BECOMING A TRUE SUPPLY CHAIN ENABLER 2 0 1 3 a n n u a l r e p o r t Contents 1 A message from the Chairman 2 A message from Claude Mongeau 4 Becoming a true supply chain enabler: Making connections 6 Board of Directors 7 Financial Section (U.S. GAAP) 88 Corporate Governance – Delivering Responsibly 89 Shareholder and Investor Information Except where otherwise indicated, all financial information reflected in this document is expressed in Canadian dollars and determined on the basis of United States gener- ally accepted accounting principles (U.S. GAAP). Certain information included in this annual report constitutes “forward-looking statements” within the meaning of the United States Private Securities Litigation Reform Act of 1995 and under Canadian securities laws. CN cautions that, by their nature, these forward-looking statements involve risks, uncertainties and assumptions. The Company cautions that its assumptions may not materialize and that current economic conditions render such assumptions, although reasonable at the time they were made, subject to greater uncertainty. Such forward-looking statements 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 performance implied by such statements. Important risk factors that could affect the forward-looking statements include, but are not limited to, the effects of general economic and business conditions, industry competition, inflation, currency and interest rate fluctuations, changes in fuel prices, legislative and/or regulatory developments, compliance with environmental laws and regulations, actions by regulators, various events which could disrupt operations, including natural events such as severe weather, droughts, floods and earthquakes, labor negotiations and disruptions, environmental claims, uncertainties of investigations, proceedings or other types of claims and litigation, risks and liabilities arising from derailments, and other risks detailed from time to time in reports filed by CN with securities regulators in Canada and the United States. Reference should be made to “Manage- ment’s Discussion and Analysis” in CN’s annual and interim reports, Annual Information Form and Form 40-F filed with Canadian and U.S. securities regulators, available on CN’s website (www.cn.ca), for a summary of major risks. CN assumes no obligation to update or revise forward-looking statements to reflect future events, changes in circum- stances, or changes in beliefs, unless required by applicable Canadian securities laws. In the event CN does update any forward-looking statement, no inference should be made that CN will make additional updates with respect to that state- ment, related matters, or any other forward-looking statement. As used herein, the word “Company” or “CN” means, as the context requires, Canadian National Railway Company and/ or its subsidiaries. A message from the Chairman Dear fellow shareholders In 2013, CN’s outstanding performance further solidified the company’s position as the leader of the rail industry. CN not only continued to deliver its customers’ goods safely and efficiently, it was also recognized for Delivering Responsibly – the term CN uses to describe its sustainability, safety and corporate citizenship activities. For the fourth consecutive year, CN has earned a position in CDP’s Canada 200 Climate Disclosure Leadership Index. As well, CN’s sustainability practices earned it a place as the leader in the Transportation and Transportation Infrastructure Industry sector of the Dow Jones Sustainability World Index (DJSI). This is part of the leadership people have come to expect from CN. Since I became Chairman of CN’s Board nearly 20 years ago, the company has made enormous improvements. We embarked on a bold mission to privatize CN and we have become the best in the business. This will be my last message as CN’s Chairman before my retirement. I am proud to say we have continued to raise the bar for our achievements for many years. We have created great value for shareholders while we improved our overall performance. I believe that I leave CN in excellent shape to ensure its continued track record of excellence. All members of the Board have the fullest confidence in Robert Pace, whom we have selected as the next Chairman of the Board. Robert is a highly respected businessman who is very active in his community, and our shareholders can feel confident about his abilities to help guide CN. He will be supported by a talented team at the Board level, and of course by our President and CEO Claude Mongeau, and the 23,000 railroaders who make CN the leader in the industry. As I prepare to move on, I want to thank all of our shareholders for the support you have shown me. I am proud to retire knowing the company has everything in place that it needs to keep delivering value for its customers, its shareholders and to continue to play its role as a transportation backbone of the economy for years to come. Sincerely, David McLean, O.B.C., LL.D. Chairman of the Board Canadian National Railway Company 2013 Annual Report 1 A message from Claude Mongeau BECOMING A TRUE SUPPLY CHAIN ENABLER Dear fellow shareholders Over the last few years, I’ve frequently been asked about what the next big step forward would be for railroading. As it turns out, the next leap forward for railroading goes well beyond our tracks and trains. Of course we’re still focussed on improving how our railroad operates. CN has long earned the reputation of being the industry’s leader in efficiency, speed and service. And we’re not about to let up. We invest more than $2 billion annually to keep our network safe and fluid, balancing Operational and Service Excellence to serve customers safely and efficiently. CN’s team of dedicated railroaders delivered on our strategic agenda and produced record volumes and revenues in 2013. Our full-year 2013 adjusted diluted EPS increased nine per cent to $3.06, with adjusted 2013 net income of $2,582 million versus $2,456 million in 2012. Key operating and service metrics remained solid, and we continued to drive incremental improvement in our broad safety record. CN reduced its accident rate per million train miles by nine per cent in 2013, an additional indication of long-term gains in safety. In the past 10 years, CN’s main-track accidents have declined by approximately 50 per cent despite increased freight volumes. But CN has also raised its game through a mindset that looks at the entirety of moving goods through the complete supply chain: not just how CN handles its portion of the process. We are increasingly involved in every step of the way, with all of the players. We are a catalyst “ We are a catalyst for putting partners together in an un- precedented man- ner, for examining and improving how products and mate- rial get from point A to point B. “ for putting partners together in an unprecedented manner, for examining and improving how products and material get from point A to point B. We call this being a Supply Chain enabler. Supply Chain mindset Our aspiration at CN is to become a true Supply Chain enabler, which is to look at things not just as a railroad, but to do so end to end, with a view to driving service and efficiency. It’s about helping our customers win in the marketplace, and we’re doing that for the benefit of all the supply chain partners that we deal with. We’re doing that to improve service in all business segments. We’re helping our partners find ways 2 2013 Annual Report Canadian National Railway Company to save costs while they do likewise for us. We’re looking at ways to tactically deploy assets for their benefit and ours. That’s what true supply chain engagement is all about. And why are we doing this? Because we believe that engaging our customers, having a more customer-centric approach, is absolutely essential to help them win in the marketplace and help us grow faster, so that we can all benefit from this success. It’s also because when all the players in a supply chain see the world in the same manner, you open up greater opportunities for efficiencies and service improvement. The first port with which we signed a framework supply chain collaboration agreement a few years ago was the Port of Halifax. It led to service level agreements with the two terminal “ ...we believe that engaging our customers, having a more customer-centric approach, is abso- lutely essential to help them win in the market place and help us grow faster...” operators there and the concept caught on quickly with other players. As I’ve explained before, today we have agreements with ports and terminal operators across Canada. We measure throughput, slot utilization, and transit time end to end in the same way from every port, and we provide scorecards to our customers about our performance so that we can improve together on an ongoing basis. Those benefits are continuing to help us enhance innovation and productivity throughout the supply chain. This supply chain mentality is now part of how we approach all areas of our business. As we continue to connect and build trust among customers, shippers, suppliers, and other players, we are keenly aware that a safe supply chain is as important as an efficient one. Committed to safety In 2013, CN’s main-track accident performance was the best on record, based on statistics established by the Transportation Safety Board in Canada and the Federal Railroad Administration in the U.S. This was the result of CN’s comprehensive, integrated safety plan and our ongoing efforts to improve CN’s safety culture. CN invests continuously to maintain a safe operation. From track infrastructure, to leading-edge technology, to new training initiatives, this allows us to operate a safe railway and improve the efficiency and fluidity of the network. In addition to all that we do to improve our safety performance, we are engaging with many other stakeholders, such as shippers, regulators, government officials and other railroads. As an industry leader, CN is committed to playing our role to help ensure goods are moved through communities safely for the benefit of all. Claude Mongeau President and CEO Canadian National Railway Company 2013 Annual Report 3 BECOMiNg A TRUE SUPPLY CHAiN ENABLER MAkiNg CONNECTiONS A fresh approach to the transborder allows our customers to grow locally food supply chain and expand globally. With some of the Ensuring perishable food reaches fastest transit times in the industry, CN mar kets on time is challenging, and is delivering perishable goods in the must be achieved in a way that is condition that customers demand: cost effective, meets high food safety fresh, undamaged and unspoiled. standards and reduces environmen A cold supply chain must be tight tal impact. CN’s supply chain efforts, with little room for error. To achieve new tools and improved service is that, you need a player with enough making this happen for customers capacity, not only to meet current like never before. market demand but also to respond CN has undertaken initiatives that to growth. With recent investments, include incorporating innova tive tech including increasing its fleet of reefer nology within the CargoCool Pro containers, CN provides a sustainable gram, CN’s refrigerated or reefer transportation solution that is adapt service. The stateoftheart remote able to growing volumes. monitoring technology provides end toend visibility with realtime tracking Connecting energy partners and and tracing on CN’s net work, and suppliers even allows remote tempera ture Frac sand is used by the oil and gas adjust ments. Dedicated reefer custo industry in the process of fractur mer service personnel execute timely ing shale rock to help the release of exception management with a sense hydro carbons. The process of frac of urgency that is needed within turing, coupled with horizontal drill the food industry. CN’s expanded ing, has moved North America to rank crossborder cold supply chain among the top world producers of oil program helps connect producers and gas. Wisconsin has one of the from key markets including California, largest reserves of highquality frac Washington, Oregon and Western sand in North America, right in CN’s Canada to consumer markets in the backyard, thanks to the acquisition of U.S., Canada and Mexico, making the Wisconsin Central in 2001. CN the first railroad with this fully CN’s unique access to the containerized Transborder Reefer Wisconsin sand deposits and our service. CN’s CargoCool Program direct reach to Western Canada 4 2013 Annual Report Canadian National Railway Company oil and gas and other key North also goes beyond rail. For overseas through shale plays American its connections with all Class I railroads, sets CN apart to benefit intermodal shippers, that means we’re paying close attention to the entire roundtrip – from the from the strong growth in frac sand container’s departure overseas, to shipments taking place today. By the waiting time at the port terminal, matching and linking up producers to the rail transit time, and finally, to and users of frac sand, CN has been the container’s return back to the one of the key drivers behind the port of entry. amazing growth of frac sand along We are actively working to create our lines. Matchmaking is being ecosystems of collaboration, to share done at all stages of the projects, information, and to closely monitor from the plant design phase, to the key operating and service metrics the building of a customer base that drive a more efficient endto for our sand customers, and to the end supply chain. it also means we’re delivery of the sand to oil and gas helping our overseas customers users. This has benefited our sand lower their total supply chain costs. customers tremendously, as well as Take for example a loaded container CN, accelerating growth beyond the that arrives in Joliet, illinois. CN is normal course of doing business. working hard to find opportunities to CN moved over 55,000 carloads in reload that container with products 2013 generating $200M in revenue, destined to Asia. When we can’t a 50% increase versus 2012. By 2015, find an export load, CN seeks to use we’re aiming to achieve annual frac the empty container in its domestic sand revenues of $300M. reposition program (DRP) to deliver Intermodal: the big picture goods from greater Chicago to consumers in Western Canada. CN CN’s supply chain approach is also strives to increase export loads allowing the company to deliver and help our customers leverage value service as defined by the their container assets on the sea. At customer, not just as we see it. We the same time, this helps CN grow its measure endtoend service for revenues and volumes. That’s what customers from their point of view, we call winning with our customers. which includes the rail portion, but Canadian National Railway Company 2013 Annual Report 5 Board of Directors As at December 31, 2013 David G.A. McLean, O.B.C., LL.D. Chairman of the Board Canadian National Railway Company Chairman of the Board The McLean Group Committees: 2, 3, 4, 6, 7, 8 Donald J. Carty, O.C., LL.D. Retired Chairman and CEO American Airlines and Retired Vice-Chairman Dell, Inc. Committees: 1, 2, 3, 7, 8 The Honourable Denis Losier, C.M., P.C., LL.D. Retired President and Chief Executive Officer Assumption Life Committees: 1*, 3, 4, 5, 6, 7, 8 Directors Emeritus Purdy Crawford J.V. Raymond Cyr James K. Gray Cedric Ritchie Claude Mongeau President and Chief Executive Officer Canadian National Railway Company Committees: 4*, 7, 8 Michael R. Armellino, CFA Retired Partner The Goldman Sachs Group, L.P. Committees: 2, 3*, 5, 6, 7, 8 A. Charles Baillie, O.C., LL.D. Former Chairman and Chief Executive Officer The Toronto-Dominion Bank Committees: 2*, 3, 6, 7, 8 Hugh J. Bolton, FCA Chairman of the Board EPCOR Utilities Inc. Committees: 1, 5, 6, 7*, 8 Ambassador Gordon D. Giffin Senior Partner McKenna Long & Aldridge Committees: 1, 2, 4, 5, 6*, 7, 8 Edith E. Holiday Corporate Director and Trustee Former General Counsel United States Treasury Department Secretary of the Cabinet The White House Committees: 2, 3, 6, 7, 8 V. Maureen Kempston Darkes, O.C., D.Comm., LL.D. Retired Group Vice-President General Motors Corporation and President GM Latin America, Africa and Middle East Committees: 1, 5*, 6, 7, 8 The Honourable Edward C. Lumley, P.C., LL.D. Vice-Chairman BMO Capital Markets Committees: 2, 3, 6, 7, 8* James E. O’Connor Former Chairman and Chief Executive Officer Republic Services, Inc. Committees: 1, 2, 5, 7, 8 Robert Pace, D.Comm. Vice-Chairman of the Board Canadian National Railway Company President and Chief Executive Officer The Pace Group Committees: 1, 3, 4, 6, 7, 8 Committees: 1 Audit 2 Finance 3 Corporate governance and nominating 4 Donations and sponsorships 5 Environment, safety and security 6 Human resources and compensation 7 Strategic planning 8 Investment * denotes chairman of the committee Chairman of the Board and Select Senior Officers of the Company As at December 31, 2013 David G.A. Mc Lean Chairman of the Board Claude Mongeau President and Chief Executive Officer John Orr Vice-President Eastern Region Russell Hiscock President and Chief Executive Officer CN Investment Division Sean Finn Executive Vice-President Corporate Services and Chief Legal Officer Luc Jobin Executive Vice-President and Chief Financial Officer Jean-Jacques Ruest Executive Vice-President and Chief Marketing Officer Jim Vena Executive Vice-President and Chief Operating Officer Mike Cory Senior Vice-President Western Region Jeff Liepelt Senior Vice-President Southern Region Kimberly A. Madigan Vice-President Human Resources Janet Drysdale Vice-President Investor Relations 6 2013 Annual Report Canadian National Railway Company Contents 8 Selected Railroad Statistics 9 Management’s Discussion and Analysis 50 Management’s Report on Internal Control over Financial Reporting 50 Report of Independent Registered Public Accounting Firm 51 Report of Independent Registered Public Accounting Firm 52 Consolidated Statement of Income 53 Consolidated Statement of Comprehensive Income 54 Consolidated Balance Sheet 55 Consolidated Statement of Changes in Shareholders’ Equity 56 Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements 57 1 Summary of significant accounting policies 59 2 Accounting changes 59 3 Accounts receivable 60 4 Properties 62 5 Intangible and other assets 62 6 Accounts payable and other 62 7 Other liabilities and deferred credits 63 8 Long-term debt 65 9 Capital stock 66 10 Stock plans 71 11 Pensions and other postretirement benefits 77 12 Other income 78 13 Income taxes 79 14 Segmented information 80 15 Earnings per share 80 16 Major commitments and contingencies 84 17 Financial instruments 87 18 Accumulated other comprehensive loss Canadian National Railway Company 2013 Annual Report 7 Financial Section (U.S. GAAP) Selected Railroad Statistics Statistical operating data Rail freight revenues ($ millions) Gross ton miles (GTM) (millions) Revenue ton miles (RTM) (millions) Carloads (thousands) Route miles (includes Canada and the U.S.) (1) Employees (end of year) Employees (average for the year) Productivity Operating ratio (%) Rail freight revenue per RTM (cents) Rail freight revenue per carload ($) Operating expenses per GTM (cents) Labor and fringe benefits expense per GTM (cents) GTMs per average number of employees (thousands) Diesel fuel consumed (US gallons in millions) Average fuel price ($/US gallon) GTMs per US gallon of fuel consumed Safety indicators Injury frequency rate per 200,000 person hours (2) Accident rate per million train miles (2) (1) Rounded to the nearest hundred miles. (2) Based on Federal Railroad Administration (FRA) reporting criteria. Year ended December 31, 2013 2012 2011 9,587 8,938 8,111 401,390 383,754 357,927 210,133 201,496 187,753 5,190 5,059 4,873 20,000 20,100 20,000 23,721 23,430 23,339 23,705 23,466 23,079 63.4 4.56 62.9 4.44 63.5 4.32 1,847 1,767 1,664 1.67 0.54 1.62 0.51 1.60 0.51 16,933 16,354 15,509 403.7 388.7 367.7 3.55 994 1.69 1.92 3.47 987 1.42 2.10 3.39 973 1.55 2.25 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, as such certain of the 2012 and 2011 comparative data and related productivity measures have been restated. 8 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s discussion and analysis (MD&A) relates to the financial position 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 position 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 2013 Annual Consolidated Financial Statements and Notes thereto. Business profile Strategy overview CN is engaged in the rail and related transportation business. CN’s focus is on running a safe and efficient railroad. While CN’s network of approximately 20,000 route miles of track spans remaining at the forefront of the rail industry, CN’s goal is to be Canada and mid-America, connecting three coasts: the Atlantic, internationally regarded as one of the best-performing transpor- the Pacific and the Gulf of Mexico. CN’s extensive network, and tation companies. its co-production arrangements, routing protocols, marketing alli- CN’s commitment is to create value for both its customers and ances, and interline agreements, provide CN customers access to shareholders. By deepening customer engagement, leveraging the all three North American Free Trade Agreement (NAFTA) nations. strength of its franchise, and delivering operational and service ex- CN’s freight revenues are derived from seven commodity cellence, the Company seeks to provide quality and cost-effective groups representing a diversified and balanced portfolio of goods service that creates value for its customers. transported between a wide range of origins and destinations. This CN’s corporate goals are generally based on five key financial product and geographic diversity better positions the Company to performance targets: revenues, operating income, earnings per face economic fluctuations and enhances its potential for growth share, free cash flow and return on invested capital, as well as vari- opportunities. In 2013, no individual commodity group accounted ous key operating and customer service metrics that the Company for more than 21% of total revenues. From a geographic stand- focuses on to measure efficiency, safety and quality of service. By point, 16% of revenues relate to United States (U.S.) domestic striving for sustainable financial performance through profitable traffic, 32% transborder traffic, 20% Canadian domestic traffic and 32% overseas traffic. The Company is the originating carrier growth, adequate free cash flow and return on invested capital, CN seeks to deliver increased shareholder value. On October 22, for approximately 85% of traffic moving along its network, which 2013, the Board of Directors of the Company approved a two- allows it both to capitalize on service advantages and build on for-one common stock split which was effected in the form of a opportunities to efficiently use assets. Corporate organization stock dividend of one additional common share of CN for each share outstanding, which was paid on November 29, 2013, to shareholders of record on November 15, 2013. At the effective The Company manages its rail operations in Canada and the U.S. date of the stock split, all equity-based benefit plans and the share as one business segment. Financial information reported at this repurchase programs were adjusted to reflect the issuance of addi- level, such as revenues, operating income and cash flow from tional shares. All share and per share data presented herein reflect operations, is used by the Company’s corporate management in the impact of the stock split. In addition, the Company’s Board of evaluating financial and operational performance and allocating Directors approved an increase of 16% to the quarterly dividend resources across CN’s network. The Company’s strategic initiatives, to common shareholders, from $0.215 in 2013 to $0.250 in 2014. which drive its operational direction, are developed and managed For 2013, the Company’s Board of Directors approved share centrally by corporate management and are communicated to its repurchase programs funded mainly from cash generated from regional activity centers (the Western Region, Eastern Region and operations. The first share repurchase program, which was ap- Southern Region), whose role is to manage the day-to-day service proved on October 22, 2012, allowed for the repurchase of up to requirements of their respective territories, control direct costs $1.4 billion in common shares, not to exceed 36.0 million com- incurred locally, and execute the corporate strategy and operating mon shares, between October 29, 2012 and October 28, 2013. plan established by corporate management. The Company repurchased a total of 29.4 million common shares See Note 14 – Segmented information to the Company’s 2013 under this share repurchase program. On October 22, 2013, the Annual Consolidated Financial Statements for additional informa- Board of Directors of the Company approved a new share repur- tion on the Company’s corporate organization, as well as selected chase program which allows for the repurchase of up to 30.0 mil- financial information by geographic area. lion common shares, between October 29, 2013 and October 23, 2014. Share repurchases are made pursuant to a normal course issuer bid at prevailing market prices, plus brokerage fees, or such other prices as may be permitted by the Toronto Stock Exchange. Canadian National Railway Company U.S. GAAP 2013 Annual Report 9 Management’s Discussion and Analysis CN’s business model is anchored on five core principles: provid- Providing quality service, controlling costs and focusing on ing quality service, controlling costs, focusing on asset utilization, asset utilization committing to safety and sustainability, and developing people. For The basic driver of the Company’s business is demand for reliable, many years, CN has operated with a mindset that drives efficiency. efficient, and cost effective transportation. As such, the Company’s The CN Precision Railroading model, which focuses on improving focus is the pursuit of its long-term business plan, delivering oper- every process that affects delivery of customers’ goods, continues ational and service excellence by providing a high level of service to guide the Company’s performance. It is a highly disciplined pro- to customers while operating safely and efficiently, and meeting cess whereby CN handles individual rail shipments according to a short- and long-term financial commitments. specific trip plan and manages all aspects of railroad operations to In 2013, the Company benefited from a modest increase in meet customer commitments efficiently and profitably. It demands North American industrial production, a significant increase in U.S. discipline to execute the trip plan, the relentless measurement of housing starts and moderate growth in U.S. automotive sales. In results, and the use of such results to generate further execution 2014, the Company expects North American industrial production improvements in the service provided to customers. It also aims to increase by approximately three percent as well as continued to increase velocity, improve reliability, lower costs, enhance asset improvements in U.S. housing starts and U.S. automotive sales. utilization and, ultimately, help the Company to grow the top line. For the 2013/2014 crop year, the Company assumes Canadian The Company maintains that philosophy today and works hard grain production to be well above the five-year average and U.S. to run more efficient trains, reduce dwell times at terminals and grain production to be above the five-year average. With respect improve overall network velocity. With CN’s business model, fewer to the 2014/2015 crop year, the Company assumes Canadian railcars and locomotives are needed to ship the same amount of and U.S. grain production to be in line with their respective freight in a tight, reliable and efficient operation. The railroad is five-year averages. run based on a disciplined operating methodology, executing with To meet its business plan objectives, the Company’s priority is a sense of urgency and accountability. This philosophy has been to grow the business at low incremental cost. The Company’s strat- a key contributor to CN’s earnings growth and improved return egy to pursue deeper customer engagement and service improve- on invested capital. The Company has also set its sights on be- ments is expected to continue to drive growth. Improvements coming a true supply chain enabler by helping to elevate service are coming from several key thrusts including first-mile/last-mile performance end-to-end. CN is pursuing better end-to-end service initiatives that improve customer service at origin and destination, and greater operating efficiencies while helping customers win in and a supply chain perspective that emphasizes collaboration and their own markets. While CN is a leader in fast and reliable service better end-to-end service. The Company sees opportunities for hub-to-hub, the Company strives to distinguish itself by bringing growth across most markets, led by energy-related commodities, greater value to the entire range of customer touch points. The particularly crude oil and frac sand; by overseas container traffic; Company continues to strengthen its commitment to operational by market share gains against truck in domestic intermodal; by and service excellence through a wide range of innovations an- a continued recovery in the U.S. housing market; as well as by chored on its continuous improvement philosophy. CN’s major strong offshore grain exports due to record western Canadian push in first-mile/last-mile activities is all about quality interaction crop. Longer term, the Company expects continued growth in with customers – from developing a sharper outside-in perspective offshore export markets including metallurgical and thermal coal to better monitoring of traffic forecasts; from the Company’s car as well as potash. management distribution activities to higher and more responsive To grow the business at low incremental cost and to operate car order fulfillment; and from improving customer communica- efficiently and safely while maintaining a high level of customer tion to iAdvise (proactive customer communication system at service, the Company continues to invest in capital programs to the local level). CN’s broad-based service innovations benefit maintain a safe and fluid railway and pursue strategic initiatives to customers and support the Company’s goal to grow the business improve its franchise, as well as undertake productivity initiatives faster than the overall economy. CN understands the importance to reduce costs and leverage its assets. Opportunities to improve of being the best operator in the business, and being the best productivity extend across all functions in the organization. Train service innovator as well. Service excellence means expanding CN’s productivity is being improved through the acquisition of loco- perspective, working more closely, and building on mutual trust, motives that are more fuel-efficient than the ones they replace, with customers and supply chain customers as well as involving which will also improve service reliability for customers and reduce all relevant areas of the Company in the process. The success of greenhouse gas emissions. In addition, the Company’s locomotives the business model is dependent on commercial principles and a are being equipped with distributed power capability, which allows supportive regulatory environment, both of which are key to an ef- the Company to run longer, more efficient trains, particularly in fective rail transportation marketplace throughout North America. cold weather conditions, while improving train handling, reducing train separations and improving the overall safety of operations. These initiatives, combined with CN’s investments in longer sidings 10 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis over the years, offer train-mile savings, allow for efficient long-train of available funds based on short-term operational requirements, operations and reduce wear on rail and wheels. Yard throughput is expenditures to continue to operate a safe railway and pursue being improved through SmartYard, an innovative use of real-time strategic initiatives, while also considering its long-term contrac- traffic information to sequence cars effectively and get them out tual obligations and returning value to its shareholders. on the line more quickly in the face of constantly changing con- ditions. In Engineering, the Company is continuously working to Delivering responsibly increase the productivity of its field forces, through better use of The Company’s commitment to safety is reflected in the wide traffic information and the optimization of work scheduling and as range of initiatives that CN is pursuing and in the size of its capital a result, better management of its engineering forces on the track. programs. Comprehensive plans are in place to address safety, The Company also intends to continue focusing on the reduction security, employee well-being and environmental management. of accidents and related costs, as well as costs for legal claims and CN’s Safety Management Plan is the framework for putting safety health care. at the center of its day-to-day operations. This proactive plan is CN’s capital expenditure programs support the Company’s com- designed to minimize risk and drive continuous improvement in mitment to its core principles and strategy and its ability to grow the reduction of injuries and accidents, and engages employees at the business profitably. In 2014, CN plans to invest approximately all levels of the organization. $2.1 billion on capital programs, of which over $1.2 billion is tar- The Company has made sustainability an integral part of its geted towards track infrastructure to continue operating a safe business strategy by aligning its sustainability agenda with its busi- railway and improve the productivity and fluidity of the network; ness model. As part of the Company’s comprehensive sustainability and includes the replacement of rail, ties, and other track materials, action plan and to comply with the CN Environmental Policy, the bridge improvements, as well as various branch line upgrades. This Company engages in a number of initiatives, including the use of amount also includes funds for strategic initiatives and additional fuel-efficient locomotives that reduce greenhouse gas emissions; enhancements to the track infrastructure in western and eastern increasing operational and building efficiencies; investing in virtu- Canada as well as in the U.S. In 2013, the Company invested ap- alization technologies, energy-efficient data centers and recycling proximately $100 million in the Edmonton-Winnipeg corridor in programs for information technology systems; reducing, recycling order to increase rail capacity and support strong volumes of grain and reusing waste at its facilities and on its network; engaging in and other commodities. modal shift agreements that favor low emission transport services; In 2014, CN’s equipment capital expenditures are targeted and participating in the Carbon Disclosure Project to gain a more to reach approximately $300 million, allowing the Company to comprehensive view of its carbon footprint. tap growth opportunities and improve the quality of the fleet. In The CN Environmental Policy aims to minimize the impact of the order to handle expected traffic increase and improve operational Company’s activities on the environment. The Company strives to efficiency, in 2013 CN took delivery of 44 new and 37 second- contribute to the protection of the environment by integrating en- hand high-horsepower locomotives. In 2014, CN expects to take vironmental priorities into the Company’s overall business plan and delivery of an additional 45 new high-horsepower locomotives. through the specific monitoring and measurement of such priorities In 2014, CN also expects to spend approximately $600 million against historical performance and in some cases, specific targets. All on facilities to grow the business including transloads, distribution employees must demonstrate commitment to the CN Environmental centers, and the completion of its Calgary Logistics Park project; Policy at all times and it is the Environment, Safety and Security on information technology to improve service and operating Committee of the Board of Directors that has the responsibility of efficiency; and on other projects to increase productivity. overseeing this policy. This committee’s responsibilities, powers and To meet short- and long-term financial commitments, the operation are further described in its charter, which is included in the Company pursues a solid financial policy framework with the goal Company’s Corporate Governance Manual available on CN’s website. of maintaining a strong balance sheet by monitoring its credit Certain risk mitigation strategies, such as periodic audits, employee ratios and preserving an investment-grade credit rating to be able training programs and emergency plans and procedures, are in place to maintain access to public financing. The Company’s principal to minimize the environmental risks to the Company. source of liquidity is cash generated from operations, which can be The CN Environmental Policy, the Company’s Carbon Disclo- supplemented by its commercial paper program and its accounts sure Project report, and the Corporate Citizenship Report receivable securitization program to meet short-term liquidity “Delivering Responsibly” are available on CN’s website. In 2013, needs. The Company’s primary uses of funds are for working the Company’s sustainability practices earned it a place as the capital requirements, including income tax installments, pen- leader in the Transportation and Transportation Infrastructure sion contributions, contractual obligations, capital expenditures Industry sector of the Dow Jones Sustainability World Index (DJSI). relating to track infrastructure and other, acquisitions, dividend This is also the second consecutive year that the Company has payouts, and the repurchase of shares through share buyback pro- been listed on the DJSI World Index and the fifth straight year on grams, when applicable. The Company sets priorities on its uses the DJSI North American Index. Canadian National Railway Company U.S. GAAP 2013 Annual Report 11 Management’s Discussion and Analysis Developing people Impact of foreign currency translation on reported results CN’s ability to develop the best railroaders in the industry has been Although the Company conducts its business and reports its earn- a key contributor to the Company’s success. CN recognizes that ings in Canadian dollars, a large portion of revenues and expenses without the right people – no matter how good a service plan or is denominated in US dollars. As such, the Company’s results are business model a company may have – it will not be able to fully affected by exchange rate fluctuations. execute. The Company is focused on recruiting the right people, Management’s discussion and analysis includes reference to developing employees with the right skills, motivating them to do “constant currency,” which allows the financial results to be viewed the right thing, and training them to be the future leaders of the without the impact of fluctuations in foreign exchange rates, there- Company. In 2014, CN expects to open two new state-of-the-art by facilitating period-to-period comparisons in the analysis of trends training centers located in Winnipeg, Manitoba and suburban in business performance. Financial results at constant currency are Chicago, Illinois as part of a new revitalized company-wide training obtained by translating the current period results denominated in program aimed at preparing railroaders to be highly skilled, safety US dollars at the foreign exchange rate of the comparable period conscious and confident in their work environment. The Company of the prior year. The average foreign exchange rate for the year continues to address changes in employee demographics that will ended December 31, 2013 was $1.03 per US$1.00 compared to span multiple years. The Human Resources and Compensation $1.00 per US$1.00 for 2012. Measures at constant currency are Committee of the Board of Directors reviews the progress made considered non-GAAP measures and do not have any standardized in developing current and future leaders through the Company’s meaning prescribed by GAAP and therefore may not be compar- leadership development programs. These programs and initiatives able to similar measures presented by other companies. provide a solid platform for the assessment and development of the Company’s talent pool. The leadership development programs are tightly integrated with the Company’s business strategy. The forward-looking statements discussed in this MD&A are subject to risks and uncertainties that could cause actual results or performance to differ materially from those expressed or im- plied 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 materialize or that may be offset entirely or partially by other events and developments. See the section of this MD&A entitled Forward-looking statements for assumptions and risk factors affecting such forward-looking statements. 12 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis Forward-looking statements Certain information included in this MD&A are “forward-looking statements” within the meaning of the United States Private Securities Litigation Reform Act of 1995 and under Canadian securities laws. CN cautions that, by their nature, forward-looking statements involve risks, uncertainties and assumptions. The Company cautions that its assumptions may not materialize and that current economic conditions render such assumptions, although reasonable at the time they were made, subject to greater uncertainty. These forward-looking statements include, but are not limited to, statements with respect to growth opportunities; statements that the Company will benefit from growth in North American and global economies; the anticipation that cash flow from operations and from various sources of financing will be sufficient to meet debt repayments and future obligations in the foreseeable future; statements regarding future payments, including income taxes and pension contributions; as well as the projected capital spending program. Forward-looking statements could further be identified by the use of terminology such as the Company “believes,” “expects,” “anticipates” or other similar words. Such forward-looking statements 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 performance implied by such statements. Key assumptions used in determining forward-looking information are set forth below. Forward-looking statements Key assumptions or expectations Statements relating to general economic • North American and global economic growth and business conditions, including those • Long-term growth opportunities being less affected by current economic referring to revenue growth opportunities conditions • Year-over-year carload growth Statements relating to the Company’s ability • North American and global economic growth to meet debt repayments and future • Adequate credit ratios obligations in the foreseeable future, including • Investment grade credit rating income tax payments, and capital spending • Access to capital markets • Adequate cash generated from operations Statements relating to pension contributions • Adequate cash generated from operations and other sources of financing • Adequate long-term return on investment on pension plan assets • Level of funding as determined by actuarial valuations, particularly influenced by discount rates for funding purposes Important risk factors that could affect the forward-looking statements include, but are not limited to, the effects of general economic and business conditions; industry competition; inflation, currency and interest rate fluctuations; changes in fuel prices; legislative and/or regulatory developments; compliance with environmental laws and regulations; actions by regulators; various events which could disrupt operations, including natural events such as severe weather, droughts, floods and earthquakes; labor negotiations and disruptions; environ- mental claims; uncertainties of investigations, proceedings or other types of claims and litigation; risks and liabilities arising from derailments; and other risks detailed from time to time in reports filed by CN with securities regulators in Canada and the U.S. See the section of this MD&A entitled Business risks for detailed information on major risk factors. CN assumes no obligation to update or revise forward-looking statements to reflect future events, changes in circumstances, or changes in beliefs, unless required by applicable Canadian securities laws. In the event CN does update any forward-looking statement, no inference should be made that CN will make additional updates with respect to that statement, related matters, or any other forward-looking statement. Financial outlook During the year, the Company issued and updated its financial outlook. The 2013 actual results are in line with the latest financial outlook as disclosed by the Company. Canadian National Railway Company U.S. GAAP 2013 Annual Report 13 Management’s Discussion and Analysis Financial and statistical highlights $ in millions, except per share data, or unless otherwise indicated 2013 2012 2011 2013 vs. 2012 2012 vs. 2011 Change Favorable/(Unfavorable) Financial results Revenues Operating income Net income (1) (2) (3) Operating ratio Basic earnings per share (1) (2) (3) Diluted earnings per share (1) (2) (3) Dividend declared per share Financial position Total assets Total long-term liabilities $ 10,575 $ 9,920 $ 9,028 $ 3,873 $ 3,685 $ 3,296 $ 2,612 $ 2,680 $ 2,457 7% 5% (3%) 10% 12% 9% 63.4% 62.9% 63.5% (0.5)-pts 0.6-pts $ $ $ 3.10 3.09 0.86 $ $ $ 3.08 3.06 0.75 $ $ $ 2.72 2.70 0.65 $ 30,163 $ 26,659 $ 26,026 $ 14,712 $ 13,438 $ 13,631 1% 1% 15% 13% (9%) 1% 4% 1% 13% 13% 15% 2% 1% 2% 5% 1% Statistical operating data and productivity measures (4) Employees (average for the year) 23,705 23,466 23,079 Gross ton miles (GTM) per average number of employees (thousands) 16,933 16,354 15,509 GTMs per US gallon of fuel consumed 994 987 973 (1) The 2013 figures include a gain on exchange of perpetual railroad operating easements on specific rail lines of $29 million, or $18 million after-tax ($0.02 per basic or diluted share); a gain on disposal of a segment of the Oakville subdivision of $40 million, or $36 million after-tax ($0.04 per basic or diluted share); and an income tax expense of $24 million ($0.03 per basic or diluted share) resulting from the enactment of higher provincial corporate income tax rates. (2) The 2012 figures include a gain on disposal of a segment of the Bala and a segment of the Oakville subdivisions of $281 million, or $252 million after-tax ($0.29 per basic share or $0.28 per diluted share); and a net income tax expense of $28 million ($0.03 per basic or diluted share) consisting of a $35 million income tax expense resulting from the enactment of higher provincial corporate income tax rates that was partly offset by a $7 million income tax recovery resulting from the recapitalization of a foreign investment. (3) The 2011 figures include gains on disposal of substantially all of the assets of IC RailMarine Terminal Company of $60 million, or $38 million after-tax ($0.04 per basic or diluted share) and of a segment of the Kingston subdivision known as the Lakeshore East of $288 million, or $254 million after-tax ($0.28 per basic or diluted share). The 2011 figures also included a net income tax expense of $40 million ($0.04 per basic or diluted share) resulting from the enactment of state corporate income tax rate changes and other legislated state tax revisions, and an income tax recovery of $11 million ($0.01 per basic or diluted share) relating to certain fuel costs attributed to various wholly-owned subsidiaries’ fuel consumption in prior periods. (4) Based on estimated data available at such time and subject to change as more complete information becomes available. Financial results 2013 compared to 2012 income tax rates that was partly offset by a $7 million income tax recovery resulting from the recapitalization of a foreign investment. In 2013, net income was $2,612 million, a decrease of $68 million, Foreign exchange fluctuations have an impact on the comparabil- or 3%, when compared to 2012, with diluted earnings per share ity of the results of operations. The fluctuation of the Canadian dollar rising 1% to $3.09. The $68 million decrease was mainly due to a relative to the US dollar, which affects the conversion of the Company’s reduction in Other income resulting from lower gains on disposal of US dollar-denominated revenues and expenses, resulted in a positive rail assets that was partly offset by an increase in Operating income. impact to net income of $33 million ($0.04 per diluted share) in 2013. Included in the 2013 figures was a gain on exchange of per- Revenues for the year ended December 31, 2013 increased petual railroad operating easements including the track and by $655 million, or 7%, to $10,575 million, mainly attributable roadway assets on specific rail lines (collectively the “exchange of to freight rate increases; higher freight volumes due to strong easements”), of $29 million, or $18 million after-tax ($0.02 per energy markets, market share gains, as well as growth in the North diluted share) and a gain on disposal of a segment of the Oakville American economy; the positive translation impact of the weaker subdivision, together with the rail fixtures and certain passenger Canadian dollar on US dollar-denominated revenues; and the im- agreements (collectively the “Lakeshore West”), of $40 million, or pact of a higher fuel surcharge, mainly as a result of higher volumes. $36 million after-tax ($0.04 per diluted share). The 2013 figures also Operating expenses for the year ended December 31, 2013 included a $24 million ($0.03 per diluted share) income tax expense increased by $467 million, or 7%, to $6,702 million, mainly due to from the enactment of higher provincial corporate income tax rates. higher labor and fringe benefits expense; the negative translation Included in the 2012 figures was a gain on disposal of a segment of impact of the weaker Canadian dollar on US dollar-denominated the Bala and a segment of the Oakville subdivisions, together with expenses; and increased purchased services and material expense, the rail fixtures and certain passenger agreements (collectively the in part due to weather-related conditions. These factors were part- “Bala-Oakville”), of $281 million, or $252 million after-tax ($0.28 ly offset by lower casualty and other expense. per diluted share); and a net income tax expense of $28 million The operating ratio, defined as operating expenses as a per- ($0.03 per diluted share) consisting of a $35 million income tax ex- centage of revenues, was 63.4% in 2013, compared to 62.9% in pense resulting from the enactment of higher provincial corporate 2012, a 0.5-point deterioration. 14 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis Revenues In millions, unless otherwise indicated Year ended December 31, 2013 2012 % Change % Change at constant currency Rail freight revenues $ 9,587 $ 8,938 Other revenues Total revenues 988 982 $ 10,575 $ 9,920 7% 1% 7% 5% (1%) 5% Rail freight revenues Petroleum and chemicals $ 1,939 $ 1,640 18% 16% Metals and minerals 1,216 1,133 Forest products 1,413 1,331 7% 6% 5% 4% Petroleum and chemicals Year ended December 31, 2013 2012 % Change % Change at constant currency Revenues (millions) $ 1,939 $ 1,640 18% 16% Coal 693 712 (3%) (4%) RTMs (millions) 44,634 37,449 19% 19% Grain and fertilizers 1,610 1,590 Intermodal Automotive 2,167 1,994 549 538 Total rail freight revenues $ 9,587 $ 8,938 1% 9% 2% 7% Revenue ton miles (RTM) (millions) 210,133 201,496 4% Rail freight revenue/RTM (cents) Carloads 4.56 4.44 3% (thousands) 5,190 5,059 3% Rail freight revenue/carload (dollars) 1,847 1,767 5% - 8% - 5% 4% 1% 3% 3% Revenues for the year ended December 31, 2013 totaled $10,575 million compared to $9,920 million in 2012. The increase of $655 million, or 7%, was mainly attributable to freight rate increases; higher freight volumes due to strong energy markets, market share gains, as well as growth in the North American econ- omy; the positive translation impact of the weaker Canadian dollar on US dollar-denominated revenues; and the impact of a higher fuel surcharge of approximately $35 million, mainly as a result of higher volumes. In 2013, revenue ton miles (RTM), measuring the relative weight and distance of rail freight transported by the Company, increased by 4% relative to 2012. Rail freight revenue per revenue ton mile, a measurement of yield defined as revenue earned on the movement of a ton of freight over one mile, increased by 3% when compared to 2012, driven by freight rate increases and the positive translation impact of the weaker Canadian dollar, partly offset by an increase in the average length of haul. Revenue/RTM (cents) 4.34 4.38 (1%) (3%) The petroleum and chemicals commodity group comprises a wide range of commodities, including chemicals and plastics, refined petroleum products, natural gas liquids, crude oil and sulfur. The primary markets for these commodities are within North America, and as such, the performance of this commodity group is closely correlated with the North American economy as well as oil and gas production. Most of the Company’s petroleum and chemicals ship- ments originate in the Louisiana petrochemical corridor between New Orleans and Baton Rouge; in Western Canada, a key oil and gas development area and a major center for natural gas feed- stock and world-scale petrochemicals and plastics; and in eastern Canadian regional plants. For the year ended December 31, 2013, revenues for this commodity group increased by $299 million, or 18%, when compared to 2012. The increase was mainly due to significantly higher crude oil shipments and increased volumes of propane, freight rate increases, the positive translation impact of a weaker Canadian dollar, and a higher fuel surcharge due to longer haul volumes. These factors were partly offset by lower volumes of sulfur and reduced shipments of refined petroleum products due to a customer conversion to pipeline. Revenue per revenue ton mile decreased by 1% in 2013, mainly due to a significant increase in the average length of haul, offset by freight rate increases and the positive translation impact of a weaker Canadian dollar. Percentage of revenues Carloads (thousands) 42% Chemicals and plastics Year ended December 31, 28% Refined petroleum products 24% Crude and condensate 6% Sulfur 2011 560 2012 594 2013 611 42% 28% 24% 6% Canadian National Railway Company U.S. GAAP 2013 Annual Report 15 Management’s Discussion and Analysis Metals and minerals Forest products Year ended December 31, 2013 2012 % Change % Change at constant currency Year ended December 31, 2013 2012 % Change % Change at constant currency Revenues (millions) $ 1,216 $ 1,133 RTMs (millions) 21,342 20,236 Revenue/RTM (cents) 5.70 5.60 7% 5% 2% 5% 5% (1%) Revenues (millions) $ 1,413 $ 1,331 RTMs (millions) 29,630 29,674 Revenue/RTM (cents) 4.77 4.49 6% - 6% 4% - 4% The metals and minerals com- The forest products commodity group includes various types of modity group consists primarily lumber, panels, paper, wood pulp and other fibers such as logs, re- of materials related to oil and cycled paper, wood chips, and wood pellets. The Company has ex- gas development, steel, iron tensive rail access to the western and eastern Canadian fiber-pro- ore, non-ferrous base metals ducing regions, which are among the largest fiber source areas in and ores, construction materials North America. In the U.S., the Company is strategically located to and machinery and dimensional (large) loads. The Company pro- vides unique rail access to base serve both the midwest and southern U.S. corridors with interline connections to other Class I railroads. The key drivers for the vari- ous commodities are: for newsprint, advertising lineage, non-print metals, iron ore and frac sand media and overall economic conditions, primarily in the U.S.; for mining as well as aluminum and fibers (mainly wood pulp), the consumption of paper, pulpboard steel producing regions, which and tissue in North American and offshore markets; and for lum- are among the most important ber and panels, housing starts and renovation activities primarily in North America. This strong in the U.S. For the year ended December 31, 2013, revenues for origin franchise, coupled with this commodity group increased by $82 million, or 6%, when the Company’s access to port compared to 2012. The increase was mainly due to freight rate facilities and the end markets increases, the positive translation impact of a weaker Canadian for these commodities, has dollar, and increased shipments of lumber and panels to the U.S. made CN a leader in the trans- due to an improvement in the housing market. These factors were portation of metals and minerals partly offset by a decrease in shipments of wood pulp, in part due products. The key drivers for to a mill closure in western Canada. Revenue per revenue ton mile this market segment are oil and gas development, automotive increased by 6% in 2013 mainly due to freight rate increases and production, and non-residential construction. For the year ended the positive translation impact of a weaker Canadian dollar. December 31, 2013, revenues for this commodity group increased by $83 million, or 7%, when compared to 2012. The increase was mainly due to freight rate increases, higher volumes of frac Percentage of revenues Carloads (thousands) 54% Pulp and paper Year ended December 31, sand and the positive translation impact of a weaker Canadian 46% Lumber and panels dollar. These factors were partly offset by lower shipments of steel products and non-ferrous ores. Revenue per revenue ton mile in- creased by 2% in 2013, mainly due to freight rate increases and the positive translation impact of a weaker Canadian dollar, partly offset by an increase in the average length of haul, mainly in the fourth quarter. Percentage of revenues Carloads (thousands) 54% 46% 2011 443 2012 445 2013 446 43% Minerals 39% Metals 18% Iron ore 43% 39% 18% Year ended December 31, 2011 1,013 2012 1,024 2013 1,048 16 2013 Annual Report U.S. GAAP Management’s Discussion and Analysis Coal Year ended December 31, 2013 2012 % Change % Change at constant currency Revenues (millions) $ 693 $ 712 RTMs (millions) 22,315 23,570 Revenue/RTM (cents) 3.11 3.02 (3%) (5%) 3% (4%) (5%) 2% The coal commodity group consists of thermal grades of bitumin- ous coal, metallurgical coal and petroleum coke. Canadian ther- mal and metallurgical coal are largely exported via terminals on the west coast of Canada to offshore markets. In the U.S., thermal Grain and fertilizers Year ended December 31, 2013 2012 % Change % Change at constant currency Revenues (millions) $ 1,610 $ 1,590 RTMs (millions) 43,180 45,417 Revenue/RTM (cents) 3.73 3.50 1% (5%) 7% - (5%) 5% coal is transported from mines served in southern Illinois, or from The grain and fertilizers commodity group depends primarily on western U.S. mines via interchange with other railroads, to major crops grown and fertilizers processed in western Canada and the utilities in the midwest and southeast U.S., as well as offshore U.S. midwest. The grain segment consists of three primary seg- markets via terminals in the Gulf and the Port of Prince Rupert. For ments: food grains (mainly wheat, oats and malting barley), feed the year ended December 31, 2013, revenues for this commodity grains and feed grain products (including feed barley, feed wheat, group decreased by $19 million, or 3%, when compared to 2012. peas, corn, ethanol and dried distillers grains), and oilseeds and oil- The decrease was mainly due to lower volumes of export thermal seed products (primarily canola seed, oil and meal, and soybeans). coal through west coast ports and reduced shipments of domestic Production of grain varies considerably from year to year, affected thermal coal to U.S. utilities. These factors were partly offset by primarily by weather conditions, seeded and harvested acreage, the higher shipments of export metallurgical coal through west coast mix of grains produced and crop yields. Grain exports are sensitive ports; freight rate increases; and the positive translation impact of to the size and quality of the crop produced, international market a weaker Canadian dollar. Revenue per revenue ton mile increased conditions and foreign government policy. The majority of grain by 3% in 2013, mainly due to freight rate increases and the posi- produced in western Canada and moved by CN is exported via tive translation impact of a weaker Canadian dollar. the ports of Vancouver, Prince Rupert and Thunder Bay. Certain of Percentage of revenues Carloads (thousands) 84% Coal 16% Petroleum coke 16% 84% Year ended December 31, 2011 464 2012 435 2013 416 these rail movements are subject to government regulation and to a revenue cap, which effectively establishes a maximum revenue entitlement that railways can earn. In the U.S., grain grown in Illinois and Iowa is exported as well as transported to domestic processing facilities and feed markets. The Company also serves major pro- ducers 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, 2013, revenues for this commodity group increased by $20 million, or 1%, when compared to 2012. The in- crease was mainly due to freight rate increases, greater volumes of potash for offshore export and the positive translation impact of a weaker Canadian dollar. These factors were partly offset by lower shipments of canola and Canadian wheat, mainly for export, and lower volumes of barley. Revenue per revenue ton mile increased by 7% in 2013, mainly due to freight rate increases and the positive translation impact of a weaker Canadian dollar. Percentage of revenues Carloads (thousands) 30% Oilseeds 26% Food grains 23% Feed grains 21% Fertilizers 30% 26% 21% 23% Year ended December 31, 2011 592 2012 597 2013 572 Canadian National Railway Company U.S. GAAP 2013 Annual Report 17 Management’s Discussion and Analysis Management’s Discussion and Analysis Automotive Year ended December 31, 2013 2012 % Change % Change at constant currency Revenues (millions) $ 549 $ 538 RTMs (millions) 2,741 2,754 Revenue/RTM (cents) 20.03 19.54 2% - 3% - - - The automotive commodity group moves both finished vehicles and parts throughout North America, providing rail access to certain vehicle assembly plants in Canada, and Michigan and Intermodal Year ended December 31, 2013 2012 % Change % Change at constant currency Revenues (millions) $ 2,167 $ 1,994 RTMs (millions) 46,291 42,396 Revenue/RTM (cents) 4.68 4.70 9% 9% - 8% 9% (1%) The intermodal commodity group is comprised of two segments: do- Mississippi in the U.S. The Company mestic and international. The domestic segment transports consumer also serves vehicle distribution facilities products and manufactured goods, operating through both retail and in Canada and the U.S., as well as parts wholesale channels, within domestic Canada, domestic U.S., Mexico production facilities in Michigan and and transborder, while the international segment handles import and Ontario. The Company serves shippers export container traffic, directly serving the major ports of Vancouver, of import vehicles via the ports of Prince Rupert, Montreal, Halifax and New Orleans. The domestic seg- Halifax and Vancouver, and through ment is driven by consumer markets, with growth generally tied to the interchange with other railroads. The economy. The international segment is driven by North American eco- Company’s automotive revenues are nomic and trade conditions. For the year ended December 31, 2013, closely correlated to automotive pro- revenues for this commodity group increased by $173 million, or 9%, duction and sales in North America. For when compared to 2012. The increase was mainly due to higher the year ended December 31, 2013, revenues for this commodity shipments through the Port of Vancouver, in part as a result of new group increased by $11 million, or 2%, when compared to 2012. business, and increased volumes of domestic intermodal; the impact The increase was mainly due to the positive translation impact of of a higher fuel surcharge; the positive translation impact of a weaker a weaker Canadian dollar and freight rate increases. These fac- Canadian dollar; and freight rate increases. These factors were partly tors were partly offset by a non-recurring movement of military offset by lower volumes through the Port of Prince Rupert. Revenue equipment in 2012. Revenue per revenue ton mile increased by per revenue ton mile was flat in 2013, mainly due to the positive trans- 3% in 2013, mainly due to the positive translation impact of a lation impact of a weaker Canadian dollar and freight rate increases, weaker Canadian dollar, freight rate increases, and a decrease in entirely offset by an increase in the average length of haul. the average length of haul. Percentage of revenues Carloads (thousands) Percentage of revenues Carloads (thousands) 58% International 42% Domestic 58% 42% Year ended December 31, 90% Finished vehicles Year ended December 31, 2011 1,584 2012 1,742 2013 1,875 10% Auto parts 10% 90% 2011 217 2012 222 2013 222 Other revenues Year ended December 31, 2013 2012 % Change % Change at constant currency Revenues (millions) $ 988 $ 982 1% (1%) Percentage of revenues 50% Other non-rail services 31% Vessels and docks 50% 31% 19% Other revenues are largely derived from non-rail services that support CN’s rail business including vessels, docks, warehousing and distribution, automotive logistic services, trucking operations, as well as from other items which include interswitching and commuter train revenues. In 2013, Other revenues amounted to $988 million, an increase of $6 million, or 1%, when compared to 2012, mainly due to higher revenues from vessels and docks, partly offset by lower revenues from transportation management 19% Interswitching and other revenues services and trucking operations. 18 2013 Annual Report U.S. GAAP Canadian National Railway Company Operating expenses Operating expenses for the year ended December 31, 2013 amounted to $6,702 million, compared to $6,235 million in 2012. The increase of $467 million, or 7%, in 2013 was mainly due to higher labor and fringe benefits expense; the negative translation impact of the weaker Canadian dollar on US dollar-denominated expenses; and increased purchased services and material expense, in part due to weather-related conditions. These factors were partly offset by lower casualty and other expense. In millions Year ended December 31, 2013 2012 % Change % Change at constant currency Percentage of revenues 2013 2012 Labor and fringe benefits Purchased services and material Fuel Depreciation and amortization Equipment rents Casualty and other Total operating expenses $ 2,182 $ 1,952 (12%) (11%) 20.6% 1,351 1,248 1,619 1,524 980 275 295 924 249 338 (8%) (6%) (6%) (10%) (7%) (3%) (5%) (8%) 13% 15% 12.8% 15.3% 9.3% 2.6% 2.8% 19.7% 12.6% 15.4% 9.3% 2.5% 3.4% $ 6,702 $ 6,235 (7%) (6%) 63.4% 62.9% Labor and fringe benefits: Labor and fringe benefits expense in- Depreciation and amortization: Depreciation and amortization cludes wages, payroll taxes, and employee benefits such as incen- expense relates to the Company’s rail and related operations. tive compensation, including stock-based compensation; health Depreciation expense is affected by capital additions, railroad and welfare; and pension and other postretirement benefits. property retirements from disposal, sale and/or abandonment and Certain incentive and stock-based compensation plans are based other adjustments including asset impairments. These expenses on financial and market performance targets and the related ex- increased by $56 million, or 6%, in 2013 when compared to 2012. pense is recorded in relation to the attainment of such targets. The increase was mainly due to the impact of net capital additions, Labor and fringe benefits expense increased by $230 million, or some asset impairments, as well as the effect of a depreciation 12%, in 2013 when compared to 2012. The increase was primarily study on certain U.S. track and roadway properties, which were a result of increased pension expense, higher wages due to the im- partly offset by the effect of a depreciation study on Canadian pact of a higher workforce level as a result of volume growth and track and roadway properties. See the section of this MD&A en- general wage increases, higher incentive compensation, as well titled Critical accounting policies for additional information relat- as the negative translation impact of the weaker Canadian dollar. ing to the depreciation studies. Purchased services and material: Purchased services and material ex- Equipment rents: Equipment rents expense includes rental expense pense primarily includes the cost of services purchased from outside for the use of freight cars owned by other railroads or private contractors; materials used in the maintenance of the Company’s companies and for the short- or long-term lease of freight cars, track, facilities and equipment; transportation and lodging for train locomotives and intermodal equipment, net of rental income from crew employees; utility costs; and the net costs of operating facilities other railroads for the use of the Company’s cars and locomotives. jointly used by the Company and other railroads. These expenses These expenses increased by $26 million, or 10%, in 2013 when increased by $103 million, or 8%, in 2013 when compared to 2012. compared to 2012. The increase was primarily due to higher lease The increase was mainly due to weather-related conditions impacting costs for intermodal equipment on account of volume increases, materials, crew accommodation and utilities expenses; higher main- higher net car hire expenses, and the negative translation impact tenance expenses for track, rolling stock and other equipment; the of the weaker Canadian dollar. negative translation impact of the weaker Canadian dollar; and higher costs for third-party non-rail transportation providers. Casualty and other: Casualty and other expense includes expenses for personal injuries, environmental, freight and property damage, Fuel: Fuel expense includes fuel consumed by assets, including insurance, bad debt, operating taxes, and travel expenses. These locomotives, vessels, vehicles and other equipment as well as fed- expenses decreased by $43 million, or 13%, in 2013 when com- eral, provincial and state fuel taxes. These expenses increased by pared to 2012. The decrease was mainly due to a reduction to the $95 million, or 6%, in 2013 when compared to 2012. The increase liability for U.S. legal claims pursuant to an actuarial valuation, as was primarily due to higher freight volumes and the negative well as overall lower legal expenses; lower environmental expenses; translation impact of the weaker Canadian dollar. These factors and lower workers’ compensation expenses; that were partly offset were partly offset by productivity improvements. by the negative translation impact of the weaker Canadian dollar. Canadian National Railway Company U.S. GAAP 2013 Annual Report 19 Management’s Discussion and Analysis Other Income tax expense: The Company recorded income tax expense Interest expense: In 2013, interest expense was $357 million of $977 million for the year ended December 31, 2013 compared compared to $342 million in 2012. The increase was mainly due to $978 million in 2012. The 2013 figure includes a net income to a higher level of debt and the negative translation impact of tax recovery of $7 million which consisted of a $15 million income the weaker Canadian dollar on US dollar-denominated interest tax recovery from the recognition of U.S. state income tax losses expense, partly offset by a lower weighted-average interest rate. and a $16 million income tax recovery from a revision of the ap- portionment of U.S. state income taxes which were partly offset by Other income: In 2013, the Company recorded other income of a combined $24 million income tax expense resulting from the en- $73 million compared to $315 million in 2012. Included in Other actment of higher provincial corporate income tax rates. Included income for 2013 was a gain on exchange of easements in the in the 2012 figure was a net income tax expense of $28 million, amount of $29 million and a gain on disposal of the Lakeshore which consisted of a $35 million income tax expense resulting from West of $40 million. Included in Other income for 2012 was a gain the enactment of higher provincial corporate income tax rates that on disposal of the Bala-Oakville of $281 million. was partly offset by a $7 million income tax recovery resulting from the recapitalization of a foreign investment. The effective tax rate for 2013 was 27.2% compared to 26.7% in 2012. 2012 compared to 2011 In 2012, net income was $2,680 million, an increase of $223 million, or 9%, when compared to 2011, with diluted earnings per share increasing 13% to $3.06. Included in the 2012 figures was a gain on disposal of a segment of the Bala and a segment of the Oakville subdivisions (collectively the “Bala-Oakville”) of $281 million, or $252 million after-tax ($0.28 per diluted share); and a net income tax expense of $28 million ($0.03 per diluted share) consisting of a $35 million income tax expense resulting from the enactment of higher provincial corporate income tax rates that was partly offset by a $7 million income tax recovery resulting from the recapitalization of a foreign investment. Included in the 2011 figures were gains on disposal of substantially all of the assets of IC RailMarine Terminal Company (“IC RailMarine”) of $60 million, or $38 million after-tax ($0.04 per diluted share) and of a segment of the Kingston subdivision known as the Lakeshore East of $288 million, or $254 million after-tax ($0.28 per diluted share). The 2011 figures also included a net income tax expense of $40 million ($0.04 per diluted share) resulting from the enactment of state corporate income tax rate changes and other legislated state tax revisions and an income tax recovery of $11 million ($0.01 per diluted share) relating to certain fuel costs attributed to various wholly-owned subsidiaries’ fuel consump- tion in prior periods. Foreign exchange fluctuations continue to have an impact on the comparability of the results of operations. The fluctuation of the Canadian dollar relative to the US dollar, which affects the conversion of the Company’s US dollar-denominated revenues and expenses, resulted in a positive impact to net income of $11 million ($0.01 per diluted share) in 2012. Revenues for the year ended December 31, 2012 increased by $892 million, or 10%, to $9,920 million, mainly attributable to higher freight volumes, due in part to growth in North American and Asian economies, and the Company’s performance above market conditions in a number of segments, as well as increased volumes in the second quarter as a result of a labor disruption at a key competitor; freight rate increases; the impact of a higher fuel surcharge as a result of year-over-year increases in applicable fuel prices and higher volumes; and the positive translation impact of the weaker Canadian dollar on US dollar-denominated revenues. Operating expenses for the year ended December 31, 2012 increased by $503 million, or 9%, to $6,235 million, mainly due to higher labor and fringe benefits expense, increased purchased services and material expense, as well as increased fuel costs. The operating ratio, defined as operating expenses as a percentage of revenues, was 62.9% in 2012, compared to 63.5% in 2011, a 0.6-point improvement. 20 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis Revenues Petroleum and chemicals In millions, unless otherwise indicated Year ended December 31, 2012 2011 % Change % Change at constant currency Rail freight revenues $ 8,938 $ 8,111 10% 10% Other revenues Total revenues 982 917 7% $ 9,920 $ 9,028 10% 6% 9% Rail freight revenues Petroleum and chemicals $ 1,640 $ 1,420 15% 15% Metals and minerals 1,133 1,006 13% 12% Forest products 1,331 1,270 5% 4% Coal 712 618 15% 15% Grain and fertilizers 1,590 1,523 4% 4% Intermodal Automotive 1,994 1,790 11% 11% 538 484 11% 10% Total rail freight revenues $ 8,938 $ 8,111 10% 10% Revenue ton miles (RTM) (millions) 201,496 187,753 7% Rail freight revenue/RTM (cents) Carloads 4.44 4.32 3% (thousands) 5,059 4,873 4% Rail freight revenue/carload (dollars) 1,767 1,664 6% 7% 2% 4% 6% Revenues for the year ended December 31, 2012 totaled Year ended December 31, 2012 2011 % Change % Change at constant currency Revenues (millions) $ 1,640 $ 1,420 15% 15% RTMs (millions) 37,449 32,962 14% 14% Revenue/RTM (cents) 4.38 4.31 2% 1% For the year ended December 31, 2012, revenues for this commodity group increased by $220 million, or 15%, when compared to 2011. The increase was mainly due to higher shipments of crude oil, pro- pane, condensate, petroleum lubricants, and asphalt; freight rate increases; a higher fuel surcharge; and the positive translation impact of a weaker Canadian dollar. These gains were partly offset by lower volumes of molten sulfur to the U.S. market and reduced shipments of gasoline and diesel. Revenue per revenue ton mile increased by 2% in 2012, mainly due to freight rate increases, a higher fuel surcharge and the positive translation impact of a weaker Canadian dollar, partly offset by a significant increase in the average length of haul. Metals and minerals Year ended December 31, 2012 2011 % Change % Change at constant currency Revenues (millions) $ 1,133 $ 1,006 13% 12% RTMs (millions) 20,236 18,899 Revenue/RTM (cents) 5.60 5.32 7% 5% 7% 4% $9,920 million compared to $9,028 million in 2011. The increase For the year ended December 31, 2012, revenues for this com- of $892 million, or 10%, was mainly attributable to higher freight modity group increased by $127 million, or 13%, when compared volumes, due in part to growth in North American and Asian to 2011. The increase was mainly due to greater shipments of economies, and the Company’s performance above market con- materials supporting oil and gas development, increased volumes ditions in a number of segments, as well as increased volumes of machinery and dimensional loads, steel products, and industrial in the second quarter as a result of a labor disruption at a key materials; freight rate increases; a higher fuel surcharge; and the competitor; freight rate increases; the impact of a higher fuel sur- positive translation impact of a weaker Canadian dollar. These charge of approximately $140 million, as a result of year-over-year gains were partly offset by lower volumes of non-ferrous metals increases in applicable fuel prices and higher volumes; and the and iron ore. Revenue per revenue ton mile increased by 5% in positive translation impact of the weaker Canadian dollar on US 2012, mainly due to freight rate increases, a higher fuel surcharge, dollar-denominated revenues. and the positive translation impact of a weaker Canadian dollar, In 2012, revenue ton miles increased by 7% relative to 2011. partly offset by an increase in the average length of haul. Rail freight revenue per revenue ton mile increased by 3% when compared to 2011, driven by freight rate increases, the impact of Forest products a higher fuel surcharge, and the positive translation impact of the weaker Canadian dollar. These factors were partly offset by an increase in the average length of haul. Year ended December 31, 2012 2011 % Change % Change at constant currency Revenues (millions) $ 1,331 $ 1,270 RTMs (millions) 29,674 29,336 Revenue/RTM (cents) 4.49 4.33 5% 1% 4% 4% 1% 3% For the year ended December 31, 2012, revenues for this com- modity group increased by $61 million, or 5%, when compared to 2011. The increase was mainly due to freight rate increases, a higher fuel surcharge, the positive translation impact of a weaker Canadian dollar and increased shipments of lumber and panels to the U.S. market. These factors were partly offset by reduced Canadian National Railway Company U.S. GAAP 2013 Annual Report 21 Management’s Discussion and Analysis paper shipments due to mill closures and curtailments, as well as Intermodal decreased shipments of lumber for offshore export. Revenue per revenue ton mile increased by 4% in 2012, mainly due to freight rate increases, a higher fuel surcharge, and the positive translation impact of a weaker Canadian dollar. Coal Year ended December 31, 2012 2011 % Change % Change at constant currency Revenues (millions) $ 712 $ 618 15% 15% RTMs (millions) 23,570 19,980 18% 18% Revenue/RTM (cents) 3.02 3.09 (2%) (3%) Year ended December 31, 2012 2011 % Change % Change at constant currency Revenues (millions) $ 1,994 $ 1,790 11% 11% RTMs (millions) 42,396 38,563 10% 10% Revenue/RTM (cents) 4.70 4.64 1% 1% For the year ended December 31, 2012, revenues for this com- modity group increased by $204 million, or 11%, when com- pared to 2011. The increase was mainly due to higher shipments through the west coast ports and increased volumes of domestic shipments of consumer and industrial products; a higher fuel surcharge; freight rate increases; and the positive translation im- For the year ended December 31, 2012, revenues for this com- pact of a weaker Canadian dollar. Revenue per revenue ton mile modity group increased by $94 million, or 15%, when compared increased by 1% in 2012, mainly due to a higher fuel surcharge, to 2011. The increase was mainly due to higher volumes of U.S. freight rate increases and the positive translation impact of a thermal coal to the Gulf and west coast ports, Canadian petrol- weaker Canadian dollar. eum coke and metallurgical coal for offshore export; freight rate increases; a higher fuel surcharge; and the positive translation im- Automotive pact of a weaker Canadian dollar. These factors were partly offset by reduced volumes of thermal coal to U.S. utilities. Revenue per revenue ton mile decreased by 2% in 2012, due to a significant increase in the average length of haul, partly offset by freight rate increases, a higher fuel surcharge and the positive translation impact of a weaker Canadian dollar. Grain and fertilizers Year ended December 31, 2012 2011 % Change % Change at constant currency Revenues (millions) $ 1,590 $ 1,523 RTMs (millions) 45,417 45,468 Revenue/RTM (cents) 3.50 3.35 4% - 4% 4% - 4% Year ended December 31, 2012 2011 % Change % Change at constant currency Revenues (millions) $ 538 $ 484 11% 10% RTMs (millions) 2,754 2,545 Revenue/RTM (cents) 19.54 19.02 8% 3% 8% 2% For the year ended December 31, 2012, revenues for this com- modity group increased by $54 million, or 11%, when compared to 2011. The increase was mainly due to higher volumes of im- ported finished vehicles via the Port of Vancouver and spot moves of military equipment; freight rate increases; a higher fuel sur- charge; and the positive translation impact of a weaker Canadian dollar. Revenue per revenue ton mile increased by 3% in 2012, mainly due to freight rate increases, a higher fuel surcharge and For the year ended December 31, 2012, revenues for this com- the positive translation impact of a weaker Canadian dollar, partly modity group increased by $67 million, or 4%, when compared to offset by an increase in the average length of haul. 2011. The increase was mainly due to freight rate increases; a high- er fuel surcharge; higher volumes of Canadian wheat exports, U.S. Other revenues soybean product exports to the Gulf, and Canadian barley to the U.S.; and the positive translation impact of a weaker Canadian dol- lar. These gains were partly offset by lower volumes of corn, peas, and ethanol. Revenue per revenue ton mile increased by 4% in Year ended December 31, 2012 2011 % Change % Change at constant currency Revenues (millions) $ 982 $ 917 7% 6% 2012, mainly due to freight rate increases, a higher fuel surcharge In 2012, Other revenues amounted to $982 million, an increase of and the positive translation impact of a weaker Canadian dollar. $65 million, or 7%, when compared to 2011, mainly due to higher revenues from freight forwarding and transportation manage- ment, vessels and docks, intermodal trucking, and warehousing and distribution, partly offset by the loss of revenues due to the sale of IC RailMarine in August 2011 and lower commuter train revenues. 22 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis Operating expenses Operating expenses for the year ended December 31, 2012 amounted to $6,235 million, compared to $5,732 million in 2011. The increase of $503 million, or 9%, in 2012 was mainly due to higher labor and fringe benefits expense, increased purchased services and material expense, as well as increased fuel costs. In millions Year ended December 31, 2012 2011 % Change % Change at constant currency Percentage of revenues 2012 2011 Labor and fringe benefits Purchased services and material Fuel Depreciation and amortization Equipment rents Casualty and other Total operating expenses $ 1,952 $ 1,812 1,248 1,120 1,524 1,412 924 249 338 884 228 276 (8%) (11%) (8%) (5%) (9%) (7%) 19.7% (11%) 12.6% (7%) (4%) (8%) 15.4% 9.3% 2.5% (22%) (22%) 3.4% 20.1% 12.4% 15.6% 9.8% 2.5% 3.1% $ 6,235 $ 5,732 (9%) (8%) 62.9% 63.5% Labor and fringe benefits: Labor and fringe benefits expense increased Casualty and other: Casualty and other expense increased by by $140 million, or 8%, in 2012 when compared to 2011. The in- $62 million, or 22%, in 2012 when compared to 2011. The in- crease was primarily a result of the impact of a higher workforce level crease was mainly due to increased provisions for environmental due to volume growth, and general wage increases; and increased and legal expenses, higher property taxes and workers’ compen- pension expense; which were offset by the recognition of a net settle- sation expenses pursuant to an actuarial study, which were partly ment gain from the termination of the former Chief Executive Officer’s offset by lower expenses for loss and damage claims. retirement benefit plan in the fourth quarter of 2012. Other Purchased services and material: Purchased services and material Interest expense: In 2012, interest expense was $342 million com- expense increased by $128 million, or 11%, in 2012 when com- pared to $341 million in 2011. The increase was mainly due to the pared to 2011. The increase was mainly due to higher expenses issuance of a higher level of debt with a lower interest rate and for contracted services and for third-party non-rail transportation the negative translation impact of the weaker Canadian dollar on services as a result of higher volumes; as well as higher mainten- US dollar-denominated interest expense, which were offset by a ance expenses for track, rolling stock and other equipment. These repayment of debt with a higher interest rate. factors were partly offset by lower accident-related expenses; as well as reduced expenses for snow removal and utilities, primarily Other income: In 2012, the Company recorded other income of as a result of milder winter conditions at the beginning of the year. $315 million compared to $401 million in 2011. Included in Other income for 2012 was a gain on disposal of the Bala-Oakville of Fuel: Fuel expense increased by $112 million, or 8%, in 2012 $281 million compared to gains on disposal of substantially all of when compared to 2011. The increase was primarily due to higher the assets of IC RailMarine of $60 million and the Lakeshore East freight volumes and a higher average price for fuel, which were of $288 million in 2011. partly offset by productivity improvements. Depreciation and amortization: Depreciation and amortization of $978 million for the year ended December 31, 2012 compared expense increased by $40 million, or 5%, in 2012 when compared to $899 million in 2011. The 2012 figure includes a net income tax to 2011. The increase was mainly due to the impact of net capital expense of $28 million, which consisted of a $35 million income tax Income tax expense: The Company recorded income tax expense additions. expense resulting from the enactment of higher provincial corporate income tax rates that was partly offset by a $7 million income tax Equipment rents: Equipment rents expense increased by $21 mil- recovery resulting from the recapitalization of a foreign investment. lion, or 9%, in 2012 when compared to 2011. The increase was Included in the 2011 figure was a net income tax expense of $40 mil- due to increased lease expenses on account of volume increases, lion, resulting from the enactment of state corporate income tax rate as well as higher car hire expenses. changes and other legislated state tax revisions, and an income tax re- covery of $11 million relating to certain fuel costs attributed to various wholly-owned subsidiaries’ fuel consumption in prior periods. The effective tax rate for 2012 was 26.7% compared to 26.8% in 2011. Canadian National Railway Company U.S. GAAP 2013 Annual Report 23 Management’s Discussion and Analysis Summary of quarterly financial data In millions, except per share data 2013 Quarters 2012 Quarters Fourth Third Second First Fourth Third Second First Revenues Operating income Net income $ 2,745 $ 2,698 $ 2,666 $ 2,466 $ 2,534 $ 2,497 $ 2,543 $ 2,346 $ $ 967 635 $ 1,084 $ 1,042 $ 705 $ 717 $ $ 780 555 $ $ 922 610 $ $ 985 664 $ $ 985 631 $ $ 793 775 Basic earnings per share $ 0.76 $ 0.84 $ 0.85 $ 0.65 $ 0.71 $ 0.77 $ 0.72 $ 0.88 Diluted earnings per share $ 0.76 $ 0.84 $ 0.84 $ 0.65 $ 0.71 $ 0.76 $ 0.72 $ 0.87 Dividend declared per share $ 0.2150 $ 0.2150 $ 0.2150 $ 0.2150 $ 0.1875 $ 0.1875 $ 0.1875 $ 0.1875 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 (see the section of this MD&A entitled Business risks). Operating expenses reflect the impact of freight volumes, seasonal weather conditions, labor costs, fuel prices, and the Company’s productivity initiatives. Fluctuations in the Canadian dollar relative to the US dollar have also affected the conversion of the Company’s US dollar-denominated revenues and expenses and resulted in fluctuations in net income in the rolling eight quarters presented above. The Company’s quarterly results include items that impacted the quarter-over-quarter comparability of the results of operations as dis- cussed below: In millions, except per share data 2013 Quarters 2012 Quarters Fourth Third Second First Fourth Third Second Income tax expenses (1) After-tax gain on disposal of property (2) (3) (4) Impact on net income Impact on basic earnings per share Impact on diluted earnings per share $ $ $ $ - - - - - $ (19) $ (5) $ - $ (19) $ 18 13 $ - 36 36 $ (0.02) $ 0.01 $ 0.04 $ (0.02) $ 0.01 $ 0.04 $ $ $ $ - - - - - $ $ $ $ - - - - - First - 252 $ (28) $ - $ $ $ (28) $ 252 (0.03) $ 0.29 (0.03) $ 0.28 (1) Income tax expenses resulted mainly from the enactment of provincial corporate income tax rate changes and the recapitalization of a foreign investment. (2) The Company entered into an exchange of easements without monetary consideration. A gain on disposal of $29 million ($18 million after-tax) was recognized in Other income. (3) The Company sold the Lakeshore West for $52 million. A gain on disposal of $40 million ($36 million after-tax) was recognized in Other income. (4) The Company sold the Bala-Oakville for $311 million. A gain on disposal of $281 million ($252 million after-tax) was recognized in Other income. Summary of fourth quarter 2013 compared to corresponding quarter in 2012 Fourth quarter 2013 net income was $635 million, an increase of $25 million, or 4%, when compared to the same period in 2012, with diluted earnings per share rising 7% to $0.76. Foreign exchange fluctuations have an impact on the comparability of the results of operations. The fluctuation of the Canadian dollar relative to the US dollar, which affects the conversion of the Company’s US dollar-denominated revenues and expenses, resulted in a positive impact of $18 million ($0.02 per diluted share) to fourth-quarter 2013 net income. Revenues for the fourth quarter of 2013 increased by $211 million, or 8%, to $2,745 million, when compared to the same period in 2012. The increase was mainly attributable to higher freight volumes due to strong energy markets, market share gains, as well as growth in the North American economy; the positive translation impact of the weaker Canadian dollar on US dollar-denominated revenues; freight rate increases; and the impact of a higher fuel surcharge, as a result of higher volumes and year-over-year increases in applicable fuel prices. Operating expenses for the fourth quarter of 2013 increased by $166 million, or 10%, to $1,778 million, when compared to the same period in 2012. The increase was primarily due to higher labor and fringe benefits expense as a result of increased pension expense and higher incentive compensation; the negative translation impact of the weaker Canadian dollar on US dollar-denominated expenses; and increased purchased services and material expense, in part due to weather-related conditions. These factors were partly offset by lower casualty and other expense. The operating ratio was 64.8% in the fourth quarter of 2013 compared to 63.6% in the fourth quarter of 2012, a 1.2-point deterioration. 24 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis Financial position The following tables provide an analysis of the Company’s balance sheet as at December 31, 2013 as compared to 2012. Assets and liabilities denominated in US dollars have been translated to Canadian dollars using the foreign exchange rate in effect at the balance sheet date. As at December 31, 2013 and 2012, the foreign exchange rate was $1.0636 per US$1.00 and $0.9949 per US$1.00, respectively. In millions As at December 31, 2013 2012 Foreign exchange impact Variance excluding foreign exchange Explanation of variance, other than foreign exchange impact Total assets $ 30,163 $ 26,659 $ 789 $ 2,715 Variance mainly due to: Properties $ 26,227 $ 24,541 $ 707 $ 979 Intangible and other assets $ 1,959 $ 249 $ 8 $ 1,702 Total liabilities $ 17,210 $ 15,641 $ 747 $ 822 Variance mainly due to: Accounts payable and other $ 1,477 $ 1,626 $ 37 $ (186) Deferred income taxes $ 6,537 $ 5,555 $ 226 $ 756 Increase primarily due to gross property additions of $2,017 million, partly offset by depreciation of $979 million. Increase primarily due to the increase in pension asset of $1,662 million. Decrease primarily due to lower income and other taxes of $201 million. Increase due to deferred income tax expense of $331 million recorded in Net income excluding recog- nized tax benefits and deferred income tax expense of $414 million recorded in Other comprehensive loss. Pension and other postretirement benefits, net of current portion Total long-term debt, including the current portion $ 541 $ 784 $ 11 $ (254) Decrease due primarily to the increase in the year-end discount rate from 4.15% in 2012 to 4.73% in 2013. $ 7,840 $ 6,900 $ 450 $ 490 Increase primarily due issuances of $1,850 million, partly offset by debt repayments of $1,413 million. to debt In millions As at December 31, 2013 2012 Variance Explanation of variance Total shareholders’ equity $ 12,953 $ 11,018 $ 1,935 Variance mainly due to: Common shares $ 4,015 $ 4,108 $ (93) Accumulated other comprehensive loss $ (1,850) $ (3,257) $ 1,407 Retained earnings $ 10,788 $ 10,167 $ 621 Decrease due to share repurchase programs of $133 million, partly offset by issuances of common shares of $40 million upon the exercise of stock options and other. Decrease in comprehensive loss due to after-tax amounts of $1,302 million due to the improvement of the funded status of the Company’s pension and other postretirement benefit plans and $105 million for foreign exchange gains. Increase due to current year net income of $2,612 mil- lion partly offset by share repurchase programs of $1,267 million and dividends paid of $724 million. Canadian National Railway Company U.S. GAAP 2013 Annual Report 25 Management’s Discussion and Analysis Liquidity and capital resources The Company’s principal source of liquidity is cash generated from operations and is supplemented by borrowings in the money markets and capital markets. 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. The strong focus on cash generation from all sources gives the Company increased flexibility in terms of its financing requirements. As part of its financing strategy, the Company regularly reviews its optimal capital structure, cost of cap- ital, and the need for additional debt financing, and considers from time to time the feasibility of dividend increases and share repurchases. To meet short-term liquidity needs, the Company has a commercial paper program, which is backstopped by its revolving credit facility, expiring on May 5, 2018. Access to commercial paper is dependent on market conditions. If the Company were to lose access to its commer- cial paper program for an extended period of time, the Company could rely on its $800 million revolving credit facility to meet its short-term liquidity needs. The Company also has a $450 million accounts receivable securitization program that can be used to meet its liquidity needs. See the section of this MD&A entitled Available financing arrangements for additional information. The Company has at times had working capital deficits which are considered common in the rail industry because it is capital-intensive, and such deficits are not an indication of a lack of liquidity. The Company maintains adequate resources to meet daily cash requirements, and has sufficient financial capacity to manage its day-to-day cash requirements and current obligations. As at December 31, 2013 and December 31, 2012, the Company had Cash and cash equivalents of $214 million and $155 million, respectively, Restricted cash and cash equivalents of $448 million and $521 million, respectively, and a working capital deficit of $521 million and $334 million, respectively. The cash and cash equivalents pledged as collateral for a minimum term of one month pursuant to the Company’s bilateral letter of credit facilities are recorded as Restricted cash and cash equivalents. See the section of this MD&A entitled Available financing arrangements for additional information. There are currently no specific requirements relating to working capital other than in the normal course of business as discussed herein. The Company’s access to long-term funds in the debt capital markets depends on its credit rating and market conditions. The Company believes that it continues to have access to the long-term debt capital markets. If the Company were unable to borrow funds at acceptable rates in the long-term debt capital markets, the Company could borrow under its revolving credit facility, draw down on its accounts receiv- able securitization program, raise cash by disposing of surplus properties or otherwise monetizing assets, reduce discretionary spending or take a combination of these measures to assure that it has adequate funding for its business. The Company’s U.S. and other foreign subsidiaries hold cash to meet their respective operational requirements. The Company can decide to repatriate funds associated with either undistributed earnings or the liquidation of its foreign operations, including its U.S. and other foreign subsidiaries. Such repatriation of funds would not cause significant tax implications to the Company under the tax treaties currently in effect between Canada and the U.S. and other foreign tax jurisdictions. Therefore, the impact on liquidity resulting from the repatriation of funds held outside Canada would not be significant. Operating activities In millions Net cash receipts from customers and other Net cash payments for: Employee services, suppliers and other expenses Interest Personal injury and other claims Pensions Income taxes Net cash provided by operating activities Year ended December 31, 2013 2012 Variance $ 10,640 $ 9,877 $ 763 (5,558) (5,241) (317) (344) (61) (239) (890) (364) (79) (844) (289) 20 18 605 (601) $ 3,548 $ 3,060 $ 488 Net cash receipts from customers and other increased mainly due to higher revenues. Payments for employee services, suppliers and other expenses increased principally due to higher payments for labor and fringe benefits and increased fuel costs. Company contributions to its various pension plans are made in accordance with the applicable legislation in Canada and the U.S. and are determined by actuarial valuations. Actuarial valuations are generally required on an annual basis both in Canada and the U.S. The latest actuarial valuations for funding purposes for the Company’s Canadian pension plans, based on a valuation date of December 31, 2012, were filed in June 2013 and identified a going-concern surplus of approximately $1.4 billion, and a solvency deficit of approximately $2.1 billion calculated using the three-year average of the Company’s hypothetical wind-up ratio in accordance with the Pension Benefit Standards Regulations, 1985. The Company’s next actuarial valuations required as at December 31, 2013 will be performed in 2014. These actuarial valuations are expected to identify a going-concern surplus of approximately $1.7 billion, while on a solvency basis a funding deficit of approximately $1.7 billion is expected due to the level interest rates applicable at their respective measurement dates. Under Canadian 26 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis legislation, the solvency deficit is required to be funded through special solvency payments, for which each annual amount is equal to one fifth of the solvency deficit, and is re-established at each valuation date. In anticipation of its future funding requirements, the Company may occasionally make voluntary contributions in excess of the required contributions mainly to strengthen the financial position of its main pension plan, the CN Pension Plan. The Company has been advised by the Office of the Superintendent of Financial Institutions (OSFI) that voluntary contributions can be treated as a prepayment against the Company’s required special solvency payments and as at December 31, 2013, the Company had approximately $470 million of accumulated prepayments which remain available to offset future required solvency deficit payments. Pension contributions made in 2013 and 2012 of $226 million and $833 million, respectively, mainly represent contributions to the Company’s main pension plan, the CN Pension Plan and include voluntary contributions of $100 million and $700 million, respectively. The pension contributions also include contributions for the current service cost as determined under the Company’s current actuarial valuations for funding purposes. Additional information relating to the pension plans is provided in Note 11 – Pensions and other postretirement benefits to the Company’s 2013 Annual Consolidated Financial Statements. Net income tax payments increased in 2013 mainly due to a higher final payment for the 2012 fiscal year of $208 million, made in February 2013, and increased installments for the 2013 fiscal year. In 2014, net income tax payments are expected to be approximately $800 million. The Company expects cash from operations and its other sources of financing to be sufficient to meet its funding obligations. Investing activities In millions Year ended December 31, 2013 2012 Variance Net cash used in investing activities $ 1,852 $ 1,421 $ (431) The Company’s investing activities in 2013 included property additions of $1,973 million and cash proceeds of $52 million from the disposal of the Lakeshore West. Investing activities in 2012 included property additions of $1,731 million and cash proceeds of $311 million from the disposal of the Bala-Oakville. See the section of this MD&A entitled Disposal of property for additional information. The following table details property additions for the years expenditures to replace and/or upgrade the basic track infra- ended December 31, 2013 and 2012: In millions Year ended December 31, 2013 2012 structure are generally planned and programmed in advance and carried out by the Company’s engineering workforce. In both 2013 and 2012, approximately 90% of the Track and roadway capital Track and roadway Rolling stock Buildings Information technology Other Gross property additions Less: Capital leases (1) Property additions $ 1,400 $ 1,351 expenditures were incurred to renew the basic track infrastructure. 286 104 130 97 206 66 125 77 Expenditures relating to the Company’s properties that do not meet the Company’s capitalization criteria are considered normal repairs and maintenance and are expensed. In 2013, approximate- ly 20% of the Company’s total operating expenses were for such 2,017 1,825 expenditures (approximately 20% in both 2012 and 2011). For 44 94 Track and roadway properties, normal repairs and maintenance $ 1,973 $ 1,731 include but are not limited to spot tie replacement, spot or broken (1) During 2013, the Company recorded $44 million in assets it acquired through equip- ment leases ($94 million in 2012), for which an equivalent amount was recorded in debt. rail replacement, physical track inspection for detection of rail de- fects and minor track corrections, and other general maintenance of track structure. On an ongoing basis, the Company invests in capital expendi- For 2014, the Company expects to invest approximately ture programs for the renewal of the basic track infrastructure, $2.1 billion on its capital programs, of which over $1.2 billion is the acquisition of rolling stock and other investments to take ad- targeted towards track infrastructure to continue to operate a safe vantage of growth opportunities and to improve the Company’s railway and to improve the productivity and fluidity of the network. productivity and the fluidity of its network. Implementation costs associated with the U.S. federal government Expenditures are generally capitalized if they meet a minimum legislative requirement to implement Positive Train Control (PTC) level of activity, extend the life of the asset or provide future bene- by 2015 will amount to approximately US$335 million, of which fits such as increased revenue-generating capacity, functionality, approximately US$62 million has been spent at the end of 2013. or physical or service capacity. For Track and roadway properties, Canadian National Railway Company U.S. GAAP 2013 Annual Report 27 Management’s Discussion and Analysis Free cash flow were paid upon maturity. In November 2013, under its previous Free cash flow does not have any standardized meaning pre- shelf prospectus and registration statement, the Company issued scribed by GAAP and therefore, may not be comparable to similar US$350 million (C$365 million) floating rate Notes due 2015 and measures presented by other companies. The Company believes US$250 million (C$260 million) 4.50% Notes due 2043 in the U.S. that free cash flow is a useful measure of performance as it dem- capital markets, which resulted in net proceeds of US$592 million onstrates the Company’s ability to generate cash. In the past, (C$617 million), intended for general corporate purposes, includ- the Company defined free cash flow as the difference between ing the redemption and refinancing of outstanding indebtedness. net cash provided by operating activities and net cash used in in- In 2012, the Company made issuances and repayments of debt vesting activities; adjusted for changes in restricted cash and cash of $493 million and $140 million, respectively. In November 2012, equivalents, the payment of dividends, changes in cash and cash under its previous shelf prospectus and registration statement, the equivalents resulting from foreign exchange fluctuations, and the Company issued US$250 million (C$249 million) 2.25% Notes impact of major acquisitions, if any. due 2022 and US$250 million (C$249 million) 3.50% Notes due Beginning with the fourth quarter of 2013, the Company has 2042 in the U.S. capital markets, which resulted in net proceeds redefined its free cash flow measure as the difference between of US$494 million (C$493 million), intended for general corporate net cash provided by operating activities and net cash used in purposes, including the redemption and refinancing of outstand- investing activities; adjusted for changes in restricted cash and ing indebtedness. cash equivalents and the impact of major acquisitions, if any. The Cash received from stock options exercised and the related Company believes that free cash flow, as redefined, is a better excess tax benefits realized upon exercise during 2013 and 2012 measure of the Company’s available cash for debt obligations and was $31 million and $117 million, respectively. for discretionary uses such as payment of dividends and strategic In 2013, the Company repurchased a total of 27.6 million opportunities. In millions Year ended December 31, 2013 2012 common shares for $1,400 million (weighted-average price of $50.65 per share) under its share repurchase programs. In 2012, the Company repurchased a total of 33.8 million common shares Net cash provided by operating activities $ 3,548 $ 3,060 for $1,400 million (weighted-average price of $41.36 per share) Net cash used in investing activities (1,852) (1,421) under its share repurchase programs. See the section of this Net cash provided before financing activities 1,696 1,639 MD&A entitled Common shares for the activity under the 2013 Adjustment: share repurchase programs, as well as the share repurchase pro- Change in restricted cash and cash equivalents (73) 22 grams of the prior years. Free cash flow $ 1,623 $ 1,661 During 2013, the Company paid quarterly dividends of $0.2150 Dividends paid (724) (652) per share amounting to $724 million, compared to $652 million, at the rate of $0.1875 per share, in 2012. Effect of foreign exchange fluctuations on US dollar-denominated cash and cash equivalents 19 (3) Credit measures Free cash flow – as previously defined $ 918 $ 1,006 Management believes that the adjusted debt-to-total capitaliza- Financing activities In millions Year ended December 31, 2013 2012 Variance Net cash used in financing activities $ 1,656 $ 1,582 $ (74) Beginning with the fourth quarter of 2013, in order to better re- tion ratio is a useful credit measure that aims to show the true leverage of the Company. Similarly, the adjusted debt-to-adjusted earnings before interest, income taxes, depreciation and amortiza- tion (EBITDA) multiple is another useful credit measure because it reflects the Company’s ability to service its debt. The Company ex- cludes Other income in the calculation of EBITDA. However, since these measures do not have any standardized meaning prescribed flect the net cash used in financing activities, the issuances and by GAAP, they may not be comparable to similar measures pre- repayments of commercial paper, all of which have a maturity of sented by other companies and, as such, should not be considered three months or less, which were previously reported on a gross in isolation. basis, are now shown on a net basis. In 2013, the Company made issuances and repayments of debt of $1,850 million and $1,413 million, respectively. In March 2013, the Company, through a wholly-owned subsidiary, repurchased 85% of the 4.40% Notes due March 15, 2013, with a carrying value of US$340 million pursuant to a tender offer for a total cost of US$341 million, including consent payments. The remaining 15% of the 4.40% Notes with carrying value of US$60 million 28 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis Adjusted debt-to-total capitalization ratio Commercial paper December 31, 2013 2012 Debt-to-total capitalization ratio (1) 37.7% 38.5% Add: Impact of present value of operating lease commitments (2) 1.7% 1.9% Adjusted debt-to-total capitalization ratio 39.4% 40.4% Adjusted debt-to-adjusted EBITDA $ in millions, unless otherwise indicated The Company has a commercial paper program, which is backed by its revolving credit facility, enabling it to issue commercial paper up to a maximum aggregate principal amount of $800 million, or the US dollar equivalent. As at December 31, 2013, the Company had total borrowings of $273 million presented in Current portion of long-term debt on the Consolidated Balance Sheet (nil as at December 31, 2012). The weighted-average interest rate on these borrowings was 1.14%. Accounts receivable securitization program Twelve months ended December 31, 2013 2012 On December 20, 2012, the Company entered into a three-year Debt $ 7,840 $ 6,900 agreement, commencing on February 1, 2013, to sell an undivided Add: Present value of operating lease commitments (2) 570 559 Adjusted debt Operating income Add: Depreciation and amortization EBITDA (excluding Other income) 8,410 7,459 3,873 3,685 980 924 4,853 4,609 Add: Deemed interest on operating leases 28 29 Adjusted EBITDA $ 4,881 $ 4,638 Adjusted debt-to-adjusted EBITDA 1.72 times 1.61 times (1) 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. (2) The operating lease commitments have been discounted using the Company’s implicit interest rate for each of the periods presented. The decrease in the Company’s adjusted debt-to-total capitalization ratio at December 31, 2013, as compared to 2012, was mainly due to an improvement in the funded status of the Company’s pension co-ownership interest in a revolving pool of accounts receivable to unrelated trusts for maximum cash proceeds of $450 million. The trusts are multi-seller trusts and the Company is not the primary beneficiary. Funding for the acquisition of these assets is custom- arily through the issuance of asset-backed commercial paper notes by the unrelated trusts. The Company has retained the responsibility for servicing, adminis- tering and collecting the receivables sold. The average servicing period is approximately one month. Subject to customary indemnifications, each trust’s recourse is limited to the accounts receivable transferred. The Company is subject to customary reporting requirements for which failure to perform could result in termination of the pro- gram. In addition, the program 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 plans, partly offset by an increased debt level, reflecting the imple- could cause such termination. mentation of the accounts receivable securitization program, a higher use of commercial paper and a weaker Canadian-to-US dollar foreign exchange rate in effect at the balance sheet date. This increased debt level as at December 31, 2013, partly offset by a higher operating income earned during 2013, resulted in an increase in the Company’s adjusted debt-to-adjusted EBITDA multiple, as compared to 2012. Available financing arrangements Revolving credit facility The Company has an $800 million revolving credit facility agreement with a consortium of lenders. The agreement, which contains cus- tomary terms and conditions, allows for an increase in the facility amount, up to a maximum of $1.3 billion, as well as the option to The accounts receivable securitization program provides the Company with readily available short-term financing for general cor- porate 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 fa- cility and commercial paper program, and/or access to capital markets. The Company accounts for its accounts receivable securitiza- tion program under Accounting Standards Codification (ASC) 860, Transfers and Servicing. Based on the structure of the program, the Company accounts for the proceeds as a secured borrowing. As such, as at December 31, 2013, the Company recorded $250 million of proceeds received under the accounts receivable securitization pro- gram in the Current portion of long-term debt on the Consolidated Balance Sheet at a weighted-average interest rate of 1.18% which is extend the term by an additional year at each anniversary date, sub- secured by and limited to $281 million of accounts receivable. ject to the consent of individual lenders. The Company exercised such option and on March 22, 2013, the expiry date of the agreement was Bilateral letter of credit facilities and Restricted cash and cash extended by one year to May 5, 2018. The Company plans to use the equivalents credit facility for working capital and general corporate purposes, in- cluding backstopping its commercial paper program. As at December 31, 2013 and December 31, 2012, the Company had no outstanding borrowings under its revolving credit facility and there were no draws during the years ended December 31, 2013 and 2012. The Company has a series of bilateral letter of credit facility agree- ments with various banks to support its requirements to post letters of credit in the ordinary course of business. On March 22, 2013, the expiry date of these agreements was extended by one year to April 28, 2016. Under these agreements, the Company Canadian National Railway Company U.S. GAAP 2013 Annual Report 29 Management’s Discussion and Analysis has the option from time to time to pledge collateral in the form providing for the issuance by CN of up to $3.0 billion of debt of cash or cash equivalents, for a minimum term of one month, securities in the Canadian and U.S. markets. The current shelf pro- equal to at least the face value of the letters of credit issued. As at spectus and registration statement expires January 2, 2016 and December 31, 2013, the Company had letters of credit drawn of replaces CN’s previous shelf prospectus and registration statement $481 million ($551 million as at December 31, 2012) from a total that was filed on November 4, 2011. Access to capital markets committed amount of $503 million ($562 million as at December under the shelf prospectus and registration statement is depend- 31, 2012) by the various banks. As at December 31, 2013, cash ent on market conditions at the time of pricing. and cash equivalents of $448 million ($521 million as at December 31, 2012) were pledged as collateral and recorded as Restricted All forward-looking information provided in this section is subject cash and cash equivalents on the Consolidated Balance Sheet. to risks and uncertainties and is based on assumptions about events and developments that may not materialize or that may Shelf prospectus and registration statement be offset entirely or partially by other events and developments. On December 3, 2013, the Company filed a new shelf prospectus See the section of this MD&A entitled Forward-looking statements with Canadian securities regulators and a registration statement for assumptions and risk factors affecting such forward-looking with the United States Securities and Exchange Commission (SEC) 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, 2013: In millions Debt obligations (1) Interest on debt obligations Capital lease obligations (2) Operating lease obligations (3) Purchase obligations (4) Pension contributions (5) Other long-term liabilities reflected on the balance sheet (6) Other commitments (7) Total obligations Total 2014 2015 2016 2017 2018 2019 & thereafter $ 7,058 $ 868 $ 369 $ 582 $ 263 $ 556 $ 4,420 5,302 991 680 482 1,207 754 363 326 209 132 397 3 65 61 317 113 111 70 196 66 302 308 317 84 7 336 44 - 296 154 66 4 336 44 - 271 3,784 14 56 2 336 42 - 184 231 2 - 493 - $ 16,837 $ 2,061 $ 1,544 $ 1,678 $ 1,163 $ 1,277 $ 9,114 (1) Presented net of unamortized discounts, of which $833 million relates to non-interest bearing Notes due in 2094, and excludes capital lease obligations of $782 million which are included in “Capital lease obligations“. Also includes $250 million under the accounts receivable securitization program. (2) Includes $782 million of minimum lease payments and $209 million of imputed interest at rates ranging from 0.7% to 8.5%. (3) 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 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. (4) Includes commitments for railroad ties, rail, freight cars, locomotives and other equipment and services, and outstanding information technology service contracts and licenses. (5) The Company’s pension contributions are based on actuarial funding valuations. The estimated minimum required payments for pension contributions, excluding current service cost, are based on actuarial funding valuations as at December 31, 2012 that were filed in June 2013. As a result of the voluntary contributions made by the Company of $100 million and $700 million in 2013 and 2012, respectively, there are no minimum required payments for pension contributions, excluding current service costs for 2014, for the Company’s main pension plan, the CN Pension Plan. Voluntary contributions can be treated as prepayment against the Company’s required special solvency payments and as at December 31, 2013 the Company had approximately $470 million of accumulated prepayments which remain available to offset future required solvency deficit payments. The Company expects to make total contributions in 2014 of approximately $130 million for all the Company’s pension plans and to apply approximately $335 million from its accumulated prepayments to satisfy its estimated 2014 required solvency deficit payment. Actuarial valuations are required annually and as such, future payments for pension contributions are subject to re-evaluation on an annual basis. See the section of this MD&A entitled Business risks, Other risks – Pensions as well as the section of this MD&A entitled Critical accounting policies – Pensions and other postretirement benefits. (6) (7) Includes expected payments for workers’ compensation, workforce reductions, postretirement benefits other than pensions, net unrecognized tax benefits and environmental liabilities that have been classified as contractual settlement agreements. Includes estimated remaining commitments of approximately $291 million (US$273 million), in relation to the U.S. federal government legislative requirement to implement PTC by 2015. In August 2012, the FRA reported an update of the PTC implementation progress to Congress concluding that the majority of the carriers would be unable to meet the December 31, 2015 implementation deadline. In August 2013, legislation was introduced in the Senate that would delay PTC implementation by five years to the end of 2020, and in the same month, the U.S. Government Accountability Office published a report recommending that Congress give the FRA authority to extend the deadline for individual carriers on a case-by-case basis. It also includes estimated remaining commitments of approximately $72 million (US$68 million), in relation to the acquisition of principal lines of the former Elgin, Joliet and Eastern Railway Company, for railroad infrastructure improvements, grade separation projects as well as commitments under a series of agreements with individual communities and a comprehensive voluntary mitigation program established to address surrounding municipalities’ concerns. For 2014 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. See the section of this MD&A entitled Forward-looking statements for assumptions and risk factors affecting such forward-looking statements. 30 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis Disposal of property 2013 Exchange of easements On June 8, 2013, the Company entered into an agreement with another Class I railroad to exchange perpetual railroad operating easements including the track and roadway assets on specific rail between rail, ship and barge, serving customers in North American and global markets. Under the sale agreement, the Company will benefit from a 10-year rail transportation agreement with Savatran LLC, an affiliate of Foresight and Cline, to haul a minimum annual volume of coal from four Illinois mines to the IC RailMarine transfer facility. The transaction resulted in a gain on disposal of $60 million lines (collectively the “exchange of easements”) without monetary ($38 million after-tax) that was recorded in Other income. consideration. The Company has accounted for the exchange of easements at fair value pursuant to Financial Accounting Standards Lakeshore East Board (FASB) ASC 845, Nonmonetary Transactions. The trans- On March 24, 2011, the Company entered into an agreement action resulted in a gain on exchange of easements of $29 million with Metrolinx to sell a segment of the Kingston subdivision ($18 million after-tax) that was recorded in Other income. known as the Lakeshore East in Pickering and Toronto, Ontario, Lakeshore West together with the rail fixtures and certain passenger agreements (collectively the “Lakeshore East”), for cash proceeds of $299 mil- On March 19, 2013, the Company entered into an agreement lion before transaction costs. Under the agreement, the Company with Metrolinx to sell a segment of the Oakville subdivision in obtained the perpetual right to operate freight trains over the Oakville and Burlington, Ontario, together with the rail fixtures Lakeshore East at its then current level of operating activity, with and certain passenger agreements (collectively the “Lakeshore the possibility of increasing its operating activity for additional West”), for cash proceeds of $52 million before transaction costs. consideration. The transaction resulted in a gain on disposal of Under the agreement, the Company obtained the perpetual right $288 million ($254 million after-tax) that was recorded in Other to operate freight trains over the Lakeshore West at its then cur- income under the full accrual method of accounting for real es- rent level of operating activity, with the possibility of increasing tate transactions. its operating activity for additional consideration. The transaction resulted in a gain on disposal of $40 million ($36 million after-tax) Off balance sheet arrangements that was recorded in Other income under the full accrual method Guarantees and indemnifications of accounting for real estate transactions. In the normal course of business, the Company, including certain 2012 Bala-Oakville of its subsidiaries, enters into agreements that may involve pro- viding guarantees or indemnifications to third parties and others, which may extend beyond the term of the agreements. These On March 23, 2012, the Company entered into an agreement include, but are not limited to, residual value guarantees on oper- with Metrolinx to sell a segment of the Bala and a segment of ating leases, standby letters of credit, surety and other bonds, and the Oakville subdivisions in Toronto, Ontario, together with the rail indemnifications that are customary for the type of transaction or fixtures and certain passenger agreements (collectively the “Bala- for the railway business. Oakville”), for cash proceeds of $311 million before transaction The Company is required to recognize a liability for the fair value costs. Under the agreement, the Company obtained the perpetual of the obligation undertaken in issuing certain guarantees on the date right to operate freight trains over the Bala-Oakville at its then the guarantee is issued or modified. In addition, where the Company current level of operating activity, with the possibility of increasing expects to make a payment in respect of a guarantee, a liability will its operating activity for additional consideration. The transaction be recognized to the extent that one has not yet been recognized. resulted in a gain on disposal of $281 million ($252 million af- The nature of these guarantees or indemnifications, the max- ter-tax) that was recorded in Other income under the full accrual imum potential amount of future payments, the carrying amount method of accounting for real estate transactions. of the liability, if any, and the nature of any recourse provisions are 2011 IC RailMarine disclosed in Note 16 – Major commitments and contingencies to the Company’s 2013 Annual Consolidated Financial Statements. On August 1, 2011, the Company sold substantially all of the assets Stock plans of IC RailMarine Terminal Company (“IC RailMarine”), an indirect The Company has various stock-based incentive plans for eligible subsidiary of the Company, to Raven Energy, LLC, an affiliate of employees. All share and per share data for such plans reflect the Foresight Energy, LLC (“Foresight”) and the Cline Group (“Cline”), impact of the stock split (see Note 9 – Capital stock to the Company’s for cash proceeds of $70 million (US$73 million) before transaction 2013 Annual Consolidated Financial Statements). A description of costs. IC RailMarine is located on the east bank of the Mississippi the Company’s major plans is provided in Note 10 – Stock plans River and stores and transfers bulk commodities and liquids to the Company’s 2013 Annual Consolidated Financial Statements. Canadian National Railway Company U.S. GAAP 2013 Annual Report 31 Management’s Discussion and Analysis The following table provides the total stock-based compensa- shareholders of record on November 15, 2013. All share and per tion expense for awards under all plans, as well as the related tax share data presented herein reflect the impact of the stock split. benefit recognized in income, for the years ended December 31, 2013, 2012 and 2011: Share repurchase programs In millions Year ended December 31, 2013 2012 2011 Cash settled awards Share Unit Plan Voluntary Incentive Deferral Plan Stock option awards On October 22, 2012, the Board of Directors of the Company approved a share repurchase program which allowed for the repurchase of up to $1.4 billion in common shares, not to exceed 36.0 million common $ 92 $ 76 $ 81 shares, between October 29, 2012 and October 28, 2013 pursuant to 35 127 9 19 95 10 21 102 10 a normal course issuer bid at prevailing market prices plus brokerage fees, or such other prices as may be permitted by the Toronto Stock Exchange. The Company repurchased a total of 29.4 million common Total stock-based compensation expense $ 136 $ 105 $ 112 shares for $1.4 billion under this share repurchase program. Tax benefit recognized in income $ 35 $ 25 $ 24 Financial instruments In the normal course of business, the Company is exposed to various risks such as customer credit risk, commodity price risk, interest rate risk, foreign currency risk, and liquidity risk. To manage these risks, the Company follows a financial risk management framework, which is monitored and approved by the Company’s Finance Committee, with a goal of maintaining a strong balance sheet, optimizing earnings per share and free cash flow, financing its operations at an optimal cost of capital and preserving its liquidity. The Company has limited involvement with derivative financial instruments in the management of its risks and does not use them for trading purposes. See Note 17 – Financial instruments to the Company’s 2013 Annual Consolidated Financial Statements for a discussion of such risks. At December 31, 2013 and 2012, the Company did not have any On October 22, 2013, the Board of Directors of the Company approved a new share repurchase program which allows for the repurchase of up to 30.0 million common shares, between October 29, 2013 and October 23, 2014 pursuant to a normal course issuer bid at prevailing market prices plus brokerage fees, or such other prices as may be permitted by the Toronto Stock Exchange. The following table provides the information related to the share repurchase programs for the years ended December 31, 2013, 2012 and 2011: In millions, except per share data Year ended December 31, 2013 2012 2011 October 2013 – October 2014 program Number of common shares (1) 5.5 Weighted-average price per share (2) $ 55.25 Amount of repurchase $ 305 N/A N/A N/A significant derivative financial instruments outstanding. October 2012 – October 2013 program Payments for income taxes The Company is required to make scheduled installment payments Number of common shares (1) 22.1 7.2 Weighted-average price per share (2) $ 49.51 $ 42.11 Amount of repurchase $ 1,095 $ 305 as prescribed by the tax authorities. In Canada, the Company’s October 2011 – October 2012 program domestic jurisdiction, tax installments in a given year are generally Number of common shares (1) N/A 26.6 6.8 based on the prior year’s taxable income whereas in the U.S., the Weighted-average price per share (2) N/A $ 41.16 $ 37.54 Company’s predominate foreign jurisdiction, they are based on Amount of repurchase N/A $ 1,095 $ 256 forecasted taxable income of the current year. In 2013, net income tax payments to Canadian tax author- ities were $610 million ($138 million in 2012) and net income tax payments to U.S. tax authorities were $280 million ($151 million in 2012). For the 2014 fiscal year, the Company’s net income tax payments are expected to be approximately $800 million. See the section of this MD&A entitled Forward-looking statements for assumptions and risk factors affecting such forward-looking statement. Common shares Common stock split January 2011 – December 2011 program Number of common shares (1) N/A N/A 33.0 Weighted-average price per share (2) N/A N/A $ 35.28 Amount of repurchase N/A N/A $ 1,164 Total for the year Number of common shares (1) 27.6 33.8 39.8 Weighted-average price per share (2) $ 50.65 $ 41.36 $ 35.67 Amount of repurchase $ 1,400 $ 1,400 $ 1,420 (1) Includes common shares purchased in the first and fourth quarters of 2013, 2012 and 2011 pursuant to private agreements between the Company and arm’s-length third-party sellers. (2) Includes brokerage fees. On October 22, 2013, the Board of Directors of the Company approved a two-for-one common stock split in the form of a Outstanding share data stock dividend of one additional common share of CN for each share outstanding, which was paid on November 29, 2013, to As at February 3, 2014, the Company had 829.9 million common shares and 7.7 million stock options outstanding. 32 2013 Annual Report U.S. GAAP Canadian National Railway Company N/A N/A N/A N/A N/A N/A Management’s Discussion and Analysis Recent accounting pronouncements Personal injury and other claims In February 2013, the FASB issued Accounting Standards Update In the normal course of business, the Company becomes involved (ASU) 2013-02, Reporting of Amounts Reclassified Out of in various legal actions seeking compensatory and occasionally Accumulated Other Comprehensive Income. ASU 2013-02 added punitive damages, including actions brought on behalf of various new disclosure requirements to ASC 220, Comprehensive Income, purported classes of claimants and claims relating to employee and for items reclassified out of accumulated other comprehensive third-party personal injuries, occupational disease and property income (AOCI) effective for reporting periods beginning after damage, arising out of harm to individuals or property allegedly December 15, 2012. It requires entities to disclose additional in- caused by, but not limited to, derailments or other accidents. formation about amounts reclassified out of AOCI by component including changes in AOCI balances and significant items reclassi- Canada fied out of AOCI by the respective line items of net income. The Employee injuries are governed by the workers’ compensation Company has adopted ASU 2013-02 for the reporting period legislation in each province whereby employees may be awarded beginning January 1, 2013 and the prescribed disclosures are pre- either a lump sum or a future stream of payments depending on sented in Note 18 – Accumulated other comprehensive loss to the the nature and severity of the injury. As such, the provision for Company’s 2013 Annual Consolidated Financial Statements. employee injury claims is discounted. In the provinces where the Company is self-insured, costs related to employee work-related The Accounting Standards Board of the Canadian Institute of injuries are accounted for based on actuarially developed esti- Chartered Accountants required all publicly accountable enter- mates of the ultimate cost associated with such injuries, including prises to report under International Financial Reporting Standards compensation, health care and third-party administration costs. A (IFRS) for the fiscal years beginning on or after January 1, 2011. comprehensive actuarial study is generally performed at least on a However, National Instrument 52-107 issued by the Ontario triennial basis. For all other legal actions, the Company maintains, Securities Commission allows SEC issuers, as defined by the SEC, and regularly updates on a case-by-case basis, provisions for such such as CN, to file with Canadian securities regulators financial items when the expected loss is both probable and can be reason- statements prepared in accordance with U.S. GAAP. As such, the ably estimated based on currently available information. Company decided not to report under IFRS and continues to re- In 2013, the Company recorded a $1 million increase to its pro- port under U.S. GAAP. The SEC is currently evaluating the implica- vision for personal injuries and other claims in Canada as a result tions of incorporating IFRS into the U.S. financial reporting system. of a comprehensive actuarial study for employee injury claims as Should the SEC decide it will move forward, the Company will well as various other legal claims. convert its reporting to IFRS when required. As at December 31, 2013, 2012 and 2011, the Company’s provision for personal injury and other claims in Canada was as Critical accounting policies The preparation of financial statements in conformity with gener- ally accepted accounting principles requires management to make follows: In millions estimates and assumptions that affect the reported amounts of Balance January 1 revenues and expenses during the period, the reported amounts Accruals and other of assets and liabilities, and the disclosure of contingent assets Payments and liabilities at the date of the financial statements. On an on- Balance December 31 2013 2012 2011 $ 209 $ 199 $ 200 38 (37) 55 (45) 31 (32) $ 210 $ 209 $ 199 going basis, management reviews its estimates based upon cur- rently available information. Actual results could differ from these estimates. The Company’s policies for personal injury and other claims, environmental matters, 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 considered to be critical. The following information should be read in conjunction with the Company’s 2013 Annual Consolidated Financial Statements and Notes thereto. Current portion – Balance December 31 $ 31 $ 39 $ 39 The assumptions used in estimating the ultimate costs for Canadian employee injury claims include, among other factors, the discount rate, the rate of inflation, wage increases and health care costs. The Company periodically reviews its assumptions to reflect currently available information. Over the past three years, the Company has not significantly changed any of these assump- tions. Changes in any of these assumptions could materially affect Casualty and other expense as reported in the Company’s results Management discusses the development and selection of the of operations. 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. For all other legal claims in Canada, estimates are based on the specifics of the case, trends and judgment. Canadian National Railway Company U.S. GAAP 2013 Annual Report 33 Management’s Discussion and Analysis United States As at December 31, 2013, 2012 and 2011, the Company’s Personal injury claims by the Company’s employees, including provision for personal injury and other claims in the U.S. was as claims alleging occupational disease and work-related injuries, are follows: subject to the provisions of the Federal Employers’ Liability Act (FELA). Employees are compensated under FELA for damages as- In millions 2013 2012 2011 sessed based on a finding of fault through the U.S. jury system Balance January 1 or through individual settlements. As such, the provision is undis- Accruals and other counted. With limited exceptions where claims are evaluated on Payments a case-by-case basis, the Company follows an actuarial-based ap- Balance December 31 $ 105 $ 111 $ 146 25 (24) 28 (34) 30 (65) $ 106 $ 105 $ 111 proach and accrues the expected cost for personal injury, including asserted and unasserted occupational disease claims, and property damage claims, based on actuarial estimates of their ultimate cost. A comprehensive actuarial study is performed annually. For employee work-related injuries, including asserted occupa- tional disease claims, and third-party claims, including grade cross- ing, trespasser and property damage claims, the actuarial valuation considers, among other factors, the Company’s historical patterns of claims filings and payments. For unasserted occupational disease claims, the actuarial study includes the projection of the Company’s experience into the future considering the potentially exposed population. The Company adjusts its liability based upon manage- Current portion – Balance December 31 $ 14 $ 43 $ 45 For the U.S. personal injury and other claims liability, histor- ical 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 asbestos average claim cost or a 1% change in the inflation trend rate for all injury types would result in an increase or decrease in the liability recorded of approximately $1 million. ment’s assessment and the results of the study. On an ongoing Environmental matters basis, management reviews and compares the assumptions inher- ent in the latest actuarial study with the current claim experience and, if required, adjustments to the liability are recorded. Due to the inherent uncertainty involved in projecting future events, including events related to occupational diseases, which include but are not limited to, the timing and number of actual claims, the average cost per claim and the legislative and judicial environment, the Company’s future payments may differ from current amounts recorded. In 2013, the Company recorded an $11 million reduction to its provision for U.S. personal injury and other claims attributable to non-occupational disease, third-party and occupational disease claims pursuant to the 2013 external actuarial study. In previous years, external actuarial studies have supported a net increase of $1 million and a net reduction of $6 million to the Company’s pro- vision for U.S. personal injury and other claims in 2012 and 2011, respectively. The previous years’ changes were mainly attributable to changes in the Company’s estimates of unasserted claims and costs related to asserted claims as a result of its ongoing risk miti- gation strategy focused on reducing the frequency and severity of claims through injury prevention and containment; mitigation of claims; and lower settlements for existing claims. Known existing environmental concerns The Company has identified approximately 280 sites at which it is or may be liable for remediation costs, in some cases along with other potentially responsible parties, associated with alleged contamination and is subject to environmental clean-up and en- forcement actions, including those imposed by the United States Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), also known as the Superfund law, or analogous state laws. CERCLA and similar state laws, in addition to other similar Canadian and U.S. laws, generally impose joint and several liability for clean-up and enforcement costs on current and former owners and operators of a site, as well as those whose waste is disposed of at the site, without regard to fault or the legality of the original conduct. The Company has been noti- fied that it is a potentially responsible party for study and clean-up costs at approximately 10 sites governed by the Superfund law (and analogous 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 addressing these known contaminated sites cannot be definitely established given that the estimated environmental liability for any given site may vary depending on the nature and extent of the contamination; the nature of antici- pated response actions, taking into account the available clean-up techniques; evolving regulatory standards governing environment- al liability; and the number of potentially responsible parties and their financial viability. As a result, liabilities are recorded based on the results of a four-phase assessment conducted on a site- by-site basis. A liability is initially recorded when environmental assessments occur, remedial efforts are probable, and when the 34 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis costs, based on a specific plan of action in terms of the technology (iii) the potential for new or changed laws and regulations and to be used and the extent of the corrective action required, can be for development of new remediation technologies and un- reasonably estimated. The Company estimates the costs related certainty regarding the timing of the work with respect to to a particular site using cost scenarios established by external particular sites; and consultants based on the extent of contamination and expected (iv) the determination of the Company’s liability in proportion to costs for remedial efforts. In the case of multiple parties, the other potentially responsible parties and the ability to recover Company accrues its allocable share of liability taking into account costs from any third parties with respect to particular sites. the Company’s alleged responsibility, the number of potentially responsible parties and their ability to pay their respective share of Therefore, the likelihood of any such costs being incurred or the liability. Adjustments to initial estimates are recorded as addi- whether such costs would be material to the Company cannot tional information becomes available. be determined at this time. There can thus be no assurance that The Company’s provision for specific environmental sites is un- liabilities or costs related to environmental matters will not be discounted and includes costs for remediation and restoration of incurred in the future, or will not have a material adverse effect sites, as well as monitoring costs. Environmental accruals, which on the Company’s financial position or results of operations in a are classified as Casualty and other in the Consolidated Statement particular quarter or fiscal year, or that the Company’s liquidity of Income, include amounts for newly identified sites or contam- will not be adversely impacted by such liabilities or costs, although inants as well as adjustments to initial estimates. Recoveries of management believes, based on current information, that the environmental remediation costs from other parties are recorded costs to address environmental matters will not have a material as assets when their receipt is deemed probable. adverse effect on the Company’s financial position or liquidity. As at December 31, 2013, 2012 and 2011, the Company’s Costs related to any unknown existing or future contamination provision for specific environmental sites was as follows: will be accrued in the period in which they become probable and In millions 2013 2012 2011 reasonably estimable. Balance January 1 Accruals and other Payments Balance December 31 $ 123 $ 152 $ 150 Future occurrences 14 (18) (5) (24) 17 (15) In railroad and related transportation operations, it is possible that derailments or other accidents, including spills and releases of $ 119 $ 123 $ 152 hazardous materials, may occur that could cause harm to human Current portion – Balance December 31 $ 41 $ 31 $ 63 The Company anticipates that the majority of the liability at December 31, 2013 will be paid out over the next five years. However, some costs may be paid out over a longer period. Based 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, compliance with laws and other risks, including costs relat- ing to the performance of clean-ups, payment of environmental penalties and remediation obligations, and damages relating to on the information currently available, the Company considers its harm to individuals or property. provisions to be adequate. Unknown existing environmental concerns While the Company believes that it has identified the costs likely to be incurred for environmental matters in the next several years based on known information, the discovery of new facts, future changes in laws, the possibility of releases of hazardous materi- als into the environment and the Company’s ongoing efforts to identify potential environmental liabilities that may be associated with its properties may result in the identification of additional environmental liabilities and related costs. The magnitude of such additional liabilities and the costs of complying with future en- vironmental laws and containing or remediating contamination cannot be reasonably estimated due to many factors, including: (i) the lack of specific technical information available with re- spect to many sites; (ii) the absence of any government authority, third-party orders, or claims with respect to particular sites; Regulatory compliance The Company may incur significant capital and operating costs associated with environmental regulatory compliance and clean- up requirements, in its railroad operations and relating to its past and present ownership, operation or control of real property. 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. Operating expenses for environ- mental matters amounted to $18 million in 2013, $16 million in 2012 and $4 million in 2011. For 2014, the Company expects to incur operating expenses relating to environmental matters in the same range as 2013. In addition, based on the results of its operations and maintenance programs, as well as ongoing environmental audits and other factors, the Company plans for specific capital improvements on an annual basis. Certain of these improvements help ensure facilities, such as fuelling stations and Canadian National Railway Company U.S. GAAP 2013 Annual Report 35 Management’s Discussion and Analysis waste water and storm water treatment systems, comply with establish the new depreciation rates to be used on a prospective environmental standards and include new construction and the basis. In the first quarter of 2013, the Company completed its updating of existing systems and/or processes. Other capital ex- depreciation study for Canadian track and roadway properties penditures relate to assessing and remediating certain impaired and as a result, the Company changed the estimated service properties. The Company’s environmental capital expenditures lives for various track and roadway assets and their related com- amounted to $10 million in 2013, $13 million in 2012 and posite depreciation rates. This depreciation study resulted in an $11 million in 2011. For 2014, the Company expects to incur annualized decrease to depreciation expense of approximately capital expenditures relating to environmental matters in the same $25 million. In the fourth quarter of 2013, a depreciation study range as 2013. Depreciation on U.S. track and roadway properties was completed resulting in an annualized increase to depreciation expense of approximately $30 million. Properties are carried at cost less accumulated depreciation in- In 2013, the Company recorded total depreciation expense of cluding asset impairment write-downs. The cost of properties, in- $979 million ($923 million in 2012 and $883 million in 2011). At cluding those under capital leases, net of asset impairment write- December 31, 2013, the Company had Properties of $26,227 mil- downs, is depreciated on a straight-line basis over their estimated lion, net of accumulated depreciation of $10,579 million ($24,541 mil- service lives, measured in years, except for rail which is measured lion in 2012, net of accumulated depreciation of $10,181 million). in millions of gross tons per mile. The Company follows the group Additional disclosures are provided in Note 4 – Properties to the method of depreciation whereby a single composite depreciation Company’s 2013 Annual Consolidated Financial Statements. rate is applied to the gross investment in a class of similar assets, U.S. generally accepted accounting principles require the use of despite small differences in the service life or salvage value of in- historical cost as the basis of reporting in financial statements. As dividual property units within the same asset class. The Company a result, the cumulative effect of inflation, which has significantly uses approximately 40 different depreciable asset classes. increased asset replacement costs for capital-intensive companies For all depreciable assets, the depreciation rate is based on the such as CN, is not reflected in operating expenses. Depreciation estimated service lives of the assets. Assessing the reasonableness charges on an inflation-adjusted basis, assuming that all operating of the estimated service lives of properties requires judgment and assets are replaced at current price levels, would be substantially is based on currently available information, including periodic greater than historically reported amounts. depreciation studies conducted by the Company. The Company’s U.S. properties are subject to comprehensive depreciation stud- Pensions and other postretirement benefits ies as required by the Surface Transportation Board (STB) and are The Company’s plans have a measurement date of December 31. conducted by external experts. Depreciation studies for Canadian The following table shows the Company’s pension asset, pension properties are not required by regulation and are conducted in- liability and other postretirement benefits liability at December 31, ternally. Studies are performed on specific asset groups on a per- 2013 and December 31, 2012: iodic basis. Changes in the estimated service lives of the assets and their related composite depreciation rates are implemented prospectively. In millions Pension asset The studies consider, among other factors, the analysis of Pension liability historical retirement data using recognized life analysis tech- Other postretirement benefits liability December 31, 2013 2012 $ 1,662 $ - $ 303 $ 524 $ 256 $ 277 niques, 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 service lives differing from the Company’s estimates. A change in the remaining service 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 service life of the Company’s fixed asset base would impact annual depreciation expense by approximately $26 million. Depreciation studies are a means of ensuring that the assump- tions used to estimate the service lives of particular asset groups are still valid and where they are not, they serve as the basis to The descriptions in the following paragraphs pertaining to pen- sions relate generally to the Company’s main pension plan, the CN Pension Plan, unless otherwise specified. Calculation of net periodic benefit cost (income) The Company accounts for net periodic benefit cost for pen- sions and other postretirement benefits as required by FASB ASC 715, Compensation – Retirement Benefits. Under the standard, assumptions are made regarding the valuation of benefit obliga- tions and performance of plan assets. In the calculation of net periodic benefit cost, the standard allows for a gradual recognition of changes in benefit obligations and fund performance over the expected average remaining service life of the employee group covered by the plans. 36 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis In accounting for pensions and other postretirement benefits, AA corporate curve for longer term maturities based on spreads assumptions are required for, among other things, the discount between observed AA corporate bonds and AA provincial bonds. rate, the expected long-term rate of return on plan assets, the rate The derived curve is expected to generate cash flows that match of compensation increase, health care cost trend rates, mortal- the estimated future benefit payments of the plans as the bond ity rates, employee early retirements, terminations and disability. rate for each maturity year is applied to the plans’ corresponding Changes in these assumptions result in actuarial gains or losses, expected benefit payments of that year. A discount rate of 4.73%, which are recognized in Other comprehensive income (loss). The based on bond yields prevailing at December 31, 2013 (4.15% at Company amortizes these gains or losses into net periodic bene- December 31, 2012) was considered appropriate by the Company fit cost over the expected average remaining service life of the to match the approximately 11-year average duration of estimated employee group covered by the plans only to the extent that the future benefit payments. The current estimate for the expected unrecognized net actuarial gains and losses are in excess of the average remaining service life of the employee group covered by corridor threshold, which is calculated as 10% of the greater of the plans is approximately 11 years. the beginning-of-year balances of the projected benefit obligation The Company amortizes net actuarial gains and losses over the or market-related value of plan assets. The Company’s net period- expected average remaining service life of the employee group ic benefit cost for future periods is dependent on demographic covered by the plans, only to the extent they are in excess of the experience, economic conditions and investment performance. corridor threshold. For the year ended December 31, 2013, the Recent demographic experience has revealed no material net Company amortized a net actuarial loss of $227 million related to gains or losses on termination, retirement, disability and mortality. the accumulated actuarial losses of its pension plans as part of net Experience with respect to economic conditions and investment periodic benefit cost. The Company also recognized $5 million of performance is further discussed herein. actuarial losses related to settlements in its various pension plans, For the years ended December 31, 2013, 2012 and 2011, the and recorded a net actuarial gain of $1,517 million on its pension consolidated net periodic benefit cost (income) for pensions and plans decreasing the net actuarial loss recognized in Accumulated other postretirement benefits were as follows: other comprehensive loss to $1,515 million ($3,264 million in In millions Year ended December 31, 2013 2012 2011 Net periodic benefit cost (income) for pensions $ 90 $ (9) $ (80) Net periodic benefit cost for other postretirement benefits $ 14 $ 14 $ 19 2012). The decrease in the net actuarial loss was primarily due to the positive liability experience resulting from the increase in the discount rate from 4.15% to 4.73%, as well as the difference in the actual and expected return on plan assets for the year ended December 31, 2013. For the year ended December 31, 2013, a 0.25% decrease in At December 31, 2013 and 2012, the projected pension the 4.73% discount rate used to determine the projected benefit benefit obligation and accumulated other postretirement benefit obligation would have resulted in a decrease of approximately obligation were as follows: In millions December 31, 2013 2012 $440 million to the funded status for pensions and would result in an increase of approximately $35 million to the 2014 net periodic benefit cost. A 0.25% increase in the discount rate would have re- Projected pension benefit obligation $ 15,510 $ 16,335 sulted in an increase of approximately $425 million to the funded Accumulated other postretirement benefit obligation $ 256 $ 277 status for pensions and would result in a decrease of approximate- ly $35 million to the 2014 net periodic benefit cost. Discount rate assumption The Company’s discount rate assumption, which is set annually Expected long-term rate of return assumption at the end of each year, is used to determine the projected bene- To develop its expected long-term rate of return assumption used fit obligation at the end of the year and the net periodic benefit in the calculation of net periodic benefit cost applicable to the cost for the following year. The discount rate is used to meas- market-related value of assets, the Company considers multiple ure the single amount that, if invested at the measurement date factors. The expected long-term rate of return is determined based in a portfolio of high-quality debt instruments with a rating of on expected future performance for each asset class and is weight- AA or better, would provide the necessary cash flows to pay for ed based on the current asset portfolio mix. Consideration is taken pension benefits as they become due. The discount rate is de- of the historical performance, the premium return generated from termined by management with the aid of third-party actuaries. an actively managed portfolio, as well as current and future an- For the Canadian pension and other postretirement benefit plans, ticipated asset allocations, economic developments, inflation rates future expected benefit payments at each measurement date are and administrative expenses. Based on these factors, the rate is discounted using spot rates from a derived AA corporate bond determined by the Company. For 2013, the Company used a long- yield curve. The derived curve is based on observed rates for term rate of return assumption of 7.00% on the market-related AA corporate bonds with short term maturities and a projected value of plan assets to compute net periodic benefit cost. For Canadian National Railway Company U.S. GAAP 2013 Annual Report 37 Management’s Discussion and Analysis 2014, the Company will maintain the expected long-term rate of rate of return is subject to risks and uncertainties that could cause return on plan assets at 7.00% to reflect management’s current the actual rate of return to differ materially from management’s view of long-term investment returns. The Company has elected assumption. There can be no assurance that the plan assets will be to use a market-related value of assets, whereby realized and un- able to earn the expected long-term rate of return on plan assets. realized gains/losses and appreciation/depreciation in the value of the investments are recognized over a period of five years, while Net periodic benefit cost for pensions for 2014 investment income is recognized immediately. If the Company In 2014, the Company expects a net periodic benefit cost of ap- had elected to use the market value of assets, which for the CN proximately $10 million for all its defined benefit pension plans. Pension Plan at December 31, 2013 was above the market-related The favorable variance compared to 2013 is mainly the result of a value of assets by $1,340 million, the projected net periodic bene- decrease in the amortization of actuarial losses due to an increase fit cost for 2014 would decrease by approximately $90 million. in the discount rate used from 4.15% to 4.73%, partly offset by The assets of the Company’s various plans are held in separate higher interest costs. trust funds which are diversified by asset type, country and in- vestment strategies. Each year, the CN Board of Directors reviews Plan asset allocation and confirms or amends the Statement of Investment Policies and Based on the fair value of the assets held as at December 31, 2013, Procedures (SIPP) which includes the plans’ long-term asset mix excluding the economic exposure of derivatives, the assets of the and related benchmark indices (Policy). This Policy is based on a Company’s various plans are comprised of 5% in cash and short-term long-term forward-looking view of the world economy, the dy- investments, 25% in bonds and mortgages, 41% in equities, 2% in namics of the plans’ benefit liabilities, the market return expecta- real estate assets, 8% in oil and gas, 5% in infrastructure, 10% in tions of each asset class and the current state of financial markets. absolute return investments, and 4% in risk-based allocation invest- The target long-term asset mix in 2013 was: 3% cash and short- ments. See Note 11 – Pensions and other postretirement benefits to term investments, 37% bonds and mortgages, 45% equities, 4% the Company’s 2013 Annual Consolidated Financial Statements for real estate, 7% oil and gas and 4% infrastructure assets. information on the fair value measurements of such assets. Annually, the CN Investment Division (Investment Manager), A significant portion of the plans’ assets are invested in publicly a division of the Company created to invest and administer traded equity securities whose return is primarily driven by stock the assets of the plans, proposes a short-term asset mix target market performance. Debt securities also account for a significant (Strategy) for the coming year, which is expected to differ from the portion of the plans’ investments and provide a partial offset to Policy, because of current economic and market conditions and ex- the variation in the pension benefit obligation that is driven by pectations. The Investment Committee of the Board (Committee) changes in the discount rate. The funded status of the plan fluc- regularly compares the actual asset mix to the Policy and Strategy tuates with market conditions and impacts funding requirements. and compares the actual performance of the Trusts to the per- The Company will continue to make contributions to the pension formance of the benchmark indices. plans that as a minimum meet pension legislative requirements. The Committee’s approval is required for all major investments in illiquid securities. The SIPP allows for the use of derivative fi- Rate of compensation increase and health care cost trend rate nancial instruments to implement strategies or to hedge or adjust The rate of compensation increase is determined by the Company existing or anticipated exposures. The SIPP prohibits investments based upon its long-term plans for such increases. For 2013, a in securities of the Company or its subsidiaries. During the last 10 rate of compensation increase of 3.00% was used to determine years ended December 31, 2013, the CN Pension Plan earned an the projected benefit obligation and the net periodic benefit cost. annual average rate of return of 7.56%. For postretirement benefits other than pensions, the Company The actual, market-related value, and expected rates of return reviews external data and its own historical trends for health care on plan assets for the last five years were as follows: costs to determine the health care cost trend rates. For measure- Rates of return 2013 2012 2011 2010 2009 ment purposes, the projected health care cost trend rate for pre- scription drugs was assumed to be 8% in 2013, and it is assumed Actual 11.2% Market-related value 7.3% 7.7% 2.3% 0.3% 3.0% 8.7% 10.8% that the rate will decrease gradually to 4.5% in 2028 and remain 4.8% 6.5% at that level thereafter. Expected 7.00% 7.25% 7.50% 7.75% 7.75% For the year ended December 31, 2013, a one-percent- The Company’s expected long-term rate of return on plan assets reflects management’s view of long-term investment re- turns 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 $85 million. Management’s assumption of the expected long-term age-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. 38 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis Funding of pension plans current pension regulations, to be paid over a number of years. For accounting purposes, the funded status is calculated under Actuarial valuations are also required annually for the Company’s generally accepted accounting principles for all pension plans. U.S. pension plans. For funding purposes, the funded status is also calculated under In 2013, in anticipation of its future funding requirements, the going-concern and solvency scenarios as prescribed under pen- Company made voluntary contributions of $100 million in excess sion legislation and subject to guidance issued by the Canadian of the required contributions to strengthen the financial position Institute of Actuaries (CIA) for all of the registered Canadian of its main pension plan, the CN Pension Plan. These contributions defined benefit pension plans. The Company’s funding require- can be treated as a prepayment against its future required special ments are determined upon completion of actuarial valuations. solvency payments. As at December 31, 2013, the Company had Actuarial valuations are generally required on an annual basis for $470 million of accumulated prepayments which remain available all Canadian plans, or when deemed appropriate by the OSFI. to offset future required solvency deficit payments. The Company The Company’s latest actuarial valuations for funding purposes expects to use approximately $335 million of these prepayments conducted as at December 31, 2012 indicated a funding excess to satisfy its 2014 required solvency deficit payment. As a result, on a going-concern basis of approximately $1.4 billion and a the Company’s cash contributions for 2014 are expected to be funding deficit on a solvency basis of approximately $2.1 billion. approximately $130 million, for all the Company’s pension plans. The Company’s next actuarial valuations required as at December The Company expects cash from operations and its other sources 31, 2013 will be performed in 2014. These actuarial valuations of financing to be sufficient to meet its 2014 funding obligations. are expected to identify a going-concern surplus of approximately Adverse changes to the assumptions used to calculate the $1.7 billion, while on a solvency basis a funding deficit of ap- Company’s funding status, particularly the discount rate, as well as proximately $1.7 billion is expected due to the level of interest changes to existing federal pension legislation could significantly rates applicable at their respective measurement dates. The federal impact the Company’s future contributions. pension legislation requires funding deficits, as calculated under Information disclosed by major pension plan The following table provides the Company’s plan assets by category, projected benefit obligation at end of year, as well as Company and employee contributions by major defined benefit pension plan: In millions Plan assets by category Cash and short-term investments Bonds Mortgages Equities Real estate Oil and gas Infrastructure Absolute return Risk-based allocation Other (1) Total plan assets Projected benefit obligation at end of year Company contributions in 2013 Employee contributions in 2013 December 31, 2013 CN Pension Plan BC Rail Ltd Pension Plan U.S. and other plans Total $ 852 $ 31 $ 3,834 160 6,566 288 1,329 758 1,638 586 48 $ 16,059 $ 14,458 $ $ 197 56 $ $ $ $ 163 5 212 10 46 27 53 19 2 568 513 1 - $ $ $ $ 14 88 1 110 1 5 3 7 2 11 242 539 28 - $ 897 4,085 166 6,888 299 1,380 788 1,698 607 61 $ 16,869 $ 15,510 $ $ 226 56 (1) Other consists of operating assets of $85 million ($94 million in 2012) and liabilities of $24 million ($93 million in 2012) required to administer the trust funds’ investment assets and the plans’ benefit and funding activities. Additional disclosures are provided in Note 11 – Pensions and other postretirement benefits to the Company’s 2013 Annual Consolidated Financial Statements. Canadian National Railway Company U.S. GAAP 2013 Annual Report 39 Management’s Discussion and Analysis Income taxes Company’s federal and provincial income tax returns filed for the The Company follows the asset and liability method of accounting years 2007 to 2012 remain subject to examination by the taxation for income taxes. Under the asset and liability method, the change authorities. An examination of the Company’s federal income tax in the net deferred income tax asset or liability is included in the returns for the 2009 year is currently in progress and is expected to computation of Net income or Other comprehensive income (loss). be completed during 2014. Examinations on specific tax positions Deferred income tax assets and liabilities are measured using en- taken for federal and provincial income tax returns for the years acted income tax rates expected to apply to taxable income in the 2007 and 2008 are currently in progress and are also expected to be years in which temporary differences are expected to be recovered completed during 2014. In the U.S., the federal income tax returns or settled. As a result, a projection of taxable income is required filed for the year 2007 as well as for the years 2009 to 2012 remain for those years, as well as an assumption of the ultimate recovery/ subject to examination by the taxation authorities, and the state settlement period for temporary differences. The projection of income tax returns filed for the years 2009 to 2012 remain subject future taxable income is based on management’s best estimate to examination by the taxation authorities. An examination of the and may vary from actual taxable income. On an annual basis, federal income tax returns for the year 2007 as well as for the years the Company assesses the need to establish a valuation allowance 2009 to 2011 is currently in progress. Examinations of certain state for its deferred income tax assets, and if it is deemed more likely income tax returns by the state taxation authorities are currently in than not that its deferred income tax assets will not be realized, progress. The Company does not anticipate any significant impacts a valuation allowance is recorded. The ultimate realization of to its results of operations or financial position as a result of the final deferred income tax assets is dependent upon the generation of resolutions of such matters. future taxable income during the periods in which those tempor- The Company’s deferred income tax assets are mainly com- ary differences become deductible. Management considers the posed of temporary differences related to the pension liability, scheduled reversals of deferred income tax liabilities including accruals for personal injury claims and other reserves, other po- the available carryback and carryforward periods, projected fu- stretirement benefits liability, and net operating losses and tax ture taxable income, and tax planning strategies in making this credit carryforwards. The majority of these accruals will be paid assessment. As at December 31, 2013, in order to fully realize out over the next five years. The Company’s deferred income tax all of the deferred income tax assets, the Company will need to liabilities are mainly composed of temporary differences related generate future taxable income of approximately $1.6 billion and, to properties. The reversal of temporary differences is expected at based upon the level of historical taxable income and projections future-enacted income tax rates which could change due to fiscal of future taxable income over the periods in which the deferred budget changes and/or changes in income tax laws. As a result, income tax assets are deductible, management believes it is more a change in the timing and/or the income tax rate at which the likely than not that the Company will realize the benefits of these components will reverse, could materially affect deferred income deductible differences. Management has assessed the impacts of tax expense as recorded in the Company’s results of operations. A the current economic environment and concluded there are no one-percentage-point change in the Company’s reported effective significant impacts to its assertions for the realization of deferred income tax rate would have the effect of changing the income tax income tax assets. expense by $36 million in 2013. In addition, Canadian, or domestic, tax rules and regulations, From time to time, the federal, provincial, and state govern- as well as those relating to foreign jurisdictions, are subject to in- ments enact new corporate income tax rates resulting in either terpretation and require judgment by the Company that may be lower or higher tax liabilities. Such enactments occurred in each of challenged by the taxation authorities upon audit of the filed in- 2013 and 2012 and resulted in an income tax expense of $24 mil- come tax returns. Tax benefits are recognized if it is more likely than lion and $35 million, respectively, with corresponding adjustments not that the tax position will be sustained on examination by the to the Company’s net deferred income tax liability. taxation authorities. As at December 31, 2013, the total amount of For the year ended December 31, 2013, the Company record- gross unrecognized tax benefits was $30 million before considering ed total income tax expense of $977 million, of which $331 mil- tax treaties and other arrangements between taxation authorities. lion was a deferred income tax expense and included a net income The amount of net unrecognized tax benefits as at December 31, tax recovery of $7 million which consisted of a $15 million income 2013 was $25 million. If recognized, all of the net unrecognized tax recovery from the recognition of U.S. state income tax losses tax benefits as at December 31, 2013 would affect the effective and a $16 million income tax recovery from a revision of the ap- tax rate. The Company believes that it is reasonably possible that portionment of U.S. state income taxes which were partly offset approximately $8 million of the net unrecognized tax benefits as at by a combined $24 million income tax expense resulting from December 31, 2013 related to various federal, state, and provincial the enactment of higher provincial corporate income tax rates. income tax matters, each of which are individually insignificant, may For the year ended December 31, 2012, the Company recorded be recognized over the next twelve months as a result of settlements total income tax expense of $978 million, of which $451 million of and a lapse of the applicable statute of limitations. In Canada, the the reported income tax expense was for deferred income taxes, 40 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis and included a net income tax expense of $28 million, which for our customers can result in an imbalance of transportation consisted of a $35 million income tax expense resulting from the capacity relative to demand. An extended period of supply/de- enactment of higher provincial corporate income tax rates that mand imbalance could negatively impact market rate levels for all was partly offset by a $7 million income tax recovery resulting from transportation services, and more specifically the Company’s ability the recapitalization of a foreign investment. For the year ended to maintain or increase rates. This, in turn, could materially and December 31, 2011, the Company recorded total income tax adversely affect the Company’s business, results of operations or expense of $899 million, of which $531 million of the reported financial position. income tax expense was for deferred income taxes, and included a The level of consolidation of rail systems in the U.S. has re- $40 million net income tax expense resulting from the enactment sulted in larger rail systems that are able to offer seamless services of state corporate income tax rate changes and other legislated in larger market areas and, accordingly, compete effectively with state tax revisions that was partly offset by an income tax recovery the Company in numerous markets. This requires the Company of $11 million relating to certain fuel costs attributed to various to consider arrangements or other initiatives that would similarly wholly-owned subsidiaries’ fuel consumption in prior periods. enhance its own service. The Company’s net deferred income tax liability at December 31, On June 27, 2013, the Department of Justice in Canada noti- 2013 was $6,463 million ($5,512 million at December 31, 2012). fied the Company that the Commissioner of Competition had Additional disclosures are provided in Note 13 – Income taxes to opened an inquiry into allegations that the Company engaged in the Company’s 2013 Annual Consolidated Financial Statements. tied selling and/or abuse of a dominant position in respect of the Business risks rail transportation and transloading of lumber products in western Canada. The Commissioner sought the Company’s consent to In the normal course of business, the Company is exposed to vari- the issuance of an order under the Competition Act of Canada to ous business risks and uncertainties that can have an effect on obtain records and information in furtherance of its inquiry. The the Company’s results of operations, financial position, or liquidity. Company did not object to the issuance of the order and is fully While some exposures may be reduced by the Company’s risk cooperating with the Competition Bureau’s inquiry. management strategies, many risks are driven by external factors There can be no assurance that the Company will be able to beyond the Company’s control or are of a nature which cannot be compete effectively against current and future competitors in the eliminated. The following is a discussion of key areas of business transportation industry, and that further consolidation within the risks and uncertainties. Competition transportation industry and legislation allowing for more leniency in size and weight for motor carriers will not adversely affect the Company’s competitive position. No assurance can be given that The Company faces significant competition, including from rail competitive pressures will not lead to reduced revenues, profit carriers and other modes of transportation, and is also affected margins or both. by its customers’ flexibility to select among various origins and destinations, including ports, in getting their products to market. Environmental matters Specifically, the Company faces competition from Canadian Pacific The Company’s operations are subject to numerous federal, Railway Company (CP), which operates the other major rail system provincial, state, municipal and local environmental laws and in Canada and services most of the same industrial areas, com- regulations in Canada and the U.S. concerning, among other modity resources and population centers as the Company; major things, emissions into the air; discharges into waters; the gener- U.S. railroads and other Canadian and U.S. railroads; long-distance ation, handling, storage, transportation, treatment and disposal trucking companies, transportation via the St. Lawrence-Great of waste, hazardous substances and other materials; decommis- Lakes Seaway and the Mississippi River and transportation via sioning of underground and aboveground storage tanks; and soil pipelines. In addition, while railroads must build or acquire and and groundwater contamination. A risk of environmental liability maintain their rail systems, motor carriers and barges are able to is inherent in railroad and related transportation operations; real use public rights-of-way that are built and maintained by public estate ownership, operation or control; and other commercial entities without paying fees covering the entire costs of their activities of the Company with respect to both current and past usage. operations. As a result, the Company incurs significant operating Competition is generally based on the quality and the reliabil- and capital costs, on an ongoing basis, associated with environ- ity of the service provided, access to markets, as well as price. mental regulatory compliance and clean-up requirements in its Factors affecting the competitive position of customers, including railroad operations and relating to its past and present ownership, exchange rates and energy cost, could materially adversely affect operation or control of real property. the demand for goods supplied by the sources served by the While the Company believes that it has identified the costs Company and, therefore, the Company’s volumes, revenues and likely to be incurred for environmental matters in the next several profit margins. Factors affecting the general market conditions years based on known information, the discovery of new facts, Canadian National Railway Company U.S. GAAP 2013 Annual Report 41 Management’s Discussion and Analysis future changes in laws, the possibility of releases of hazardous ma- certain amounts. The final outcome with respect to actions out- terials into the environment and the Company’s ongoing efforts to standing or pending at December 31, 2013, or with respect to identify potential environmental liabilities that may be associated future claims, cannot be predicted with certainty, and therefore with its properties may result in the identification of additional there can be no assurance that their resolution will not have a environmental liabilities and related costs. material adverse effect on the Company’s results of operations, In railroad and related transportation operations, it is possible financial position or liquidity, in a particular quarter or fiscal year. that derailments or other accidents, including spills and releases of hazardous materials, may occur that could cause harm to human Labor negotiations health or to the environment. In addition, the Company is also Canadian workforce exposed to potential catastrophic liability risk, faced by the rail- As at December 31, 2013, CN employed a total of 16,507 em- road industry generally, in connection with the transportation of ployees in Canada, of which 12,337 were unionized employees. toxic inhalation hazard materials such as chlorine and anhydrous From time to time, the Company negotiates to renew collective ammonia, or other dangerous commodities like crude oil and pro- agreements with various unionized groups of employees. pane that the Company may be required to transport to the extent On January 31, 2013, the tentative agreement reached of its common carrier obligations. As a result, the Company may on December 21, 2012 between CN and the International incur costs in the future, which may be material, to address any Brotherhood of Electrical Workers (IBEW), covering approximately such harm, compliance with laws or other risks, including costs re- 700 signals and communications employees was ratified. The new lating to the performance of clean-ups, payment of environmental collective agreement will expire on December 31, 2016. penalties and remediation obligations, and damages relating to On October 30, 2013, a tentative agreement was reached harm to individuals or property. between CN and the Teamsters Canada Rail Conference (TCRC) The environmental liability for any given contaminated site to renew the collective agreements covering approximately 3,000 varies depending on the nature and extent of the contamination; mainline conductors and yard crews, which expired on July 22, the available clean-up techniques; evolving regulatory standards 2013. On January 31, 2014, CN announced that the TCRC advised governing environmental liability; and the number of potentially the Company that the membership did not ratify the tentative responsible parties and their financial viability. As such, the ul- agreement. CN and the TCRC will resume discussions during the timate cost of addressing known contaminated sites cannot be week of February 3, 2014. definitively established. Also, additional contaminated sites yet unknown may be discovered or future operations may result in Disputes relating to the renewal of collective agreements could accidental releases. potentially result in strikes, work stoppages, slowdowns and loss While some exposures may be reduced by the Company’s risk of business. Future labor agreements or renegotiated agreements mitigation strategies (including periodic audits, employee training could increase labor and fringe benefits expenses. There can be programs and emergency plans and procedures), many environ- no assurance that the Company will be able to renew and have mental risks are driven by external factors beyond the Company’s its collective agreements ratified without any strikes or lockouts control or are of a nature which cannot be completely eliminat- or that the resolution of these collective bargaining negotiations ed. Therefore, there can be no assurance, notwithstanding the will not have a material adverse effect on the Company’s results of Company’s mitigation strategies, that liabilities or costs related to operations or financial position. environmental matters will not be incurred in the future or that environmental matters will not have a material adverse effect on U.S. workforce the Company’s results of operations, financial position or liquidity, As at December 31, 2013, CN employed a total of 7,214 employ- and reputation in a particular quarter or fiscal year. ees in the U.S., of which 5,725 were unionized employees. Personal injury and other claims As of February 3, 2014, the Company had in place agreements with bargaining units representing the entire unionized workforce at In the normal course of business, the Company becomes involved Grand Trunk Western Railroad Company (GTW), companies owned in various legal actions seeking compensatory and occasionally by Illinois Central Railroad Company (ICRR), companies owned by punitive damages, including actions brought on behalf of various Wisconsin Central Ltd. (WC), Bessemer & Lake Erie Railroad Company purported classes of claimants and claims relating to employee and (BLE) and The Pittsburgh and Conneaut Dock Company (PCD). third-party personal injuries, occupational disease, and property Agreements in place have various moratorium provisions, ranging damage, arising out of harm to individuals or property allegedly from 2010 to 2018, which preserve the status quo in respect of the caused by, but not limited to, derailments or other accidents. The given collective agreement during the terms of such moratoriums. Company maintains provisions for such items, which it considers Some of these agreements are currently under renegotiation. to be adequate for all of its outstanding or pending claims and benefits from insurance coverage for occurrences in excess of The general approach to labor negotiations by U.S. Class I rail- roads is to bargain on a collective national basis. GTW, ICRR, WC, 42 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis BLE and PCD have bargained on a local basis rather than holding No assurance can be given that any current or future legislative national, industry-wide negotiations because they believe it results action by the federal government or other future government in- in agreements that better address both the employees’ concerns itiatives will not materially adversely affect the Company’s results and preferences, and the railways’ actual operating environment. of operations or financial position. However, local negotiations may not generate federal intervention in a strike or lockout situation, since a dispute may be localized. Economic regulation – U.S. The Company believes the potential mutual benefits of local bar- The STB serves as both an adjudicatory and regulatory body and gaining outweigh the risks. has jurisdiction over railroad rate and service issues and rail restruc- Where negotiations are ongoing, the terms and conditions of turing transactions such as mergers, line sales, line construction existing agreements generally continue to apply until new agree- and line abandonments. As such, various Company business trans- ments are reached or the processes of the Railway Labor Act have actions must gain prior regulatory approval, with attendant risks been exhausted. and uncertainties. The STB has undertaken proceedings in the past few years in There can be no assurance that there will not be any work action a number of areas. On February 24, 2011, the STB held a hearing by any of the bargaining units with which the Company is cur- to review the commodities and forms of service currently exempt rently in negotiations or that the resolution of these negotiations from STB regulation and is considering the comments on these will not have a material adverse effect on the Company’s results of matters and may take further action. On May 7, 2012, the STB operations or financial position. Regulation proposed new regulations concerning the liability of third parties for rail car demurrage providing that any person receiving rail cars from a carrier for loading or unloading who detains the cars be- The Company’s rail operations in Canada are subject to (i) economic yond a specified period of time may be held liable for demurrage regulation by the Canadian Transportation Agency under the Canada if that person has actual notice of the carrier’s demurrage tariff Transportation Act (CTA), and (ii) safety regulation by the Federal providing for such liability prior to the carrier’s placement of the Minister of Transport under the Railway Safety Act and certain other cars. On July 25, 2012, following hearings in June 2011 on the statutes. The Company’s U.S. rail operations are subject to (i) econom- state of competition in the railroad industry, the STB commenced ic regulation by the Surface Transportation Board (STB) and (ii) safety a proceeding to consider a proposal by the National Industrial regulation by the Federal Railroad Administration (FRA). Transportation League for competitive switching. In a first phase, Economic regulation – Canada parties submitted at STB’s request on March 1, 2013, a wide variety of data to assess the scope and potential impact of the proposal The CTA provides rate and service remedies, including final and submitted reply comments on May 30, 2013. It is anticipated offer arbitration (FOA), competitive line rates and compulsory that the STB will be holding a hearing in early 2014 to further interswitching. The CTA also regulates the maximum revenue en- review these matters. On July 18, 2013, the STB issued a decision titlement for the movement of grain, charges for railway ancillary raising relief caps and making certain other technical changes services and noise-related disputes. In addition, various Company for rate complaints brought under its simplified rate guidelines. business transactions must gain prior regulatory approval, with On December 12, 2013, the STB instituted a proceeding to invite attendant risks and uncertainties. comments on how to ensure its rate complaint procedures are ac- On June 26, 2013, the Government enacted Bill C-52 which cessible to grain shippers and provide effective protection against gives shippers a right to an agreement respecting the level of ser- unreasonable grain rates. On December 20, 2013, the STB insti- vice to be provided by a railway company. Bill C-52 also sets out a tuted a rulemaking proceeding in response to a petition to abolish process by which the level of service to be provided by the railway the use of a multi-stage discounted cash flow model used in part company can be established through an arbitration process in the for determining the rail industry’s cost of capital and instead rely event that the parties cannot reach agreement through their own exclusively on the Capital Asset Pricing model. commercial negotiations. However, the arbitration process will not As part of the Passenger Rail Investment and Improvement Act be available to a shipper in respect of a matter that is governed by of 2008 (PRIIA), the U.S. Congress has authorized the STB to in- a written agreement between the shipper and the railway com- vestigate any railroad over whose track Amtrak operates that fails pany or in respect of traffic that is subject to a decision issued to meet an 80 percent on-time performance standard for Amtrak under the final arbitration process. operations extending over two calendar quarters and to determine On November 19, 2013, the Canadian Transportation Agency the cause of such failures. Compliance with this mandate began initiated a consultation on the current approach to determining the with the third quarter of 2010 and is governed by performance adequacy of railway third party liability coverage and solicited input metrics and standards jointly issued by the FRA and Amtrak on on possible improvements to the current regulatory framework. May 12, 2010. Should the STB commence an investigation and determine that a failure to meet these standards is due to the host Canadian National Railway Company U.S. GAAP 2013 Annual Report 43 Management’s Discussion and Analysis railroad’s failure to provide preference to Amtrak, the STB is au- the acquisition to be approximately $72 million (US$68 million). thorized to assess damages against the host railroad. On January The commitment for the grade separation projects is based on 19, 2012, Amtrak filed a petition with the STB to commence such estimated costs provided by the STB at the time of acquisition and an investigation, including a request for damages for preference could be subject to adjustment. failures, for allegedly sub-standard performance of Amtrak trains The STB also imposed a five-year monitoring and oversight on CN’s ICRR and GTW lines. CN responded on March 9, 2012 condition, subsequently extended to six years, during which the to Amtrak’s petition. CN and Amtrak entered into STB-supervised Company is required to file with the STB monthly operational re- mediation from April 10, 2012 until October 4, 2012 and the pro- ports as well as quarterly reports on the implementation status ceedings resumed afterwards. On joint motion of the parties, the of the STB-imposed mitigation conditions. This permits the STB STB stayed the proceedings until July 31, 2013. The Company par- to take further action if there is a material change in the facts ticipated in a railroad industry challenge to the constitutionality of and circumstances upon which it relied in imposing the specific the joint FRA/Amtrak performance metrics and standards. On July mitigation conditions. On November 8, 2012, the STB denied the 2, 2013, the U.S. Court of Appeals for the D.C. Circuit reversed a request of the Village of Barrington, IL that the STB impose addi- U.S. District Court decision and determined that Congress’ delega- tional mitigation that would require CN to fund the full cost of a tion to Amtrak of joint legislative authority with the FRA to prom- grade separation at a location along the EJ&E line in Barrington. ulgate the metrics and standards to be unconstitutional. In light of On December 26, 2012, the Village appealed the STB’s decision the Court’s decision, and on joint motion of the parties, the STB to the U.S. Court of Appeals for the D.C. Circuit. Oral arguments has stayed the proceedings until July 31, 2014, to provide time were heard on November 15, 2013 and a decision is expected in that may be necessary for a final resolution on the constitutionality early 2014. of the metrics and standards pending further appeals. On October A first oversight audit of the Company’s EJ&E’s operational and 11, 2013, the D.C. Circuit denied the Government’s petition for environmental reporting was completed in April 2010, and after hearing en banc. The Government has until February 7, 2014 to public comment was finalized by the STB in December 2010. In seek U.S. Supreme Court review. December 2011, the STB directed a second oversight audit that On July 30, 2013, Amtrak filed an application with the STB commenced on February 17, 2012, that audit was completed on requesting the agency to set terms and compensation for a new April 30, 2012, and released publicly by the STB on June 18, 2012. CN/Amtrak Operating Agreement to replace the one that was The resolution of matters that could arise during the STB’s expiring on August 11, 2013. On August 1, 2013, CN agreed to remaining oversight of the transaction cannot be predicted with continue to make its facilities available to Amtrak during the STB’s certainty, and therefore, there can be no assurance that their reso- consideration under the terms of the expired agreement. lution will not have a material adverse effect on the Company’s The U.S. Congress has had under consideration for several financial position or results of operations. years various pieces of legislation that would increase federal eco- The Company’s ownership of the former Great Lakes nomic regulation of the railroad industry. In the current session of Transportation vessels is subject to regulation by the U.S. Coast Congress, legislation to repeal the rail industry’s limited antitrust Guard (USCG) and the Department of Transportation, Maritime exemptions (Bill S. 638) has been introduced in the Senate, and Administration, which regulate the ownership and operation of there is no assurance that this or other legislation to increase fed- vessels operating on the Great Lakes and in U.S. coastal waters. In eral economic regulation of the railroad industry will not progress addition, the Environmental Protection Agency (EPA) has authority through the legislative process. to regulate air emissions from these vessels. Regulatory initiatives The acquisition of the Elgin, Joliet and Eastern Railway Company of these U.S. government agencies may materially adversely affect (EJ&E) in 2009 followed an extensive regulatory approval process the Company’s financial position or results of operations. by the STB, which included an Environmental Impact Statement On November 8, 2011, the Federal Maritime Commission (EIS) that resulted in conditions imposed to mitigate municipalities’ (FMC), which has authority over oceanborne transport of cargo concerns regarding increased rail activity expected along the EJ&E into and out of the U.S., initiated a Notice of Inquiry to exam- line (see the section of this MD&A entitled Contractual obliga- ine whether the U.S. Harbor Maintenance Tax (HMT) and other tions). The Company accepted the STB-imposed conditions with factors may be contributing to the diversion of U.S.-bound cargo one exception. The Company filed an appeal at the U.S. Court of to Canadian and Mexican seaports, which could affect CN rail Appeals for the District of Columbia Circuit challenging the STB’s operations. The Company filed comments in this proceeding on condition requiring the installation of grade separations at two January 9, 2012. In July 2012, the FMC issued its study, which locations along the EJ&E line at Company funding levels signifi- found that carriers shipping cargo through Canadian or Mexican cantly beyond prior STB practice. Appeals were also filed by certain ports violate no U.S. law, treaty, agreement, or FMC regulation. communities challenging the sufficiency of the EIS. On March 15, The report stated, however, that the HMT is one of many fac- 2011, the Court denied the CN and community appeals. As such, tors affecting the increased use of foreign ports for cargo bound the Company estimates its total remaining commitment related to for U.S. destinations and that amendment of the current HMT 44 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis structure should be considered so as to assist U.S. seaports. On tank cars; (2) route planning and analysis; and (3) emergency re- September 17, 2013, the Maritime Goods Movement Act (Bill S. sponse assistance plans. 1509) was introduced and assigned to a congressional commit- In 2014, Transport Canada is expected to finalize new regu- tee for consideration. The bill proposes to replace the HMT with lations for highway-railway crossings. These will specify specific a Maritime Goods Movement Fee which would be imposed on standards for new crossings and require that existing crossings be any U.S.-destined cargo regardless of its point of entry into North upgraded to basic safety standards within seven years. America. Among the bill’s goals is to discourage diversion of U.S.- bound goods through Canadian or Mexican ports. Safety regulation – U.S. Rail safety regulation in the U.S. is the responsibility of the FRA, No assurance can be given that any future regulatory or legislative which administers the Federal Railroad Safety Act, as well as the initiatives by the U.S. federal government related to this inquiry and rail portions of other safety statutes. In 2008, the U.S. federal proposed legislation will not materially adversely affect the Company’s government enacted legislation reauthorizing the Federal Railroad results of operations or its competitive and financial position. Safety Act. This legislation covers a broad range of safety issues, Safety regulation – Canada Rail safety regulation in Canada is the responsibility of Transport Canada, which administers the Canadian Railway Safety Act, as including fatigue management, Positive Train Control (PTC), grade crossings, bridge safety, and other matters. The legislation re- quires all Class I railroads and intercity passenger and commuter railroads to implement a PTC system by December 31, 2015 on well as the rail portions of other safety-related statutes. On May 1, mainline track where intercity passenger railroads and commuter 2013, Bill S-4 came into force which prohibits anyone from oper- railroads operate and where toxic inhalation hazard materials are ating a railway without having first obtained a Railway Operating transported. PTC is a collision avoidance technology intended to Certificate issued by the Minister. The Bill also includes the ability override locomotive controls and stop a train before an accident. for the government to establish Administrative Monetary Penalties The Company is taking steps to ensure implementation of PTC in the event of contravention of prescribed provisions of the Act or regulations. On July 23, 2013, following a significant derailment involving in accordance with the new law, including working with other Class I railroads to satisfy the requirements for U.S. network inter- operability. The Company’s PTC Implementation Plan, submitted in a non-related short-line railroad within the Province of Quebec April 2010, has been approved by the FRA. CN’s total implementa- (“Lac-Mégantic derailment”), the Federal Minister of Transport tion costs associated with PTC are estimated to be US$335 million. issued an Emergency Directive under the Canada Railway Safety The legislation also caps the number of on-duty and limbo time Act to enhance the effectiveness of train securement procedures hours for certain rail employees on a monthly basis. The Company and safety across the Canadian rail industry and to help reduce the is taking appropriate steps and is working with the FRA to ensure risk of unintended train movements that can lead to catastroph- that its operations conform to the law’s requirements. ic accidents. CN has reviewed its safety policies for unattended In August 2012, the FRA reported an update of the PTC imple- trains and adjusted its safety practices to comply with Transport mentation progress to Congress concluding that the majority of Canada’s order. Transport Canada also issued an order requiring the carriers would be unable to meet the December 31, 2015 im- all federal railways to formulate or revise rules, as the case may plementation deadline. In August 2013, legislation was introduced be, respecting the securement of unattended locomotives and in the Senate that would delay PTC implementation by five years crew size requirements. On November 20, 2013, the Railway to the end of 2020, and in the same month, the U.S. Government Association of Canada filed revised rules on behalf of CN and its Accountability Office published a report recommending that other member railway companies in compliance with this order. Congress give the FRA authority to extend the deadline for indi- On December 26, 2013, the Minister issued a notice approving vidual carriers on a case-by-case basis. the revised rules. The suspension by the Federal Communication Commission On November 20, 2013, the Federal Minister of Transport (FCC) in May 2013 of its normal processes to review possible im- issued Protective Direction No. 32 under the Transportation of pacts to tribal historic and cultural artifacts of the installation of Dangerous Goods Act, requiring railway companies to provide tens of thousands of poles industry-wide that are required to host designated municipal emergency planning officials with yearly PTC radio operations, and the uncertainty of yet-to-be determined aggregate information on the nature and volume of dangerous changes to those procedures needed to accommodate that vol- goods the company transports by rail through the municipality. ume, may further threaten the PTC implementation deadline. On January 23, 2014, the Transportation Safety Board of In the aftermath of the July 2013 Lac-Mégantic derailment, the Canada (TSB) issued a series of recommendations to Transport FRA issued Emergency Order No. 28, Notice No. 1 on August 2, Canada to improve the safe transportation of crude oil by rail. The 2013 directing that railroads take specific actions regarding TSB recommendations call for: (1) tougher standards for Class 111 unattended trains transporting specified hazardous materials, including securement of these trains. That same day, FRA and the Canadian National Railway Company U.S. GAAP 2013 Annual Report 45 Management’s Discussion and Analysis Pipeline and Hazardous Materials Safety Administration (PHMSA) No assurance can be given that these or any future regulatory issued Safety Advisory 2013-06, which made recommendations to initiatives by the Canadian and U.S. federal governments will not railroads on issues including crew staffing practices and operational materially adversely affect the Company’s results of operations, or testing to ensure employees’ compliance with securement-related its competitive and financial position. rules, as well as recommendations to shippers of crude oil to be transported by rail. In addition, the railroad industry has acted on Security its own to enhance rail safety in light of the Lac-Mégantic de- The Company is subject to statutory and regulatory directives in railment and fire. Effective August 5, 2013, the Association of the U.S. addressing homeland security concerns. In the U.S., safe- American Railroads (AAR) amended the industry’s Recommended ty matters related to security are overseen by the Transportation Railroad Operating Practices for Transportation of Hazardous Security Administration (TSA), which is part of the U.S. Department Materials (Circular No. OT-55-N) by expanding the definition of of Homeland Security (DHS) and the PHMSA, which, like the FRA, a “key train” (for which heightened operating safeguards are is part of the U.S. Department of Transportation. Border security required) to include trains carrying one tank car load of poison falls under the jurisdiction of U.S. Customs and Border protection or toxic inhalation hazard, anhydrous ammonia, or ammonia (CBP), which is part of the DHS. In Canada, the Company is subject solutions and to include trains carrying 20 car loads or portable to regulation by the Canada Border Services Agency (CBSA). More tank loads of any combination of hazardous materials (including specifically, the Company is subject to: ethanol and crude oil). (i) Border security arrangements, pursuant to an agreement the On August 12, 2013, the FRA established the Railroad Safety Company and CP entered into with the CBP and the CBSA. Advisory Committee (RSAC) to provide advice and recommenda- (ii) The CBP’s Customs-Trade Partnership Against Terrorism tions to the FRA on railroad safety matters. The FRA’s Emergency (C-TPAT) program and designation as a low-risk carrier under Order No. 28 resulted in four new tasks accepted by the RSAC. The CBSA’s Customs Self-Assessment (CSA) program. four tasks are: train crew size; operational testing for securement; (iii) Regulations imposed by the CBP requiring advance notifica- securement; and hazardous material issues. The FRA has asked tion by all modes of transportation for all shipments into the RSAC’s four task groups to conclude meetings by April 2014 and U.S. The CBSA is also working on similar requirements for submit their recommendations to the FRA for drafting Emergency Canada-bound traffic. Order No. 28 into new regulation. CN is an active participant in all (iv) Inspection for imported fruits and vegetables grown in Canada four task groups. and the agricultural quarantine and inspection (AQI) user fee On September 6, 2013, PHMSA published an Advance Notice for all traffic entering the U.S. from Canada. of Proposed Rulemaking considering improvement of the regula- tions related to the transportation by rail of hazardous materials in The Company has worked with the AAR to develop and put in tank cars. On November 14, 2013, CN was a participant in AAR’s place an extensive industry-wide security plan to address terror- comments filed with PHMSA in this proceeding, which urged ism and security-driven efforts by state and local governments PHMSA to require that all tank cars used to transport flammable seeking to restrict the routings of certain hazardous materials. liquids be retrofitted or phased out, and that new cars be built to If such state and local routing restrictions were to go into force, more stringent standards. The AAR comments included specific they would be likely to add to security concerns by foreclosing the tank cars safety standard improvements, which AAR maintained Company’s most optimal and secure transportation routes, leading will substantially decrease the likelihood of a release if a tank car is to increased yard handling, longer hauls, and the transfer of traffic involved in an accident. to lines less suitable for moving hazardous materials, while also On January 23, 2014 the National Transportation Safety Board infringing upon the exclusive and uniform federal oversight over (NTSB) issued a series of recommendations to the U.S. Department railroad security matters. of Transportation, to address the safety risk of transporting crude oil by rail. The NTSB’s recommendations complement those issued Transportation of hazardous materials by the TSB and specifically: (1) require expanded hazardous ma- The Company may be required to transport toxic inhalation hazard terials route planning for railroads to avoid populated and other materials to the extent of its common carrier obligations and, as sensitive areas; (2) development of an FRA/PHMSA audit pro- such, is exposed to additional regulatory oversight. gram to ensure that railroads carrying petroleum products have (i) The PHMSA requires carriers operating in the U.S. to report adequate emergency response capabilities to address worst-case annually the volume and route-specific data for cars con- discharges of the product; and (3) require audits of shippers and taining these commodities; conduct a safety and security risk railroads to ensure that they are properly classifying hazardous analysis for each used route; identify a commercially practic- materials being transported and that they have adequate safety able alternative route for each used route; and select for use and security plans in place. the practical route posing the least safety and security risk. 46 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis (ii) The TSA requires rail carriers to provide upon request, within and consumers of the commodities carried by the Company, includ- five minutes for a single car and 30 minutes for multiple cars, ing customer insolvency, may have a material adverse effect on the location and shipping information on cars on their networks volume of rail shipments and/or revenues from commodities carried containing toxic inhalation hazard materials and certain radio- by the Company, and thus materially and negatively affect its results active or explosive materials; and ensure the secure, attended of operations, financial position, or liquidity. transfer of all such cars to and from shippers, receivers and other carriers that will move from, to, or through designated Pensions high-threat urban areas. Overall returns in the capital markets and the level of interest rates (iii) The PHMSA has issued regulations to enhance the crash- affect the funded status of the Company’s defined benefit pension worthiness protection of tank cars used to transport toxic in- plans. halation hazard materials and to limit the operating conditions For accounting purposes, the funded status of all pension plans of such cars. is calculated at the measurement date, which for the Company (iv) In Canada, the Transportation of Dangerous Goods Act es- is December 31, using generally accepted accounting principles. tablishes the safety requirements for the transportation of Adverse changes with respect to pension plan returns and the level goods classified as dangerous and enables the establishment of interest rates from the last measurement date may have a ma- of regulations for security training and screening of personnel terial adverse effect on the funded status and significantly impact working with dangerous goods, as well as the development future pension expense. of a program to require a transportation security clearance For funding purposes, the funded status of the Canadian pen- for dangerous goods and that dangerous goods be tracked sion plans is calculated to determine the required level of contri- during transport. butions using going-concern and solvency scenarios as prescribed under pension legislation and subject to guidance issued by the While the Company will continue to work closely with the CBSA, Canadian Institute of Actuaries (CIA). Adverse changes with re- CBP, and other Canadian and U.S. agencies, as described above, spect to pension plan returns and the level of interest rates from the no assurance can be given that these and future decisions by the date of the last actuarial valuations as well as changes to existing U.S., Canadian, provincial, state, or local governments on home- federal pension legislation may significantly impact future pension land security matters, legislation on security matters enacted by contributions and have a material adverse effect on the funded the U.S. Congress or Parliament, or joint decisions by the industry status of the plans and the Company’s results of operations. The in response to threats to the North American rail network, will not Company’s funding requirements are determined upon comple- materially adversely affect the Company’s results of operations, or tion of actuarial valuations which are generally required on an its competitive and financial position. Radio communications annual basis for all Canadian plans, or when deemed appropriate by the OSFI. The latest actuarial valuations for funding purposes for the Company’s Canadian pension plans, based on a valuation The Company uses radios for a variety of operational purposes. date of December 31, 2012, were filed in June 2013 and identi- Licenses for these activities, as well as the transfer or assignment fied a going-concern surplus of approximately $1.4 billion and a of these licenses, require authorization of the FCC. The Company solvency deficit of approximately $2.1 billion calculated using the uncovered a number of instances where such authorization was not three-year average of the Company’s hypothetical wind-up ratio obtained and disclosed those instances to the FCC on a voluntary in accordance with the Pension Benefit Standards Regulations, basis. The Company is undertaking a number of corrective actions 1985. Under Canadian legislation, the solvency deficit is required with the FCC to address the situation, the whole without prejudice to be funded through special solvency payments, for which each to a future FCC enforcement action and the imposition of fines. annual amount is equal to one fifth of the solvency deficit, and is Other risks Economic conditions re-established at each valuation date. Actuarial valuations are also required annually for the Company’s U.S. pension plans. In anticipation of its future funding requirements, the Company The Company, like other railroads, is susceptible to changes in the may occasionally make voluntary contributions in excess of the economic conditions of the industries and geographic areas that pro- required contributions mainly to strengthen the financial position duce and consume the freight it transports or the supplies it requires of its main pension plan, the CN Pension Plan. The Company has to operate. In addition, many of the goods and commodities carried been advised by the OSFI that voluntary contributions can be by the Company experience cyclicality in demand. Many of the treated as a prepayment against the Company’s required special bulk commodities the Company transports move offshore and are solvency payments and as at December 31, 2013, the Company affected more by global rather than North American economic con- had approximately $470 million of accumulated prepayments ditions. Adverse North American and global economic conditions, which remain available to offset future required solvency deficit or economic or industrial restructuring, that affect the producers payments. Pension contributions made in 2013 and 2012 of Canadian National Railway Company U.S. GAAP 2013 Annual Report 47 Management’s Discussion and Analysis $226 million and $833 million, respectively, mainly represent con- customers could have a material adverse effect on the Company’s tributions to the Company’s main pension plan, the CN Pension results of operations, financial position or liquidity. Plan and include voluntary contributions of $100 million and $700 million, respectively. The pension contributions also include Liquidity contributions for the current service cost as determined under the Disruptions in the financial markets or deterioration of the Company’s current actuarial valuations for funding purposes. Company’s credit ratings could hinder the Company’s access to On July 31, 2013, the CIA published a draft report for com- external sources of funding to meet its liquidity needs. There can ment on Canadian Pensioners Mortality. Final guidance on mor- be no assurance that changes in the financial markets will not tality assumptions is expected in early 2014. The report contains have a negative effect on the Company’s liquidity and its access to proposed Canadian pensioners mortality tables and improvement capital at acceptable rates. scales based on experience studies conducted by the CIA. Based on the CIA’s report, the overall level of recent mortality experience Supplier risk is significantly lower than that anticipated by the current mortal- The Company operates in a capital-intensive industry where the ity tables which are commonly used. Furthermore, improvement complexity of rail equipment limits the number of suppliers avail- rates experienced in recent years have been substantially higher able. The supply market could be disrupted if changes in the econ- than current projections. Based on the draft CIA’s report and CN’s omy caused any of the Company’s suppliers to cease production or experience, revised mortality tables and improvement scales that to experience capacity or supply shortages. This could also result were used for the 2013 year end accounting valuation increased in cost increases to the Company and difficulty in obtaining and the Company’s projected benefit obligation as at December 31, maintaining the Company’s rail equipment and materials. Since the 2013. Company also has foreign suppliers, international relations, trade re- The Company expects cash from operations and its other strictions and global economic and other conditions may potentially sources of financing to be sufficient to meet its funding obligations. interfere with the Company’s ability to procure necessary equip- Trade restrictions ment. To manage its supplier risk, it is the Company’s long-standing practice to ensure that more than one source of supply for a key Global as well as North American trade conditions, including trade product or service, where feasible, is available. Widespread business barriers on certain commodities, may interfere with the free circu- failures of, or restrictions on suppliers, could have a material adverse lation of goods across Canada and the U.S. effect on the Company’s results of operations or financial position. Terrorism and international conflicts Availability of qualified personnel Potential terrorist actions can have a direct or indirect impact on The Company, like other companies in North America, may experi- the transportation infrastructure, including railway infrastructure ence demographic challenges in the employment levels of its work- in North America, and can interfere with the free flow of goods. force. Changes in employee demographics, training requirements Rail lines, facilities and equipment could be directly targeted or be- and the availability of qualified personnel, particularly locomotive come indirect casualties, which could interfere with the free flow engineers and trainmen, could negatively impact the Company’s of goods. International conflicts can also have an impact on the ability to meet demand for rail service. The Company expects that Company’s markets. Government response to such events could ad- approximately 40% of its workforce will be eligible to retire or leave versely affect the Company’s operations. Insurance premiums could through normal attrition (death, termination, resignation) within the also increase significantly or coverage could become unavailable. next five-year period. The Company monitors employment levels to Customer credit risk ensure that there is an adequate supply of personnel to meet rail service requirements. However, the Company’s efforts to attract and In the normal course of business, the Company monitors the fi- retain qualified personnel may be hindered by specific conditions nancial condition and credit limits of its customers and reviews in the job market. No assurance can be given that demographic or the credit history of each new customer. Although the Company other challenges will not materially adversely affect the Company’s believes there are no significant concentrations of credit risk, eco- results of operations or its financial position. nomic conditions can affect the Company’s customers and can result in an increase to the Company’s credit risk and exposure to Fuel costs the business failures of its customers. To manage its credit risk on The Company, like other railroads, is susceptible to the volatility of an ongoing basis, the Company’s focus is on keeping the average fuel prices due to changes in the economy or supply disruptions. daily sales outstanding within an acceptable range and working Fuel shortages can occur due to refinery disruptions, production with customers to ensure timely payments, and in certain cases, quota restrictions, climate, and labor and political instability. Rising requiring financial security, including letters of credit. A wide- fuel prices could materially adversely affect the Company’s expenses. spread deterioration of customer credit and business failures of As such, CN has implemented a fuel surcharge program with a 48 2013 Annual Report U.S. GAAP Canadian National Railway Company Management’s Discussion and Analysis view of offsetting the impact of rising fuel prices. The surcharge Company and its customers. Climate change, including the impact of applied to customers is determined in the second calendar month global warming, has the potential physical risk of increasing the fre- prior to the month in which it is applied, and is calculated using quency of adverse weather events, which can disrupt the Company’s the average monthly price of West-Texas Intermediate crude oil operations, damage its infrastructure or properties, or otherwise have a (WTI) for revenue-based tariffs and On-Highway Diesel (OHD) for material adverse effect on the Company’s results of operations, finan- mileage-based tariffs. Increases in fuel prices or supply disruptions cial position or liquidity. In addition, although the Company believes may materially adversely affect the Company’s results of oper- that the growing support for climate change legislation is likely to result ations, financial position or liquidity. Foreign currency in changes to the regulatory framework in Canada and the U.S., it is too early to predict the manner or degree of such impact on the Company at this time. Restrictions, caps, taxes, or other controls on emissions The Company conducts its business in both Canada and the U.S. of greenhouse gasses, including diesel exhaust, could significantly in- and as a result, is affected by currency fluctuations. The estimated crease the Company’s capital and operating costs or affect the markets annual impact on net income of a year-over-year one-cent change for, or the volume of, the goods the Company carries thereby resulting in the Canadian dollar relative to the US dollar is in the range of in a material adverse effect on operations, financial position, results $10 million to $15 million. Changes in the exchange rate between of operations or liquidity. More specifically, climate change legislation the Canadian dollar and other currencies (including the US dollar) and regulation could (a) affect CN’s utility coal customers due to coal make the goods transported by the Company more or less com- capacity being replaced with natural gas generation and renewable petitive in the world marketplace and thereby may adversely affect energy; (b) make it difficult for CN’s customers to produce products the Company’s revenues and expenses. in a cost-competitive manner due to increased energy costs; and (c) increase legal costs related to defending and resolving legal claims and Reliance on technology other litigation related to climate change. The Company relies on information technology in all aspects of its business. While the Company has business continuity and Controls and procedures disaster recovery plans, as well as other mitigation programs in The Company’s Chief Executive Officer and its Chief Financial Officer, place, a cyber security attack and significant disruption or failure after evaluating the effectiveness of the Company’s “disclosure con- of its information technology and communications systems could trols and procedures” (as defined in Exchange Act Rules 13a-15(e) result in service interruptions, safety failures, security violations, and 15d-15(e)) as of December 31, 2013, have concluded that the regulatory compliance failures or other operational difficulties and Company’s disclosure controls and procedures were effective. compromise corporate information and assets against intruders During the fourth quarter ended December 31, 2013, there was and, as such, could adversely affect the Company’s results of oper- no change in the Company’s internal control over financial reporting ations, financial position or liquidity. If the Company is unable to that has materially affected, or is reasonably likely to materially af- acquire or implement new technology, it may suffer a competitive fect, the Company’s internal control over financial reporting. disadvantage, which could also have an adverse effect on the As of December 31, 2013, management has assessed the ef- Company’s results of operations, financial position or liquidity. fectiveness of the Company’s internal control over financial report- Transportation network disruptions ing using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Due to the integrated nature of the North American freight Control – Integrated Framework (1992). Based on this assess- transportation infrastructure, the Company’s operations may be ment, management has determined that the Company’s internal negatively affected by service disruptions of other transportation control over financial reporting was effective as of December 31, links such as ports and other railroads which interchange with the 2013, and issued Management’s Report on Internal Control over Company. A significant prolonged service disruption of one or more Financial Reporting dated February 3, 2014 to that effect. of these entities could have an adverse effect on the Company’s results of operations, financial position or liquidity. Furthermore, The Company’s 2013 Annual Information Form (AIF) and Form 40-F, deterioration in the cooperative relationships with the Company’s may be found on SEDAR at www.sedar.com and on EDGAR at connecting carriers could directly affect the Company’s operations. www.sec.gov, respectively. Copies of such documents, as well as Weather and climate change the Company’s Notice of Intention to Make a Normal Course Issuer Bid, may be obtained by contacting the Corporate Secretary’s office. The Company’s success is dependent on its ability to operate its railroad efficiently. Severe weather and natural disasters, such as extreme cold Montreal, Canada or heat, flooding, drought, hurricanes and earthquakes, can disrupt February 3, 2014 operations and service for the railroad, affect the performance of loco- motives and rolling stock, as well as disrupt operations for both the Canadian National Railway Company U.S. GAAP 2013 Annual Report 49 Management’s Discussion and Analysis Management’s Report on Internal Control Report of Independent Registered Public Accounting Firm over Financial Reporting Management is responsible for establishing and maintaining ad- To the Shareholders and Board of Directors of the Canadian equate internal control over financial reporting. Internal control National Railway Company over financial reporting is a process designed to provide reason- able assurance regarding the reliability of financial reporting and We have audited the accompanying consolidated balance sheets the preparation of financial statements for external purposes in ac- of the Canadian National Railway Company (the “Company”) cordance with generally accepted accounting principles. Because as of December 31, 2013 and 2012, and the related consolidat- of its inherent limitations, internal control over financial reporting ed statements of income, comprehensive income, changes in may not prevent or detect misstatements. shareholders’ equity and cash flows for each of the years in the Management has assessed the effectiveness of the Company’s three-year period ended December 31, 2013. These consolidat- internal control over financial reporting as of December 31, 2013 ed financial statements are the responsibility of the Company’s using the criteria set forth by the Committee of Sponsoring management. Our responsibility is to express an opinion on these Organizations of the Treadway Commission (COSO) in Internal consolidated financial statements based on our audits. Control – Integrated Framework (1992). Based on this assessment, We conducted our audits in accordance with Canadian gener- management has determined that the Company’s internal control ally accepted auditing standards and the standards of the Public over financial reporting was effective as of December 31, 2013. Company Accounting Oversight Board (United States). Those stan- KPMG LLP, an independent registered public accounting firm, dards require that we plan and perform the audit to obtain rea- has issued an unqualified audit report on the effectiveness of the sonable assurance about whether the financial statements are free Company’s internal control over financial reporting as of December of material misstatement. An audit includes examining, on a test 31, 2013 and has also expressed an unqualified audit opinion on basis, evidence supporting the amounts and disclosures in the fi- the Company’s 2013 consolidated financial statements as stated nancial statements. An audit also includes assessing the accounting in their Reports of Independent Registered Public Accounting Firm principles used and significant estimates made by management, as dated February 3, 2014. Claude Mongeau President and Chief Executive Officer February 3, 2014 Luc Jobin Executive Vice-President and Chief Financial Officer February 3, 2014 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 consolidated financial position of the Company as of December 31, 2013 and 2012, and its consolidated results of operations and its consolidat- ed cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with United States generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 3, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. KPMG LLP* Montreal, Canada February 3, 2014 * FCPA auditor, FCA, public accountancy permit No. A106087 KPMG LLP is a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. KPMG Canada provides services to KPMG LLP. 50 2013 Annual Report U.S. GAAP Canadian National Railway Company Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors of the Canadian reporting includes those policies and procedures that (1) pertain to National Railway Company the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of We have audited the Canadian National Railway Company’s the company; (2) provide reasonable assurance that transactions (the “Company”) internal control over financial reporting as of are recorded as necessary to permit preparation of financial state- December 31, 2013, based on criteria established in Internal ments in accordance with generally accepted accounting princi- Control – Integrated Framework (1992) issued by the Committee ples, and that receipts and expenditures of the company are being of Sponsoring Organizations of the Treadway Commission made only in accordance with authorizations of management and (“COSO”). The Company’s management is responsible for main- directors of the company; and (3) provide reasonable assurance taining effective internal control over financial reporting, and for regarding prevention or timely detection of unauthorized acquisi- its assessment of the effectiveness of internal control over financial tion, use, or disposition of the company’s assets that could have a reporting included in the accompanying Management’s Report on material effect on the financial statements. Internal Control over Financial Reporting. Our responsibility is to Because of its inherent limitations, internal control over fi- express an opinion on the Company’s internal control over finan- nancial reporting may not prevent or detect misstatements. Also, cial reporting based on our audit. projections of any evaluation of effectiveness to future periods are We conducted our audit in accordance with the standards of subject to the risk that controls may become inadequate because the Public Company Accounting Oversight Board (United States). of changes in conditions, or that the degree of compliance with Those standards require that we plan and perform the audit to ob- the policies or procedures may deteriorate. tain reasonable assurance about whether effective internal control In our opinion, the Company maintained, in all material re- over financial reporting was maintained in all material respects. spects, effective internal control over financial reporting as of Our audit included obtaining an understanding of internal control December 31, 2013, based on criteria established in Internal over financial reporting, assessing the risk that a material weak- Control – Integrated Framework (1992) issued by the COSO. ness exists, and testing and evaluating the design and operating We also have audited, in accordance with Canadian gener- effectiveness of internal control based on the assessed risk. Our ally accepted auditing standards and the standards of the Public audit also included performing such other procedures as we con- Company Accounting Oversight Board (United States), the con- sidered necessary in the circumstances. We believe that our audit solidated balance sheets of the Company as of December 31, provides a reasonable basis for our opinion. 2013 and 2012, and the related consolidated statements of A company’s internal control over financial reporting is a pro- income, comprehensive income, changes in shareholders’ equity cess designed to provide reasonable assurance regarding the reli- and cash flows for each of the years in the three-year period ability of financial reporting and the preparation of financial state- ended December 31, 2013, and our report dated February 3, ments for external purposes in accordance with generally accepted 2014 expressed an unqualified opinion on those consolidated accounting principles. A company’s internal control over financial financial statements. KPMG LLP* Montreal, Canada February 3, 2014 * FCPA auditor, FCA, public accountancy permit No. A106087 KPMG LLP is a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. KPMG Canada provides services to KPMG LLP. Canadian National Railway Company U.S. GAAP 2013 Annual Report 51 Consolidated Statement of Income In millions, except per share data Year ended December 31, 2013 2012 2011 Revenues Operating expenses Labor and fringe benefits Purchased services and material Fuel Depreciation and amortization Equipment rents Casualty and other Total operating expenses Operating income Interest expense Other income (Note 12) Income before income taxes Income tax expense (Note 13) Net income Earnings per share (Note 15) Basic Diluted Weighted-average number of shares (Note 15) Basic Diluted $ 10,575 $ 9,920 $ 9,028 2,182 1,952 1,812 1,351 1,248 1,120 1,619 1,524 1,412 980 275 295 924 249 338 884 228 276 6,702 6,235 5,732 3,873 3,685 3,296 (357) 73 (342) 315 (341) 401 3,589 3,658 3,356 (977) (978) (899) $ 2,612 $ 2,680 $ 2,457 $ 3.10 $ 3.08 $ 2.72 $ 3.09 $ 3.06 $ 2.70 843.1 871.1 902.2 846.1 875.4 908.9 See accompanying notes to consolidated financial statements. 52 2013 Annual Report U.S. GAAP Canadian National Railway Company Consolidated Statement of Comprehensive Income In millions Net income Other comprehensive income (loss) (Note 18) Foreign exchange gain (loss) on: Year ended December 31, 2013 2012 2011 $ 2,612 $ 2,680 $ 2,457 Translation of the net investment in foreign operations 440 (128) 130 Translation of US dollar-denominated long-term debt designated as a hedge of the net investment in U.S. subsidiaries (394) 123 (122) Pension and other postretirement benefit plans (Note 11): Net actuarial gain (loss) arising during the year Prior service cost arising during the year Amortization of net actuarial loss included in net periodic benefit cost (income) Amortization of prior service cost included in net periodic benefit cost (income) Derivative instruments (Note 17) Other comprehensive income (loss) before income taxes Income tax recovery (expense) Other comprehensive income (loss) Comprehensive income 1,544 (660) (1,541) - 226 5 - (6) 119 7 - (28) 8 4 (2) 1,821 (545) (1,551) (414) 127 421 1,407 (418) (1,130) $ 4,019 $ 2,262 $ 1,327 See accompanying notes to consolidated financial statements. Canadian National Railway Company U.S. GAAP 2013 Annual Report 53 Consolidated Balance Sheet In millions Assets Current assets Cash and cash equivalents Restricted cash and cash equivalents (Note 8) Accounts receivable (Note 3) Material and supplies Deferred and receivable income taxes (Note 13) Other Total current assets Properties (Note 4) Intangible and other assets (Note 5) Total assets Liabilities and shareholders’ equity Current liabilities Accounts payable and other (Note 6) Current portion of long-term debt (Note 8) Total current liabilities Deferred income taxes (Note 13) Pension and other postretirement benefits, net of current portion (Note 11) Other liabilities and deferred credits (Note 7) Long-term debt (Note 8) Shareholders’ equity Common shares (Note 9) Accumulated other comprehensive loss (Note 18) Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity On behalf of the Board: David G. A. McLean Director Claude Mongeau Director December 31, 2013 2012 $ 214 $ 448 815 274 137 89 155 521 831 230 43 89 1,977 1,869 26,227 24,541 1,959 249 $ 30,163 $ 26,659 $ 1,477 $ 1,626 1,021 2,498 577 2,203 6,537 5,555 541 815 784 776 6,819 6,323 4,015 4,108 (1,850) (3,257) 10,788 10,167 12,953 11,018 $ 30,163 $ 26,659 See accompanying notes to consolidated financial statements. 54 2013 Annual Report U.S. GAAP Canadian National Railway Company Consolidated Statement of Changes in Shareholders’ Equity In millions Issued and outstanding Accumulated other Total common shares Common comprehensive Retained shareholders’ (Note 9) shares loss earnings equity Balances at December 31, 2010 918.7 $ 4,252 $ (1,709) $ 8,741 $ 11,284 Net income Stock options exercised and other (Notes 9, 10) Share repurchase programs (Note 9) Other comprehensive loss (Note 18) Dividends ($0.65 per share) Balances at December 31, 2011 Net income Stock options exercised and other (Notes 9, 10) Share repurchase programs (Note 9) Other comprehensive loss (Note 18) Dividends ($0.75 per share) Balances at December 31, 2012 Net income Stock options exercised and other (Notes 9, 10) Share repurchase programs (Note 9) Other comprehensive income (Note 18) Dividends ($0.86 per share) Balances at December 31, 2013 - 5.3 (39.8) - - - 74 (185) - - 2,457 2,457 - - - - (1,235) 74 (1,420) (1,130) (585) (1,130) - - (585) 884.2 4,141 (2,839) 9,378 10,680 - 6.4 (33.8) - - - 128 (161) - - - - - 2,680 2,680 - 128 (1,239) (1,400) (418) - - (652) (418) (652) 856.8 4,108 (3,257) 10,167 11,018 - 1.4 (27.6) - - - 40 (133) - - - - - 2,612 2,612 - 40 (1,267) (1,400) 1,407 - 1,407 - (724) (724) 830.6 $ 4,015 $ (1,850) $ 10,788 $ 12,953 See accompanying notes to consolidated financial statements. Canadian National Railway Company U.S. GAAP 2013 Annual Report 55 Consolidated Statement of Cash Flows In millions Operating activities Net income Year ended December 31, 2013 2012 2011 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Deferred income taxes (Note 13) Gain on disposal of property (Notes 4, 12) Changes in operating assets and liabilities: Accounts receivable Material and supplies Accounts payable and other Other current assets Pensions and other, net Net cash provided by operating activities Investing activities Property additions Disposal of property (Note 4) Change in restricted cash and cash equivalents Other, net Net cash used in investing activities Financing activities Issuance of debt (Note 8) Repayment of debt (Note 8) Issuance of common shares due to exercise of stock options and related excess tax benefits realized (Note 10) Repurchase of common shares (Note 9) Dividends paid Net cash used in financing activities Effect of foreign exchange fluctuations on US dollar-denominated cash and cash equivalents 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 Personal injury and other claims (Note 16) Pensions (Note 11) Income taxes (Note 13) Net cash provided by operating activities See accompanying notes to consolidated financial statements. $ 2,612 $ 2,680 $ 2,457 980 331 924 451 884 531 (69) (281) (348) 32 (38) (245) 13 (68) (20) (30) 129 (13) (51) 11 34 (2) (780) (540) 3,548 3,060 2,976 (1,973) (1,731) (1,625) 52 73 (4) 311 (22) 21 369 (499) 26 (1,852) (1,421) (1,729) 1,850 (1,413) 493 (140) 787 (509) 31 117 77 (1,400) (1,400) (1,420) (724) (652) (585) (1,656) (1,582) (1,650) 19 59 155 (3) 54 101 14 (389) 490 $ 214 $ 155 $ 101 $ 10,640 $ 9,877 $ 8,995 (5,558) (5,241) (4,643) (344) (61) (239) (890) (364) (79) (844) (289) (329) (97) (468) (482) $ 3,548 $ 3,060 $ 2,976 56 2013 Annual Report U.S. GAAP Canadian National Railway Company 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 freight revenues are derived from the movement of a diversified and balanced portfolio of goods, including petroleum and chemicals, grain and fertilizers, coal, metals and minerals, forest products, intermodal and automotive. 1 Summary of significant accounting policies C. Foreign currency All of the Company’s operations in the United States (U.S.) are These consolidated financial statements are expressed in Canadian self-contained foreign entities with the US dollar as their function- dollars, except where otherwise indicated, and have been prepared al currency. Accordingly, the U.S. operations’ assets and liabilities in accordance with United States generally accepted accounting are translated into Canadian dollars at the rate in effect at the principles (U.S. GAAP). The preparation of financial statements in balance sheet date and the revenues and expenses are translated conformity with generally accepted accounting principles requires at average exchange rates during the year. All adjustments re- management to make estimates and assumptions that affect the sulting from the translation of the foreign operations are recorded reported amounts of revenues and expenses during the period, in Other comprehensive income (loss) (see Note 18 – Accumulated the reported amounts of assets and liabilities, and the disclosure of other comprehensive loss). contingent assets and liabilities at the date of the financial state- The Company designates the US dollar-denominated long-term ments. On an ongoing basis, management reviews its estimates, debt of the parent company as a foreign currency hedge of its including those related to personal injury and other claims, en- net investment in U.S. subsidiaries. Accordingly, foreign exchange vironmental matters, depreciation, pensions and other postretire- gains and losses, from the dates of designation, on the translation ment benefits, and income taxes, based upon currently available of the US dollar-denominated long-term debt are also included in information. Actual results could differ from these estimates. Other comprehensive income (loss). On October 22, 2013, the Board of Directors of the Company D. Cash and cash equivalents approved a two-for-one common stock split in the form of a stock Cash and cash equivalents include highly liquid investments pur- dividend of one additional common share of CN for each share chased three months or less from maturity and are stated at cost, outstanding, which was paid on November 29, 2013, to share- which approximates market value. holders of record on November 15, 2013. All share and per share data presented herein reflect the impact of the stock split. E. Restricted cash and cash equivalents A. Principles of consolidation The Company has the option, under its bilateral letter of cred- it facility agreements with various banks, to pledge collateral in These consolidated financial statements include the accounts of all the form of cash and cash equivalents for a minimum term of subsidiaries. The Company’s investments in which it has significant one month, equal to at least the face value of the letters of credit influence are accounted for using the equity method and all other issued. Restricted cash and cash equivalents are shown separately investments are accounted for using the cost method. on the balance sheet and include highly liquid investments pur- chased three months or less from maturity and are stated at cost, B. Revenues which approximates market value. Freight revenues are recognized using the percentage of com- pleted service method based on the transit time of freight as it F. Accounts receivable moves from origin to destination. The allocation of revenues be- Accounts receivable are recorded at cost net of billing adjust- tween reporting periods is based on the relative transit time in ments and an allowance for doubtful accounts. The allowance for each period with expenses being recorded as incurred. Revenues doubtful accounts is based on expected collectability and consid- related to non-rail transportation services are recognized as service ers historical experience as well as known trends or uncertainties is performed or as contractual obligations are met. Revenues are related to account collectability. When a receivable is deemed presented net of taxes collected from customers and remitted to uncollectible, it is written off against the allowance for doubtful governmental authorities. accounts. Subsequent recoveries of amounts previously written off are credited to the bad debt expense in Casualty and other in the Consolidated Statement of Income. Canadian National Railway Company U.S. GAAP 2013 Annual Report 57 Notes to Consolidated Financial Statements 1 Summary of significant accounting policies continued G. Material and supplies Material and supplies, which consist mainly of rail, ties, and other items for construction and maintenance of property and equip- ment, as well as diesel fuel, are valued at weighted-average cost. H. Properties I. Intangible assets Intangible assets consist mainly of customer contracts and rela- tionships assumed through past acquisitions and are being amor- tized on a straight-line basis over 40 to 50 years. The Company reviews the carrying amounts of intangible assets held and used whenever events or changes in circumstances indi- cate 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 Railroad properties are carried at cost less accumulated depreci- amount or fair value. ation including asset impairment write-downs. Labor, materials and other costs associated with the installation of rail, ties, bal- J. Pensions last and other structures are capitalized to the extent they meet Pension costs are determined using actuarial methods. Net periodic the Company’s capitalization criteria. Major overhauls and large benefit cost is charged to income and includes: refurbishments of equipment are also capitalized when they result in an extension to the service life or increase the functionality of the asset. Repair and maintenance costs are expensed as incurred. (i) the cost of pension benefits provided in exchange for employ- ees’ services rendered during the year; (ii) the interest cost of pension obligations; The cost of properties, including those under capital leases, net (iii) the expected long-term return on pension fund assets; of asset impairment write-downs, is depreciated on a straight-line basis over their estimated service lives, measured in years, except for rail which is measured in millions of gross tons per mile. The Company follows the group method of depreciation whereby a single composite depreciation rate is applied to the gross invest- ment in a class of similar assets, despite small differences in the service life or salvage value of individual property units within the same asset class. In accordance with the group method of depreciation, upon sale or retirement of properties in the normal course of business, cost less net salvage value is charged to accumulated deprecia- tion. As a result, no gain or loss is recognized in income under the (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 bal- ances 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. group method as it is assumed that the assets within the group K. Postretirement benefits other than pensions on average have the same life and characteristics and therefore that gains or losses offset over time. For retirements of depreciable properties that do not occur in the normal course of business, a gain or loss may be recognized if the retirement varies significantly The Company accrues the cost of postretirement benefits other than pensions using actuarial methods. These benefits, which are funded as they become due, include life insurance programs, medical benefits and, for a closed group of employees, free rail from the retirement pattern identified through depreciation stud- travel benefits. ies. A gain or loss is recognized in Other income for the sale of land or disposal of assets that are not part of railroad operations. Assets held for sale are measured at the lower of their carry- 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 ser- ing amount or fair value, less cost to sell. Losses resulting from vice life of the employee group covered by the plan. significant rail line sales are recognized in income when the asset meets the criteria for classification as held for sale, whereas losses resulting from significant rail line abandonments are recognized in the Consolidated Statement of Income when the asset ceases to be used. Gains are recognized in income when they are realized. 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 fu- ture 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. 58 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements L. Personal injury and other claims P. Stock-based compensation In Canada, the Company accounts for costs related to employee The Company follows the fair value based approach for stock work-related injuries based on actuarially developed estimates of option awards based on the grant-date fair value using the Black- the ultimate cost associated with such injuries, including compen- Scholes option-pricing model. The Company expenses the fair value sation, health care and third-party administration costs. of its stock option awards on a straight-line basis, over the period In the U.S., the Company accrues the expected cost for person- during which an employee is required to provide service (requisite al injury, property damage and occupational disease claims, based service period) or until retirement eligibility is attained, whichever on actuarial estimates of their ultimate cost. is shorter. The Company also follows the fair value based approach for cash settled awards using a lattice-based valuation model. For all other legal actions in Canada and the U.S., the Company Compensation cost for cash settled awards is based on the fair maintains, and regularly updates on a case-by-case basis, provisions value of the awards at period-end and is recognized over the period for such items when the expected loss is both probable and can during which an employee is required to provide service (requisite be reasonably estimated based on currently available information. service period) or until retirement eligibility is attained, whichever is shorter. See Note 10 – Stock plans, for the assumptions used to M. Environmental expenditures determine fair value and for other required disclosures. Environmental expenditures that relate to current operations, or to an existing condition caused by past operations, are expensed unless they can contribute to current or future operations. Environmental 2 Accounting changes liabilities are recorded when environmental assessments occur, re- medial efforts are probable, and when the costs, based on a specific The Company adopts accounting standards that are issued by the plan of action in terms of the technology to be used and the extent Financial Accounting Standards Board (FASB), if applicable. For the of the corrective action required, can be reasonably estimated. The years 2013, 2012 and 2011, there were no accounting standard up- Company accrues its allocable share of liability taking into account dates issued by FASB that had a significant impact on the Company’s the Company’s alleged responsibility, the number of potentially consolidated financial statements, except as noted below. responsible parties and their ability to pay their respective shares of the liability. Recoveries of environmental remediation costs from In February 2013, the FASB issued Accounting Standards Update other parties are recorded as assets when their receipt is deemed (ASU) 2013-02, Reporting of Amounts Reclassified Out of probable and collectability is reasonably assured. Accumulated Other Comprehensive Income. ASU 2013-02 added N. Income taxes new disclosure requirements to Accounting Standards Codification (ASC) 220, Comprehensive Income, for items reclassified out of The Company follows the asset and liability method of accounting accumulated other comprehensive income (AOCI) effective for for income taxes. Under the asset and liability method, the change reporting periods beginning after December 15, 2012. It requires in the net deferred income tax asset or liability is included in the entities to disclose additional information about amounts reclassi- computation of Net income or Other comprehensive income (loss). fied out of AOCI by component including changes in AOCI balan- Deferred income tax assets and liabilities are measured using enacted ces and significant items reclassified out of AOCI by the respective tax rates expected to apply to taxable income in the years in which line items of net income. The Company has adopted ASU 2013-02 temporary differences are expected to be recovered or settled. for the reporting period beginning January 1, 2013 and the pre- scribed disclosures are presented in Note 18 – Accumulated other O. Derivative financial instruments comprehensive loss. The Company uses derivative financial instruments from time to time in the management of its interest rate and foreign currency exposures. Derivative instruments are recorded on the balance sheet 3 Accounts receivable at fair value and the changes in fair value are recorded in Net income or Other comprehensive income (loss) depending on the nature and In millions December 31, 2013 2012 effectiveness of the hedge transaction. Income and expense related Freight to hedged derivative financial instruments are recorded in the same Non-freight category as that generated by the underlying asset or liability. Gross accounts receivable Allowance for doubtful accounts Net accounts receivable $ 675 147 822 $ 674 167 841 (7) (10) $ 815 $ 831 Canadian National Railway Company U.S. GAAP 2013 Annual Report 59 Notes to Consolidated Financial Statements 4 Properties In millions Depreciation rate December 31, 2013 Accumulated Cost depreciation Net December 31, 2012 Accumulated depreciation Cost Net Track and roadway (1) Rolling stock Buildings Information technology (2) Other 2% 4% 2% 12% 6% $ 27,833 $ 7,103 $ 20,730 $ 26,209 $ 6,948 $ 19,261 5,193 1,392 1,000 1,388 1,894 3,299 521 455 606 871 545 782 4,989 1,275 976 1,273 1,785 3,204 492 427 529 783 549 744 Total properties including capital leases $ 36,806 $ 10,579 $ 26,227 $ 34,722 $ 10,181 $ 24,541 Capital leases included in properties Track and roadway (3) $ 417 $ 58 $ 359 $ 417 $ 53 $ Rolling stock Buildings Other 982 109 102 358 21 22 624 88 80 1,222 109 91 353 18 17 364 869 91 74 Total capital leases included in properties $ 1,610 $ 459 $ 1,151 $ 1,839 $ 441 $ 1,398 (1) Includes the cost of land of $1,911 million and $1,766 million as at December 31, 2013 and December 31, 2012, respectively. (2) The Company capitalized $85 million in 2013 and $93 million in 2012 of internally developed software costs pursuant to FASB ASC 350-40, “Intangibles – Goodwill and Other, Internal – Use Software.” (3) Includes $108 million of right-of-way access in both years. Accounting policy for capitalization of costs • Ties: installation of 5 or more ties per 39 feet; The Company’s railroad operations are highly capital intensive. The • Ballast: installation of 171 cubic yards of ballast per mile. Company’s properties consist mainly of a large base of homogen- eous or network-type assets such as rail, ties, ballast and other Expenditures relating to the Company’s properties that do not structures, which form the Company’s Track and roadway proper- meet the Company’s capitalization criteria are considered normal ties, and Rolling stock. The Company’s capital expenditures are for repairs and maintenance and are expensed. For Track and roadway the replacement of assets and for the purchase or construction of properties, such expenditures include but are not limited to spot assets to enhance operations or provide new service offerings to tie replacement, spot or broken rail replacement, physical track customers. A large portion of the Company’s capital expenditures inspection for detection of rail defects and minor track corrections, are for self-constructed properties including the replacement of and other general maintenance of track infrastructure. existing track and roadway assets and track line expansion, as well For the ballast asset, the Company also engages in “shoulder as major overhauls and large refurbishments of rolling stock. ballast undercutting” that consists of removing some or all of the Expenditures are generally capitalized if they extend the life ballast, which has deteriorated over its service life, and replacing of the asset or provide future benefits such as increased revenue- it with new ballast. When ballast is installed as part of a shoulder generating capacity, functionality, or physical or service capacity. ballast undercutting project, it represents the addition of a new The Company has a process in place to determine whether its asset and not the repair or maintenance of an existing asset. As capital programs qualify for capitalization. For Track and road- such, the Company capitalizes expenditures related to shoulder way properties, the Company establishes basic capital programs ballast undercutting given that an existing asset is retired and re- to replace or upgrade the track infrastructure assets which are placed with a new asset. Under the group method of accounting capitalized if they meet the capitalization criteria. These basic for properties, the deteriorated ballast is retired at its average cost capital programs are planned in advance and carried out by the measured using the quantities of new ballast added. Company’s engineering workforce. For purchased assets, the Company capitalizes all costs neces- In addition, for Track and roadway properties, expenditures that sary to make the asset ready for its intended use. Expenditures that meet the minimum level of activity as defined by the Company are are capitalized as part of self-constructed properties include direct also capitalized as detailed below: • Land: all purchases of land; material, labor, and contracted services, as well as other allocat- ed costs which are not charged directly to capital projects. These • Grading: installation of road bed, retaining walls, drainage allocated costs include, but are not limited to, fringe benefits, structures; small tools and supplies, machinery used on projects and project • Rail and related track material: installation of 39 or more con- supervision. The Company reviews and adjusts its allocations, as tinuous feet of rail; required, to reflect the actual costs incurred each year. 60 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements Costs of deconstruction and removal of replaced assets, The service life of the rail asset is increased incrementally as rail referred to herein as dismantling costs, are distinguished from grinding is performed thereon. As such, the costs incurred for rail installation costs for self-constructed properties based on the grinding are capitalized given that the activity extends the service nature of the related activity. For Track and roadway properties, life of the rail asset beyond its original or current condition as employees concurrently perform dismantling and installation additional gross tons can be carried over the rail for its remaining of new track and roadway assets and, as such, the Company service life. The Company amortizes the cost of rail grinding over estimates the amount of labor and other costs that are related to the remaining life of the rail asset, which includes the incremental dismantling. The Company determines dismantling costs based on life extension generated by the rail grinding. an analysis of the track and roadway installation process. Accounting policy for depreciation Disposal of property 2013 Properties are carried at cost less accumulated depreciation in- Exchange of easements cluding asset impairment write-downs. The cost of properties, in- cluding those under capital leases, net of asset impairment write- downs, is depreciated on a straight-line basis over their estimated On June 8, 2013, the Company entered into an agreement with another Class I railroad to exchange perpetual railroad operating easements including the track and roadway assets on specific rail service lives, measured in years, except for rail which is measured lines (collectively the “exchange of easements”) without monetary in millions of gross tons per mile. The Company follows the group consideration. The Company has accounted for the exchange of method of depreciation whereby a single composite depreciation easements at fair value pursuant to FASB ASC 845, Nonmonetary rate is applied to the gross investment in a class of similar assets, Transactions. The transaction resulted in a gain on exchange of despite small differences in the service life or salvage value of in- easements of $29 million ($18 million after-tax) that was recorded dividual property units within the same asset class. The Company in Other income. uses approximately 40 different depreciable asset classes. For all depreciable assets, the depreciation rate is based on Lakeshore West the estimated service lives of the assets. Assessing the reason- On March 19, 2013, the Company entered into an agreement ableness of the estimated service lives of properties requires with Metrolinx to sell a segment of the Oakville subdivision in judgment and is based on currently available information, includ- Oakville and Burlington, Ontario, together with the rail fixtures ing periodic depreciation studies conducted by the Company. and certain passenger agreements (collectively the “Lakeshore The Company’s U.S. properties are subject to comprehensive West”), for cash proceeds of $52 million before transaction costs. depreciation studies as required by the Surface Transportation Under the agreement, the Company obtained the perpetual right Board (STB) and are conducted by external experts. Depreciation to operate freight trains over the Lakeshore West at its then cur- studies for Canadian properties are not required by regulation rent level of operating activity, with the possibility of increasing and are conducted internally. Studies are performed on specific its operating activity for additional consideration. The transaction asset groups on a periodic basis. Changes in the estimated ser- resulted in a gain on disposal of $40 million ($36 million after-tax) vice lives of the assets and their related composite depreciation that was recorded in Other income under the full accrual method rates are implemented prospectively. of accounting for real estate transactions. For the rail asset, the estimated service life is measured in mil- lions of gross tons per mile and varies based on rail characteristics 2012 such as weight, curvature and metallurgy. The annual composite Bala-Oakville depreciation rate for rail assets is determined by dividing the es- On March 23, 2012, the Company entered into an agreement timated annual number of gross tons carried over the rail by the with Metrolinx to sell a segment of the Bala and a segment of estimated service life of the rail measured in millions of gross tons the Oakville subdivisions in Toronto, Ontario, together with the rail per mile. For the rail asset, the Company capitalizes the costs of rail fixtures and certain passenger agreements (collectively the “Bala- grinding which consists of restoring and improving the rail profile Oakville”), for cash proceeds of $311 million before transaction and removing irregularities from worn rail to extend the service costs. Under the agreement, the Company obtained the perpetual life. The service life of the rail asset is based on expected future right to operate freight trains over the Bala-Oakville at its then usage of the rail in its existing condition, determined using railroad current level of operating activity, with the possibility of increasing industry research and testing, less the rail asset’s usage to date. its operating activity for additional consideration. The transaction resulted in a gain on disposal of $281 million ($252 million af- ter-tax) that was recorded in Other income under the full accrual method of accounting for real estate transactions. Canadian National Railway Company U.S. GAAP 2013 Annual Report 61 Notes to Consolidated Financial Statements 4 Properties continued 5 Intangible and other assets 2011 IC RailMarine In millions December 31, 2013 2012 Pension asset (Note 11) $ 1,662 $ On August 1, 2011, the Company sold substantially all of the assets Deferred and long-term receivables of IC RailMarine Terminal Company (“IC RailMarine”), an indirect Intangible assets (A) subsidiary of the Company, to Raven Energy, LLC, an affiliate of Investments (B) Foresight Energy, LLC (“Foresight”) and the Cline Group (“Cline”), Other 109 59 57 72 for cash proceeds of $70 million (US$73 million) before transaction Total intangible and other assets $ 1,959 $ 249 - 87 57 30 75 costs. IC RailMarine is located on the east bank of the Mississippi River and stores and transfers bulk commodities and liquids be- tween rail, ship and barge, serving customers in North American and global markets. Under the sale agreement, the Company will benefit from a 10-year rail transportation agreement with Savatran LLC, an affiliate of Foresight and Cline, to haul a minimum annual volume of coal from four Illinois mines to the IC RailMarine transfer facility. The transaction resulted in a gain on disposal of $60 million ($38 million after-tax) that was recorded in Other income. Lakeshore East On March 24, 2011, the Company entered into an agreement with Metrolinx to sell a segment of the Kingston subdivision known as the Lakeshore East in Pickering and Toronto, Ontario, together with the rail fixtures and certain passenger agreements (collective- ly the “Lakeshore East”), for cash proceeds of $299 million before transaction costs. Under the agreement, the Company obtained the perpetual right to operate freight trains over the Lakeshore East at its then current level of operating activity, with the possibil- ity of increasing its operating activity for additional consideration. The transaction resulted in a gain on disposal of $288 million ($254 million after-tax) that was recorded in Other income under the full accrual method of accounting for real estate transactions. A. Intangible assets Intangible assets consist mainly of customer contracts and rela- tionships assumed through past acquisitions. B. Investments As at December 31, 2013, the Company had $46 million ($20 mil- lion as at December 31, 2012) of investments accounted for under the equity method and $11 million ($10 million as at December 31, 2012) of investments accounted for under the cost method. 6 Accounts payable and other In millions Trade payables Payroll-related accruals Accrued charges Accrued interest Income and other taxes Stock-based incentives liability (Note 10) Personal injury and other claims provisions (Note 16) Environmental provisions (Note 16) Other postretirement benefits liability (Note 11) December 31, 2013 2012 $ 408 $ 386 351 156 125 96 80 45 41 18 340 135 105 294 88 82 31 17 Other Total accounts payable and other 157 148 $ 1,477 $ 1,626 7 Other liabilities and deferred credits In millions December 31, 2013 2012 Personal injury and other claims provisions, net of current portion (Note 16) $ 271 $ 232 Stock-based incentives liability, net of current portion (Note 10) Environmental provisions, net of current portion (Note 16) Deferred credits and other 240 203 78 226 92 249 Total other liabilities and deferred credits $ 815 $ 776 62 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements 8 Long-term debt In millions Debentures and notes: (A) Canadian National series: 4.40% 10-year notes (B) 4.95% 6-year notes (B) - 2-year floating rate notes (C) 5.80% 10-year notes (B) 1.45% 5-year notes (B) 5.85% 10-year notes (B) 5.55% 10-year notes (B) 6.80% 20-year notes (B) 5.55% 10-year notes (B) 2.85% 10-year notes (B) 2.25% 10-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) 6.38% 30-year debentures (B) 3.50% 30-year notes (B) 4.50% 30-year notes (B) Illinois Central series: 5.00% 99-year income debentures 7.70% 100-year debentures Outstanding US dollar- denominated amount Maturity December 31, 2013 2012 Mar. 15, 2013 $ - $ - $ 398 Jan. 15, 2014 Nov. 6, 2015 June 1, 2016 Dec. 15, 2016 Nov. 15, 2017 May 15, 2018 July 15, 2018 Mar. 1, 2019 Dec. 15, 2021 Nov. 15, 2022 May 15, 2023 July 15, 2028 Oct. 15, 2031 Aug. 1, 2034 June 1, 2036 July 15, 2036 Nov. 15, 2037 Nov. 15, 2042 Nov. 7, 2043 Dec. 1, 2056 Sep. 15, 2096 325 350 250 300 250 325 200 550 400 250 150 475 200 500 450 250 300 250 250 7 125 346 372 266 319 266 346 213 585 425 266 159 505 213 532 479 266 319 266 266 7 133 323 - 249 298 249 323 199 547 398 249 149 473 199 498 448 249 298 249 - 7 124 Total US dollar-denominated debentures and notes $ 6,157 6,549 5,927 BC Rail series: Non-interest bearing 90-year subordinated notes (D) July 14, 2094 Total debentures and notes Other: Commercial paper (E) (F) Accounts receivable securitization (G) Capital lease obligations and other (H) Total debt, gross Less: Net unamortized discount Total debt (I) (1) Less: Current portion of long-term debt (I) Total long-term debt (1) See Note 17 – Financial instruments, for the fair value of debt. 842 842 7,391 6,769 273 250 783 - - 985 8,697 7,754 857 854 7,840 6,900 1,021 577 $ 6,819 $ 6,323 Footnotes to the table follow on the next page. Canadian National Railway Company U.S. GAAP 2013 Annual Report 63 Notes to Consolidated Financial Statements 8 Long-term debt continued 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 formu- The Company has revised the Consolidated Statement of Cash Flows for 2012 and 2011 to present the cash flows from the issuances and repayments of commercial paper on a net basis, consistent with the presentation adopted for 2013. The Company chose to present such cash flows on a net basis since the issuance and repayments of commercial paper are part of the Company’s cash management activities and this debt matures in la price based on interest rates prevailing at the time of redemption. less than 90 days. C. These floating rate notes bear interest at the three-month London Interbank Offered Rate (LIBOR) plus 0.20%. The interest rate as at December 31, 2013 was 0.44%. D. The Company records these notes as a discounted debt of $9 million, using an imputed interest rate of 5.75%. The discount of $833 million is included in the net unamortized discount. G. On December 20, 2012, the Company entered into a three-year agreement, commencing on February 1, 2013, to sell an undivided co-ownership interest in a revolving pool of accounts receivable to unrelated trusts for maximum cash proceeds of $450 million. The trusts are multi-seller trusts and the Company is not the primary beneficiary. Funding for the acquisition of these assets is custom- arily through the issuance of asset-backed commercial paper notes by the unrelated trusts. E. The Company has an $800 million revolving credit facility agree- ment with a consortium of lenders. The agreement allows for an increase in the facility amount, up to a maximum of $1.3 billion, as well as the option to extend the term by an additional year at each The Company has retained the responsibility for servicing, administering and collecting the receivables sold. The average servicing period is approximately one month. Subject to customary indemnifications, each trust’s recourse is limited to the accounts anniversary date, subject to the consent of individual lenders. The receivable transferred. Company exercised such option and on March 22, 2013, the expiry date of the agreement was extended by one year to May 5, 2018. The credit facility, containing customary terms and conditions, is avail- able for working capital and general corporate purposes, including back-stopping the Company’s commercial paper program, and pro- vides for borrowings at various interest rates, including the Canadian The Company is subject to customary reporting requirements for which failure to perform could result in termination of the pro- gram. In addition, the program 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 prime rate, bankers’ acceptance rates, the U.S. federal funds effective could cause such termination. rate and the LIBOR, plus applicable margins. The credit facility agree- ment has one financial covenant, which limits debt as a percentage of total capitalization, and with which the Company is in compliance. As at December 31, 2013 and December 31, 2012, the Company had no outstanding borrowings under its revolving credit facility and there were no draws during the years ended December 31, 2013 and 2012. F. The Company has a commercial paper program, which is backed by its revolving credit facility, enabling it to issue commercial paper up to a maximum aggregate principal amount of $800 million, or the US dollar equivalent. As at December 31, 2013, the Company had total borrowings of $273 million presented in Current portion of long-term debt on the Consolidated Balance Sheet (nil as at December 31, 2012). The weighted-average interest rate on these borrowings was 1.14%. The accounts receivable securitization program provides the Company with readily available short-term financing for general corporate use. In the event the program is terminated before its scheduled maturity, the Company expects to meet its future pay- ment obligations through its various sources of financing including its revolving credit facility and commercial paper program, and/or access to capital markets. The Company accounts for its accounts receivable securitiza- tion program under ASC 860, Transfers and Servicing. Based on the structure of the program, the Company accounts for the pro- ceeds as a secured borrowing. As such, as at December 31, 2013, the Company recorded $250 million of proceeds received under the accounts receivable securitization program in the Current por- tion of long-term debt on the Consolidated Balance Sheet at a weighted-average interest rate of 1.18% which is secured by and The Company presents issuances and repayments of commercial limited to $281 million of accounts receivable. paper in the Consolidated Statement of Cash Flows, all of which have a maturity less than 90 days, on a net basis. The following table presents the gross issuances and repayments of commercial paper: In millions Year ended December 31, 2013 2012 2011 Issuances of commercial paper $ 3,255 $ 1,861 $ 659 Repayments of commercial paper $ (2,987) $ (1,943) $ (575) 64 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements H. During 2013, the Company recorded $44 million in assets 9 Capital stock it acquired through equipment leases ($94 million in 2012), for which an equivalent amount was recorded in debt. A. Authorized capital stock Interest rates for capital lease obligations range from ap- proximately 0.7% to 8.5% with maturity dates in the years 2014 through 2037. The imputed interest on these leases amounted 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 to $209 million as at December 31, 2013 and $249 million as at value, issuable in series December 31, 2012. • Unlimited number of Class B Preferred Shares, without par The capital lease obligations are secured by properties with a value, issuable in series net carrying amount of $779 million as at December 31, 2013 and $1,021 million as at December 31, 2012. I. Long-term debt maturities, including repurchase arrangements and capital lease repayments on debt outstanding as at December 31, 2013, for the next five years and thereafter, are as follows: In millions 2014 (1) 2015 2016 2017 2018 Capital leases Debt Total $ 153 $ 868 $ 1,021 83 287 143 7 369 582 263 556 452 869 406 563 B. Issued and outstanding common shares Common stock split On October 22, 2013, the Board of Directors of the Company approved a two-for-one common stock split in the form of a stock dividend of one additional common share of CN for each share outstanding, which was paid on November 29, 2013, to share- holders of record on November 15, 2013. All share and per share data presented herein reflect the impact of the stock split. The following table provides the activity of the issued and outstanding common shares of the Company for the years ended December 31, 2013, 2012 and 2011: In millions Year ended December 31, 2013 2012 2011 2019 and thereafter 109 4,420 4,529 Issued and outstanding common shares $ 782 $ 7,058 $ 7,840 at beginning of year 856.8 884.2 918.7 (1) Current portion of long-term debt. J. The aggregate amount of debt payable in US currency as at December 31, 2013 was US$6,730 million (C$7,158 million), in- cluding US$573 million relating to capital leases and other; and US$6,690 million (C$6,656 million), including US$733 million relating to capital leases and other, as at December 31, 2012. K. The Company has a series of bilateral letter of credit facility agreements with various banks to support its requirements to post letters of credit in the ordinary course of business. On March 22, 2013, the expiry date of these agreements was extended by one year to April 28, 2016. Under these agreements, the Company has the option from time to time to pledge collateral in the form of cash or cash equivalents, for a minimum term of one month, equal to at least the face value of the letters of credit issued. As at December 31, 2013, the Company had letters of credit drawn of $481 million ($551 million as at December 31, 2012) from a total committed amount of $503 million ($562 million as at December 31, 2012) by the various banks. As at December 31, 2013, cash and cash equivalents of $448 million ($521 million as at December 31, 2012) were pledged as collateral and recorded as Restricted cash and cash equivalents on the Consolidated Balance Sheet. Number of shares repurchased through buyback programs Stock options exercised Issued and outstanding common shares (27.6) (33.8) (39.8) 1.4 6.4 5.3 at end of year 830.6 856.8 884.2 Share repurchase programs On October 22, 2012, the Board of Directors of the Company approved a share repurchase program which allowed for the re- purchase of up to $1.4 billion in common shares, not to exceed 36.0 million common shares, between October 29, 2012 and October 28, 2013 pursuant to a normal course issuer bid at pre- vailing market prices plus brokerage fees, or such other prices as may be permitted by the Toronto Stock Exchange. The Company repurchased a total of 29.4 million common shares for $1.4 billion under this share repurchase program. On October 22, 2013, the Board of Directors of the Company approved a new share repurchase program which allows for the repurchase of up to 30.0 million common shares, between October 29, 2013 and October 23, 2014 pursuant to a normal course issuer bid at prevailing market prices plus brokerage fees, or such other prices as may be permitted by the Toronto Stock Exchange. Canadian National Railway Company U.S. GAAP 2013 Annual Report 65 Notes to Consolidated Financial Statements 9 Capital stock continued B. Stock-based compensation plans The following table provides the information related to the expense for awards under all plans, as well as the related tax bene- share repurchase programs for the years ended December 31, fit recognized in income, for the years ended December 31, 2013, The following table provides the total stock-based compensation 2013, 2012 and 2011: In millions, except per share data 2012 and 2011: In millions Year ended December 31, 2013 2012 2011 Year ended December 31, 2013 2012 2011 Number of common shares (1) 27.6 33.8 39.8 Cash settled awards Share Unit Plan Weighted-average price per share (2) $ 50.65 $ 41.36 $ 35.67 Voluntary Incentive Deferral Plan Amount of repurchase $ 1,400 $ 1,400 $ 1,420 (1) Includes common shares purchased in the first and fourth quarters of 2013, 2012 and 2011 pursuant to private agreements between the Company and arm’s-length third-party sellers. (2) Includes brokerage fees. 10 Stock plans The Company has various stock-based incentive plans for eligible employees. All share and per share data for such plans reflect the impact of the stock split (see Note 9 – Capital stock). 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. The following table provides the number of participants hold- ing shares, the total number of ESIP shares purchased on behalf of employees, including the Company’s contributions, as well as the resulting expense recorded for the years ended December 31, 2013, 2012 and 2011: $ 92 $ 76 $ 81 35 127 9 19 95 10 21 102 10 Stock option awards Total stock-based compensation expense $ 136 $ 105 $ 112 Tax benefit recognized in income $ 35 $ 25 $ 24 (i) Cash settled awards Share Unit Plan In 2013, the Company granted 0.8 million performance share units (PSUs), previously known as restricted share units (RSUs), (0.9 million in both 2012 and 2011) to designated management employees entitling them to receive payout in cash based on the Company’s share price. The PSUs granted are generally scheduled for payout after three years (“plan period”) and vest conditionally upon the attainment of a target relating to return on invested cap- ital (ROIC) over the plan period. Such performance vesting criteria results in a performance vesting factor that ranges from 0% to 150% depending on the level of ROIC attained. Payout is conditional upon the attainment of a minimum share price, calculated using the average of the last three months of the plan period. In addition, commencing at various dates, for senior and executive management employees (“executive employees”), payout for PSUs is also conditional on compliance with the con- ditions of their benefit plans, award or employment agreements, including but not limited to non-compete, non-solicitation and non-disclosure of confidential information conditions. Current or former executive employees who breach such conditions of their Year ended December 31, 2013 2012 2011 benefit plans, award or employment agreements will forfeit the PSU Number of participants holding shares 18,488 17,423 16,218 Total number of ESIP shares purchased on behalf of employees (millions) 2.3 Expense for Company contribution (millions) $ 30 payout. Should the Company reasonably determine that a current or former executive employee may have violated the conditions of 2.5 $ 24 2.6 $ 21 their benefit plans, award or employment agreement, the Company may at its discretion change the manner of vesting of the PSUs to suspend payout on any PSUs pending resolution of such matter. The value of the payout is equal to the number of PSUs award- ed multiplied by the performance vesting factor and by the 20-day average closing share price ending on January 31 of the following year. On December 31, 2013, for the 2011 grant, the level of ROIC attained resulted in a performance vesting factor of 150%. As the minimum share price condition was met, payout under the plan of approximately $80 million, calculated using the Company’s aver- age share price during the 20-day period ending on January 31, 2014, will be paid to employees meeting the conditions of their 66 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements benefit plans, award or employment agreements in the first quar- Voluntary Incentive Deferral Plan ter of 2014. The Company has a Voluntary Incentive Deferral Plan (VIDP), pro- In February 2012, the Company’s Board of Directors unani- viding eligible senior management employees the opportunity to mously voted to forfeit and cancel the PSU payout of approximate- elect to receive their annual incentive bonus payment and other ly $18 million otherwise due in February 2012 to its former Chief eligible incentive payments in deferred share units (DSUs). A DSU is Executive Officer (CEO) after determining that the former CEO equivalent to a common share of the Company and also earns divi- was likely in breach of his non-compete and non-disclosure of dends when normal cash dividends are paid on common shares. confidential information conditions contained in the former CEO’s The number of DSUs received by each participant is established employment agreement. On February 4, 2013, the Company’s using the average closing price for the 20 trading days prior to and Executive Vice-President and Chief Operating Officer (COO) re- including the date of the incentive payment. For each participant, signed to join the Company’s major competitor in Canada. As a the Company will grant a further 25% of the amount elected in result of the COO’s resignation, compensation amounts subject DSUs, which will vest over a period of four years. The election to to non-compete, non-solicitation and other applicable terms of receive eligible incentive payments in DSUs is no longer available his long-term incentive award agreements and related plans, and to a participant when the value of the participant’s vested DSUs certain amounts accumulated under non-registered pension plans is sufficient to meet the Company’s stock ownership guidelines. and arrangements were forfeited. In February 2013, the Company The value of each participant’s DSUs is payable in cash at the time entered into confidential agreements to settle these matters. As of cessation of employment. The Company’s liability for DSUs is a result, in the quarter ended March 31, 2013, the stock-based marked-to-market at each period-end based on the Company’s compensation liability was reduced by approximately $20 million. closing stock price. The following table provides the 2013 activity for all cash settled awards: In millions Outstanding at December 31, 2012 Granted (Payout) Transferred into plan Forfeited/Settled Vested during year Outstanding at December 31, 2013 PSUs VIDP Nonvested Vested Nonvested Vested 1.9 0.8 - (0.1) (0.9) 1.7 1.4 (1) (0.9) - (0.5) (1) 0.9 0.9 - - - - - - 2.8 (0.6) 0.1 - - 2.3 (1) The balance outstanding at December 31, 2012 included the units of the PSU payout otherwise due to the Company’s former CEO that were in dispute which were settled in the first quarter of 2013. Canadian National Railway Company U.S. GAAP 2013 Annual Report 67 Notes to Consolidated Financial Statements 10 Stock plans continued The following table provides valuation and expense information for all cash settled awards: In millions, unless otherwise indicated PSUs (1) VIDP (2) Total Year of grant 2013 2012 2011 2010 2009 Stock-based compensation expense (recovery) recognized over requisite service period Year ended December 31, 2013 (3) Year ended December 31, 2012 Year ended December 31, 2011 Liability outstanding December 31, 2013 December 31, 2012 Fair value per unit December 31, 2013 ($) $ 34 N/A N/A $ 34 N/A $ $ $ $ 37 24 N/A 61 24 $ $ $ $ $ 34 26 19 80 45 $ $ $ $ $ (4) 26 27 - 70 $ $ $ $ $ (9) - 35 - 18 $ $ $ 35 19 21 $ 127 $ 95 $ 102 $ 145 $ 134 $ 320 $ 291 $ 55.12 $ 59.66 $ 60.56 N/A N/A $ 60.56 N/A Fair value of awards vested during the year Year ended December 31, 2013 Year ended December 31, 2012 Year ended December 31, 2011 Nonvested awards at December 31, 2013 Unrecognized compensation cost Remaining recognition period (years) $ - N/A N/A $ 26 2.0 $ $ - - N/A $ 15 $ $ $ $ 80 - - - 1.0 N/A $ $ Assumptions (5) Stock price ($) Expected stock price volatility (6) Expected term (years) (7) Risk-free interest rate (8) Dividend rate ($) (9) $ 60.56 $ 60.56 $ 60.56 14% 2.0 14% 1.0 1.13% 0.99% $ 0.86 $ 0.86 N/A N/A N/A N/A N/A 70 - N/A N/A N/A N/A N/A N/A N/A N/A N/A $ 82 $ $ $ 1 1 1 $ $ $ 81 71 83 N/A N/A N/A N/A N/A N/A N/A $ 1 $ 42 N/A (4) N/A $ 60.56 N/A N/A N/A N/A N/A N/A N/A N/A N/A (1) Compensation cost is based on the fair value of the awards at period-end using the lattice-based valuation model that uses the assumptions as presented herein. (2) Compensation cost is based on intrinsic value. (3) Includes the reversal of stock-based compensation expense related to the forfeiture of PSUs by the Company’s former CEO and COO. (4) The remaining recognition period has not been quantified as it relates solely to the 25% Company grant and the dividends earned thereon, representing a minimal number of units. (5) Assumptions used to determine fair value are at December 31, 2013. (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. (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. 68 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements (ii) Stock option awards December 31, 2013, 20.2 million common shares remained au- The Company has stock option plans for eligible employees to thorized for future issuances under these plans. acquire common shares of the Company upon vesting at a price For 2013, 2012 and 2011, the Company granted 1.1 million, equal to the market value of the common shares at the date of 1.2 million and 1.3 million, respectively, of conventional stock op- granting. The options issued by the Company are conventional tions to designated senior management employees that vest over options that vest over a period of time. The right to exercise op- a period of four years of continuous employment. tions generally accrues over a period of four years of continuous The total number of conventional options outstanding at employment. Options are not generally exercisable during the first December 31, 2013 was 7.7 million. 12 months after the date of grant and expire after 10 years. At The following table provides the activity of stock option awards during 2013, and for options outstanding and exercisable at December 31, 2013, the weighted-average exercise price: Outstanding at December 31, 2012 (1) Granted Forfeited Exercised Vested Outstanding at December 31, 2013 (1) Exercisable at December 31, 2013 (1) Options outstanding Number Weighted- average of options exercise price In millions 8.5 1.1 (0.5) (1.4) N/A 7.7 5.0 $ 26.05 $ 47.47 $ 36.06 $ 19.54 N/A $ 30.97 $ 25.58 Nonvested options Weighted- Number average grant of options date fair value In millions 3.4 1.1 (0.2) N/A (1.6) 2.7 N/A $ 7.28 $ 8.52 $ 7.93 N/A $ 6.95 $ 7.89 N/A (1) Stock options with a US 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 the number of stock options outstanding and exercisable as at December 31, 2013 by range of exercise price and their related intrinsic value, and for options outstanding, the weighted-average years to expiration. The table also provides the aggregate intrinsic value for in-the-money stock options, which represents the value that would have been received by option holders had they exercised their options on December 31, 2013 at the Company’s closing stock price of $60.56. Range of exercise prices $15.52 – $18.17 $18.18 – $23.76 $23.77 – $30.79 $30.80 – $40.61 $40.62 – $53.34 Balance at December 31, 2013 (1) of options In millions 0.9 0.8 2.8 2.2 1.0 7.7 Options outstanding Weighted- Number average years Weighted- average to expiration exercise price Aggregate intrinsic value In millions $ 40 31 95 50 11 $ 227 Options exercisable Number Weighted- average of options exercise price In millions Aggregate intrinsic value In millions 0.9 0.8 2.4 0.8 0.1 5.0 $ 17.47 $ 21.96 $ 26.03 $ 37.19 $ 42.25 $ 25.58 $ 40 31 84 19 - $ 174 2.8 4.5 4.4 7.6 9.1 5.7 $ 17.47 $ 21.96 $ 26.18 $ 37.79 $ 49.13 $ 30.97 (1) Stock options with a US 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, 2013, all stock options outstanding were in-the-money. The weighted-average years to expiration of exercisable stock options was 4.5 years. Canadian National Railway Company U.S. GAAP 2013 Annual Report 69 Notes to Consolidated Financial Statements 10 Stock plans continued The following table provides valuation and expense information for all stock option awards: In millions, unless otherwise indicated Year of grant 2013 2012 2011 2010 2009 2008 2007 Total Stock-based compensation expense recognized over requisite service period (1) Year ended December 31, 2013 $ 5 Year ended December 31, 2012 Year ended December 31, 2011 N/A N/A $ $ 2 4 N/A $ $ $ 1 2 5 $ $ $ 1 2 2 $ $ $ - 2 2 N/A - 1 $ $ N/A N/A $ - $ $ $ 9 10 10 Fair value per unit At grant date ($) $ 8.52 $ 7.74 $ 7.83 $ 6.55 $ 6.30 $ 6.22 $ 6.68 N/A Fair value of awards vested during the year Year ended December 31, 2013 $ - Year ended December 31, 2012 Year ended December 31, 2011 N/A N/A $ $ 2 - N/A $ $ $ 3 2 - Nonvested awards at December 31, 2013 Unrecognized compensation cost $ 3 $ 2 $ 1 Remaining recognition period (years) 3.0 2.0 1.0 $ $ $ $ 2 2 2 - - $ $ $ $ 4 4 4 - - $ $ N/A 3 3 N/A N/A N/A N/A $ 3 $ $ $ 11 11 12 N/A N/A $ 6 N/A Assumptions Grant price ($) $ 47.47 $ 38.35 $ 34.47 $ 27.38 $ 21.07 $ 24.25 $ 26.40 Expected stock price volatility (2) 23% 26% 26% 28% 39% 27% 24% Expected term (years) (3) Risk-free interest rate (4) Dividend rate ($) (5) 5.4 5.4 5.3 5.4 5.3 5.3 1.41% 1.33% 2.53% 2.44% 1.97% 3.58% $ 0.86 $ 0.75 $ 0.65 $ 0.54 $ 0.51 $ 0.46 5.2 4.12% $ 0.42 N/A N/A N/A N/A N/A (1) Compensation cost is based on the grant date fair value using the Black-Scholes option-pricing model that uses the assumptions at the grant date. (2) Based on the average of the historical volatility of the Company’s stock over a period commensurate with the expected term of the award and the implied volatility from traded options on the Company’s stock. (3) Represents the period of time that awards are expected to be outstanding. 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. (4) Based on the implied yield available on zero-coupon government issues with an equivalent term commensurate with the expected term of the awards. (5) Based on the annualized dividend rate. The following table provides information related to stock op- (iii) Stock price volatility tions exercised for the years ended December 31, 2013, 2012 and Compensation cost for the Company’s Share Unit Plan is based on 2011: In millions Year ended December 31, 2013 2012 2011 Total intrinsic value Cash received upon exercise of options Related excess tax benefit realized $ 45 $ 28 $ 3 $ 167 $ 101 $ 16 $ 122 $ 68 $ 9 the fair value of the awards at period end using the lattice-based valuation model for which a primary assumption is the Company’s share price. In addition, the Company’s liability for the VIDP is marked-to-market at period-end and, as such, is also reliant on the Company’s share price. Fluctuations in the Company’s share price cause volatility to stock-based compensation expense as recorded in net income. The Company does not currently hold any derivative financial instruments to manage this exposure. A $1 increase in the Company’s share price at December 31, 2013 would have increased stock-based compensation expense by $6 million, whereas a $1 decrease in the price would have reduced it by $5 million. 70 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements 11 Pensions and other postretirement benefits The Company has various retirement benefit plans under which substantially all of its employees are entitled to benefits at retire- ment age, generally based on compensation and length of service and/or contributions. Senior and executive management employ- ees (“executive employees”) subject to certain minimum service and age requirements, are also eligible for an additional retirement benefit under their Special Retirement Stipend Agreements (SRS), loss sharing mechanism, subject to guaranteed minimum increases. An independent trust company is the Trustee of the Company’s pen- sion trust funds (including the CN Pension Trust Fund). As Trustee, the trust company performs certain duties, which include holding legal title to the assets of the CN Pension Trust Fund and ensuring that the Company, as Administrator, complies with the provisions of the CN Pension Plan and the related legislation. The Company util- izes a measurement date of December 31 for the CN Pension Plan. the Supplemental Executive Retirement Plan (SERP) or the Defined B. Funding policy Contribution Supplemental Executive Retirement Plan (DC SERP). Executive employees who breach the non-compete, non-solicita- tion and non-disclosure of confidential information conditions of the SRS, SERP or DC SERP plans or other employment agreement will forfeit the retirement benefit under these plans. Should the Company reasonably determine that a current or former executive employee may have violated the conditions of their SRS, SERP, or DC SERP plan or other employment agreement, the Company may at its discretion withhold or suspend payout of the retirement benefit pending resolution of such matter. On February 4, 2013, the Company’s COO resigned to join the Company’s major competitor in Canada. As a result, compen- sation amounts accumulated under the non-registered pension plans subject to non-compete and non-solicitation agreements were forfeited. The Company has recorded an actuarial gain relat- ed to the amounts forfeited. In 2012, the Company cancelled the $1.5 million annual retirement benefit otherwise due to its former CEO after determining that the former CEO was likely in breach of the non-compete, non-solicitation and non-disclosure of confi- dential information conditions contained in the former CEO’s em- ployment agreement. The Company recorded a settlement gain of $20 million from the termination of the former CEO’s retirement benefit plan for the period beyond June 28, 2012, which was partially offset by the recognition of past accumulated actuarial losses of approximately $4 million. In February 2013, the Company Employee contributions to the CN Pension 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, including amendments and regulations thereto, and are determined by actuarial valuations. Actuarial valuations are generally required on an annual basis for all Canadian plans, or when deemed appropriate by the Office of the Superintendent of Financial Institutions (OSFI). These actuarial valuations are prepared in accordance with legislative require- ments and with the recommendations of the Canadian Institute of Actuaries for the valuation of pension plans. The Company’s most recently filed actuarial valuations conducted as at December 31, 2012 indicated a funding excess on a going-concern basis of ap- proximately $1.4 billion and a funding deficit on a solvency basis of approximately $2.1 billion calculated using the three-year average of the Company’s hypothetical wind-up ratio in accordance with the Pension Benefit Standards Regulations, 1985. The Company’s next actuarial valuations required as at December 31, 2013 will be per- formed in 2014. These actuarial valuations are expected to identify a going-concern surplus of approximately $1.7 billion, while on a solvency basis a funding deficit of approximately $1.7 billion is ex- pected due to the level of interest rates applicable at their respective measurement dates. The federal pension legislation requires fund- ing deficits, as calculated under current pension regulations, to be paid over a number of years. Actuarial valuations are also required entered into confidential agreements to settle these matters. annually for the Company’s U.S. pension plans. The Company also offers postretirement benefits to certain employees providing life insurance, medical benefits and, for a closed group of employees, free rail travel benefits during retire- ment. These postretirement benefits are funded as they become due. The information in the tables that follow pertains to all of the Company’s defined benefit plans. However, the following descrip- tions relate solely to the Company’s main pension plan, the CN Pension Plan, unless otherwise specified. A. Description of the CN Pension Plan The CN Pension Plan is a contributory defined benefit pension plan that covers the majority of CN employees. It provides for pensions based mainly on years of service and final average pensionable earn- In 2013, in anticipation of its future funding requirements, the Company made voluntary contributions of $100 million in excess of the required contributions mainly to strengthen the financial position of its main pension plan, the CN Pension Plan. These vol- untary contributions can be treated as a prepayment against its fu- ture required special solvency deficit payments. As at December 31, 2013, the Company had $470 million of accumulated prepayments which remain available to offset future required solvency deficit payments. The Company expects to use approximately $335 mil- lion of these prepayments to satisfy its 2014 required solvency deficit payment. As a result, the Company’s cash contributions for 2014 are expected to be $130 million, for all the Company’s pension plans. As at February 3, 2014, the Company contributed ings and is generally applicable from the first day of employment. $89 million to its defined benefit pension plans for 2014. Indexation of pensions is provided after retirement through a gain/ Canadian National Railway Company U.S. GAAP 2013 Annual Report 71 Notes to Consolidated Financial Statements 11 Pensions and other postretirement benefits (iii) Equity investments are primarily publicly traded securities, continued C. Plan assets The assets of the Company’s various Canadian defined benefit pen- sion plans are held in separate trust funds (Trusts) which are diversified by asset type, country and investment strategies. Each year, the CN Board of Directors reviews and confirms or amends the Statement of Investment Policies and Procedures (SIPP) which includes the plans’ long-term asset mix and related benchmark indices (Policy). This Policy is based on a long-term forward-looking view of the world economy, the dynamics of the plans’ benefit liabilities, the market return expect- ations of each asset class and the current state of financial markets. Annually, the CN Investment Division (Investment Manager), a div- ision of the Company created to invest and administer the assets of the plans, proposes a short-term asset mix target (Strategy) for the coming year, which is expected to differ from the Policy, because of current economic and market conditions and expectations. The Investment Committee of the Board (Committee) regularly compares the actual asset mix to the Policy and Strategy and compares the actual perform- ance of the Trusts to the performance of the benchmark indices. The Company’s 2013 target long-term asset mix and actual asset allocation for the Company’s pension plans based on fair value, are as follows: Asset allocation Cash and short-term investments Bonds and mortgages Equities Real estate Oil and gas Infrastructure Absolute return Risk-based allocation Total Target long-term asset mix Percentage of plan assets 2012 2013 3% 37% 45% 4% 7% 4% - - 5% 25% 41% 2% 8% 5% 10% 4% 4% 28% 41% 2% 8% 4% 9% 4% 100% 100% 100% The Committee’s approval is required for all major investments in illiquid securities. The SIPP allows for the use of derivative fi- nancial instruments to implement strategies, hedge, and adjust existing or anticipated exposures. The SIPP prohibits investments in securities of the Company or its subsidiaries. Investments held in the Trusts consist mainly of the following: (i) Cash and short-term investments consist primarily of highly liquid investments which ensure adequate cash flows are available to cover near-term benefit payments. Short-term investments are mainly obligations issued by Canadian chartered banks. (ii) Bonds include bond instruments, issued or guaranteed by gov- ernments and corporate entities, as well as corporate notes. As at December 31, 2013, 91% of bonds were issued or guar- anteed by Canadian, U.S. or other governments. Mortgages consist of mortgage products which are primarily conventional or participating loans secured by commercial properties. well diversified by country, issuer and industry sector. In 2013, the most significant allocation to an individual issuer was approximately 2% and the most significant allocation to an industry sector was approximately 25%. (iv) Real estate is a diversified portfolio of Canadian land and com- mercial properties held by the Trusts’ wholly-owned subsidiaries. (v) Oil and gas investments include petroleum and natural gas prop- erties operated by the Trusts’ wholly-owned subsidiaries and list- ed and non-listed Canadian securities of oil and gas companies. (vi) Infrastructure investments include participations in private infra- structure funds, public and private debt and publicly traded equity securities of infrastructure and utility companies. Some of these investments are held by the Trusts’ wholly-owned subsidiaries. (vii) Absolute return investments are a portfolio of units of externally managed hedge funds, which are invested in various long/short strategies within fixed income, commodities, equities, global macro and multi-strategy funds, as presented in the table of fair value measurement. External managers are monitored on a con- tinuous basis through investment and operational due diligence. (viii) Risk-based allocation is a portfolio of externally managed funds where each asset class contributes equally to the over- all risk of the portfolio in order to capture over time different asset classes risk premiums. Some of these investments are held by the Trusts’ wholly-owned subsidiaries. The plans’ Investment Manager monitors market events and exposures to markets, currencies and interest rates daily. When investing in foreign securities, the plans are exposed to foreign cur- rency risk that may be adjusted or hedged; the effect of which is included in the valuation of the foreign securities. Net of the effects mentioned above, the plans were 66% exposed to the Canadian dollar, 14% to the US dollar, 8% to European currencies, and 12% to various other currencies as at December 31, 2013. Interest rate risk represents the risk that the fair value of the investments will fluc- tuate due to changes in market interest rates. Sensitivity to interest rates is a function of the timing and amount of cash flows of the assets and liabilities of the plans. To manage credit risk, established policies require dealing with counterparties considered to be of high credit quality. Derivatives are used from time to time to adjust asset mix or exposures to foreign currencies, interest rate or market risks of the portfolio or anticipated transactions. Derivatives are contrac- tual agreements whose value is derived from interest rates, foreign exchange rates, and equity or commodity prices. They include for- wards, futures, options and swaps and are included in investment categories based on their underlying exposure. When derivatives are used for hedging purposes, the gains or losses on the derivatives are offset by a corresponding change in the value of the hedged assets. The tables on the following page present the fair value of plan assets as at December 31, 2013 and 2012 by asset class, their level within the fair value hierarchy and the valuation techniques and inputs used to measure such fair value. 72 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements In millions Asset class Cash and short-term investments (1) Bonds (2) Canada, U.S. and supranational Provinces of Canada and municipalities Corporate Emerging market debt Mortgages (3) Equities (4) Canadian U.S. International Real estate (5) Oil and gas (6) Infrastructure (7) Absolute return funds (8) Multi-strategy Fixed income Equity Global macro Risk-based allocation (9) Other (10) Total plan assets In millions Asset class Cash and short-term investments (1) Bonds (2) Canada, U.S. and supranational Provinces of Canada and municipalities Corporate Emerging market debt Mortgages (3) Equities (4) Canadian U.S. International Real estate (5) Oil and gas (6) Infrastructure (7) Absolute return funds (8) Multi-strategy Fixed income Commodity Equity Global macro Risk-based allocation (9) Other (10) Total plan assets Total Fair value measurements at December 31, 2013 Level 3 Level 2 Level 1 $ 897 $ 16 $ 881 $ 1,416 2,297 111 261 166 2,160 1,307 3,421 299 1,380 788 460 519 391 328 607 - - - - - 2,138 1,307 3,421 - 379 10 - - 2 - - 1,416 2,297 111 261 166 - - - - 40 115 460 486 389 328 607 - - - - - - 22 - - 299 961 663 - 33 - - - $ 16,808 $ 7,273 $ 7,557 $ 1,978 61 $ 16,869 Total Fair value measurements at December 31, 2012 Level 3 Level 1 Level 2 $ 615 $ 13 $ 602 $ 1,735 2,152 35 353 133 2,220 1,121 3,082 279 1,339 679 410 425 91 259 296 586 - - - - - 2,198 1,121 3,082 - 370 8 - - - - - - 1,735 2,152 35 353 133 - - - - 29 94 410 415 91 259 296 586 - - - - - - 22 - - 279 940 577 - 10 - - - - $ 15,810 $ 6,792 $ 7,190 $ 1,828 1 $ 15,811 Level 1: Fair value based on quoted prices in active markets for identical assets. Level 2: Fair value based on significant observable inputs. Level 3: Fair value based on significant unobservable inputs. Footnotes to the table follow on the next page. Canadian National Railway Company U.S. GAAP 2013 Annual Report 73 Notes to Consolidated Financial Statements 11 Pensions and other postretirement benefits continued The following table reconciles the beginning and ending balances of the fair value of investments classified as Level 3: Fair value measurements based on significant unobservable inputs (Level 3) Absolute In millions Equities (4) Real estate (5) Oil and gas (6) Infrastructure (7) return (8) Total Beginning balance at December 31, 2011 $ 22 $ 214 $ 889 $ 619 Actual return relating to assets still held at the reporting date Purchases, sales and settlements 2 (2) 68 (3) 90 (39) (13) (29) Balance at December 31, 2012 $ 22 $ 279 $ 940 $ 577 Actual return relating to assets still held at the reporting date Purchases, sales and settlements 2 (2) 26 (6) 72 (51) 43 43 $ $ - - 10 10 3 20 $ 1,744 147 (63) $ 1,828 146 4 Ending balance at December 31, 2013 $ 22 $ 299 $ 961 $ 663 $ 33 $ 1,978 (1) Cash and short-term investments are valued at cost, which approximates fair value, and are categorized as Level 1 for cash and Level 2 for short-term investments. (2) Bonds are valued using mid-price bids obtained from independent pricing data suppliers, predominantly TMX Group Inc. When prices are not available from independent sources, the fair value is based on the present value of future cash flows using current market yields for comparable instruments. All bonds are categorized as Level 2. (3) Mortgages are secured by real estate. The fair value of $166 million ($133 million in 2012) of mortgages categorized as Level 2 is based on the present value of future cash flows using current market yields for comparable instruments. (4) The fair value of equity investments categorized as Level 1 is based on quoted prices in active markets. The fair value of equity investments of $22 million ($22 million in 2012) categorized as Level 3 represent units in private equity funds which are valued by their independent administrators. (5) The fair value of real estate investments of $299 million ($279 million in 2012) includes land and buildings classified as Level 3 and is presented net of related mortgage debt of $41 million ($48 million in 2012). Land is valued based on the fair value of comparable assets, and buildings are valued based on the present value of estimated future net cash flows or the fair value of comparable assets. Independent valuations of land and buildings are performed triennially on a rotational basis. (6) Oil and gas investments categorized as Level 1 are valued based on quoted prices in active markets. Investments in oil and gas equities traded on a secondary market are valued based on the most recent transaction price and are categorized as Level 2. Investments of $961 million ($940 million in 2012) classified as Level 3 consist of operating oil and gas properties and the fair value is based on estimated future net cash flows that are discounted using prevailing market rates for transactions in similar assets. The future net cash flows are based on forecasted oil and gas prices and projected future annual production and costs. (7) Infrastructure investments consist of $10 million ($8 million in 2012) of publicly traded equity securities of infrastructure companies classified as Level 1, $115 million ($94 million in 2012) of public and private debt issued by infrastructure companies classified as Level 2 and $663 million ($577 million in 2012) of infrastructure funds that are classified as Level 3 and are valued based on discounted cash flows or earnings multiples. Infrastructure funds cannot be redeemed; distributions will be received from the funds as the underlying investments are liquidated. (8) Absolute return investments are valued using the net asset value as reported by the independent fund administrators. All absolute return investments have contractual redemption frequen- cies, ranging from monthly to annually, and redemption notice periods varying from 5 to 90 days. Absolute return investments that have redemption dates less frequent than every four months or that have restrictions on contractual redemption features at the reporting date are classified as Level 3. (9) Risk-based allocation investments are valued using the net asset value as reported by the independent fund administrators and are classified as Level 2. All funds have contractual redemption frequencies ranging from daily to annually, and redemption notice periods varying from 5 to 60 days. (10) Other consists of operating assets of $85 million ($94 million in 2012) and liabilities of $24 million ($93 million in 2012) required to administer the Trusts’ investment assets and the plans’ benefit and funding activities. Such assets are valued at cost and have not been assigned to a fair value category. 74 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements D. Additional disclosures (i) Obligations and funded status In millions Year ended December 31, 2013 2012 Pensions Other postretirement benefits 2012 2013 Change in benefit obligation Projected benefit obligation at beginning of year $ 16,335 $ 15,548 $ 277 $ 284 Amendments Interest cost Actuarial loss (gain) Service cost Curtailment gain Plan participants’ contributions Foreign currency changes - 658 (747) 155 - 56 16 - 740 812 134 - 55 (5) - 11 (22) 3 - - 5 6 13 (3) 4 (6) - (3) Benefit payments, settlements and transfers (1) (963) (949) (18) (18) Projected benefit obligation at end of year $ 15,510 $ 16,335 $ 256 $ 277 Component representing future salary increases (344) (443) - - Accumulated benefit obligation at end of year $ 15,166 $ 15,892 $ 256 $ 277 Change in plan assets Fair value of plan assets at beginning of year $ 15,811 $ 14,719 Employer contributions Plan participants’ contributions Foreign currency changes Actual return on plan assets Benefit payments, settlements and transfers 226 56 10 1,728 (962) 833 55 (2) 1,135 (929) Fair value of plan assets at end of year $ 16,869 $ 15,811 $ $ - - - - - - - $ $ - - - - - - - Funded status (Excess (deficiency) of fair value of plan assets over projected benefit obligation at end of year) $ 1,359 $ (524) $ (256) $ (277) (1) Includes the settlement gain related to the termination of the former CEO’s retirement benefit plan in 2012. Measurement date for all plans is December 31. The projected benefit obligation and fair value of plan assets for the CN Pension Plan at December 31, 2013 were $14,458 million and $16,059 million, respectively ($15,247 million and $15,042 million, respectively, at December 31, 2012). (ii) Amounts recognized in the Consolidated Balance Sheet In millions Noncurrent assets (Note 5) Current liabilities (Note 6) Noncurrent liabilities Total amount recognized December 31, 2013 2012 Pensions Other postretirement benefits 2012 2013 $ 1,662 $ - - - (303) (524) $ - $ - (18) (238) (17) (260) $ 1,359 $ (524) $ (256) $ (277) (iii) Amounts recognized in Accumulated other comprehensive loss (Note 18) In millions Net actuarial gain (loss) Prior service cost December 31, 2013 2012 Pensions Other postretirement benefits 2012 2013 $ (1,515) $ (3,264) $ (22) $ (26) $ $ 27 (5) $ $ 6 (6) Canadian National Railway Company U.S. GAAP 2013 Annual Report 75 Notes to Consolidated Financial Statements 11 Pensions and other postretirement benefits continued (iv) Information for the pension plans with an accumulated benefit obligation in excess of plan assets In millions Projected benefit obligation Accumulated benefit obligation Fair value of plan assets (v) Components of net periodic benefit cost (income) December 31, 2013 2012 Pensions Other postretirement benefits 2012 2013 $ $ $ 527 475 224 $ $ $ 526 461 201 N/A N/A N/A N/A N/A N/A In millions Service cost Interest cost Curtailment gain Settlement loss (gain) (1) Expected return on plan assets Amortization of prior service cost Amortization of net actuarial loss (gain) Year ended December 31, 2013 Pensions 2012 2011 Other postretirement benefits 2011 2012 2013 $ 155 $ 134 $ 124 $ 658 - 4 (958) 4 227 740 - (12) (994) 4 119 788 - 3 (1,005) 2 8 3 11 - - - 1 (1) $ $ 4 13 (6) - - 3 - 4 14 (1) - - 2 - Net periodic benefit cost (income) $ 90 $ (9) $ (80) $ 14 $ 14 $ 19 (1) Includes the settlement gain related to the termination of the former CEO’s retirement benefit plan in 2012. 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 (income) over the next fiscal year are $4 million and $129 million, respectively. 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 (income) over the next fiscal year are $2 million and $4 million, respectively. (vi) Weighted-average assumptions used in accounting for pensions and other postretirement benefits December 31, 2013 Pensions 2012 2011 Other postretirement benefits 2011 2012 2013 To determine projected benefit obligation Discount rate (1) Rate of compensation increase (2) To determine net periodic benefit cost Discount rate (1) Rate of compensation increase (2) Expected return on plan assets (3) 4.73% 4.15% 4.84% 4.69% 4.01% 4.70% 3.00% 3.00% 3.25% 3.00% 3.00% 3.25% 4.15% 4.84% 5.32% 4.01% 4.70% 5.29% 3.00% 3.25% 3.50% 3.00% 3.25% 3.50% 7.00% 7.25% 7.50% N/A N/A N/A (1) 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. For the Canadian pension and other postretirement benefit plans, future expected benefit payments at each measurement date are discounted using spot rates from a derived AA corporate bond yield curve. The derived curve is based on observed rates for AA corporate bonds with short-term maturities and a projected AA corporate curve for longer term maturities based on spreads between observed AA corporate bonds and AA provincial bonds. The derived curve 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. (2) The rate of compensation increase is determined by the Company based upon its long-term plans for such increases. (3) 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 multiple factors. The expected long-term rate of return is determined based on expected future performance for each asset class and is weighted based on the current asset portfolio mix. Consideration is taken of the historical performance, the premium return generated from an actively managed portfolio, as well as current and future anticipated asset allocations, economic developments, inflation rates and administrative expenses. Based on these factors, the rate is determined by the Company. For 2013, the Company used a long-term rate of return assumption of 7.00% on the market-related value of plan assets to compute net periodic benefit cost. 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. In 2014, the Company will maintain the expected long-term rate of return on plan assets at 7.00% to reflect management’s current view of long-term investment returns. 76 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements (vii) Health care cost trend rate for other postretirement benefits For measurement purposes, increases in the per capita cost of covered health care benefits were assumed to be 8% for 2013 and 2014. It is assumed that the rate will decrease gradually to 4.5% in 2028 and remain at that level thereafter. Assumed health care costs have a significant effect on the amounts reported for the health care plan. A one-percentage-point change in the assumed health care cost trend rate would have the following effect: In millions One-percentage-point Effect on total service and interest costs Effect on benefit obligation (viii) Estimated future benefit payments In millions 2014 2015 2016 2017 2018 Years 2019 to 2023 Increase $ $ 1 10 Pensions $ 991 $ 1,011 $ 1,033 $ 1,048 $ 1,058 $ 5,367 Decrease $ $ - (9) Other postretirement benefits $ $ $ $ $ $ 18 19 19 19 19 95 E. Defined contribution and other plans 12 Other income The Company maintains defined contribution pension plans for certain salaried employees as well as certain employees covered In millions Year ended December 31, 2013 2012 2011 by collective bargaining agreements. The Company also maintains Gain on disposals of properties (1) $ 64 $ 295 $ 348 other plans including Section 401(k) savings plans for certain U.S. Gain on disposal of land based employees. The Company’s contributions under these plans Other are expensed as incurred and amounted to $13 million, $11 mil- Total other income 19 (10) 20 - 30 23 $ 73 $ 315 $ 401 (1) 2013 includes $29 million and $40 million for the exchange of easements and the dis- posal of the Lakeshore West, respectively; 2012 includes $281 million for the disposal of the Bala-Oakville; and 2011 includes $60 million and $288 million for the disposal of substantially all of the assets of IC RailMarine and the Lakeshore East, respectively. See Note 4 – Properties. lion and $10 million for 2013, 2012 and 2011, respectively. F. Contributions to multi-employer plan Under collective bargaining agreements, the Company participates in a multi-employer benefit plan named the Railroad Employees National Early Retirement Major Medical Benefit Plan which is administered by the National Carriers’ Conference Committee (NCCC), and provides certain postretirement health care benefits to certain retirees. The Company’s contributions under this plan are expensed as incurred and amounted to $10 million, $11 mil- lion and $11 million in 2013, 2012 and 2011, respectively. The an- nual contribution rate for the plan is determined by the NCCC and for 2013 was $143.21 per month per active employee ($154.49 in 2012). The plan covered 867 retirees in 2013 (874 in 2012). Canadian National Railway Company U.S. GAAP 2013 Annual Report 77 Notes to Consolidated Financial Statements 13 Income taxes As at December 31, 2013, Deferred and receivable income taxes include a net deferred income tax asset of $74 million ($43 mil- The following table provides the significant components of deferred income tax assets and liabilities: In millions December 31, 2013 2012 lion as at December 31, 2012) and an income tax receivable of Deferred income tax assets $63 million (nil as at December 31, 2012). Pension liability $ 89 $ 149 The Company’s consolidated effective income tax rate differs from the Canadian, or domestic, statutory Federal tax rate. The Personal injury and legal claims Environmental and other reserves effective tax rate is affected by recurring items such as tax rates Other postretirement benefits liability in provincial, U.S. federal, state and other foreign jurisdictions Net operating losses and tax credit carryforwards (1) and the proportion of income earned in those jurisdictions. The Total deferred income tax assets effective tax rate is also affected by discrete items such as income Deferred income tax liabilities tax rate enactments and lower tax rates on capital dispositions that may occur in any given year. The following table provides a reconciliation of income tax expense: Properties Net pension asset Other Total deferred income tax liabilities 64 171 77 19 420 64 130 80 4 427 6,232 5,686 438 213 - 253 6,883 5,939 In millions Year ended December 31, 2013 2012 2011 Federal tax rate 15.0% 15.0% 16.5% Income tax expense at the statutory Federal tax rate $ (538) $ (549) $ (554) Income tax recovery (expense) resulting from: Provincial and foreign taxes (423) (425) (360) Deferred income tax adjustments due to rate enactments Gain on disposals Other (1) Income tax expense Cash payments for income taxes (24) 9 (1) (35) 44 (13) (40) 62 (7) $ $ (977) $ (978) $ (899) 890 $ 289 $ 482 (1) Comprises of adjustments relating to the resolution of matters pertaining to prior years’ income taxes, including net recognized tax benefits, and other items. The following table provides tax information on a domestic and foreign basis: In millions Year ended December 31, 2013 2012 2011 $ 2,445 $ 2,656 $ 2,464 1,144 1,002 892 $ 3,589 $ 3,658 $ 3,356 Income before income taxes Domestic Foreign Current income tax expense Domestic Foreign Deferred income tax expense Domestic Foreign Total net deferred income tax liability $ 6,463 $ 5,512 Total net deferred income tax liability Domestic Foreign $ 2,920 $ 2,267 3,543 3,245 $ 6,463 $ 5,512 Total net deferred income tax liability $ 6,463 $ 5,512 Net current deferred income tax asset 74 43 Net noncurrent deferred income tax liability $ 6,537 $ 5,555 (1) Net operating losses and tax credit carryforwards will expire between the years 2014 and 2033. On an annual basis, the Company assesses the 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, a valuation allowance is recorded. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversals of deferred income tax liabil- ities including the available carryback and carryforward periods, projected future taxable income, and tax planning strategies in making this assessment. As at December 31, 2013, in order to fully realize all of the deferred income tax assets, the Company will $ (404) $ (314) $ (340) need to generate future taxable income of approximately $1.6 bil- (242) (213) (28) lion and, based upon the level of historical taxable income and $ (646) $ (527) $ (368) projections of future taxable income over the periods in which the $ (279) $ (370) $ (288) (52) (81) (243) $ (331) $ (451) $ (531) deferred income tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. Management has assessed the im- pacts of the current economic environment and concluded there are no significant impacts to its assertions for the realization of deferred income tax assets. The Company has not recognized a deferred income tax asset ($243 million as at December 31, 2013) on the unrealized foreign exchange loss recorded in Accumulated 78 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements other comprehensive loss relating to its net investment in foreign federal income tax returns filed for the year 2007 as well as 2009 subsidiaries, as the Company does not expect this temporary dif- to 2012 remain subject to examination by the taxation authorities, ference to reverse in the foreseeable future. and the state income tax returns filed for the years 2009 to 2012 The Company recognized tax credits of nil in 2013, and $1 mil- remain subject to examination by the taxation authorities. An lion in each of 2012 and 2011 for eligible research and develop- examination of the federal income tax returns for the year 2007 ment expenditures, which reduced the cost of properties. as well as 2009 to 2011 is currently in progress. Examinations of The following table provides a reconciliation of unrecognized certain state income tax returns by the state taxation authorities tax benefits on the Company’s domestic and foreign tax positions: are currently in progress. The Company does not anticipate any In millions Year ended December 31, 2013 2012 2011 Gross unrecognized tax benefits at beginning of year $ 36 $ 46 $ 57 Increases for: Tax positions related to the current year Tax positions related to prior years Decreases for: Tax positions related to prior years Settlements 2 4 (4) (8) Lapse of the applicable statute of limitations - Gross unrecognized tax benefits at 1 3 - (13) (1) 1 11 - (21) (2) end of year $ 30 $ 36 $ 46 Adjustments to reflect tax treaties and other arrangements (5) (6) (11) Net unrecognized tax benefits at end of year $ 25 $ 30 $ 35 As at December 31, 2013, the total amount of gross un- recognized tax benefits was $30 million, before considering tax treaties and other arrangements between taxation authorities. The amount of net unrecognized tax benefits as at December 31, 2013 was $25 million. If recognized, all of the net unrecognized tax benefits as at December 31, 2013 would affect the effective tax rate. The Company believes that it is reasonably possible that approximately $8 million of the net unrecognized tax benefits as at December 31, 2013 related to various federal, state, and provincial income tax matters, each of which are individually insignificant, may be recognized over the next twelve months as a result of settlements and a lapse of the applicable statute of limitations. The Company recognizes accrued interest and penalties related to gross unrecognized tax benefits in Income tax expense in the Company’s Consolidated Statement of Income. The Company recognized approximately $2 million, $3 million and $4 million in accrued interest and penalties during the years ended Decem- ber 31, 2013, 2012 and 2011, respectively. The Company had appro xi mately $5 million and $9 million of accrued interest and penalties as at December 31, 2013 and 2012, respectively. In Canada, the Company’s federal and provincial income tax re- turns filed for the years 2007 to 2012 remain subject to examina- tion by the taxation authorities. An examination of the Company’s federal income tax returns for the 2009 year is currently in progress and is expected to be completed during 2014. Examinations on specific tax positions taken for federal and provincial income tax returns for the 2007 and 2008 year are currently in progress and are also expected to be completed during 2014. In the U.S., the significant impacts to its results of operations or financial position as a result of the final resolutions of such matters. 14 Segmented information The Company manages its 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 cor- porate management, including the Company’s chief operating de- cision-maker, in evaluating financial and operational performance and allocating resources across CN’s network. The Company’s strategic initiatives, which drive its operation- al direction, are developed and managed centrally by corporate management and are communicated to its regional activity cen- ters (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. The role of each region is to manage the day-to-day service 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 95% 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 num- ber of the movements originate in one region and pass through and/or terminate in another region. The regions also demonstrate common characteristics in each of the following areas: (i) each region’s sole business activity is the transportation of freight over the Company’s extensive rail network; (ii) the regions service national accounts that extend over the Company’s various commodity groups and across its rail network; Canadian National Railway Company U.S. GAAP 2013 Annual Report 79 Notes to Consolidated Financial Statements 14 Segmented information continued The following table provides a reconciliation between basic (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; and diluted earnings per share: In millions, except per share data Year ended December 31, 2013 2012 2011 (iv) the Company and its subsidiaries, not its regions, are subject Net income $ 2,612 $ 2,680 $ 2,457 to single regulatory regimes in both Canada and the U.S. For the years ended December 31, 2013, 2012, and 2011, no major customer accounted for more than 10% of total revenues and the largest rail freight customer represented approximately 2%, 2%, and 3%, respectively, of total rail freight revenues. 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, 2013 2012 2011 Revenues Canada U.S. $ 7,149 $ 6,770 $ 6,169 3,426 3,150 2,859 $ 10,575 $ 9,920 $ 9,028 Weighted-average shares outstanding 843.1 871.1 902.2 Effect of stock options 3.0 4.3 6.7 Weighted-average diluted shares outstanding 846.1 875.4 908.9 Basic earnings per share Diluted earnings per share $ $ 3.10 $ 3.08 $ 2.72 3.09 $ 3.06 $ 2.70 Basic earnings per share are calculated based on the weight- ed-average number of common shares outstanding over each period. Diluted earnings per share are calculated based on the weighted-average diluted shares outstanding using the treasury stock method, which assumes that any proceeds received from the exercise of in-the-money stock options would be used to purchase common shares at the average market price for the period. In millions Year ended December 31, 2013 2012 2011 16 Major commitments and contingencies Net income Canada U.S. In millions Properties Canada U.S. $ 1,762 $ 1,972 $ 1,836 850 708 621 $ 2,612 $ 2,680 $ 2,457 December 31, 2013 2012 $ 15,056 $ 14,406 11,171 10,135 $ 26,227 $ 24,541 A. Leases The Company has operating and capital leases, mainly for loco- motives, 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, 2013, the Company’s commitments under these operating and capital leases were $680 million and $991 million, respectively. Minimum rental payments for operating leases having initial non-cancelable lease terms of more than one year and minimum lease payments for capital leases for the next five years and thereafter, are as follows: In millions Operating Capital 15 Earnings per share On October 22, 2013, the Board of Directors of the Company approved a two-for-one common stock split in the form of a stock dividend of one additional common share of CN for each share 2014 2015 2016 2017 2018 outstanding, which was paid on November 29, 2013, to share- 2019 and thereafter holders of record on November 15, 2013. All share and per share data presented herein reflect the impact of the stock split. Less: Imputed interest on capital leases at rates ranging from approximately 0.7% to 8.5% Present value of minimum lease payments included in debt $ 132 $ 111 84 66 56 231 $ 680 209 113 317 154 14 184 991 209 $ 782 The Company also has operating lease agreements for its automotive fleet with one-year non-cancelable terms for which its practice is to renew monthly thereafter. The estimated annual 80 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements rental payments for such leases are approximately $30 million and items when the expected loss is both probable and can be reason- generally extend over five years. ably estimated based on currently available information. Rent expense for all operating leases was $179 million, In 2013, the Company recorded a $1 million increase to its pro- $162 million and $143 million for the years ended December 31, vision for personal injuries and other claims in Canada as a result 2013, 2012 and 2011, respectively. Contingent rentals and sub- of a comprehensive actuarial study for employee injury claims as lease rentals were not significant. well as various other legal claims. B. Commitments As at December 31, 2013, the Company had commitments to ac- quire railroad ties, rail, freight cars, locomotives, and other equip- As at December 31, 2013, 2012 and 2011, the Company’s pro- vision for personal injury and other claims in Canada was as follows: In millions 2013 2012 2011 ment and services, as well as outstanding information technology Balance January 1 service contracts and licenses, at an aggregate cost of $482 million Accruals and other ($735 million as at December 31, 2012). The Company also has Payments estimated remaining commitments of approximately $291 million Balance December 31 $ 209 $ 199 $ 200 38 (37) 55 (45) 31 (32) $ 210 $ 209 $ 199 (US$273 million), in relation to the U.S. federal government legis- lative requirement to implement Positive Train Control (PTC) by 2015. In addition, it has estimated remaining commitments of ap- proximately $72 million (US$68 million), in relation to the acquisition of the principal lines of the former Elgin, Joliet and Eastern Railway Company, for railroad infrastructure improvements, grade separation projects as well as commitments under a series of agreements with individual communities and a comprehensive voluntary mitigation program established to address surrounding municipalities’ con- cerns. The Company also has agreements with fuel suppliers which allow but do not require the Company to purchase approximately 85% of its estimated 2014 volume, 60% of its anticipated 2015 vol- ume, 55% of its anticipated 2016 volume and 20% of its anticipated 2017 volume at market prices prevailing on the date of the purchase. C. Contingencies In the normal course of business, the Company becomes involved in various legal actions seeking compensatory and occasionally punitive damages, including actions brought on behalf of various purported classes of claimants and claims relating to employee and third-party personal injuries, occupational disease and property damage, arising out of harm to individuals or property allegedly caused by, but not limited to, derailments or other accidents. Canada Employee injuries are governed by the workers’ compensation legislation in each province whereby employees may be awarded either a lump sum or a future stream of payments depending on the nature and severity of the injury. As such, the provision for employee injury claims is discounted. In the provinces where the Company is self-insured, costs related to employee work-related injuries are accounted for based on actuarially developed esti- mates of the ultimate cost associated with such injuries, including compensation, health care and third-party administration costs. A comprehensive actuarial study is generally performed at least on a triennial basis. For all other legal actions, the Company maintains, and regularly updates on a case-by-case basis, provisions for such Current portion – Balance December 31 $ 31 $ 39 $ 39 United States Personal injury claims by the Company’s employees, including claims alleging occupational disease and work-related injuries, are subject to the provisions of the Federal Employers’ Liability Act (FELA). Employees are compensated under FELA for damages assessed based on a finding of fault through the U.S. jury system or through individual settlements. As such, the provision is un- discounted. With limited exceptions where claims are evaluated on a case-by-case basis, the Company follows an actuarial-based approach and accrues the expected cost for personal injury, in- cluding asserted and unasserted occupational disease claims, and property damage claims, based on actuarial estimates of their ul- timate cost. A comprehensive actuarial study is performed annually. For employee work-related injuries, including asserted occupa- tional disease claims, and third-party claims, including grade cross- ing, trespasser and property damage claims, the actuarial valuation considers, among other factors, the Company’s historical patterns of claims filings and payments. For unasserted occupational disease claims, the actuarial study includes the projection of the Company’s experience into the future considering the potentially exposed population. The Company adjusts its liability based upon manage- ment’s assessment and the results of the study. On an ongoing basis, management reviews and compares the assumptions inher- ent in the latest actuarial study with the current claim experience and, if required, adjustments to the liability are recorded. Due to the inherent uncertainty involved in projecting future events, including events related to occupational diseases, which include but are not limited to, the timing and number of actual claims, the average cost per claim and the legislative and judicial environment, the Company’s future payments may differ from current amounts recorded. Canadian National Railway Company U.S. GAAP 2013 Annual Report 81 Notes to Consolidated Financial Statements 16 Major commitments and contingencies D. Environmental matters continued In 2013, the Company recorded an $11 million reduction to its provision for U.S. personal injury and other claims attributable to non-occupational disease, third-party and occupational disease claims pursuant to the 2013 external actuarial study. In previous years, external actuarial studies have supported a net increase of $1 million and a net reduction of $6 million to the Company’s pro- vision for U.S. personal injury and other claims in 2012 and 2011, respectively. The previous years’ changes were mainly attributable The Company’s operations are subject to numerous federal, provin- cial, state, municipal and local environmental laws and regulations in Canada and the U.S. concerning, among other things, emissions into the air; discharges into waters; the generation, handling, stor- age, transportation, treatment and disposal of waste, hazardous substances, and other materials; decommissioning of underground and aboveground storage tanks; and soil and groundwater con- tamination. A risk of environmental liability is inherent in railroad and related transportation operations; real estate ownership, oper- ation or control; and other commercial activities of the Company to changes in the Company’s estimates of unasserted claims and with respect to both current and past operations. costs related to asserted claims as a result of its ongoing risk miti- gation strategy focused on reducing the frequency and severity of Known existing environmental concerns claims through injury prevention and containment; mitigation of claims; and lower settlements for existing claims. As at December 31, 2013, 2012 and 2011, the Company’s pro- vision for personal injury and other claims in the U.S. was as follows: The Company has identified approximately 280 sites at which it is or may be liable for remediation costs, in some cases along with other potentially responsible parties, associated with alleged contamination and is subject to environmental clean-up and en- forcement actions, including those imposed by the United States 2013 2012 2011 Federal Comprehensive Environmental Response, Compensation In millions Balance January 1 Accruals and other Payments $ 105 $ 111 $ 146 25 (24) 28 (34) 30 (65) Balance December 31 $ 106 $ 105 $ 111 Current portion – Balance December 31 $ 14 $ 43 $ 45 and Liability Act of 1980 (CERCLA), also known as the Superfund law, or analogous state laws. CERCLA and similar state laws, in addition to other similar Canadian and U.S. laws, generally impose joint and several liability for clean-up and enforcement costs on current and former owners and operators of a site, as well as those whose waste is disposed of at the site, without regard to fault or Although the Company considers such provisions to be adequate the legality of the original conduct. The Company has been noti- for all its outstanding and pending claims, the final outcome with fied that it is a potentially responsible party for study and clean-up respect to actions outstanding or pending at December 31, 2013, costs at approximately 10 sites governed by the Superfund law or with respect to future claims, cannot be reasonably determined. (and analogous state laws) for which investigation and remediation When establishing provisions for contingent liabilities the Company payments are or will be made or are yet to be determined and, in considers, where a probable loss estimate cannot be made with rea- many instances, is one of several potentially responsible parties. sonable certainty, a range of potential probable losses for each such The ultimate cost of addressing these known contaminated matter, and records the amount it considers the most reasonable esti- sites cannot be definitely established given that the estimated mate within the range. However, when no amount within the range environmental liability for any given site may vary depending on is a better estimate than any other amount, the minimum amount in the nature and extent of the contamination; the nature of antici- the range is accrued. For matters where a loss is reasonably possible pated response actions, taking into account the available clean-up but not probable, a range of potential losses cannot be estimated techniques; evolving regulatory standards governing environment- due to various factors which may include the limited availability of al liability; and the number of potentially responsible parties and facts, the lack of demand for specific damages and the fact that their financial viability. As a result, liabilities are recorded based proceedings were at an early stage. Based on information currently on the results of a four-phase assessment conducted on a site- available, the Company believes that the eventual outcome of the by-site basis. A liability is initially recorded when environmental actions against the Company will not, individually or in the aggre- assessments occur, remedial efforts are probable, and when the gate, have a material adverse effect on the Company’s consolidated costs, based on a specific plan of action in terms of the technology financial position. However, due to the inherent inability to predict to be used and the extent of the corrective action required, can be with certainty unforeseeable future developments, there can be no reasonably estimated. The Company estimates the costs related assurance that the ultimate resolution of these actions will not have a to a particular site using cost scenarios established by external material adverse effect on the Company’s results of operations, finan- consultants based on the extent of contamination and expected cial position or liquidity in a particular quarter or fiscal year. costs for remedial efforts. In the case of multiple parties, the Company accrues its allocable share of liability taking into account the Company’s alleged responsibility, the number of potentially responsible parties and their ability to pay their respective share of 82 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements the liability. Adjustments to initial estimates are recorded as addi- Therefore, the likelihood of any such costs being incurred or tional information becomes available. whether such costs would be material to the Company cannot be The Company’s provision for specific environmental sites is un- determined at this time. There can thus be no assurance that liabil- discounted and includes costs for remediation and restoration of ities or costs related to environmental matters will not be incurred sites, as well as monitoring costs. Environmental accruals, which in the future, or will not have a material adverse effect on the are classified as Casualty and other in the Consolidated Statement Company’s financial position or results of operations in a particular of Income, include amounts for newly identified sites or contam- quarter or fiscal year, or that the Company’s liquidity will not be ad- inants as well as adjustments to initial estimates. Recoveries of versely impacted by such liabilities or costs, although management environmental remediation costs from other parties are recorded believes, based on current information, that the costs to address as assets when their receipt is deemed probable. environmental matters will not have a material adverse effect on As at December 31, 2013, 2012 and 2011, the Company’s the Company’s financial position or liquidity. Costs related to any provision for specific environmental sites was as follows: unknown existing or future contamination will be accrued in the period in which they become probable and reasonably estimable. In millions 2013 2012 2011 Balance January 1 Accruals and other Payments Balance December 31 $ 123 $ 152 $ 150 Future occurrences 14 (18) (5) (24) 17 (15) In railroad and related transportation operations, it is possible that derailments or other accidents, including spills and releases of hazard- $ 119 $ 123 $ 152 ous materials, may occur that could cause harm to human health or Current portion – Balance December 31 $ 41 $ 31 $ 63 The Company anticipates that the majority of the liability at December 31, 2013 will be paid out over the next five years. However, some costs may be paid out over a longer period. Based on the information currently available, the Company considers its to the environment. As a result, the Company may incur costs in the future, which may be material, to address any such harm, compliance with laws and other risks, including costs relating to the performance of clean-ups, payment of environmental penalties and remediation obligations, and damages relating to harm to individuals or property. provisions to be adequate. Regulatory compliance Unknown existing environmental concerns While the Company believes that it has identified the costs likely to be incurred for environmental matters in the next several years based on known information, the discovery of new facts, future changes in laws, the possibility of releases of hazardous materi- als into the environment and the Company’s ongoing efforts to identify potential environmental liabilities that may be associated with its properties may result in the identification of additional environmental liabilities and related costs. The magnitude of such additional liabilities and the costs of complying with future en- vironmental laws and containing or remediating contamination cannot be reasonably estimated due to many factors, including: (i) the lack of specific technical information available with re- spect 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 un- certainty regarding the timing of the work with respect to particular sites; and (iv) the determination of the Company’s liability in proportion to other potentially responsible parties and the ability to recover costs from any third parties with respect to particular sites. The Company may incur significant capital and operating costs associated with environmental regulatory compliance and clean- up requirements, in its railroad operations and relating to its past and present ownership, operation or control of real property. Operating expenses for environmental matters amounted to $18 million in 2013, $16 million in 2012 and $4 million in 2011. In addition, based on the results of its operations and mainten- ance programs, as well as ongoing environmental audits and other factors, the Company plans for specific capital improve- ments on an annual basis. Certain of these improvements help ensure facilities, such as fuelling stations and waste water and storm water treatment systems, comply with environmental standards and include new construction and the updating of existing systems and/or processes. Other capital expenditures relate to assessing and remediating certain impaired properties. The Company’s environmental capital expenditures amounted to $10 million in 2013, $13 million in 2012 and $11 million in 2011. E. Guarantees and indemnifications In the normal course of business, the Company, including certain of its subsidiaries, enters into agreements that may involve providing guarantees or indemnifications to third parties and others, which may extend beyond the term of the agreements. These include, but are not limited to, residual value guarantees on operating leases, standby letters of credit, surety and other bonds, and indemnifications that are customary for the type of transaction or for the railway business. Canadian National Railway Company U.S. GAAP 2013 Annual Report 83 Notes to Consolidated Financial Statements 16 Major commitments and contingencies continued (c) contracts for the sale of assets; (d) contracts for the acquisition of services; (e) financing agreements; The Company is required to recognize a liability for the fair (f) trust indentures, fiscal agency agreements, underwriting value of the obligation undertaken in issuing certain guarantees on the date the guarantee is issued or modified. In addition, where agreements or similar agreements relating to debt or equity securities of the Company and engagement agreements with the Company expects to make a payment in respect of a guaran- financial advisors; tee, a liability will be recognized to the extent that one has not yet (g) transfer agent and registrar agreements in respect of the 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 be- 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; tween 2014 and 2021, for the benefit of the lessor. If the fair value (i) pension transfer agreements; of the assets at the end of their respective lease term is less than (j) master agreements with financial institutions governing deriv- the fair value, as estimated at the inception of the lease, then the ative transactions; Company must, under certain conditions, compensate the lessor for the shortfall. As at December 31, 2013, the maximum expos- ure in respect of these guarantees was $160 million. There are no recourse provisions to recover any amounts from third parties. (k) settlement agreements with insurance companies or other third parties whereby such insurer or third-party has been indemnified for any present or future claims relating to insurance policies, incidents or events covered by the settlement agreements; and (l) acquisition agreements. (ii) Other guarantees As at December 31, 2013, the Company, including certain of its subsidiaries, had granted $481 million of irrevocable standby let- ters of credit and $90 million of 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, 2013, the maximum potential liability under these guarantee instruments was $571 million, of which $528 million related to workers’ compensation and other employee benefit liabilities and $43 million related to other liabil- ities. The letters of credit were drawn on the Company’s bilateral letter of credit facilities. The Company had not recorded a liability as at December 31, 2013 with respect to these guarantee instru- ments as they related to the Company’s future performance and the Company did not expect to make any payments under these guarantee instruments. The majority of the guarantee instruments 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 reasonably determined. During the year, the Company entered into various indemnifi- cation contracts with third parties for which the maximum expos- ure for future payments cannot be reasonably determined. As a re- sult, the Company was unable to determine the fair value of these guarantees and accordingly, no liability was recorded. There are no recourse provisions to recover any amounts from third parties. 17 Financial instruments mature at various dates between 2014 and 2016. A. Risk management (iii) General indemnifications In the normal course of business, the Company has provided indemnifications, customary for the type of transaction or for the railway business, in various agreements with third parties, including indemnification provisions where the Company would be required to indemnify third parties and others. Indemnifications are found in various types of contracts with third parties which include, but are not limited to: (a) contracts granting the Company the right to use or enter upon property owned by third parties such as leases, easements, trackage rights and sidetrack agreements; In the normal course of business, the Company is exposed to various risks such as customer credit risk, commodity price risk, in- terest rate risk, foreign currency risk, and liquidity risk. To manage these risks, the Company follows a financial risk management framework, which is monitored and approved by the Company’s Finance Committee, with a goal of maintaining a strong balance sheet, optimizing earnings per share and free cash flow, finan- cing its operations at an optimal cost of capital and preserving its liquidity. The Company has limited involvement with derivative financial instruments in the management of its risks and does not use them for trading purposes. At December 31, 2013 and 2012, the Company did not have any significant derivative financial in- (b) contracts granting rights to others to use the Company’s prop- struments outstanding. erty, such as leases, licenses and easements; 84 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements (i) Customer credit risk (iv) Foreign currency In the normal course of business, the Company monitors the fi- The Company conducts its business in both Canada and the U.S. nancial condition and credit limits of its customers and reviews and as a result, is affected by currency fluctuations. Changes in the credit history of each new customer. Although the Company the exchange rate between the Canadian dollar and other cur- believes there are no significant concentrations of credit risk, eco- rencies (including the US dollar) make the goods transported by nomic conditions can affect the Company’s customers and can the Company more or less competitive in the world marketplace result in an increase to the Company’s credit risk and exposure and thereby further affect the Company’s revenues and expenses. to business failures of its customers. To manage its credit risk, on All of the Company’s U.S. operations are self-contained foreign an ongoing basis, the Company’s focus is on keeping the average entities with the US dollar as their functional currency. Accordingly, daily sales outstanding within an acceptable range and working the U.S. operations’ assets and liabilities are translated into Canadian with customers to ensure timely payments, and in certain cases, dollars at the rate in effect at the balance sheet date and the rev- requiring financial security, including letters of credit. enues and expenses are translated at average exchange rates during (ii) Fuel the year. All adjustments resulting from the translation of the for- eign operations are recorded in Other comprehensive income (loss). The Company is exposed to commodity price risk related to pur- For the purpose of minimizing volatility of earnings resulting from chases of fuel and the potential reduction in net income due the conversion of US dollar-denominated long-term debt into the to increases in the price of diesel. The impact of variable fuel Canadian dollar, the Company designates the US dollar-denomin- expense is mitigated substantially through the Company’s fuel ated long-term debt of the parent company as a foreign currency surcharge program which apportions incremental changes in hedge of its net investment in U.S. subsidiaries. As a result, from the fuel prices to shippers within agreed upon guidelines. While this dates of designation, foreign exchange gains and losses on trans- program provides effective coverage, residual exposure remains lation of the Company’s US dollar-denominated long-term debt are given that fuel price risk cannot be completely mitigated due recorded in Accumulated other comprehensive loss. to timing and given the volatility in the market. As such, the Occasionally, the Company enters into short-term foreign ex- Company may enter into derivative instruments to mitigate such change contracts as part of its cash management strategy. The risk when considered appropriate. (iii) Interest rate Company does not hold or issue derivative financial instruments for trading or speculative purposes. Changes in the fair value of forward contracts, resulting from changes in foreign exchange The Company is exposed to interest rate risk, which is the risk that rates, are recognized in the Consolidated Statement of Income the fair value or future cash flows of a financial instrument will as they occur. As at December 31, 2013, a gain of $6 million, be- vary as a result of changes in market interest rates. fore tax, related to the fair value of the foreign exchange forward Such risk exists in relation to the Company’s pension and postre- contracts of US$325 million, was recorded in Other income on the tirement plans and to its long-term debt. Overall return in the capital Consolidated Statement of Income. markets and the level of interest rates affect the funded status of the Company’s pension plans, particularly the Company’s main (v) Liquidity risk Canadian pension plan. Adverse changes with respect to pension The Company monitors and manages its cash requirements to en- plan returns and the level of interest rates from the date of the last sure sufficient access to funds to meet operational and investing re- actuarial valuations may have a material adverse effect on the fund- quirements. The Company pursues a solid financial policy framework ed status of the plans and on the Company’s results of operations. with the goal of maintaining a strong balance sheet, by monitoring The Company mainly issues fixed-rate debt, which exposes the its adjusted debt-to-total capitalization ratio and its adjusted debt- Company to variability in the fair value of the debt. The Company to-adjusted earnings before interest, income taxes, depreciation and also issues debt with variable interest rates which exposes the amortization (EBITDA) multiple, and preserving an investment grade Company to variability in interest expense. To manage its interest credit rating to be able to maintain access to public financing. rate exposure, the Company manages its borrowings in line with The Company’s principal source of liquidity is cash generated from liquidity needs, maturity schedule, and currency and interest rate operations, which is supplemented by its commercial paper program profile. In anticipation of future debt issuances, the Company to meet short-term liquidity needs. If the Company were to lose access may enter into forward rate agreements. The Company does not to the program for an extended period of time, the Company could currently hold any significant derivative financial instruments to rely on its $800 million revolving credit facility. The Company’s primary manage its interest rate risk. At December 31, 2013, Accumulated uses of funds are for working capital requirements, including income other comprehensive loss included an unamortized gain of $8 mil- tax installments as they become due and pension contributions, lion, $6 million after-tax ($8 million, $6 million after-tax at December contractual obligations, capital expenditures relating to track infra- 31, 2012) relating to treasury lock transactions settled in a prior structure and other, acquisitions, dividend payouts, and the repur- year, which are being amortized over the term of the related debt. chase of shares through a share buyback program, when applicable. Canadian National Railway Company U.S. GAAP 2013 Annual Report 85 Notes to Consolidated Financial Statements 17 Financial instruments continued The Company sets priorities on its uses of available funds based 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 on short-term operational requirements, expenditures to main- Balance Sheet under the following captions: tain a safe railway and strategic initiatives, while also considering its long-term contractual obligations and returning value to its (i) Cash and cash equivalents, Restricted cash and cash equiva- lents, Accounts receivable, Other current assets, Accounts shareholders. B. Fair value of financial instruments For financial assets and liabilities measured at fair value on a recur- ring basis, fair value is the price the Company would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. In the absence of active markets for identical assets or liabilities, such measurements involve developing assumptions based on market observable data payable and other: The carrying amounts approximate fair value because of the short maturity of these instruments. Cash and cash equivalents and Restricted cash and cash equivalents include highly liquid investments purchased three months or less from maturity and are classified as Level 1. Accounts receivable, Other current assets, and Accounts payable and other are classified as Level 2 as they may not be priced using quoted prices, but rather determined from market observable information. and, in the absence of such data, internal information that is be- (ii) Intangible and other assets: lieved to be consistent with what market participants would use in a hypothetical transaction that occurs at the measurement date. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. Preference is given to observable inputs. These two types of inputs create the following fair value hierarchy: Included in Intangible and other assets are equity investments for which the carrying value approximates the fair value, with the exception of certain cost investments for which the fair value is estimated based on the Company’s proportionate share of the underlying net assets. Investments are classified as Level 3 as their fair value is based on significant unobservable Level 1: Quoted prices for identical instruments in active markets. Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in mar- kets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. inputs. (iii) Debt: The fair value of the Company’s debt is estimated based on the quoted market prices for the same or similar debt in- struments, as well as discounted cash flows using current interest rates for debt with similar terms, company rating, and remaining maturity. The Company’s debt is classified as Level 3: Significant inputs to the valuation model are unobservable. Level 2. The following table provides the carrying amounts and estimated fair values of the Company’s financial instruments as at December 31, 2013 and December 31, 2012 for which the carrying values on the Consolidated Balance Sheet are different from their fair values: In millions Financial assets Investments (Note 5) Financial liabilities Total debt (Note 8) December 31, 2013 December 31, 2012 Carrying amount Fair value Carrying amount Fair value $ 57 $ 164 $ 30 $ 125 $ 7,840 $ 8,683 $ 6,900 $ 8,379 86 2013 Annual Report U.S. GAAP Canadian National Railway Company Notes to Consolidated Financial Statements 18 Accumulated other comprehensive loss The components of Accumulated other comprehensive loss are as follows: In millions Pension and other postretirement benefit plans Foreign currency items Derivative instruments Total before tax Tax recovery (expense) Total net of tax Beginning balance at December 31, 2010 $ (1,193) $ (582) $ 10 $ (1,765) $ 56 $ (1,709) Other comprehensive income (loss) before reclassifications: Foreign currency translation adjustments Actuarial loss arising during the year Prior service cost from plan amendment arising during the year Amounts reclassified from accumulated other comprehensive income (loss): Amortization of net actuarial loss Amortization of prior service cost Amortization of gain on treasury lock Other comprehensive income (loss) Ending balance at December 31, 2011 Other comprehensive income (loss) before reclassifications: Foreign currency translation adjustments Actuarial loss arising during the year Prior service cost from plan amendment arising during the year Amounts reclassified from accumulated other comprehensive income (loss): Amortization of net actuarial loss Amortization of prior service cost Other comprehensive income (loss) Ending balance at December 31, 2012 - (1,541) (28) 8 4 - (1,557) 8 - - - - - 8 $ (2,750) $ (574) $ - (660) (6) 119 7 (540) (5) - - - - (5) - - - - - (2) (2) 8 - - - - - - 8 (1,541) (28) 19 397 7 27 (1,144) (21) 8 (1) 4 (1) (2) (2) (2) (3) (1) (3) 1 (3) 6 3 (1) (1,551) 421 (1,130) $ (3,316) $ 477 $ (2,839) (5) (660) (6) 119 (1) 7 (1) (545) (17) 176 2 (32) (3) (2) (3) (22) (484) (4) 87 5 127 (418) $ (3,290) $ (579) $ 8 $ (3,861) $ 604 $ (3,257) Other comprehensive income (loss) before reclassifications: Foreign currency translation adjustments Actuarial gain arising during the year Amounts reclassified from accumulated other comprehensive income (loss): Amortization of net actuarial loss Amortization of prior service cost Other comprehensive income (loss) - 1,544 226 5 1,775 46 - - - 46 - - - - - 46 1,544 59 (412) 226 (1) 5 (1) (60) (3) (1) (3) 105 1,132 166 4 1,821 (414) 1,407 Ending balance at December 31, 2013 $ (1,515) $ (533) $ 8 $ (2,040) $ 190 $ (1,850) (1) Reclassified to Labor and fringe benefits on the Consolidated Statement of Income and included in components of net periodic benefit cost. See Note 11 – Pensions and other postretirement benefits. (2) Reclassified to Other income on the Consolidated Statement of Income. (3) Included in Income tax expense on the Consolidated Statement of Income. Canadian National Railway Company U.S. GAAP 2013 Annual Report 87 Notes to Consolidated Financial Statements Corporate Governance – Delivering Responsibly CN is committed to being a good corporate citizen. At CN, sound We are proud of our corporate governance practices. For more corporate citizenship touches nearly every aspect of what we do, information on these practices, please refer to our website, as well from governance to business ethics, from safety to environmental as to our proxy circular – mailed to our shareholders and also avail- protection. Central to this comprehensive approach is our strong able on our website. CN understands that our long-term success is belief that good corporate citizenship is simply good business. connected to our contribution to a sustainable future. That is why CN has always recognized the importance of good governance. we are committed to the safety of our employees, the public and As it evolved from a Canadian institution to a North American the environment; delivering reliable, efficient service so our cus- publicly traded company, CN voluntarily followed certain corpor- tomers succeed in global markets; building stronger communities; ate governance requirements that, as a company based in Canada, and providing a great place to work. Our sustainability activities it was not technically compelled to follow. We continue to do so are outlined in our Delivering Responsibly report, which can be today. Since many of our peers – and shareholders – are based found on our website: www.cn.ca in the United States, we want to provide the same assurances of For the second straight year, CN’s practices have earned it a sound practices as our U.S. competitors. place on the Dow Jones Sustainability World Index (DJSI), which Hence, we adopt and adhere to corporate governance includes an assessment of CN’s governance practices, in addition practices that either meet or exceed applicable Canadian and to being named to the DJSI North America index for the fifth con- U.S. corporate governance standards. As a Canadian reporting secutive year. CN was also recognized for climate change trans- issuer with securities listed on the Toronto Stock Exchange (TSX) parency for the fourth year in a row by earning a position in CDP’s and the New York Stock Exchange (NYSE), CN complies with applic- Canada 200 Climate Disclosure Leadership Index. able rules adopted by the Canadian Securities Administrators and CN received the Best Corporate Governance Award from the rules of the U.S. Securities and Exchange Commission giving IR Magazine in 2009, 2010 and 2014. As well, in 2011 we re- effect to the provisions of the U.S. Sarbanes-Oxley Act of 2002. ceived the Canadian Coalition for Good Governance (CCGG) As a Canadian company, we are not required to comply with Award for Best Disclosure of Board Governance Practices and many of the NYSE corporate governance rules, and instead may Director Qualifications; and in 2012 the CCGG Award for Best comply with Canadian governance practices. However, except Disclosure of Approach to Executive Compensation. as summarized on our website (www.cn.ca in the Delivering Responsibly – Governance section), our governance prac tices comply with the NYSE corporate governance rules in all significant respects. Consistent with the belief that ethical conduct goes be- yond compliance and resides in a solid governance culture, the Delivering Responsibly – Governance section on the CN website contains CN’s Corporate Governance Manual (including the char- ters 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 wrong- doings be reported, CN has also adopted methods allowing em- ployees and third parties to report accounting, auditing and other concerns, as more fully described on our website. 88 2013 Annual Report Canadian National Railway Company Contents Shareholder and Investor Information 1 A message from the Chairman 2 A message from Claude Mongeau 4 Becoming a true supply chain enabler: Making connections 6 Board of Directors 7 Financial Section (U.S. GAAP) 88 Corporate Governance – Delivering Responsibly 89 Shareholder and Investor Information Except where otherwise indicated, all financial information reflected in this document is expressed in Canadian dollars and determined on the basis of United States gener- ally accepted accounting principles (U.S. GAAP). Certain information included in this annual report constitutes “forward-looking statements” within the meaning of the United States Private Securities Litigation Reform Act of 1995 and under Canadian securities laws. CN cautions that, by their nature, these forward-looking statements involve risks, uncertainties and assumptions. The Company cautions that its assumptions may not materialize and that current economic conditions render such assumptions, although reasonable at the time they were made, subject to greater uncertainty. Such forward-looking statements 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 performance implied by such statements. Important risk factors that could affect the forward-looking statements include, but are not limited to, the effects of general economic and business conditions, industry competition, inflation, currency and interest rate fluctuations, changes in fuel prices, legislative and/or regulatory developments, compliance with environmental laws and regulations, actions by regulators, various events which could disrupt operations, including natural events such as severe weather, droughts, floods and earthquakes, labor negotiations and disruptions, environmental claims, uncertainties of investigations, proceedings or other types of claims and litigation, risks and liabilities arising from derailments, and other risks detailed from time to time in reports filed by CN with securities regulators in Canada and the United States. Reference should be made to “Manage- ment’s Discussion and Analysis” in CN’s annual and interim reports, Annual Information Form and Form 40-F filed with Canadian and U.S. securities regulators, available on CN’s website (www.cn.ca), for a summary of major risks. CN assumes no obligation to update or revise forward-looking statements to reflect future events, changes in circum- stances, or changes in beliefs, unless required by applicable Canadian securities laws. In the event CN does update any forward-looking statement, no inference should be made that CN will make additional updates with respect to that state- ment, related matters, or any other forward-looking statement. As used herein, the word “Company” or “CN” means, as the context requires, Canadian National Railway Company and/ or its subsidiaries. Shareholder services Shareholders having inquiries concerning their shares, wishing to obtain information about CN, or to receive dividends by direct deposit or in U.S. dollars may obtain detailed information by communicating with: Computershare Trust Company of Canada Shareholder Services 100 University Avenue, 8th Floor Toronto, Ontario M5J 2Y1 Telephone: 1-800-564-6253 www.investorcentre.com Stock exchanges CN common shares are listed on the Toronto and New York stock exchanges. Ticker symbols: CNR (Toronto Stock Exchange) CNI (New York Stock Exchange) Investor relations Janet Drysdale Vice-President, Investor Relations Telephone: 514-399-0052 Head office Canadian National Railway Company 935 de La Gauchetière Street West Montreal, Quebec H3B 2M9 P.O. Box 8100 Montreal, Quebec H3C 3N4 Annual meeting The annual meeting of shareholders will be held at 9:00 a.m. PDT on April 23, 2014 at: The Westin Bayshore Bayshore Grand Ballroom 1601 Bayshore Drive Vancouver, British Columbia, Canada 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 It is also available on CN’s website. Transfer agent and registrar Computershare Trust Company of Canada Offices in: Montreal, Quebec; Toronto, Ontario; Calgary, Alberta; Vancouver, British Columbia Telephone: 1-800-564-6253 www.investorcentre.com Co-transfer agent and co-registrar Computershare Trust Company N.A. Att: Stock Transfer Department Overnight Mail Delivery: 250 Royall Street, Canton MA 02021 Regular Mail Delivery: P.O. Box 43078, Providence, RI 02940-3078 Telephone: 1-800-962-4284 Additional copies of this report are available from: CN Public Affairs 935 de La Gauchetière Street West Montreal, Quebec H3B 2M9 Telephone: 1-888-888-5909 Email: contact@cn.ca La version française du présent rapport est disponible à l’adresse suivante : Affaires publiques du CN 935, rue de La Gauchetière Ouest Montréal (Québec) H3B 2M9 Téléphone : 1-888-888-5909 Courriel : contact@cn.ca Canadian National Railway Company 2013 Annual Report 89 This report has been printed on FSC® paper. BECOMING A TRUE SUPPLY CHAIN ENABLER 2 0 1 3 a n n u a l r e p o r t 2 0 1 2 a n n u a l r e p o r t 935 de La Gauchetière Street West Montreal, Quebec H3B 2M9 www.cn.ca 2 0 1 3 a n n u a l r e p o r t