cost is recognized over the period from the grant date to the
date the requisite service period has been achieved.
(5) Assumptions used to determine fair value are at period-end for cash settled awards and at grant date for stock option awards.
(6) Based on the historical volatility of the Company’s stock over a period commensurate with the expected term of the award.
(7) Represents the remaining period of time that awards are expected to be outstanding. For option awards only, the Company uses historical data to estimate option exercise and employee
termination, and groups of employees that have similar historical exercise behavior are considered separately.
(8) Based on the implied yield available on zero-coupon government issues with an equivalent term commensurate with the expected term of the awards.
(9) Based on the annualized dividend rate.
Pensions
13
The Company has various retirement benefit plans under which substan-
tially 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.
A. 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
76
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 76
2/22/07 11:43:31 AM
Notes to Consolidated Financial Statements
(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.
B. 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, 2005 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 2007,
2008 and 2009 based on the plans’ current position. All of the Company’s
contributions are expected to be in the form of cash.
C. 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 $14,812 million as at
December 31, 2006 ($14,069 million at December 31, 2005). The Plan’s
target percentage allocation and weighted-average asset allocations as
at December 31, 2006 and 2005, by asset category are as follows:
Plan assets by category
Equity securities
Debt securities
Real estate
Other
Target
allocation
53%
40%
4%
3%
100%
December 31,
2006
52%
38%
2%
8%
100%
2005
56%
32%
2%
10%
100%
The Company follows a disciplined investment strategy, which
limits concentration of investments by asset class, foreign currency,
sector or company. The Investment Committee of the Board of Directors
has approved an investment policy that establishes long-term asset mix
targets based on a review of historical returns achieved by worldwide
investment markets. Investment managers may deviate from these tar-
gets but their performance is evaluated in relation to the market perfor-
mance 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.
D. Weighted-average assumptions
The following assumptions are used in accounting for pension benefits:
December 31,
2006
2005
2004
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
5.12%
3.50%
5.00%
3.75%
8.00%
5.00%
3.75%
5.75%
3.75%
8.00%
5.75%
3.75%
6.00%
3.75%
8.00%
To develop its expected long-term rate of return assumption used
in the calculation of net periodic benefit cost applicable to the market-
related value of assets, the Company considers both its past experience
and future estimates of long-term investment returns, the expected
composition of the plans’ assets as well as the expected long-term
market returns in the future. The Company has elected to use a market-
related value of assets, whereby realized and unrealized gains/losses
and appreciation/depreciation in the value of the investments are
recognized over a period of five years, while investment income is
recognized immediately.
E. Information about the Company’s defined benefit pension plans
On December 31, 2006, the Company adopted SFAS No. 158, “Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans,
an amendment of FASB Statements No. 87, 88, 106, and 132(R),” as
explained in Note 2 – Accounting changes. The following disclosures
in relation to the Company’s defined benefit pension plans are made
pursuant to SFAS No. 158 requirements.
(i) Obligations and funded status
In millions
Year ended December 31,
2006
2005
Change in benefit obligation
Benefit obligation at beginning of year
Amendments
Interest cost
Actuarial loss
Service cost
Plan participants’ contributions
Foreign currency changes
Benefit payments and transfers
Benefit obligation at end of year
Component representing future salary increases
Accumulated benefit obligation at end of year
Change in plan assets
$14,346
$13,137
–
713
237
146
55
(1)
(951)
(3)
742
1,234
138
58
(11)
(949)
$14,545
$14,346
(771)
(762)
$13,774
$13,584
Fair value of plan assets at beginning of year
$14,874
$13,053
Employer contributions
Plan participants’ contributions
Foreign currency changes
Actual return on plan assets
Benefit payments and transfers
112
55
1
1,534
(951)
127
58
(8)
2,593
(949)
Fair value of plan assets at end of year
$15,625
$14,874
Funded status (Excess of fair value of plan assets over
benefit obligation at end of year)
$÷1,080
$÷÷«528
63830_ang_065_085.indd 77
2/16/07 10:13:38 PM
U.S. GAAP
Canadian National Railway Company
77
Notes to Consolidated Financial Statements
Pensions (continued)
13
(ii) Amount recognized in the Consolidated Balance Sheet
(vi) 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
Noncurrent assets
Noncurrent liabilities:
Pension liability
Minimum pension liability (Note 9)
Total amount recognized (1)
December 31,
2006
$1,275
(195)
–
$1,080
2005
$621
(150)
(18)
$453
In millions
2007
2008
2009
2010
2011
(1) At December 31, 2005, the amount recognized in the Consolidated Balance Sheet
Years 2012 to 2016
of $453 million differs from the funded status of $528 million given the prospective
application of SFAS No. 158. The difference of $75 million is composed of (i) $57 million,
representing the excess of the fair value of plan assets over benefit obligation at end
of year, and consisting of the unrecognized net actuarial gain of $111 million offset by
the unrecognized prior service cost of $54 million existing at December 31, 2005, and
(ii) $18 million, representing an additional minimum pension liability recorded pursuant
to SFAS No. 87 requirements which arose because one of the Company’s pension plans
had an accumulated benefit obligation in excess of the fair value of the plan assets at
its measurement date. The offsetting amount was recorded in Accumulated other compre-
hensive loss (see table below). Adjustments made to the minimum pension liability and
recorded as a component of Other comprehensive income (loss) in 2005 and 2004 were
$4 million and $8 million, respectively.
(iii) Amounts recognized in Accumulated other comprehensive
loss (Note 20)
In millions
Net actuarial gain (1)
Prior service cost (1)
December 31,
Additional minimum pension liability
(1) Recognized on December 31, 2006 pursuant to SFAS No. 158.
2006
$600
(38)
–
(iv) Information for the pension plan with an accumulated benefit
obligation in excess of plan assets
In millions
December 31,
Projected benefit obligation
Accumulated benefit obligation
Fair value of plan assets
(v) Components of net periodic benefit cost
In millions
Year ended December 31,
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized net actuarial loss
Net periodic benefit cost
2006
$«146
713
(903)
19
91
2006
$130
121
109
2005
$«138
742
(884)
18
3
$÷«66
$÷«17
$÷«22
2005
$÷–
–
18
2005
$104
96
87
2004
$«124
733
(857)
19
3
The estimated prior service cost and net actuarial loss for defined
benefit pension plans that will be amortized from Accumulated other
comprehensive loss into net periodic benefit cost over the next fiscal
year are $19 million and $54 million, respectively.
$÷«840
863
886
912
934
5,015
2004
$÷(2)
32
5
(4)
(18)
(33)
$(20)
2006
$«18
16
4
(6)
(12)
(9)
$«11
2005
$«12
26
3
4
(12)
(21)
$«12
Other income (loss)
14
In millions
Year ended December 31,
Foreign exchange gain (loss)
Gain on disposal of properties
Investment income
Equity in earnings of EWS (Note 6)
Net real estate costs
Other
Income taxes
15
The Company’s consolidated effective income tax rate differs from the
Canadian statutory Federal tax rate. The reconciliation of income tax
expense is as follows:
In millions
Year ended December 31,
Federal tax rate
Income tax expense at the statutory
Federal tax rate
Income tax (expense) recovery resulting from:
2006
22.1%
2005
2004
22.1%
22.1%
$(603)
$(516)
$(410)
Provincial and other taxes
(354)
(331)
(263)
Deferred income tax adjustments
due to rate enactments
Other (1)
Income tax expense
Cash payments for income taxes
228
87
$(642)
$«307
(14)
80
$(781)
$«186
5
72
$(596)
$÷«92
(1) Includes adjustments relating to the resolution of matters pertaining to prior years’ income
taxes and other items.
The following table provides tax information for Canada and the
United States:
In millions
Year ended December 31,
2006
2005
2004
Income before income taxes
Canada
U.S.
Current income taxes
Canada
U.S.
Deferred income taxes
Canada
U.S.
$2,009
720
$2,729
$÷(440)
(199)
$÷(639)
÷$÷«102
(105)
$÷÷÷(3)
$1,769
$1,501
568
353
$2,337
$1,854
$÷÷(95)
(139)
$÷(234)
$÷(488)
(59)
$÷(547)
$÷(222)
(8)
$÷(230)
$÷(244)
(122)
$÷(366)
78
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 78
2/16/07 10:13:42 PM
Notes to Consolidated Financial Statements
Significant components of deferred income tax assets and liabilities
The role of each region is to manage the day-to-day service
are as follows:
In millions
Deferred income tax assets
Workforce reduction provisions
Personal injury claims and other reserves
Other postretirement benefits liability
Losses and tax credit carryforwards
Deferred income tax liabilities
Net pension asset
Properties and other
December 31,
2006
2005
$÷÷«32
$÷÷«51
215
99
14
360
330
5,161
5,491
234
117
9
411
168
4,995
5,163
Total net deferred income tax liability
$5,131
$4,752
requirements within their respective territories 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 strategy 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 83% of the
Company’s freight revenues are from national accounts for which freight
traffic spans North America and touches various commodity 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
Total net deferred income tax liability
the following areas:
Canada
U.S.
Total net deferred income tax liability
Net current deferred income tax asset
Long-term deferred income tax liability
$2,050
3,081
$5,131
$5,131
84
$1,802
2,950
$4,752
(i) each region’s sole business activity is the transportation of freight
over the Company’s extensive rail network;
$4,752
(ii) the regions service national accounts that extend over the
65
Company’s various commodity groups and across its rail network;
$5,215
$4,817
(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
single regulatory regimes 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,
2006
2005
2004
Revenues
Canada
U.S.
$5,116
2,600
$7,716
$4,660
2,580
$7,240
$4,126
2,422
$6,548
In millions
Year ended December 31,
2006
2005
2004
Net income
Canada
U.S.
In millions
Properties
Canada
U.S.
$1,671
416
$2,087
$1,186
$1,035
370
223
$1,556
$1,258
December 31,
2006
2005
$11,129
$10,457
9,924
9,621
$21,053
$20,078
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, 2006, the
Company had $16 million of operating loss carryforwards, resulting
from the recent acquisitions, available to reduce future taxable income
(nil at December 31, 2005). The Company has not recognized a deferred
tax asset on the foreign exchange loss (recorded in Accumulated other
comprehensive loss) on its permanent investment in U.S. rail subsidiaries,
as the Company does not expect this temporary difference to reverse in
the foreseeable future.
The Company recognized tax credits of $4 million in 2006 for eligible
research and development expenditures ($4 million in each of 2005 and
2004) not previously recognized, which reduced the cost of properties.
Segmented information
16
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 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
Region, Eastern Region and Southern Region). 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.
63830_ang_065_085.indd 79
2/16/07 10:13:46 PM
U.S. GAAP
Canadian National Railway Company
79
Notes to Consolidated Financial Statements
17
Earnings per share
Year ended December 31,
Basic earnings per share
Diluted earnings per share
2006
$3.97
$3.91
2005
$2.82
$2.77
2004
$2.21
$2.17
The following table provides a reconciliation between basic and
diluted earnings per share:
In millions
Year ended December 31,
2006
2005
2004
Net income
Weighted-average shares outstanding
Effect of stock options
Weighted-average diluted shares outstanding
$2,087
$1,556
$1,258
525.9
8.4
534.3
551.7
10.5
562.2
570.2
9.5
579.7
For the year ended December 31, 2006, the weighted-average
number of stock options that were not included in the calculation of
diluted earnings per share, as their inclusion would have had an anti-
dilutive impact, was 0.2 million. For the years ended December 31, 2005
and 2004, all stock options were dilutive.
Major commitments and contingencies
18
A. Leases
The Company has operating and capital leases, mainly for locomotives,
freight cars and intermodal equipment. Of the capital leases, many provide
the option to purchase the leased items at fixed values during or at the
end of the lease term. As at December 31, 2006, the Company’s commit-
ments under these operating and capital leases were $740 million and
$1,405 million, respectively. Minimum rental payments for operating
leases having initial non-cancelable lease terms of one year or more and
minimum lease payments for capital leases in each of the next five years
and thereafter are as follows:
In millions
2007
2008
2009
2010
2011
2012 and thereafter
Less: imputed interest on capital leases at rates ranging from
approximately 3.0% to 7.9%
Present value of minimum lease payments included in debt
144
116
95
69
132
$740
119
138
79
147
706
1,405
384
$1,021
The Company also has operating lease agreements for its automo-
tive fleet with minimum one-year non-cancelable terms for which its
practice is to renew monthly thereafter. The estimated annual rental
payments for such leases are approximately $30 million and generally
extend over five years.
Rent expense for all operating leases was $202 million, $233 million
and $242 million for the years ended December 31, 2006, 2005 and 2004,
respectively. Contingent rentals and sublease rentals were not significant.
B. Other commitments
As at December 31, 2006, the Company had commitments to acquire
railroad ties, rail, freight cars, locomotives and other equipment
and services at an aggregate cost of $742 million. Furthermore, as at
December 31, 2006, the Company had outstanding information technol-
ogy service contracts and licenses of $31 million and agreements with
fuel suppliers to purchase approximately 45% of its anticipated 2007
volume and 2% of its anticipated 2008 volume at market prices prevail-
ing on the date of the purchase.
C. Contingencies
In the normal course of its operations, the Company becomes involved
in various legal actions, including claims relating to personal injuries,
occupational disease and damage to property.
Canada
Employee injuries are governed by the workers’ compensation legisla-
tion 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 devel-
oped estimates of the ultimate cost associated with such injuries,
including compensation, health care and third-party 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, 2006, 2005 and 2004, the Company’s provision for
personal injury and other claims in Canada was as follows:
In millions
Balance January 1
Accruals and other
Payments
Operating
Capital
Balance December 31
$184
$÷«216
2006
$205
60
(70)
$195
2005
$204
46
(45)
$205
2004
$169
64
(29)
$204
United States
Employee work-related injuries, including occupational 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 represent 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 occupational disease claims,
based on actuarial estimates of their ultimate cost. Prior to 2005, the
Company’s provisions for unasserted occupational disease claims consti-
tuted the minimum amount that could be reasonably estimated, reflect-
ing 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 unasserted occu-
pational disease claims, thereby increasing the expected number of
claims to be received. These changes also rendered the recent claim
experience to be more representative of future anticipated settlements
for asserted occupational disease claims, thereby reducing the average
80
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 80
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Notes to Consolidated Financial Statements
cost per claim. Accordingly, in 2005, 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 occupa-
tional disease claims.
In 2006, the Company recorded a net reduction to its provision
for U.S. personal injury and other claims pursuant to the 2006 external
actuarial studies. The reduction was mainly attributable to a decrease in
the Company’s claims inventory as a result of its ongoing risk mitigation
strategy focused on prevention, mitigation of claims and containment
of injuries and lower settlements for existing 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.
At December 31, 2006, 2005 and 2004, the Company’s provision for
U.S. personal injury and other claims was as follows:
a potentially responsible party for study and clean-up costs at approxi-
mately 23 sites governed by the Superfund law (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.
While the Company believes that it has identified the costs likely
to be incurred in the next several years, based on known information,
for environmental matters, the Company’s ongoing efforts to identify
potential environmental concerns that may be associated with its prop-
erties may lead to future environmental investigations, which may result
in the identification of additional environmental costs and liabilities.
The magnitude of such additional liabilities and the costs of complying
with environmental laws and containing or remediating contamination
cannot be reasonably estimated due to:
(i) the lack of specific technical information available with respect
to many sites;
In millions
Balance January 1
Accruals and other
Payments
Balance December 31
2006
$452
(8)
(37)
$407
2005
$438
61
(47)
$452
2004
$421
94
(77)
$438
(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;
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, 2006, 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 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.
The Company is subject to environmental clean-up and enforce-
ment actions. In particular, the Federal Comprehensive Environmental
Response, Compensation and Liability Act of 1980 (CERCLA), also known
as the Superfund law, as well as similar state laws generally impose joint
and several liability for clean-up and enforcement costs on current and
former owners and operators of a site without regard to fault or the
legality of the original conduct. The Company has been notified that it is
(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 posi-
tion or results of operations in a particular quarter or fiscal year, or that
the Company’s liquidity will not be adversely impacted by such environ-
mental 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 competi-
tive 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, representing clean-up costs for the shoreline,
fronting residences and First Nations Land. In 2006, this liability was
adjusted for additional environmental and legal claims and reduced by
payments made pursuant to the clean-up performed. At December 31,
2006, the Company has a receivable for the remaining estimated recov-
eries from the Company’s insurance carriers since the Company’s insur-
ance policies are expected to cover substantially all expenses related to
the derailment above the self-insured retention. Operating expenses in
2005 included approximately $28 million, of which $25 million was for
environmental matters, related to this derailment, which represented the
Company’s retention under its insurance policies and other uninsured
costs. The ultimate liability for clean-up costs is not expected to materi-
ally differ from the current amount recorded, but any additional costs
are expected to be offset by a corresponding change in the insurance
63830_ang_065_085.indd 81
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U.S. GAAP
Canadian National Railway Company
81
Notes to Consolidated Financial Statements
Major commitments and contingencies (continued)
18
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.
In 2006, the Company’s expenses relating to specific environmental
sites and remediation, net of recoveries, were $17 million ($37 million
in 2005). Payments for such matters were $10 million, net of potential
insurance recoveries, in 2006 ($24 million in 2005 and $8 million in
2004). As at December 31, 2006, the Company had aggregate accruals
for such environmental costs of $131 million ($124 million as at
December 31, 2005). The Company anticipates that the majority of the
liability at December 31, 2006 will be paid out over the next five years.
The Company also incurs expenses related to environmental regula-
tory compliance and clean-up requirements. Such expenses amounted
to $10 million in 2006 ($9 million in 2005 and $10 million in 2004). In
addition, environmental capital expenditures were $18 million in 2006,
$11 million in 2005 and $13 million in 2004. The Company expects to
incur capital expenditures relating to environmental matters of approxi-
mately $19 million in 2007, $16 million in 2008 and $14 million in 2009.
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.
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 guarantee, a liability will be recog-
nized to the extent that one has not yet been recognized.
(i) 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 2007 and
2017, for the benefit of the lessor. If the fair value of the assets, at the
end of their respective lease term, is less than the fair value, as estimated
at the inception of the lease, then the Company must, under certain con-
ditions, compensate the lessor for the shortfall. At December 31, 2006,
the maximum exposure in respect of these guarantees was $148 million,
of which $1 million has been recorded and represents the Company’s
obligation to stand ready and honor the guarantees that were entered
into in accordance with FIN No. 45 requirements. There are no recourse
provisions to recover any amounts from third parties.
(ii) 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, 2006, the maximum potential liability under these guaran-
tees was $454 million, of which $380 million was for workers’ compen-
sation and other employee benefits and $74 million was for equipment
under leases and other. During 2006, the Company granted guarantees
for which no liability has been recorded, as they relate to the Company’s
future performance.
As at December 31, 2006 and 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 majority of the guarantee instruments mature at various
dates between 2007 and 2010.
(iii) 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 author-
ized 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, 2006, 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.
(iv) 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 agree-
ments relating to debt or equity securities of the Company and engage-
ment 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
82
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 82
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Notes to Consolidated Financial Statements
to insurance policies, incidents or events covered by the settlement
agreements. To the extent of any actual claims under these agreements,
the Company maintains provisions for such items, which it considers
to be adequate. Due to the nature of the indemnification clauses, the
maximum exposure for future payments may be material. However,
such exposure cannot be determined with certainty.
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, 2006 and 2005, the carry-
ing 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.
Financial instruments
19
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. At December 31,
2006, the Company did not have any derivative financial instruments
outstanding.
(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 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 had a hedging program which
called 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.
As such, the Company terminated this program in late 2006.
Since the changes in the fair value of the swap positions were
highly correlated to changes in the price of fuel, the fuel hedges were
being accounted for as cash flow hedges, whereby the effective portion
of the cumulative change in the market value of the derivative instru-
ments had been recorded in Accumulated other comprehensive loss.
During 2006, the Company’s remaining swap positions matured and
were settled. As a result, the related unrealized gains previously recorded
in Accumulated other comprehensive loss were reclassified into income
as realized gains (unrealized gains of $57 million, $39 million after tax at
December 31, 2005). At December 31, 2006, the Company is no longer
hedged through financial markets.
Realized gains from the Company’s fuel hedging activities, which are
recorded in fuel expense, were $64 million, $177 million and $112 million
for the years ended December 31, 2006, 2005 and 2004, respectively.
The Company did not recognize any material gains or losses in each
of 2006, 2005 and 2004 due to hedge ineffectiveness as the Company’s
derivative instruments were highly effective in hedging the changes in
cash flows associated with forecasted purchases of diesel fuel.
(iii) Interest rate
In 2004, the Company realized a gain of $12 million upon settlement of
treasury lock transactions that was recorded in Accumulated other com-
prehensive loss. This gain is being recorded into income, as a reduction of
interest expense, over the term of the related debt (30-year term) based
on the interest payment schedule. At December 31, 2006, Accumulated
other comprehensive loss included an unamortized gain of $12 million,
$8 million after tax ($12 million, $8 million after tax at December 31, 2005).
(iv) Foreign currency
The Company conducts its business in both Canada and the U.S. and
as a result, is affected by currency fluctuations. 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.
For the purpose of minimizing volatility of earnings resulting from
the conversion of U.S. dollar-denominated long-term debt into the
Canadian dollar, the Company designates the U.S. dollar-denominated
long-term debt of the parent company as a foreign exchange hedge of
its net investment in U.S. subsidiaries. As a result, from the dates of
designation, unrealized foreign exchange gains and losses on the trans-
lation of the Company’s U.S. dollar-denominated long-term debt are
recorded in Accumulated other comprehensive loss.
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 equity investments for which
the carrying value approximates the fair value, with the exception of
certain cost investments 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.
63830_ang_065_085.indd 83
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U.S. GAAP
Canadian National Railway Company
83
Notes to Consolidated Financial Statements
Financial instruments (continued)
19
The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments as at December 31, 2006 and
2005 for which the carrying values on the Consolidated Balance Sheet are different from their fair values:
In millions
Financial assets
Investments
Financial liabilities
December 31, 2006
December 31, 2005
Carrying
amount
Fair
value
Carrying
amount
Fair
value
$÷«142
$÷«215
$÷«132
$÷«185
Long-term debt (including current portion)
$5,604
$5,946
$5,085
$5,751
Accumulated other comprehensive loss
20
The components of Accumulated other comprehensive loss at December 31, 2006 and 2005 are as follows:
In millions
Unrealized foreign exchange loss
Pension and other postretirement benefit plans adjustments
Derivative instruments
Deferred income tax rate enactment
Accumulated other comprehensive loss
December 31,
2006
$(455)
403
8
–
$÷(44)
The components of Other comprehensive loss and the related tax effects for the years ended December 31, 2006, 2005 and 2004 are as follows:
In millions
Year ended December 31,
Accumulated other comprehensive loss – Balance January 1
Other comprehensive income (loss):
Unrealized foreign exchange loss (net of income tax (expense) recovery of $(231), $27 and $34,
for 2006, 2005 and 2004, respectively) (1)
Pension and other postretirement benefit plans adjustment (net of income tax (expense) recovery of
nil, $(1) and $(3), for 2006, 2005 and 2004, respectively) (Note 13)
Derivative instruments (net of income tax (expense) recovery of $18, $12 and $(22) for
2006, 2005 and 2004, respectively) (Note 19)
Deferred income tax rate enactment
Other comprehensive loss
Adjustment to reflect the funded status of benefit plans (Notes 2, 9, 13):
Net actuarial gain (net of income tax expense of $(200) for 2006)
Prior service cost (net of income tax recovery of $14 for 2006)
Reversal of minimum pension liability adjustment (net of income tax expense of $(6) for 2006)
Accumulated other comprehensive loss – Balance December 31
2006
$(222)
(232)
1
(39)
34
(236)
434
(31)
11
$÷(44)
2005
$(148)
(54)
3
(23)
–
(74)
–
–
–
$(222)
$(148)
2005
$(223)
(12)
47
(34)
$(222)
2004
$(129)
(68)
5
44
–
(19)
–
–
–
(1) In 2006, the Company adjusted its deferred income tax liability for changes in income tax rates applied to certain temporary differences and also for the income tax effect
on the currency translation amount resulting from the difference between the accounting and tax basis of its net investment in foreign subsidiaries. As a result, the Company
recorded a $180 million net charge for deferred income taxes in Other comprehensive income (loss).
Comparative figures
21
Certain figures, previously reported for 2005 and 2004, have been reclassified to conform with the basis of presentation adopted in the current year.
84
Canadian National Railway Company
U.S. GAAP
63830_ang_065_085.indd 84
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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 the specified item in the adjusted measures below does not, however, imply that such item is necessarily non-recurring. The
Company also 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. 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 defines free cash flow as cash provided from operating activities,
excluding changes in the accounts receivable securitization program, less investing activities, and after the payment of 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 – 2006
In millions, except per share data, or unless otherwise indicated
Year ended December 31,
Revenues
Operating expenses
Operating income
Interest expense
Other income
Income before income taxes
Income tax expense
Net income
Operating ratio
Diluted earnings per share
Reported
$ 7,716
4,686
3,030
(312)
11
2,729
(642)
$2,087
60.7%
$÷3.91
2006
Adjustment (1)
$÷÷÷ –
–
–
–
–
–
(277)
$«(277)
$(0.51)
Adjusted
$ 7,716
4,686
3,030
(312)
11
2,729
(919)
$1,810
60.7%
$÷3.40
(1) Adjusted to exclude the impact of a deferred income tax recovery of $277 million ($0.51 per diluted share) that resulted from the enactment of lower federal and provincial corporate
tax rates in Canada and the resolution of matters pertaining to prior years’ income taxes.
Free cash flow – 2006 and 2005
In millions
Cash provided from operating activities
Less:
Investing activities
Cash provided before financing activities
Adjustments:
Change in accounts receivable securitization (1)
Dividends paid
Free cash flow
(1) Changes in the Company’s accounts receivable securitization program are considered a financing activity.
Year ended December 31,
2006
$ 2,950
(1,349)
1,601
82
(340)
$ 1,343
2005
$ 2,705
(1,075)
1,630
(54)
(275)
$ 1,301
63830_ang_065_085.indd 85
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Canadian National Railway Company
85
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 securities
listed on the Toronto Stock Exchange (TSE) 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
website (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 website 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 website.
We are proud of our corporate governance practices. For more
information on these practices, please refer to our website, as well as
to our proxy circular – mailed to all shareholders and also available on
our website.
86
Canadian National Railway Company
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2006 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 2006 in the areas of Service, Cost Control, Asset Utilization, Safety and People.
Category: Service
Winner: Richard Kummen (Surrey, British Columbia)
Winner: AMEC De Beers Victor Project Team
George Adams (Toronto, Ontario), Kevin Foley (Edmonton, Alberta),
Katrina Phaneuf (Toronto, Ontario)
With the development by De Beers Canada of a new diamond mine in
northern Ontario, this team managed the complex distribution of construc-
tion material and other freight first to Moosonee, the nearest site accessible
by rail, and from there to the mine site in the very short period when the
seasonal ice road was open for operation. The CN team delivered a total
of 600 railcar shipments in the first ice road season.
Richard developed a multimodal option using a barge vessel service to
accommodate the movement of growing amounts of OSB (oriented strand
board) wood panels. Two sailings per month, providing space for 5,000
metric tonnes per voyage, are now offered from Squamish to Los Angeles.
Richard’s initiative has produced 7,200 car days of capacity or 800 available
cars for other service. Once all capacity is sold, 1,500 railcars per year will
be diverted to Squamish, producing 52,000 car days of savings.
Category: Safety
Winner: CN 9602 Crew Team
Winner: Bresolin/Louis Team
Johnny Johnson (Freeport, Illinois), Gerry Wilson (Freeport, Illinois)
Dan Bresolin (Toronto, Ontario), Bill Louis (Plainfield, Illinois)
Due to infrastructure destruction and a severe reduction in commerce in
New Orleans in the aftermath of Hurricane Katrina, CN’s Intermodal business
in the city had dropped dramatically. Dan, Bill and the Intermodal Sales team
drew on their skills and succeeded in doubling the amount of traffic CN was
handling. Working diligently, they sold shippers on CN’s reliability, speed and
capacity and made sure the company delivered.
When their locomotive collided with debris that had been placed on the
tracks, severing fuel lines, this crew acted quickly to minimize the impact of
the incident in Rockford, Illinois. Avoiding the many water crossings along
their route, they stopped the unit approximately two miles away near a
grade crossing. Alerted by the crew, the Track personnel promptly set about
stopping or reducing the leaks, containing the diesel fuel using CN-issued
spill response kits. The result: much less fuel was lost in the incident, and
surface waters were not affected by the fuel spill.
Winner: Enzo De Benetti (Montreal, Quebec)
Enzo solved an ongoing problem that had been an issue for three years.
On a 10-mile uphill grade in WC territory, trains were sometimes going into
emergency and separating without anyone understanding why, including the
hardware vendor. After an incident blocked the line for several hours, Enzo
was called for help. He detected and solved a systemic problem with the end-
of-train (EOT) units that was causing them to give false readings, avoiding
future disruptions to operations.
Winner: Tim Parker (Homewood, Illinois)
On his own time and using his own resources, Tim produces a quarterly
newsletter that achieves the Engineering Safety group’s goal of raising
safety awareness. He focuses the newsletter on the human side of safety,
creating links between the company, safety, employees and their families.
Tim is also involved in several charitable activities on behalf of CN.
Winner: Transcona Health and Safety Team
Winner: Dan Drier (Homewood, Illinois)
Fraser Fisher (Winnipeg, Manitoba), Ray Mills (Winnipeg, Manitoba)
Dan first recognized an opportunity for CN to transport ethanol in 2001. He
worked with farmers and local investors to create a new market for CN. Today,
the territory he serves has six plants completed, producing 305 million gallons
of ethanol and providing CN with 12,600 revenue loads per year. Ten more
plants are expected to bring approximately 40,000 loads on board.
Category: Cost Control
Winner: Bruce Rogers (Fond du Lac, Wisconsin)
By shutting down power when not needed, Bruce, a locomotive engineer, made
it his personal mission to save energy and then keep a record of the impact of
this move. That effort saved 58,500 gallons of fuel. Assuming an average of
U.S.$2.00 per gallon, he saved CN U.S.$117,000 in one year alone.
Category: Asset Utilization
Winner: CN/CP Direct Hit Initiative Team
Brad Bodner (Edmonton, Alberta), Gord Miller (Surrey, British Columbia),
Glen Randall (Surrey, British Columbia)
To help both CN and CP provide superior, efficient service in Vancouver, these
team members initiated discussions with CP. They were able to identify com-
mon problems and highlight creative solutions. The plan they came up with
capitalized on existing synergies between the two corporations, eliminated
redundant handling and switching of traffic and improved locomotive cycles
and manpower utilization – lowering the costs significantly and improving
customer service dramatically.
The labour and management co-chairs of the Transcona Car Shop Health and
Safety Committee have worked closely to enhance safety in the workplace,
bringing injuries down from 224 in 2003, to just 17 in 2006. In 2006, the
co-chairs focused on the top three injuries (back, hand and eye) in the shop.
They both guided their committee members, shop employees and supervi-
sors to find the true root causes and put in place corrective measures.
Category: People
Winner: Employee Performance Scorecard Taskforce Team
Terrence Gallagher (Toronto, Ontario), Christine Joanis (Montreal, Quebec),
Allan Rothwell (Homewood, Illinois), Darrell Trask (Winnipeg, Manitoba),
Susan Seebeck (Montreal, Quebec)
In 2006, CN expanded its individual performance review process to each
of its 18,000 unionized employees. This team developed 55 scorecard types
customized with local measures for the various regions, functions and sub-
groups, and they conducted 155 training sessions with supervisors on how
to give performance feedback. Reactions have been positive, and employees
have remarked that it is now easier to link their day-to-day activities to CN’s
five guiding principles.
Special Award – Terminal of the Year
Winner: MacMillan Yard, Toronto, Ontario
The winner for 2006 in this newly established annual category is MacMillan
Yard in Toronto, recognized for successful efforts to reduce dwell time, mini-
mize classifications and increase velocity, all keys to CN’s asset utilization,
cost control and service principles.
Canadian National Railway Company
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Canadian National Railway Company
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Board of Directors (As at December 31, 2006)
Fourth row, left to right:
Robert Pace
President and
The Honourable
Robert H. Lee, C.M., O.B.C., LL.D.
Hugh J. Bolton, FCA
Edward C. Lumley, P.C., LL.D.
Chairman
Chairman of the Board
Chief Executive Officer
Vice-Chairman
Prospero Group of Companies
EPCOR Utilities Inc.
The Pace Group
BMO Capital Markets
Committees: 1, 2, 7, 8
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. Giffin
J.V. Raymond Cyr, O.C., LL.D.
James K. Gray, O.C., A.O.E., LL.D.
Denis Losier, LL.D.
Senior Partner
Chairman of the Board
McKenna Long & Aldridge
PolyValor Inc.
Committees: 2, 5, 6, 7
Committees: 2, 5*, 7, 8
Corporate Director
Former Chairman and
Chief Executive Officer
President and
Chief Executive Officer
Assumption Life
Canadian Hunter Exploration Ltd.
Committees: 1, 2*, 7, 8
Committees: 3, 5, 6, 7
Second row, left to right:
Edith E. Holiday
A. Charles Baillie, O.C., LL.D.
Purdy Crawford, O.C., Q.C., LL.D.
Corporate Director and Trustee
Former Chairman and
Counsel
Former General Counsel
Chief Executive Officer
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.
E. Hunter Harrison
Michael R. Armellino, CFA
V. Maureen Kempston Darkes,
Chairman of the Board
President and
Retired Partner
Canadian National Railway Company
Chief Executive Officer
The Goldman Sachs Group, LP
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 Officer
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
5 Environment, safety and security
6 Human resources and compensation
3 Corporate governance and
7 Strategic planning
nominating
4 Donations
8 Investment
*denotes chairman of the committee
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Canadian National Railway Company
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Chairman of the Board and Executive Officers of the Company (As at December 31, 2006)
Dav id 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 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
Sameh Fahmy
Senior Vice-President
Engineering, Mechanical and
Supply Management
Edmond L. Harris
Executive Vice-President
Operations
Stan Jablonski
Senior Vice-President
Sales
Peter C. Marshall
Senior Vice-President
Western Region
Claude Mongeau
Executive Vice-President and
Chief Financial Officer
Robert E. Noorigian
Vice-President
Investor Relations
Jean-Jacques Ruest
Senior Vice-President
Marketing
Gordon T. Traf ton
Senior Vice-President
Southern Region
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Shareholder and investor information
Annual meeting
The annual meeting of shareholders will be held at
10:00 am (local time) on April 24, 2007 at the Delta Beausejour,
in Moncton, New Brunswick, Canada.
Stock exchanges
CN common shares are listed on the Toronto and
New York stock exchanges.
Nothing proves an idea like results.
Ticker symbols:
CNR (Toronto Stock Exchange)
CNI (New York Stock Exchange)
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
Investor relations
Robert Noorigian
Vice-President, Investor Relations
Telephone: 514-399-0052 or 1-800-319-9929
CN has developed a uni que model for railroading, characterized by
improvements in the numbers we’ve posted
over the past decade have been excepti onal, but we know nothing stays the same.
of business. You have to prove it every day.
balance, precision and discipline. The
It’s the nature
Computershare Trust Company of Canada
Shareholder Services
100 University Avenue, 9th Floor
Toronto, Ontario M5J 2Y1
Telephone: 1-800-564-6253
www.computershare.com
Offices in:
Montreal, QC; Toronto, ON; Calgary, AB; Vancouver, BC
Telephone: 1-800-564-6253
www.computershare.com
Shareholder services
Shareholders having inquiries concerning their shares
or wishing to obtain information about CN should contact:
Transfer agent and registrar
Computershare Trust Company of Canada
Co-transfer agent and co-registrar
Computershare Trust Company of New York
17 State Street, 28th Floor
New York, NY 10004
Telephone: 212-805-7000 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:
Head office
Canadian National Railway Company
935 de La Gauchetière Street West
Montreal, Quebec H3B 2M9
P.O. Box 8100
Montreal, Quebec H3C 3N4
That’s w hat we’re doing. We’re proving CN’s model
and resolve by conti nuing to deliver industry-leading reliability.
By continuing to drive change.
And by continuing to define new horizons for profitable growth.
Computershare Trust Company of Canada
Telephone: 1-800-564-6253
La version française du présent rapport
est disponible à l’adresse suivante :
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
Affaires publiques CN
935, rue de La Gauchetière Ouest
Montréal (Québec) H3B 2M9
Téléphone : 1 888 888-5909
Courriel : contact@cn.ca
Certain information included in this Annual Report
tees of future performance and involve known and
may be forward-looking statements within the mean-
unknown risks, uncertainties and other factors which
ing of United States and Canadian securities laws.
may cause the actual results or performance of the
Implicit in these statements is the assumption that
Company or the rail industry to be materially different
while the Company expects a moderate slowdown
from the outlook or any future results or performance
in the North American economy in the near term, its
implied by such statements. Such factors include the
business prospects assume positive economic condi-
specific risks set forth in Management’s Discussion
tions in North America and globally. This assumption,
and Analysis contained in this Annual Report as well
although considered reasonable by the Company
as other risks detailed from time to time in reports
at the time of preparation, may not materialize.
filed by the Company with securities regulators in
Such forward-looking statements are not guaran-
Canada and the United States.
Contents
2 Financial and operational highlights
4 A message from E. Hunter Harrison
10 Delivering reliability
14 Driving change
18 Defining new growth horizons
22 CN at a glance
24 A message from the Chairman
25 Pulling together for communities
28 Glossary of terms
29 Financial Section (U.S. GAAP)
85 Non-GAAP Measures – unaudited
86 Corporate Governance
87 2006 President’s Awards for Excellence
88 Board of Directors
90 Chairman of the Board and
Executive Officers of the Company
91 Shareholder and investor information
Except where otherwise
indicated, all financial infor-
mation reflected in this docu-
ment is expressed in Canadian
dollars and determined
on the basis of United States
generally accepted accounting
principles (U.S. GAAP).
This report has been printed on recycled paper.
Canadian National Railway Company
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2006 Annual Report
Proving it.
935 de La Gauchetière Street West, Montreal, Quebec H3B 2M9
www.cn.ca
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