CANADIAN NATIONAL RAILWAY CO - 6-K - 20030314 - NOTES_TO_FINANCIAL_STATEMENT
Item 3
CN 2002 Annual Report
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The long haul
Another year of challenge put our company to the test. It was a test of our
model and our mettle, a test we believe we passed. In 2002, CN delivered strong
results in the face of a severe drought affecting one of our markets, and
economic uncertainty.
We remain confident as the challenge continues. CN is on a long haul, with a
solid trip plan, a powerful engine and a worthy destination: delivering
performance that endures.
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Contents
2 The destination
4 The trip plan
6 The engine
10 Message from E. Hunter Harrison
12 Financial summary
14 The road to delivering value
16 Performance and productivity,
just in time
18 Fewer cars, smoother pipeline,
lower costs
20 From between the white lines
to the main line
22 CN at a glance
24 Message from David McLean
25 Pulling together for a brighter
future
28 Glossary of terms
29 Financial Section (U.S. GAAP)
73 Financial Section (Canadian GAAP)
118 The CN Pension Plan and the
CN 1935 Pension Plan
127 President's Awards for Excellence
128 Board of Directors
130 Executive Officers of the Company
131 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 generally accepted accounting principles (U.S. GAAP).
Canadian National Railway Company 1
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Performance that endures At CN, our destination is an objective in an
always-challenging economic and competitive landscape: growth. Long-term,
sustainable, profitable top-line growth.
Delivering profitable top-line growth is firmly connected to the ability
to create real value for customers. Customer value is determined by each one's
individual requirements, but at its core is a meaningful contribution to
efficiency, productivity and competitiveness. At CN, we know that when we
contribute in a significant way to a customer's business success, we have
formed a strong platform for expanding the relationship.
Profitable top-line growth. This is what shareholders want, along with
something equally important: financial durability. At CN, this is a critical
element of shareholder value. We have worked to build an enterprise that is
capable of generating revenue growth, steadily increasing profitability, strong
cash flow and return on investment.
Performance that endures. It is a destination at which one never truly
arrives - there are always new challenges - but in 2002, CN demonstrated that
it is well on its way to achieving its objectives.
2 Canadian National Railway Company
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The destination
Canadian National Railway Company 3
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The trip plan
4 Canadian National Railway Company
Pursuing growth one carload at a time Railroads have historically done a very
good job of providing reliable transportation solutions to bulk shippers -
primarily grain and coal and other products that move on unit trains. CN is a
well-established bulk carrier, with a number of strong, long-term customer
relationships. But in bulk commodities shipping, there is little to
differentiate between railroads, leaving less room for market share gains.
CN has a unique franchise, less dependent upon bulk commodities than other
major North American railroads. Our strengths align well with service-sensitive
businesses like merchandise - automotive, metals and minerals, petroleum and
chemicals, and forest products - as well as intermodal. Merchandise businesses,
sometimes called carload shippers, are where we have the clearest competitive
advantage, both against trucks and other rail carriers.
With its precision, velocity and reliability, the CN service plan is
perfectly suited to the merchandise shipper. Our strategy - our trip plan - is
to pursue carload business by emphasizing transportation solutions rather than
transactions. The level of service reliability we provide gives us a greater
opportunity to help customers reduce their transportation costs, enabling us to
help them succeed.
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Canadian National Railway Company 5
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What drives CN Two things drive this company: our unique service plan and the
talented, dedicated people who make it work.
With the CN service plan, we have succeeded in creating a uniquely
efficient, reliable transportation solution that's more economical than trucks
and capable of delivering more value than traditional rail carriers. We are
continually working to perfect the service plan's industry leading performance
- striving to improve upon 90 per cent-plus reliability while at the same time
increasing speed. CN is always concentrating on further enhancing service
quality in ways that go beyond speed or reliability, such as providing better
quality equipment and simplifying customer processes.
On-time performance is of little use if the shipment arrives damaged. So
CN is accelerating the process of renewing and upgrading its fleet, purchasing
equipment like state-of-the-art refrigerated rail cars for grocery shippers,
new boxcars for paper shippers and an increased number of centerbeam flatcars
for our forest product customers.
Ease of doing business is another important service quality issue. CN is
investing to make it simpler to get service schedules and rates, simpler to
order equipment and manage shipments, and simpler to manage and pay invoices.
6 Canadian National Railway Company
The engine
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Canadian National Railway Company 7
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Creating a culture of difference-makers Every CN employee has an opportunity
to have a positive impact on improved service quality for customers. Across the
entire organization, CN has launched employee development and training programs
aimed at improving skills and enhancing individual performance.
Sales has been a particular emphasis. Over the past several years, CN has
been systematically transforming and expanding its sales force, adding more
highly qualified professionals to drive a fundamental shift away from the
traditional "order-taker" approach to rail transportation sales and marketing.
An intensified focus on training is designed to improve CN sales professionals'
ability to identify, develop and present proactive, value-adding solutions that
support CN's growth strategy.
CN changed its sales compensation structure in 1999 to support the right
behaviors - with a commission-like bonus formula that rewards high achievers
and creates incentives to grow, not just maintain, revenues each year.
Meanwhile, CN is pursuing an aggressive, ongoing sales strategy aimed at
uncovering ways to reach new customers who can benefit from rail - going beyond
traditional rail channels that focus only on large nationwide accounts to
expand coverage and increase the number of opportunities to grow revenue.
8 Canadian National Railway Company
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A groundbreaking new partnership with labor CN is a different kind of railroad,
always looking for new and innovative ways to lead and excel. Nowhere is this
more in evidence than at CN's U.S. operations. This is where we worked together
with the Brotherhood of Locomotive Engineers (BLE) and with the United
Transportation Union (UTU) at the former Wisconsin Central division and with
the BLE in the former Illinois Central territory to forge truly game-changing
labor agreements in 2002. The new contracts are better for CN, better for
employees and, by strengthening our ability to improve service quality,
ultimately are better for shippers.
In contrast with other major Class 1 railroad mileage- and rule-based wage
systems, these agreements are based on an hourly wage. CN benefits from enhanced
productivity and unprecedented flexibility with the elimination of outdated
work rules and mileage caps. In addition to excellent compensation, employees
benefit from better work and home-life balance as well as job security
provisions.
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9
Dear shareholders:
CN delivered growth and generated record free cash flow and solid earnings in
spite of external factors that negatively affected revenues and increased
costs. CN performed well this year - more important, we have a great team and a
good, solid franchise that put us in an excellent position for the long haul.
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10
A year of continued challenge The year 2002 proved to be challenging, with an
increasingly tough market environment characterized by a severe drought that
decimated the Canadian wheat harvest, the ongoing decline of Canada's CN-served
metallurgical coal mines and continued uncertainty in the North American
economy.
All in all, 2002 was a test of CN's character, resiliency and strength, a
test I feel we passed. In fact, I believe we can be proud of what we
accomplished.
Rising to the challenge Our 2002 financial performance was solid in the face of
adversity. We grew revenues, driven mainly by the Wisconsin Central
acquisition, but also by the strength of our merchandise franchise, which
offset significantly weaker grain revenues. At the same time, through aggressive
cost control measures, we mitigated major cost pressures. We were able to
deliver an adjusted operating ratio of 69.4 per cent in 2002 compared to the
68.5 per cent adjusted figure in 2001. A key achievement was CN's record free
cash flow of $513 million, building on the $443 million generated in 2001.
Tough measures In the fourth quarter of 2002, we recorded charges for workforce
reductions and for U.S. personal injury and other claims. We made the difficult
decision to make a permanent workforce reduction of 1,146 employees. This move
reflects a hard reality: we must aggressively control our costs in order to
remain competitive, especially in today's economic environment.
We have a responsibility to operate as efficiently as we possibly can
without compromising safety. But it doesn't make a decision like this any
easier. My hope is to get this company to the point where these kinds of cuts
aren't necessary - to grow the business to the point where we're adding people,
rather than subtracting them. This is our goal.
Delivering value for CN investors We are determined to continue to create
shareholder value in every way we can. With our strong balance sheet and free
cash flow, we are fortunate to be able to do this in a number of ways. While we
always seek avenues to build the strength of the business, there are times when
the best means to deliver value is through share repurchases.
We decided that 2002 was just such a time. In the fourth quarter, the CN
Board authorized a share repurchase program of up to 13.0 million shares over
the course of one year beginning on October 25, 2002. The buyback potentially
represents 6.5 per cent of shares outstanding.
We have proven our ability to make and successfully integrate acquisitions
that bring real benefit to this company and its investors. The Illinois Central
integration proceeded so smoothly that the STB discontinued its formal
oversight process of the merger after two years, three years ahead of
schedule. The Wisconsin Central integration is nearly complete, following the
same step-by-step approach designed to maintain safety at the highest level and
avoid any disruption or compromise of customer service.
A solid model that is working The most encouraging aspect of our 2002
performance was our ability to deliver good overall performance in spite of an
enormous revenue hit in our grain business unit. While the revenues gained in
our Wisconsin Central acquisition helped offset the impact, a major factor in
CN's 2002 performance was the success of our growth strategy in merchandise
businesses focused on selling the benefits of premium-quality rail service.
Our merchandise businesses are steadily gaining market share, growing much
faster than the industry. We're achieving these share gains across many
segments: automotive, fuel oil, aluminum, liquified petroleum gas, lumber and
newsprint. And the sales strategy we created in 1999 to pursue smaller customers
is clearly working.
Railroading is a tough business, but not necessarily a complicated
one. Success is all about staying focused on the basics: one, providing good
service - doing what you say you'll do, every time. Two, managing your costs.
Three, focusing on asset utilization. Four, doing the first three things without
getting anyone hurt. And five, developing your people. The first three things
we're now doing at a high level, and the fourth is something we're always
working on. My biggest focus is on the fifth: people.
Canadian National Railway Company 11
Financial summary
($ in millions, except per share data,
or unless otherwise indicated) 2002(1) 2001(1) 2000(1)
-------------------------------------------------------------------------------
Financial results
Revenues $ 6,110 $ 5,652 $ 5,428
Operating income 1,469 1,682 1,648
Net income 800 1,040 937
Diluted earnings per share 3.97 5.23 4.67
Dividend per share 0.86 0.78 0.70
Net capital expenditures 938 941 958
Financial position
Total assets 21,738 21,223 17,314
Long-term debt, including current portion and
convertible preferred securities 5,577 6,293 4,665
Shareholders' equity 8,369 7,488 6,598
Financial ratios (%)
Operating ratio 76.0 70.2 69.6
Debt to total capitalization 40.0 45.7 41.4
(1) 2001 includes Wisconsin Central Transportation Corporation from October 9,
2001. In addition, the Company's financial results for 2002, 2001 and 2000
include items impacting their comparability as discussed in the Company's
Management's Discussion and Analysis on pages 31 and 35.
Employees (average for the year)
-------------------------------------------------------------------------------
2000 22,457
2001(1) 22,668
2002 23,190
Adjusted earnings per share (dollars) (2)
-------------------------------------------------------------------------------
2000 4.39
2001(1) 4.92
2002 5.22
Adjusted operating ratio (percentage) (3)
-------------------------------------------------------------------------------
2000 69.6
2001(1) 68.5
2002 69.4
(1) The 2001 figures include Wisconsin Central Transportation Corporation from
October 9, 2001.
(2) Based on 2002, 2001 and 2000 adjusted net income, as discussed in the
Company's Management's Discussion and Analysis on pages 31 and 35.
(3) Excludes a 2002 charge of $281 million to increase the Company's provision
for U.S. personal injury and other claims, and workforce reduction charges
of $120 million and $98 million in 2002 and 2001, respectively, as
discussed in the Company's Management's Discussion and Analysis on pages
31 and 35.
12 Canadian National Railway Company
All across this organization, CN people are realizing that they each can
play a significant role in the success of this company. I'm particularly proud
of the labor agreements we reached in 2002 with the Brotherhood of Locomotive
Engineers (BLE) and the United Transportation Union (UTU) at our former
Wisconsin Central division and with the BLE in our former IC territories. These
ground-breaking contracts free CN from outdated work rules and compensation
structures while giving engineers, conductors and brakemen excellent wages, job
security and more time with their families.
We're slowly transforming the culture of this great company. Are we there
yet? No. Will we ever completely get there? Probably not, because it's a
continuous process of improvement. We can always get better. That's what a
passion for performance is all about.
A strong team This company's management team is one of the most outstanding
groups of individuals I've ever seen assembled in my 38 years of railroading.
James Foote and Claude Mongeau are two of our standouts. James is one of the
top marketing people in the business. He's been in this industry his whole
career and has been involved in nearly every aspect of running a railroad,
holding positions in law, finance, operations and now marketing, his current
position. He's done a great job leading the growth in our merchandise
businesses. Claude Mongeau is among the best and brightest business minds in
Canada. At only 41, Claude is a pillar of our financial discipline and a key
architect of our strategic agenda. James and Claude are just two of many - too
many to list here - who have played an integral role in our success. This is a
solid team, and I'm proud to have this opportunity to lead them.
As you know, Paul Tellier announced in December 2002 his decision to
accept the position of President and Chief Executive Officer of Bombardier Inc.
I don't have to tell you what Paul has meant to this organization. I
congratulate him and thank him for his dedication, leadership and vision. We
worked very closely together during the time I have been with the company to
set CN's current strategic direction. That direction won't change under my
leadership.
It's a long haul As one of the leaders of this company and
throughout my management career, I've always been struck by the pressure we get
to produce short-term results. Don't misunderstand me; this isn't a bad thing -
it imposes discipline on management and supports full accountability. But if
you get too caught up in short-term performance, it can make it tougher to
pursue strategies critical to long-term success. Under my leadership, the CN
management team will continue to balance the need to protect and build your
long-term investment with the desire for strong year-over-year results.
As bulk commodities continue to struggle in 2003, we will aggressively
continue to build our service-sensitive businesses to maintain revenue growth
while we closely watch expenses. We are on a long haul, making steady progress
up the steep grade of a tough economy. When the track levels off, as we know it
will, we'll be poised to accelerate to new levels of performance. Thank you for
coming along.
Yours sincerely,
(signed)
E. Hunter Harrison
President and Chief Executive Officer
Canadian National Railway Company 13
Creating win-win relationships CN has delivered growth in difficult times
by meeting the needs of shippers with a superior rail product, the scheduled
railroad.
Our growth strategy centers upon continuing to leverage this superior
product to deliver value for service-sensitive carload customers, many of whom
use trucks for a large proportion of their transportation needs. The carload
market is much bigger than the unit train market, concentrated mostly in the
merchandise business sector. CN has a significantly higher proportion of
merchandise freight in its portfolio than other major railroads, with
experience and an operating approach that translate to a strong competitive
position.
The degree of precision and reliability of our service plan provides an
opportunity to help certain customers reduce spending on transportation while
capturing a higher percentage of it for CN. Our sales strategy is focused on
helping customers see that we can reduce total logistics costs without
sacrificing performance. There are three principal ways CN's superior rail
service enables us to deliver cost savings for customers without having to
reduce our rates:
The road to delivering value
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14 Canadian National Railway Company
Reducing customer-owned inventory Better service reliability means lower
inventory requirements - less capital in goods-in-transit; reduced need for
safety stock or express trucking costs to ensure uninterrupted processes; lower
warehousing and storage costs.
Reducing customer-owned fleets We know from our own experience that better
service reliability means smaller rail car fleet requirements - which reduces
depreciation and interest expense; lowers leasing costs; reduces maintenance
costs; and decreases overall ownership risk. We can deliver the same benefits
to customers who own significant rail car fleets.
Moving traffic from truck to rail It's a fact that most rail rates are lower
than truck, but many companies pay the higher freight costs to gain the high
degree of reliability trucks traditionally offer. Once rail reliability and
trust are established, many shippers discover that rail meets their needs at
significantly lower cost.
Considerable potential exists for truly win-win business relationships.
Shippers realize reduced transportation, inventory, equipment and back office
costs, while CN gains higher-yield business, more volume and closer customer
collaboration that forms a strong base for further growth.
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Canadian National Railway Company 15
Reducing inventory is increasingly critical in most manufacturing processes,
and a well-managed transportation chain is the principal success factor. Led by
automotive producers, more and more manufacturers are moving to just-in-time
management of inputs, which demands precision not typically found in rail
transportation. Those who do use rail often maintain substantial backup
inventory on-site to ensure that an adequate supply of products is available
for their customers.
Already a major transportation supplier to automotive manufacturers, CN is
supporting customers in other industries using scheduled rail service to bring
value through smoother logistics.
Paper manufacturers and printers are highly focused on inventory
reduction, representing a significant opportunity for CN and shippers of paper
products. Our approach here is to provide a highly reliable transportation
product that renders the need for a large safety stock obsolete. If necessary,
we offer integrated services that include the use of warehousing to hold some
buffer stock or serve non-rail served facilities. As we demonstrate
reliability, we're well positioned to take on more traffic.
Performance
and productivity,
just in time
With its velocity, precision and reliability, CN's scheduled rail service
affords magazine and newspaper printers the ability to run just-in-time
operations more cost effectively - eliminating or reducing the need to maintain
"safety stock," a backup inventory of paper supply to ensure uninterrupted
production.
16 Canadian National Railway Company
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Canadian National Railway Company 17
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18 Canadian National Railway Company
Fewer cars,
smoother
pipeline,
lower costs
Manufacturers of consumer goods such as these plastic milk containers typically
maintain large private rail car fleets in order to manage extremely complex
transportation pipelines for raw materials. CN's service plan enables dramatic
fleet reduction - we've proven it in our own operations. Now we're proving it
in our customers' operations.
Reducing private rail car fleets is an attractive way to improve productivity
of the supply chain while significantly reducing costs for industries that
depend on their own equipment to transport materials and products to and from
their plants.
The enhanced speed and dependability of CN's scheduled network can have an
immediate impact on helping customers reduce their fleets. We've proven it for
ourselves - from 1998 to 2002, CN reduced its active rail car fleet by almost
25,000 cars, or more than 28 per cent, as a direct result of the precision and
control afforded by the service plan.
Chemical manufacturers maintain extremely complex transportation
pipelines, typically with multiple inputs flowing directly from rail cars into
the plants. Their cars serve literally as warehouses on wheels. Most
manufacturers in this industry make a huge investment in rail cars in order to
maintain large fleets partly to offset variables in rail transportation. With
90 per cent-plus reliability that removes the variables, CN can help reduce
that investment.
Canadian National Railway Company 19
Moving shipments from truck to rail has an immediate impact on transportation
costs. Trucking normally commands a premium based on reliability, speed and
simplicity. Traditionally, the complexity of the carload business has been a
major barrier to rail penetration.
CN is working to change that. In recent years, we have captured a
significant amount of traffic from trucks in key intercontinental corridors
through continuous transit time reduction and ongoing investment in new
equipment.
Our strategy in merchandise is to identify areas currently handled by
trucks that are natural for railroads. Rail transportation isn't as well suited
for shippers with 24-48-hour transit windows, but there are vast numbers of
small- to medium-sized shippers who use trucks exclusively because they are
simply not accustomed to utilizing rail. For instance, shippers of rolled steel
and aluminum ingots supplying the automotive industry are increasingly
discovering the benefits - fewer weight restrictions and greater load
efficiency at two to three truckloads per car - of precision scheduled rail
service. Increasingly, they are becoming CN customers.
From between
the white
lines to the
main line
Many suppliers of aluminum ingots used in the automotive industry have
traditionally relied upon truck transportation to ship product. CN's
high-quality service is encouraging suppliers to take advantage of the greater
load efficiency and fewer weight restrictions of rail.
20 Canadian National Railway Company
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Canadian National Railway Company 21
CN at a glance
CN derives revenue from seven business units - a balanced mix of goods moving
over a network of approximately 18,000 route miles of track spanning North
America. CN is the only rail network on the continent to connect three coasts -
the Pacific, the Atlantic and the Gulf of Mexico.
Statistical summary
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2002 2001* 2000
---- ----- ----
Route miles (includes Canada and the U.S.) 17,821 17,986 15,532
Carloads (thousands) 4,164 3,821 3,796
Gross ton miles (millions) 309,295 293,857 288,150
Revenue ton miles (millions) 159,876 153,095 149,557
Rail employees (average for the year) 23,190 22,668 22,457
Diesel fuel consumed (liters in 1,420 1,328 1,292
millions)
Diesel fuel consumed (U.S. gallons in millions) 375 351 341
Average fuel price per liter (dollars) $ 0.32 $ 0.36 $ 0.33
Average fuel price per U.S. gallon (dollars) $ 1.20 $ 1.35 $ 1.24
* Includes Wisconsin Central Transportation Corporation from October 9,
2001.
2002 data
Freight revenue
Freight revenues (millions) Revenue ton miles (millions) per revenue ton mile (cents)
---------------- ---------- ----------------- ---------- -------------------- -------
Petroleum and chemicals $1,102 Petroleum and 30,006 Petroleum and 3.67
chemicals chemicals
Metals and minerals 521 Metals and minerals 13,505 Metals and minerals 3.86
Forest products 1,323 Forest products 33,551 Forest products 3.94
Coal 326 Coal 14,503 Coal 2.25
Grain and fertilizers 986 Grain and 35,773 Grain and fertilizers 2.76
fertilizers
Intermodal 1,052 Intermodal 29,257 Intermodal 3.60
Automotive 591 Automotive 3,281 Automotive 18.01
Freight revenues Revenue - traffic mix
2002 percentage data Per cent
-------------------- ---------------------
19% Petroleum and chemicals 57% U.S. domestic and transborder
9% Metals and minerals [GRAPHIC 19% Overseas
22% Forest products OMITTED] 24% Canadian domestic
[GRAPHIC 5% Coal
OMITTED] 17% Grain and fertilizers
18% Intermodal
10% Automotive
We believe the balance of our business mix positions us well to weather
economic downturns and maximizes our potential to grow revenue by competing
with trucks.
Petroleum and chemicals
Petroleum and chemicals comprise a wide range of commodities, including
chemicals, sulfur, plastics, petroleum and gas products. Most of CN's petroleum
and chemicals shipments originate in the Gulf of Mexico, in Alberta and in
eastern Canada, and are destined for customers in Canada, the United States and
overseas export.
Metals and minerals
CN's metals and minerals business consists primarily of nonferrous base metals,
steel, equipment and parts. Exclusive access to major mines and smelters
throughout North America makes CN a leader in the transportation of copper,
lead, zinc concentrates, refined metals and aluminum.
Forest products
CN is the largest carrier of forest products in North America. The product
lines for this business unit include various types of lumber, panels, wood
chips, woodpulp, printing paper, linerboard and newsprint. In Canada, CN enjoys
superior access to the major fiber-producing regions. In the United States, CN
is strategically located to serve both the northern and southern U.S. corridors
with interline capabilities to other Class 1 railroads.
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22 Canadian National Railway Company
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Coal
CN moves both Canadian and U.S. thermal coal. Canadian thermal coal is
delivered to power utilities primarily in eastern Canada. U.S. thermal coal is
transported from mines in southern Illinois or from western U.S. mines via
interchange with other railroads to utilities in the U.S. Midwest.
Grain and fertilizers
CN's grain and fertilizer business transports commodities grown in western
Canada and the U.S. Midwest. The majority of grain and grain products carried
by CN are for export. In the United States, CN handles grain grown in Illinois
and Iowa for export, as well as to domestic processing facilities and feed
markets. CN also serves producers of potash, ammonium nitrate, urea and other
fertilizers.
Intermodal
CN's intermodal business consists of two product segments. The first segment,
domestic, is responsible for consumer products and manufactured goods,
operating through both retail and wholesale channels. The second, the
international segment, handles import and export container traffic, serving the
ports of Vancouver, Montreal, Halifax, Mobile and New Orleans.
Automotive
CN is a leading carrier of automotive products originating in southwestern
Ontario and Michigan. This business unit moves both finished vehicles and parts
within the United States, Canada and Mexico. CN also serves shippers of import
vehicles via the ports of Halifax and Vancouver, and through interchange with
other railroads.
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23
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Dear Fellow Shareholders:
The past year has been one of challenge and change at CN. Economic challenges
and drought in the grain producing areas served by CN caused our management to
work even harder to produce good results. The departure of Paul Tellier in
December confirmed our resilience and our succession planning. We welcome
Hunter Harrison as our new President and Chief Executive Officer with great
enthusiasm.
The challenges of corporate governance issues throughout corporate America
highlighted our good governance practices, which have been a priority for our
company since our Initial Public Offering.
CN has always been a leader in good corporate governance. We have from our
inception had a separate non-executive chair as well as independent and
financially literate members forming our audit committee. Our Board meets
regularly without management, which illustrates the strength and independence
of our Board. Investor Relations magazine awarded CN its top corporate
governance award. CN has also received the Korn/Ferry-Revue Commerce award for
the best corporate governance practices in Quebec.
We will always strive to maintain these high standards - it is part of our
proud tradition, ensuring we will always be accountable to those who invest in
our company.
CN directors have made substantial personal investments in our company,
clearly an illustration of the close alignment of the interests of the Board of
Directors with those of our shareholders.
After 10 years as President and Chief Executive Officer of CN, Paul
Tellier has chosen to pursue new challenges at Bombardier Inc. We are grateful
to Paul for his inspired leadership and especially for leaving the company
ready for his successor with a strong balance sheet and a clear sense of
direction.
We are all committed to continue the path of excellence Paul established,
and our new President and Chief Executive Officer, Hunter Harrison, North
America's Railroader of the Year in 2001, is well equipped to take CN to the
next level.
The Board is very optimistic that with the depth of leadership at CN, we
can and intend to maintain our position as North America's most efficient and
profitable railroad.
To our dedicated employees at CN, we are grateful for your continued
commitment to excellence; to my fellow Board members, I am very appreciative of
your conscientious attention to maintaining the high standards you have set;
and finally to our shareholders, we will always appreciate and respect your
investment by our commitment to delivering solid shareholder value.
Sincerely,
(signed)
David McLean, O.B.C. LL.D.
Chairman of the Board
24 Canadian National Railway Company
Pulling together...
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Canadian National Railway Company 25
for a brighter future
Safety above all; lifelong learning; community support; and commitment to
action. These are the values that form the bedrock of CN's community investment
philosophy. Our goal is simple: we seek, through our resources, our talents and
our time, to help make our communities better places to live and work.
CN's corporate citizenship philosophy, called "Pulling Together," is
focused on four areas: community safety, transportation education, community
response and United Way/Centraide - areas carefully chosen so our efforts have
the best chance to make a difference.
Because we know North America's prosperity is closely linked to its
transportation infrastructure, we support study and research in transportation,
encouraging young people to get involved in the field and help shape the
future. We focus our support on creating and helping to sustain centers of
excellence in transportation education and policy by providing funds for
university chairs, scholarships and postgraduate fellowships. A few notable
examples of our support in 2002:
Sustainable Transport, Logistics and Supply Chain Management Chair, University
of Manitoba - A major donation from CN helped to create this chair, to be held
at the university's I.H. Asper School of Business starting in 2003. The chair
is part of a new program in logistics, transportation and supply chain
management at one of Canada's premier centers of study in the transportation
field.
The CN Transportation and Logistics Management Fund, University of
Wisconsin-Superior - In 2002, CN made a significant contribution to help
develop programs and fund scholarships at the school in the transportation
management field of study. The fund will provide income to support research
projects, scholarships for students majoring in transportation management who
maintain high academic standards and program development such as the purchase
of specialized simulation software.
The CN Intermodal Transportation Chair, Universite de Montreal -
The CN chair, created in 2002, continues a long relationship between
CN and one of Canada's most prestigious institutions of higher learning.
The chair will devote itself primarily to research on intermodal transportation,
addressing a range of topics, from the transport of goods to
government transportation policies.
26 Canadian National Railway Company
[GRAPHIC OMITTED]
Canadian National Railway Company 27
Glossary of Terms
Average length of haul - The average distance in miles one ton is
carried. Computed by dividing total ton-miles by tons of freight.
Carload - A one-car shipment of freight from one consignor to one
consignee.
Car velocity - Car velocity is an average speed calculation, expressed
in miles per day, of the car movements from time of release at one
location to arrival at the destination.
Class 1 railroad - As determined by the U.S. Surface Transportation
Board, a railroad with annual operating revenues that exceed the
threshold indexed to a base of U.S.$250 million in 1991 dollars.
Gross ton miles - The weight of railway cars and contents behind
the locomotives expressed in tons multiplied by the distance in miles
from the originating location to the destination on the railroad.
Intermodal service - In railroad transportation, the movement of
trailers or containers on railroad freight cars.
Linehaul - The movement of trains between terminals and stations on
the main or branch lines of the road, exclusive of switching movements.
Main track - A track extending through and between stations upon
which trains are operated.
Operating ratio - The ratio of operating expenses to operating
revenues.
Regional railroad - As defined by the Association of American
Railroads, a regional railroad is one that operates at least 350 miles
of track and/or has annual revenues of at least U.S.$40 million but
less than the Class 1 threshold indexed to a base of U.S.$250 million
in 1991 dollars.
Revenue ton mile - The movement of a ton of freight over one mile
for revenue.
Right-of-way - A strip of land of various widths upon which a rail
track is built.
Rolling stock - Transportation equipment on wheels, especially
locomotives and freight cars.
Route miles - The miles of right-of-way operated by a railroad. In
multiple track territories only one track counts as route miles.
Scheduled railroad - Running a scheduled railroad is a disciplined
process that handles individual car movements according to a specific
plan where possible and that manages expectations to meet agreed
upon customer commitments.
Siding - A track auxiliary to the main track for meeting or passing
trains, or a track for industrial purposes.
Through train - A train operated between two or more major
concentration or distribution points.
Trip plan - A trip plan is a detailed chain of train handling events
describing how a car(s) can be handled from the shipper's door to the
consignee's door. Trip plans are expressed in hours and are tailored
for each specific customer location.
Unit train - A train with a fixed, coupled consist of cars operated continuously
in shuttle service under load from origin and delivered intact at
destination and returning usually for reloading at the same origin.
Waybill - The document covering a shipment and showing the forwarding
and receiving stations, the name of consignor and consignee, the car
initials and number, the routing, the description and weight of the commodity,
instructions for special services, the rate, total charges, advances
and waybill reference for previous services, and the amount prepaid.
Yard - A system of tracks within defined limits, designed for switching
services.
Yard dwell - Yard dwell is the average duration, expressed in hours,
that cars spend in a specific operating terminal.
28 Canadian National Railway Company
Financial Section (U.S. GAAP)
Contents
Canadian National Railway Company
-------------------------------------------------------------------------------
30 Selected Railroad Statistics
31 Management's Discussion and Analysis
49 Management Report
49 Auditors' Report
50 Consolidated Statement of Income
51 Consolidated Statement of Comprehensive Income
52 Consolidated Balance Sheet
53 Consolidated Statement of Changes in Shareholders' Equity
54 Consolidated Statement of Cash Flows
Notes to Consolidated Financial Statements
-------------------------------------------------------------------------------
55 1 Summary of significant accounting policies
58 2 Accounting changes
58 3 Acquisition of Wisconsin Central Transportation Corporation
59 4 Accounts receivable
59 5 Properties
60 6 Other assets and deferred charges
60 7 Credit facilities
60 8 Accounts payable and accrued charges
61 9 Other liabilities and deferred credits
62 10 Long-term debt
63 11 Capital stock and convertible preferred securities
63 12 Stock plans
65 13 Pensions
66 14 Workforce reduction charges
66 15 Interest expense
66 16 Other income
67 17 Income taxes
67 18 Segmented information
68 19 Earnings per share
68 20 Major commitments and contingencies
70 21 Financial instruments
71 22 Other comprehensive income (loss)
72 23 Quarterly financial data - unaudited
72 24 Comparative figures
U.S. GAAP
Canadian National Railway Company 29
Selected Railroad Statistics
Year ended December 31, 2002 2001(1) 2000
--------------------------------------------------------------------------------
Rail operations
Freight revenues ($ millions) ...................... 5,901 5,457 5,236
Gross ton miles (millions) ......................... 309,295 293,857 288,150
Revenue ton miles (RTM) (millions) ................. 159,876 153,095 149,557
Route miles (includes Canada and the U.S.) ......... 17,821 17,986 15,532
Operating expenses per RTM (cents) ................. 2.90 2.59 2.53
Adjusted operating expenses per RTM (cents) (2) .... 2.65 2.53 2.53
Freight revenue per RTM (cents) .................... 3.69 3.56 3.50
Carloads (thousands) ............................... 4,164 3,821 3,796
Freight revenue per carload ($) .................... 1,417 1,428 1,379
Diesel fuel consumed (liters in millions) .......... 1,420 1,328 1,292
Average fuel price ($/liter) ....................... 0.32 0.36 0.33
Revenue ton miles per liter of fuel consumed ....... 113 115 116
Gross ton miles per liter of fuel consumed ......... 218 221 223
Diesel fuel consumed (U.S. gallons in millions) .... 375 351 341
Average fuel price ($/U.S. gallon) ................. 1.20 1.35 1.24
Revenue ton miles per U.S. gallon of fuel
consumed ......................................... 426 436 439
Gross ton miles per U.S. gallon of fuel consumed ... 825 837 845
Locomotive bad order ratio (%) (3) ................. 7.0 7.1 7.0
Freight car bad order ratio (%) .................... 6.0 5.7 5.1
Productivity
Adjusted operating ratio (%) (2) ................... 69.4 68.5 69.6
Freight revenue per route mile ($ thousands) ....... 331 303 337
Revenue ton miles per route mile (thousands) ....... 8,971 8,512 9,629
Freight revenue per average number of
employees ($ thousands) .......................... 254 241 233
Revenue ton miles per average number of
employees (thousands) ............................ 6,894 6,754 6,660
Employees
Number at end of period ............................ 22,114 22,868 21,378
Average number during period ....................... 23,190 22,668 22,457
Labor and fringe benefits expense per RTM (cents) .. 1.15 1.06 0.98
Adjusted labor and fringe benefits expense per
RTM (cents)(4) ................................... 1.07 1.00 0.98
Injury frequency rate per 200,000 person hours ..... 3.0 4.4 5.5
Accident rate per million train miles .............. 2.0 2.0 2.1
==========================
(1) Includes Wisconsin Central Transportation Corporation from October 9,
2001.
(2) Excludes a 2002 charge of $281 million to increase the Company's provision
for U.S. personal injury and other claims, and workforce reduction charges
of $120 million and $98 million in 2002 and 2001, respectively, as
discussed in the Company's Management's Discussion and Analysis on pages
31 and 35.
(3) In 2002, the Company expanded its measure of bad order locomotives to
include all those not available for service, including on-line failures.
The comparative figures have been restated accordingly.
(4) Excludes workforce reduction charges recorded in 2002 and 2001.
30 Canadian National Railway Company
Management's Discussion and Analysis
Management's discussion and analysis (MD&A) relates to the financial condition
and results of operations of Canadian National Railway Company (CN) together
with its wholly owned subsidiaries, including Grand Trunk Corporation (GTC),
Illinois Central Corporation (IC) and Wisconsin Central Transportation
Corporation (WC), the latter from October 9, 2001. As used herein, the word
"Company" means, as the context requires, CN and its subsidiaries. CN's common
shares are listed on the Toronto and New York stock exchanges. Except where
otherwise indicated, all financial information reflected herein is expressed in
Canadian dollars and determined on the basis of United States generally
accepted accounting principles (U.S. GAAP). This MD&A should be read in
conjunction with the Company's Consolidated Financial Statements and notes
thereto.
Financial results
2002 compared to 2001
On October 9, 2001, the Company completed its acquisition of WC and began a
phased integration of the companies' operations. Accordingly, in the following
discussion, the Company's results include the results of operations of WC,
which were fully integrated into those of the Company in 2002.
The Company recorded consolidated net income of $800 million ($4.07 per basic
share) for the year ended December 31, 2002 compared to $1,040 million ($5.41
per basic share) for the year ended December 31, 2001.Diluted earnings per
share were $3.97 for the current year compared to $5.23 in 2001. Operating
income was $1,469 million for 2002 compared to $1,682 million in 2001.
The years ended December 31, 2002 and 2001 included items impacting the
comparability of the results of operations. Included in 2002 is a fourth quarter
charge of $281 million, or $173 million after tax, to increase the Company's
provision for U.S. personal injury and other claims, and a charge for workforce
reductions of $120 million, or $79 million after tax. In 2001, the Company
recorded a deferred income tax recovery of $122 million resulting from the
enactment of lower corporate tax rates in Canada, a charge for workforce
reductions of $98 million, or $62 million after tax, a charge to write down the
Company's net investment in 360networks Inc. of $99 million, or $71 million
after tax and a gain of $101 million, or $73 million after tax related to the
sale of the Company's 50 percent interest in the Detroit River Tunnel Company
(DRT).
Excluding the effects of the items discussed in the preceding paragraph,
adjusted consolidated net income(1) was $1,052 million ($5.35 per basic share
or $5.22 per diluted share) in 2002 compared to $978 million ($5.09 per basic
share or $4.92 per diluted share) in 2001, an increase of $74 million, or
8%. Adjusted operating income,(1) which excludes the 2002 charge to increase the
Company's provision for U.S. personal injury and other claims and the 2002 and
2001 workforce reduction charges, increased by $90 million, or 5%, to $1,870
million. The adjusted operating ratio was 69.4% in 2002 compared to 68.5% in
2001, a 0.9-point increase.
(1) The Company's results of operations include items affecting the
comparability of results. Management believes adjusted consolidated net income
and the resulting adjusted performance measures for such items as operating
income, operating ratio, per share data and other statistical measures are
useful measures of performance that facilitate period-to-period comparisons.
These adjusted measures do not have any standardized meaning prescribed by GAAP
and are not necessarily comparable to similar measures presented by other
companies, and therefore, should not be considered in isolation.
Revenues
Revenues for the year ended December 31, 2002 totaled $6,110 million compared
to $5,652 million in 2001. The increase of $458 million, or 8%, was mainly due
to the inclusion of a full year of revenues attributable to the operations of
WC in 2002.In addition, revenue gains were made in petroleum and chemicals,
automotive, intermodal and forest products. These overall increases in revenues
were partly offset by continued weakness in Canadian grain, coal, and metals
and minerals. Revenue ton miles increased by 4% relative to 2001 and freight
revenue per revenue ton mile increased by 4%.
Year ended December 31, 2002 2001 2002 2001 2002 2001
-----------------------------------------------------------------------------------------
Freight revenue
Revenues Revenue ton miles per revenue ton mile
-----------------------------------------------------------------------------------------
In millions In cents
-----------------------------------------------------------------------------------------
Petroleum and chemicals $ 1,102 $ 923 30,006 25,243 3.67 3.66
Metals and minerals ... 521 458 13,505 10,777 3.86 4.25
Forest products ....... 1,323 1,088 33,551 29,639 3.94 3.67
Coal .................. 326 338 14,503 15,566 2.25 2.17
Grain and fertilizers . 986 1,161 35,773 42,728 2.76 2.72
Intermodal ............ 1,052 969 29,257 26,257 3.60 3.69
Automotive ............ 591 520 3,281 2,885 18.01 18.02
Other items* .......... 209 195 - - - -
------------------------------------
Total ................. $ 6,110 $ 5,652 159,876 153,095 3.69 3.56
=====================================
* Principally non-freight revenues derived from third parties.
U.S. GAAP
Canadian National Railway Company 31
Management's Discussion and Analysis
Petroleum and chemicals
Revenues for the year ended December 31, 2002 increased by $179 million,
or 19%, over 2001.Growth was mainly due to the inclusion of a full
year of revenues attributable to the operations of WC in 2002, strong
sulfur traffic to the United States and offshore markets and market share
gains in various sectors. The revenue per revenue ton mile remained relatively
unchanged for the year as the effect of the weaker Canadian dollar
was offset by an increase in the average length of haul for non-WC traffic.
Forest products
Revenues for the year ended December 31, 2002 increased by $235 million,
or 22%, over 2001.Growth was mainly due to the inclusion of a full
year of revenues attributable to the operations of WC in 2002, a strong
North American housing market and improving pulp and paper markets.
Also contributing to growth in the second half of the year were strong
lumber shipments from CN's western lumber producers. The increase in
revenue per revenue ton mile of 7% was mainly due to the effect of the
weaker Canadian dollar and the inclusion of shorter haul WC traffic.
[GRAPHIC OMITTED]
Metals and minerals
Revenues for the year ended December 31, 2002 increased by $63 million,
or 14%, over 2001. The increase was mainly due to the inclusion
of a full year of revenues attributable to the operations of WC in 2002,
market share gains in the non-ferrous segment, particularly aluminum,
and strong construction materials traffic. Partly offsetting these gains
were the effects of weak steel markets in the first half of the year,
one-time gains in 2001 and reduced traffic in specific segments due to
ongoing customer strikes. Revenue per revenue ton mile decreased by
9% over 2001 mainly due to an increase in longer haul traffic and the
inclusion of certain lower rated WC traffic.
Coal
Revenues for the year ended December 31, 2002 decreased by $12 million,
or 4%, from 2001. The decrease was mainly attributable to weak
Canadian coal exports to offshore markets and reduced demand from
power utilities in the first half of the year. The revenue per revenue ton
mile increase of 4% was mainly due to a decrease in longer haul traffic.
[GRAPHIC OMITTED]
U.S. GAAP
32 Canadian National Railway Company
Management's Discussion and Analysis
Grain and fertilizers
Revenues for the year ended December 31, 2002 decreased by $175 million,
or 15%, from 2001. The decrease reflects a significant deterioration
in the Canadian grain crop, a decline in U.S. originated traffic and the
loss of a potash move. Revenue per revenue ton mile increased by 1%
mainly as a result of an increase in regulated grain rates.
Automotive
Revenues for the year ended December 31, 2002 increased by $71 million,
or 14%, over 2001. The increase reflects strong motor vehicle production
in both Canada and the United States. Revenue per revenue ton
mile remained relatively unchanged for the year as the effect of the
weaker Canadian dollar was offset by an increase in the average length
of haul.
[GRAPHIC OMITTED]
Intermodal
Revenues for the year ended December 31, 2002 increased by $83 million,
or 9%, over 2001. Growth in the international segment was driven
by market share gains by steamship lines served by CN. The domestic
segment benefited from growing North American markets, particularly in
Canada. Revenue per revenue ton mile decreased by 2%, mainly due to
a higher average fuel surcharge in 2001 and an increase in the average
length of haul.
[GRAPHIC OMITTED]
U.S. GAAP
Canadian National Railway Company 33
Management's Discussion and Analysis
Operating expenses
Operating expenses amounted to $4,641 million in 2002 compared to
$3,970 million in 2001. The increase was mainly due to the inclusion of a
full year of expenses attributable to the operations of WC in 2002, higher
Casualty and other expenses resulting primarily from the 2002 charge to
increase the Company's provision for U.S. personal injury and other
claims, and increased expenses for labor and fringe benefits that
included a higher workforce reduction charge in 2002 compared to 2001.
These increases were partly offset by lower fuel costs. Operating
expenses, excluding the 2002 charge for U.S. personal injury and other
claims and the 2002 and 2001 workforce reduction charges, amounted
to $4,240 million, an increase of $368 million, or 10%, from 2001.(1)
Dollars in millions Year ended December 31,
-------------------------------------------------------------------------------
2002 2001
---------------------------------------------
% of % of
Amount revenue Amount revenue
------ ------- ------ -------
Labor and fringe benefits ..... $1,837 30.1% $1,624 28.7%
Purchased services and material 778 12.7% 692 12.2%
Depreciation and amortization . 584 9.6% 532 9.4%
Fuel .......................... 459 7.5% 484 8.6%
Equipment rents ............... 346 5.7% 309 5.5%
Casualty and other ............ 637 10.4% 329 5.8%
---------------------------------------------
Total ......................... $4,641 $ 3,970
=============================================
Labor and fringe benefits: Labor and fringe benefit expenses in 2002
increased by $213 million, or 13%, as compared to 2001. The increase
was mainly due to the inclusion of a full year of expenses attributable to
the operations of WC in 2002, a higher workforce reduction charge in
2002, wage increases, and higher benefit expenses, including health and
welfare, particularly in the U.S. These increases were partly offset by the
effects of a reduced workforce in 2002.
In 2002, the Company announced 1,146 job reductions across all
corporate and operating functions in a renewed drive to improve productivity
and recorded a workforce reduction charge of $120 million.
Reductions relating to this and the 2001 workforce reduction charge
were 388 in 2001, 433 in 2002, with the remainder to be completed by
the end of 2003. The charges included payments for severance, early
retirement incentives and bridging to early retirement, to be made to
affected employees.
Purchased services and material: These costs increased by $86 million,
or 12%, in 2002 as compared to 2001. The increase was mainly due to
the inclusion of a full year of expenses attributable to the operations of
WC in 2002 and higher expenses for professional services and joint facilities.
These increases were partly offset by reduced expenses for crew
transportation and lodging in 2002.
Depreciation and amortization: Depreciation and amortization expense
in 2002 increased by $52 million, or 10%, as compared to 2001. The
increase was mainly due to the inclusion of a full year of expenses attributable
to the operations of WC in 2002 and the impact of net capital
additions in the current year.
Fuel: Fuel expense in 2002 decreased by $25 million, or 5%, as compared
to 2001. The decrease was primarily due to a lower average price of fuel,
partially offset by the inclusion of a full year of expenses attributable to
the operations of WC in 2002.
Equipment rents: These expenses increased by $37 million, or 12%, in
2002 as compared to 2001. The increase was mainly due to the inclusion
of a full year of expenses attributable to the operations of WC in 2002
and lower car hire income, partly offset by reduced expenses for long-term
operating leases.
Casualty and other: These expenses increased by $308 million, or 94%,
in 2002 as compared to 2001. The increase was mainly due to higher
expenses for personal injury and other claims which included a fourth
quarter 2002 charge of $281 million to increase the provision for U.S.
personal injury and other claims, and higher derailment related expenses.
Partly offsetting these increases were lower expenses related to environmental
matters and bad debts.
U.S. GAAP
34 Canadian National Railway Company
Management's Discussion and Analysis
Other
Interest expense: Interest expense increased by $34 million to $361 million
for the year ended December 31, 2002 as compared to 2001. The
increase was mainly due to the financing related to the acquisition of
WC and the inclusion of a full year of WC expenses in 2002. Partly offsetting
these increases was lower interest expense as a result of the conversion
of the convertible preferred securities in July 2002 and the maturity
of certain notes in 2001.
Other income: In 2002, the Company recorded other income of $76 million
compared to $65 million in 2001. The increase was mainly due to
the inclusion of a full year of equity in earnings of English Welsh and
Scottish Railway (EWS) in 2002 partly offset by lower gains on disposal
of properties. Included in 2001 was a charge of $99 million to write
down the Company's net investment in 360networks Inc. and a gain of
$101 million related to the sale of the Company's 50 percent interest in
DRT.
Income tax expense: The Company recorded income tax expense of $384
million for the year ended December 31, 2002 compared to $380 million
in 2001. The effective tax rate for the year ended December 31, 2002
was 32.4% compared to 35.4% in 2001, excluding the 2001 deferred
income tax recovery of $122 million resulting from the enactment of
lower corporate tax rates in Canada. The decrease in 2002 was primarily
due to lower income tax rates in Canada.
2001 compared to 2000
The Company recorded consolidated net income of $1,040 million
($5.41 per basic share) for the year ended December 31, 2001 compared
to $937 million ($4.81 per basic share) for the year ended December 31,
2000. Diluted earnings per share were $5.23 for 2001 compared to $4.67
in 2000. The results for 2001 include net income of $17 million related
to the acquisition of WC. Operating income was $1,682 million for 2001
compared to $1,648 million in 2000. This represents an increase of
$34 million, or 2%.
The years ended December 31, 2001 and 2000 included items
impacting the comparability of the results of operations. Included in
2001 is a deferred income tax recovery of $122 million resulting from the
enactment of lower corporate tax rates in Canada, a charge for workforce
reductions of $98 million, or $62 million after tax, a charge to write
down the Company's net investment in 360networks Inc. of $99 million,
or $71 million after tax and a gain of $101 million, or $73 million after
tax related to the sale of the Company's 50 percent interest in DRT. In
2000, the Company recorded a gain of $84 million, or $58 million after
tax related to the exchange of its minority equity investments in certain
joint venture companies for 11.4 million shares of 360networks Inc.
Excluding the effects of the items discussed in the preceding paragraph,
adjusted consolidated net income(1) was $978 million ($5.09 per
basic share or $4.92 per diluted share) in 2001 compared to $879 million
($4.51 per basic share or $4.39 per diluted share) in 2000. Adjusted
operating income,(1) which excludes the 2001 charge for workforce reductions,
increased by $132 million, or 8%, to $1,780 million. The adjusted
operating ratio, which excludes the 2001 charge for workforce reductions,
improved to 68.5% in 2001 from 69.6% in 2000, a 1.1-point betterment.
Revenues
Revenues for the year ended December 31, 2001 totaled $5,652 million
compared to $5,428 million in 2000. The increase of $224 million, or 4%,
was mainly attributable to the inclusion of $129 million of WC revenues
and to gains in metals and minerals, intermodal, forest products and
grain and fertilizers. This was partially offset by lower automotive revenues.
Revenue ton miles and freight revenue per revenue ton mile each
increased by 2% as compared to 2000.
Year ended December 31, 2001 2000 2001 2000 2001 2000
----------------------------------------------------------------------------------------
Freight revenue
Revenues Revenue ton miles per revenue ton mile
----------------------------------------------------------------------------------------
In In
millions cents
----------------------------------------------------------------------------------------
Petroleum and chemicals $ 923 $ 894 25,243 24,858 3.66 3.60
Metals and minerals ... 458 392 10,777 9,207 4.25 4.26
Forest products ....... 1,088 1,008 29,639 28,741 3.67 3.51
Coal .................. 338 328 15,566 15,734 2.17 2.08
Grain and fertilizers . 1,161 1,136 42,728 42,396 2.72 2.68
Intermodal ............ 969 919 26,257 25,456 3.69 3.61
Automotive ............ 520 559 2,885 3,165 18.02 17.66
Other items* .......... 195 192 - - - -
-------------------------------------
Total ................. $ 5,652 $ 5,428 153,095 149,557 3.56 3.50
=====================================
* Principally non-freight revenues derived from third parties.
U.S. GAAP
Canadian National Railway Company 35
Management's Discussion and Analysis
Petroleum and chemicals
Revenues for the year ended December 31, 2001 increased by $29 million,
or 3%, over 2000 of which $22 million resulted from the inclusion
of WC revenues. Excluding WC, growth in 2001 was driven by market
share gains and plant expansions in the petroleum products sector,
increased salt traffic, mainly in the early part of the year, and the weaker
Canadian dollar. Significant weakness in sulfur demand partially offset
these increases. The revenue per revenue ton mile increase of 2% for
2001 was mainly attributable to the effect of the weaker Canadian dollar.
Metals and minerals
Revenues for the year ended December 31, 2001 increased by $66 million,
or 17%, over 2000 of which $22 million resulted from the inclusion
of WC revenues. Excluding WC, growth in 2001 was driven by strong
Canadian aluminum exports to the United States in line with weaker U.S.
production, increased levels of equipment traffic, market share gains in
steel, ores and concentrates, and increased stone and rock shipments to
the United States. Significant weakness in the steel markets partially
offset overall growth. Revenue per revenue ton mile was essentially flat
year over year.
Forest products
Revenues for the year ended December 31, 2001 increased by $80 million,
or 8%, over 2000 of which $55 million resulted from the inclusion
of WC revenues. Excluding WC, growth was driven by market share gains
in the panels segment and the effect of the weaker Canadian dollar. These
gains were partially offset by weakness in the pulp and paper markets
due, in part, to a significant reduction in U.S. paper consumption. The
increase in revenue per revenue ton mile of 5% was mainly due to the
effect of the weaker Canadian dollar and the inclusion of shorter haul
WC traffic.
Coal
Revenues for the year ended December 31, 2001 increased by $10 million,
or 3%, over 2000 of which $7 million resulted from the inclusion of
WC revenues. Excluding WC, strong demand for thermal coal in 2001
was partially offset by reduced shipments of metallurgical coal due to
the closure of some Canadian mines in 2000. The revenue per revenue
ton mile increase of 4% was mainly due to an increase in rates tied to
commodity prices and the effect of the weaker Canadian dollar.
Grain and fertilizers
Revenues for the year ended December 31, 2001 increased by $25 million,
or 2%, over 2000 of which $15 million resulted from the inclusion
of WC revenues. Excluding WC, growth was mainly driven by higher
wheat shipments to the United States, increased market share of U.S.
corn and soybean traffic and higher exports of canola through Vancouver.
The 1% increase in revenue per revenue ton mile was mainly due to a
shift to shorter haul traffic and the effect of the weaker Canadian dollar,
partially offset by the introduction of the Canadian grain revenue cap in
August 2000.
Intermodal
Revenues for the year ended December 31, 2001 increased by $50 million,
or 5%, over 2000 of which $7 million resulted from the inclusion
of WC revenues. Excluding WC, growth was driven by market share gains
in the international segment and from new service offerings in the
domestic segment. Weaker economic conditions in the second half of
2001 led to slower growth. Revenue per revenue ton mile increased by
2% due to rate increases and the effect of the weaker Canadian dollar,
partially offset by a shift to longer haul traffic.
Automotive
Revenues for the year ended December 31, 2001 decreased by $39 million,
or 7%, from 2000. The revenue decline resulted from weakness in
North American vehicle production in 2001 and from one-time gains
obtained in 2000 due, in part, to competitors' service problems. The
decline was partially offset by the effect of the weaker Canadian dollar.
The increase in revenue per revenue ton mile of 2% was mainly due to
the weaker Canadian dollar partially offset by an increase in the average
length of haul.
U.S. GAAP
36 Canadian National Railway Company
Management's Discussion and Analysis
Operating expenses
Operating expenses amounted to $3,970 million in 2001 compared to
$3,780 million in 2000. The increase in 2001 was mainly due to the
inclusion of $86 million of WC expenses, higher labor and fringe benefit
expenses that included a charge for workforce reductions of $98 million,
higher fuel costs, and increased expenses for equipment rents. Partially
offsetting these increases were lower expenses for purchased services
and material. Operating expenses, excluding the workforce reduction
charge, amounted to $3,872 million, an increase of $92 million, or 2%,
from 2000.(1)
Dollars in millions Year ended December 31, 2001 2000
-----------------------------------------------------------------------------------------------------
% of % of
Amount revenue Amount revenue
Labor and fringe benefits ........................... $1,624 28.7% $1,472 27.1%
Purchased services and material ..................... 692 12.2% 746 13.8%
Depreciation and amortization ....................... 532 9.4% 525 9.7%
Fuel ................................................ 484 8.6% 446 8.2%
Equipment rents ..................................... 309 5.5% 285 5.2%
Casualty and other .................................. 329 5.8% 306 5.6%
--------------------------------------------
Total ............................................... $3,970 $3,780
==============================
Labor and fringe benefits: Labor and fringe benefit expenses in 2001
increased by $152 million, or 10%, as compared to 2000. The increase
was mainly attributable to the workforce reduction charge, the inclusion
of WC labor expense of $40 million, wage increases and the impact of
the weaker Canadian dollar on U.S. denominated expenses. This was partially
offset by lower pension and other benefit related expenses.
The Company recorded a workforce reduction charge of $98 million in the
second quarter of 2001 for the reduction of 690 positions (388 occurred in 2001
and the remainder was completed by the end of 2002). The charge included
payments for severance, early retirement incentives and bridging to early
retirement, to be made to affected employees.
Purchased services and material: These expenses decreased by $54 million,
or 7%, in 2001 as compared to 2000. The decrease was mainly due
to one-time consulting and professional fees related to a proposed combination
in 2000, lower contracted services and higher recoveries in 2001
from work performed for third parties. This was partially offset by higher
equipment repair and maintenance expenses and $12 million resulting
from the inclusion of WC expenses.
Depreciation and amortization: Depreciation and amortization expense
in 2001 increased by $7 million, or 1%, as compared to 2000. The effect
of revised depreciation rates for certain assets mostly offset the
increases related to net capital additions and the inclusion of WC depreciation
of $10 million.
Fuel: Fuel expense in 2001 increased by $38 million, or 9%, as compared
to 2000, primarily due to an increase in the average cost of fuel and the
inclusion of $10 million of WC fuel expense.
Equipment rents: These expenses increased by $24 million, or 8%, in
2001 as compared to 2000. The increase was mainly attributable to
lower lease and offline car hire income and the inclusion of $6 million
of WC equipment rents. This was partially offset by lower private car
mileage payments.
Casualty and other: These expenses increased by $23 million, or 8%, in
2001 as compared to 2000. The increase resulted from higher expenses
for occupational disease claims and environmental matters, higher
provincial capital taxes and the inclusion of $8 million of WC expenses.
This was partially offset by lower expenses for damaged equipment and
merchandise claims and provincial sales tax recoveries in 2001.
Other
Interest expense: Interest expense increased by $16 million to $327 million
for the year ended December 31, 2001 as compared to 2000. The
increase was mainly due to the financing related to the acquisition of WC,
the inclusion of $4 million of WC interest expense, and the impact of the
weaker Canadian dollar on U.S. denominated interest costs. This was, in
part, offset by the refinancing of a portion of matured debt at lower rates.
Other income: In 2001, the Company recorded other income of $65 million
compared to $136 million in 2000.Included in 2001 is a charge of
$99 million to write down the Company's net investment in 360networks
Inc., a gain of $101 million related to the sale of the Company's 50 percent
interest in DRT and $11 million of WC other income. The comparative
2000 period included an $84 million gain related to the 360networks Inc.
transaction.
U.S. GAAP
Canadian National Railway Company 37
Management's Discussion and Analysis
Income tax expense: The Company recorded an income tax expense
of $380 million for the year ended December 31, 2001 compared to
$536 million in 2000. The decrease in income tax expense was mainly
due to a $122 million deferred income tax recovery recorded in 2001
resulting from the enactment of lower corporate tax rates in Canada.
Excluding this item, the effective tax rate for the year ended December
31, 2001 decreased to 35.4% from 36.4% in 2000 due mainly to lower
tax rates in 2001.
Liquidity and capital resources
The Company's principal source of liquidity is cash generated from operations.
The Company also has the ability to fund liquidity requirements
through its revolving credit facility, the issuance of debt and/or equity,
and the sale of a portion of its accounts receivable through its Accounts
receivable securitization program. In addition, from time to time, the
Company's liquidity requirements can be supplemented by the disposal
of surplus properties and the monetization of assets.
Operating activities: Cash provided from operating activities was
$1,612 million for the year ended December 31, 2002 compared to
$1,621 million for 2001.Cash generated in 2002 was partially consumed
by payments for interest, workforce reductions and personal injury and
other claims of $398 million, $177 million and $156 million, respectively,
compared to $322 million, $169 million and $149 million, respectively
in 2001. Pension contributions and payments for income taxes were
$92 million and $65 million, respectively, compared to $69 million and
$63 million, respectively in 2001. The Company increased the level of
accounts receivable sold under its Accounts receivable securitization program
by $5 million in 2002 and $133 million in 2001. Payments in 2003
for workforce reductions are expected to be $168 million while pension
contributions are expected to be approximately $92 million.
Investing activities: Cash used by investing activities in 2002 amounted
to $924 million compared to $2,173 million in 2001. The Company's
investing activities in 2002 included aggregate net proceeds of $69 million
from the sale of its investments in Tranz Rail Holdings Limited and
Australian Transport Network Limited, and $28 million from the sale of
IC Terminal Holdings Company. Investing activities in 2001 included
$1,278 million related to the acquisition of WC as at October 9, 2001
and net proceeds of $112 million from the sale of DRT. Net capital
expenditures for the year ended December 31, 2002 amounted to $938
million, including $76 million related to WC, a decrease of $3 million
over 2001. Net capital expenditures included expenditures for roadway
renewal, rolling stock, and other capacity and productivity improvements.
The Company anticipates that capital expenditures for 2003 will remain at
approximately the same level as 2002.T his will include funds required for
ongoing renewal of the basic plant and other acquisitions and investments
required to improve the Company's operating efficiency and customer service.
As at December 31, 2002, the Company had commitments to acquire railroad
ties, rail, freight cars and locomotives at an aggregate cost of $183 million.
Dividends: During 2002, the Company paid dividends totaling $170 million
to its shareholders at the quarterly rate of $0.215 per share.
Free cash flow
The Company generated $513 million of free cash flow for the year
ended December 31, 2002, compared to $443 million for the same 2001
period, excluding $1,278 million related to the 2001 acquisition of WC.
The Company defines free cash flow as cash provided from operating
activities, excluding increases in the level of accounts receivable sold
under the securitization program ($5 million in 2002, $133 million in 2001),
less capital expenditures, other investing activities and dividends paid.
Financing activities: Cash used by financing activities totaled $546 million
for the year ended December 31, 2002 compared to cash generated
of $740 million in 2001.In 2002, issuances and repayments of long-term
debt related principally to the Company's commercial paper and revolving
credit facilities. In 2001, the Company issued debt securities in two
series, U.S.$400 million (Cdn$629 million) 6.375% Notes due 2011 and
U.S.$200 million (Cdn$314 million) 7.375% Debentures due 2031,
related to the acquisition of WC.
In 2002, $203 million was used to repurchase common shares under the share
repurchase program. In 2001, the Company also had a share repurchase program,
under which it did not repurchase any common shares.
During 2002, the Company recorded $114 million in capital lease
obligations ($91 million in 2001) related to new equipment and the exercise of
purchase options on existing equipment.
The Company has access to various financing arrangements:
Revolving credit facilities
In December 2002, the Company entered into a U.S.$1,000 million three-year
revolving credit facility and concurrently terminated its previous
revolving credit facilities before their scheduled maturity in March 2003.
The credit facility provides for borrowings at various interest rates, plus
applicable margins, and contains customary financial covenants.
Throughout the year, the Company was in compliance with all financial
covenants contained in its outstanding revolving credit agreements. The
Company's borrowings of U.S.$172 million (Cdn$273 million) outstanding
U.S. GAAP
38 Canadian National Railway Company
Management's Discussion and Analysis
at December 31, 2001 were entirely repaid in the first quarter of 2002. At
December 31, 2002, the Company had borrowings under its revolving credit
facility of U.S.$90 million (Cdn$142 million) at an average interest rate of
1.77%. Outstanding letters of credit under the previous facilities were
transferred into the current facility. As at December 31, 2002, letters of
credit under the revolving credit facility amounted to $295 million.
Commercial paper
The Company has a commercial paper program, which is backed by a portion of its
revolving credit facility, enabling it to issue commercial paper up to a
maximum aggregate principal amount of $600 million, or the U.S. dollar
equivalent. Commercial paper debt is due within one year but has been classified
as long-term debt, reflecting the Company's intent and contractual ability to
refinance the short-term borrowing through subsequent issuances of commercial
paper or drawing down on the long-term revolving credit facility. As at December
31, 2002, the Company had outstanding commercial paper of U.S.$136 million
(Cdn$214 million) compared to U.S.$213 million (Cdn$339 million) as at December
31, 2001.
Shelf registration statement
At December 31, 2002, the Company had U.S.$400 million remaining for issuance
under its shelf registration statement, which expires in August 2003.
Accounts receivable securitization program
The sale of a portion of the Company's accounts receivable is conducted
under a securitization program, which has a $350 million maximum limit
and will expire in June 2003. The program is subject to customary credit
rating and reporting requirements. In the event the program is terminated
before its scheduled maturity, the Company expects to have sufficient
liquidity remaining in its revolving credit facility to meet its payment
obligations. The Company intends to renew or replace the program upon
expiration. At December 31, 2002, pursuant to the agreement, $173 million
and U.S.$113 million (Cdn$177 million) had been sold on a limited
recourse basis, an increase of $5 million from the level of accounts
receivable sold at December 31, 2001.
The Receivables Purchase Agreement provides for customary indemnification
provisions, which survive for a period of two years following the final
purchase of any receivable, three years from the final collection date or until
statute barred, in the case of taxes. As at December 31, 2002, the Company has
not recorded a liability associated with these indemnifications, for which
there is no monetary limitation, as the Company does not expect to make any
payments pertaining to the indemnifications of this program. Although there is
no monetary limitation with respect to these indemnifications, the Company
would not expect the amount to exceed the maximum limit under the program.
Contractual obligations and commercial commitments
In the normal course of business, the Company incurs contractual obligations
and commercial commitments. The following tables set forth material obligations
and commitments as of December 31, 2002:
Contractual obligations 2008
and
In millions ................... Total 2003 2004 2005 2006 2007 thereafter
-------------------------------------------------------------------------------------------------
Debentures and notes .......... $4,167 $ 394 $ 419 $ 158 $ 394 $ 79 $2,723
Capital leases and other(a) ... 1,424 180 141 444 46 90 523
------------------------------------------------------------
Long-term debt ................ 5,591 574 560 602 440 169 3,246
Operating leases .............. 1,154 212 188 167 139 120 328
------------------------------------------------------------
Total obligations ............. $6,745 $ 786 $ 748 $ 769 $ 579 $ 289 $3,574
============================================================
Commercial commitments
2008
and
In millions ................... Total 2003 2004 2005 2006 2007 thereafter
-------------------------------------------------------------------------------------------------
Standby letters of credit ..... $ 403 $ 401 $ 1 $ - $ 1 $ - $ -
Other commercial commitments(b) 183 112 71 - - - -
------------------------------------------------------------
Total commitments ............. $ 586 $ 513 $ 72 $ - $ 1 $ - $ -
============================================================
(a) Excludes $498 million of imputed interest on capital leases at rates
ranging from approximately 3.0% to 14.6%.'=
(b) Includes commitments for railroad ties, rail, freight cars and
locomotives.
For 2003 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.
U.S. GAAP
Canadian National Railway Company 39
Management's Discussion and Analysis
Guarantees
Guarantee of residual values of operating leases
The Company has guaranteed a portion of the residual values of certain of its
assets under operating leases with expiry dates between 2004 and 2012, for the
benefit of the lessor. If the fair value of the assets, at the end of their
respective lease term, is less than the fair value, as estimated at the
inception of the lease, then the Company must, under certain conditions,
compensate the lessor for the shortfall. The maximum exposure in respect of
these guarantees is $63 million. As at December 31, 2002, the Company has not
recorded a liability associated with these guarantees, as the Company does not
expect to make any payments pertaining to the guarantees of these leases.
Standby letters of credit
The Company, including certain of its subsidiaries, has granted irrevocable
standby letters of credit, issued by highly rated banks, to third parties to
indemnify them in the event the Company does not perform its contractual
obligations. As at December 31, 2002, the maximum potential liability under
these letters of credit was $403 million of which $334 million was for workers'
compensation and other employee benefits and $69 million was for equipment
under leases and other.
As at December 31, 2002, the Company has not recorded a liability with
respect to these guarantees, as the Company does not expect to make any
payments in excess of what is recorded on the Company's financial statements
for the aforementioned items. The standby letters of credit mature at various
dates between 2003 and 2007.
Indemnifications
CN Pension Plan and CN 1935 Pension Plan
The Company has indemnified and held harmless the current trustee and the
former trustee of the Canadian National Railways Pension Trust Funds, and the
respective officers, directors, employees and agents of such trustees, from any
and all taxes, claims, liabilities, damages, costs and expenses arising out of
the performance of their obligations under the relevant trust agreements and
trust deeds, including in respect of their reliance on authorized instructions
of the Company or for failing to act in the absence of authorized instructions.
These indemnifications survive the termination of such agreements or trust
deeds. As at December 31, 2002, the Company has not recorded a liability
associated with these indemnifications, as the Company does not expect to make
any payments pertaining to these indemnifications.
Share repurchase program
On October 22, 2002, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 13.0 million common
shares between October 25, 2002 and October 24, 2003 pursuant to a normal
course issuer bid, at prevailing market prices. As at December 31, 2002, $203
million was used to repurchase 3.0 million common shares at an average price of
$67.68 per share.
Termination of conversion rights of
5.25% convertible preferred securities ("Securities")
On May 6, 2002, the Company met the conditions required to terminate the
Securities holders' right to convert their Securities into common shares of the
Company, and set the conversion termination date as July 3, 2002. The
conditions were met when the Company's common share price exceeded 120% of the
conversion price of U.S.$38.48 per share for a specified period, and all
accrued interest on the Securities had been paid. On July 3, 2002, Securities
that had not been previously surrendered for conversion were deemed converted,
resulting in the issuance of 6.0 million common shares of the Company.
Acquisition of Wisconsin Central Transportation Corporation
On October 9, 2001, the Company completed its acquisition of WC for an
acquisition cost of $1,301 million (U.S.$833 million) and began a phased
integration of the companies' operations.
The Company accounted for the merger using the purchase method of
accounting as required by the Financial Accounting Standards Board's (FASB)
Statement of Financial Accounting Standards (SFAS) No. 141 "Business
Combinations." As such, the Company's consolidated financial statements include
the assets, liabilities and results of operations of WC as of October 9, 2001,
the date of acquisition. The Company had estimated, on a preliminary basis, the
fair values of the assets and liabilities acquired based on currently available
information. In 2002, the Company finalized the allocation of the purchase
price and adjusted the preliminary fair values of the assets and liabilities
acquired as follows: Current assets decreased by $10 million, Properties
increased by $141 million, Other assets and deferred charges decreased by $98
million, Current liabilities increased by $10 million, Deferred income taxes
increased by $16 million and Other liabilities and deferred credits increased
by $3 million. The increase in Properties and decrease in Other assets and
deferred charges was mainly due to the final valuation of the Company's foreign
equity investment. The remaining adjustments resulted from additional
information obtained for conditions and circumstances that existed at the time
of acquisition.
U.S. GAAP
40 Canadian National Railway Company
Management's Discussion and Analysis
The following table outlines the final fair values of WC's assets and
liabilities acquired:
In millions
--------------------------------------------------------------------------------
Current assets ..........................................$ 165
Properties .............................................. 2,576
Other assets and deferred charges........................ 335
------
Total assets acquired.................................... 3,076
------
Current liabilities ..................................... 363
Deferred income taxes ................................... 759
Other liabilities and deferred credits .................. 181
Long-term debt........................................... 472
------
Total liabilities assumed ............................... 1,775
------
Net assets acquired .....................................$1,301
------
Recent accounting pronouncements
In January 2003, the FASB issued FASB Interpretation (FIN) No. 46,
"Consolidation of Variable Interest Entities." FIN No. 46 requires that an
enterprise holding other than a voting interest in a Variable Interest Entity
(VIE) could, subject to certain conditions, be required to consolidate the VIE
if the enterprise will absorb a majority of the VIE's expected losses and/or
receive a majority of its expected residual returns. This interpretation is
effective for newly created entities after January 31, 2003. For pre-existing
VIEs, the provisions of the interpretation are effective for periods beginning
after June 15, 2003. The Company does not expect FIN No. 46 to have a material
impact on its financial statements.
In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," which requires that a guarantor disclose and recognize
in its financial statements its obligations relating to guarantees that it has
issued. Liability recognition is required at the inception of the guarantee,
whether or not payment is probable. The disclosure requirements are effective
for periods ending after December 15, 2002, and have been reflected in the
notes to the Company's 2002 consolidated financial statements. The recognition
and measurement provisions are effective for guarantees issued or modified
after December 31, 2002. The Company will apply the recognition and measurement
provisions of FIN No. 45 on a prospective basis and, as such, does not expect
it to have an initial material impact on its financial statements upon
adoption.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which requires that a liability
for costs associated with an exit or disposal activity be recognized when the
liability is incurred. SFAS No. 146 also establishes that the liability should
be initially measured at fair value and subsequently adjusted for changes in
estimated cash flows. SFAS No. 146 is to be applied to exit or disposal
activities initiated after December 31, 2002. The Company will apply SFAS No.
146 on a prospective basis and, as such, does not expect it to have an initial
material impact on its financial statements upon adoption.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which requires an entity to record the fair value of
an asset retirement obligation as a liability in the period in which it incurs
a legal obligation associated with the retirement of tangible long-lived
assets. As a result of the issuance of SFAS No. 143, the Company is reviewing
the accounting policy of its asset replacement program. A change in this policy
will be treated as a change in accounting principle with a cumulative effect
adjustment being recorded in the first quarter of 2003. This statement is
effective for the Company's fiscal year beginning January 1, 2003. The Company
is currently evaluating the impact of this statement on its financial
statements.
Critical accounting policies
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of revenues and expenses during the period,
the reported amounts of assets and liabilities, and the disclosure of
contingent assets and liabilities at the date of the financial statements. On
an ongoing basis, management reviews its estimates, including those related to
personal injury and other claims, environmental matters, depreciation lives,
pensions and other post- retirement benefits, and income taxes, based upon
currently available information. Actual results could differ from these
estimates. The following accounting policies require management's more
significant judg - ments 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
Consolidated Financial Statements and notes thereto.
Management has discussed the development and selection of the Company's
critical accounting estimates with the Audit, Finance and Risk Committee of the
Company's Board of Directors and the Audit, Finance and Risk Committee has
reviewed the Company's related disclosures herein.
U.S. GAAP
Canadian National Railway Company 41
Management's Discussion and Analysis
Personal injury and other claims
In the normal course of its operations, the Company becomes involved
in various legal actions, including claims relating to personal injuries,
occupational disease and damage to property.
In Canada, employee injuries are governed by the workers' compensation
legislation in each province whereby employees may be awarded either a lump sum
or future stream of payments depending on the nature and severity of the
injury. Accordingly, the Company accounts for costs related to employee
work-related injuries based on actuarially developed estimates of the ultimate
cost associated with such injuries, including compensation, health care and
administration costs. For all other legal actions, the Company maintains, and
regularly updates on a case-by-case basis, provisions for such items when the
expected loss is both probable and can be reasonably estimated based on
currently available information.
Assumptions used in estimating the ultimate costs for Canadian employee
injury claims consider, among others, the discount rate, the rate of inflation,
wage increases and health care costs. The Company periodically reviews its
assumptions to reflect currently available information. Over the past three
years, the Company has changed certain of these assumptions, which have not had
a material effect on its results of operations. For all other legal claims in
Canada, estimates are based on case history, trends and judgment.
In the United States, employee work-related injuries, including
occupational disease claims, are compensated according to the provisions of the
Federal Employers' Liability Act (FELA) and represent a major expense for the
railroad industry. The FELA system, which requires either the finding of fault
through the U.S. jury system or individual settlements, has contributed to the
significant increase in the Company's personal injury expense in recent years.
In view of the Company's growing presence in the United States and the increase
in the number of occupational disease claims over the past few years, an
actuarial study was conducted in 2002, and in the fourth quarter of 2002 the
Company changed its methodology for estimating its liability for U.S. personal
injury and other claims, including occupational disease claims and claims for
property damage, from a case-by-case approach to an actuarial-based approach.
Consequently, and as discussed in Note 2 to the Consolidated Financial
Statements, the Company recorded a charge of $281 million ($173 million after
tax) to increase its provision for these claims.
Under the actuarial-based approach, the Company accrues the cost for the
expected personal injury and property damage claims and existing occupational
disease claims, based on actuarial estimates of their ultimate cost. The
Company is unable to estimate the total cost for unasserted occupational
disease claims. However, a liability for unasserted occupational disease claims
is accrued to the extent they are probable and can be reasonably estimated.
Under the case-by-case approach, the Company was accruing the cost for
claims as incidents were reported based on currently available information. In
addition, the Company did not record a liability for unasserted claims, as such
amounts could not be reasonably estimated under the case-by-case approach.
For the U.S. personal injury and other claims liability, historical claim
data is used to formulate assumptions relating to the expected number of claims
and average cost per claim (severity) for each year. Changes in any one of
these assumptions could materially affect Casualty and other expense as
reported in the Company's results of operations. For example, a 5% change in
the number of claims or severity would have the effect of changing the
provision by approximately $25 million and the annual expense by approximately
$5 million.
The Company's expenses for personal injury and other claims, net of
recoveries, and including the above-mentioned charge, were $393 million in 2002
($78 million in 2001 and $60 million in 2000) and payments for such items were
$156 million in 2002 ($149 million in 2001 and $111 million in 2000). As at
December 31, 2002, the Company had aggregate reserves for personal injury and
other claims of $664 million ($430 million at December 31, 2001).
Environmental matters
Regulatory compliance
A risk of environmental liability is inherent in railroad and related
transportation operations; real estate ownership, operation or control; and
other commercial activities of the Company with respect to both current and
past operations. As a result, the Company incurs significant compliance and
capital costs, on an ongoing basis, associated with environmental regulatory
compliance and clean-up requirements in its railroad operations and relating to
its past and present ownership, operation or control of real property.
Environmental expenditures that relate to current operations are expensed
unless they relate to an improvement to the property. Expenditures that relate
to an existing condition caused by past operations and which are not expected
to contribute to current or future operations are expensed.
Known existing environmental concerns
The ultimate cost of known contaminated sites cannot be definitely established,
and the estimated environmental liability for any given site may vary depending
on the nature and extent of the contamination, the available clean-up
technique, the Company's share of the costs and evolving regulatory standards
governing environmental liability. As a result, liabilities are recorded based
on the results of a four-phase environmental assessment conducted on a
site-by-site basis. A liability is initially recorded at the completion of the
second phase and adjusted, if necessary, upon completion of the third and/or
fourth phase depending on the facts, as they become known.
U.S. GAAP
42 Canadian National Railway Company
Management's Discussion and Analysis
The initial phase entails an overview of the pertinent site and includes
obtaining and reviewing historical data. At the end of the second phase, the
presence or absence of contamination is confirmed for those sites identified as
a concern in the initial phase. Upon completion of phase three, the extent of
the contamination is determined and if necessary, options are developed to
monitor, contain or remediate the contamination. In the final phase, the
remediation or containment program is put in operation.
Cost scenarios are established by external consultants based on extent of
contamination and expected costs for remedial efforts. The Company uses these
scenarios to estimate the costs related to a particular site. At December 31,
2002, most of the Company's properties not acquired through recent acquisitions
are approaching phase four and therefore costs related to such sites may change
based on information as it becomes available. For properties acquired through
recent acquisitions, the Company obtained assessments from both external and
internal consultants and a liability has been accrued based on such
assessments. These estimates may change based on information as it becomes
available.
Unknown existing environmental concerns
The Company's ongoing efforts to identify potential environmental concerns that
may be associated with its properties may lead to future environmental
investigations, which may result in the identification of additional
environmental costs and liabilities. The magnitude of such additional
liabilities and costs cannot be reasonably estimated due to:
(i) the lack of specific technical information available with respect to
many sites;
(ii) the absence of any government authority, third-party orders, or claims
with respect to particular sites;
(iii) the potential for new or changed laws and regulations and for
development of new remediation technologies and uncertainty regarding
the timing of the work with respect to particular sites;
(iv) the ability to recover costs from any third parties with respect to
particular sites;
and as such, costs related to future remediation will be accrued in the year
they become known.
Future occurrences
In the operation of a railroad, it is possible that derailments, explosions or
other accidents may occur that could cause harm to human health or to the
environment. As a result, the Company may incur costs in the future, which may
be material, to address any such harm, including costs relating to the
performance of clean-ups, natural resource damages and compensatory or punitive
damages relating to harm to individuals or property.
The Company's expenses relating to environmental matters, net of
recoveries, have not been significant in the past three years. Payments for
such items were $16 million in 2002 ($14 million in 2001 and $11 million in
2000). As at December 31, 2002, the Company had aggregate accruals for
environmental costs of $106 million ($112 million at December 31, 2001). The
Company anticipates that the majority of the liability will be paid out over
the next five years.
Depreciation lives
Railroad properties are carried at cost less accumulated depreciation including
asset impairment write-downs. The Company follows the group method of
depreciation and, as such, depreciates the cost of railroad properties, less
net salvage value, on a straight-line basis over their estimated useful lives.
In addition, under the group method of depreciation, the cost of railroad
properties, less net salvage value, retired or disposed of in the normal course
of business, is charged to accumulated depreciation.
Assessing the reasonableness of the estimated useful lives of properties
requires judgment and is based on currently available information, including
periodic depreciation studies conducted by the Company. The Company's U.S.
properties are subject to comprehensive depreciation studies conducted by
external consultants as required by the Surface Transportation Board (STB).
Depreciation studies for Canadian properties are not required by regulation and
are therefore conducted internally. Studies are performed on specific asset
groups on a periodic basis. The studies consider, among others, the analysis of
historical retirement data using recognized life analysis techniques, and the
forecasting of asset life characteristics. Changes in circumstances, such as
technological advances, changes to the Company's business strategy, changes in
the Company's capital strategy or changes in regulations can result in the
actual useful lives differing from the Company's estimates.
A change in the remaining useful life of a group of assets, or their
estimated net salvage, will affect the depreciation rate used to amortize the
group of assets and thus affect depreciation expense as reported in the
Company's results of operations. A change of one year in the composite useful
life of the Company's fixed asset base would impact annual depreciation expense
by approximately $12 million.
Depreciation studies are a means of ensuring that the assumptions used to
estimate the useful lives of particular asset groups are still valid and where
they are not, they serve as the basis to establish the new depreciation rates
to be used on a prospective basis. In 2001, the Company conducted a
comprehensive study for its Canadian properties, which revealed that estimated
depreciable lives for certain asset types had increased, and therefore those
asset lives were extended prospectively. As a result, depreciation expense was
reduced by $44 million for the year ended December 31, 2001. The study
conducted in 2000 for the Company's U.S. properties did not have an impact on
depreciation expense.
U.S. GAAP
Canadian National Railway Company 43
Management's Discussion and Analysis
In 2002, the Company recorded total depreciation and amortization expense
of $591 million ($538 million in 2001 and $533 million in 2000). At December
31, 2002, the Company had Properties of $19,681 million, net of accumulated
depreciation of $9,159 million ($19,145 million in 2001, net of accumulated
depreciation of $9,006 million).
Pensions and other post-retirement benefits
The Company accounts for pension and other post-retirement benefits as required
by SFAS No. 87, "Employers' Accounting for Pensions," and SFAS No. 106,
"Employers' Accounting for Post-retirement Benefits Other Than Pensions,"
respectively. Under these accounting standards, assumptions are made regarding
the valuation of benefit obligations and performance of plan assets. Deferred
recognition of differences between actual results and those assumed is a
guiding principle of these standards. This approach allows for a gradual
recognition of changes in benefit obligations and plan performance over the
expected average remaining service life of the employee group covered by the
plans. The following description pertaining to pensions relate generally to the
Company's main pension plan, the CN Pension Plan. The Company's other pension
plans are not significant.
For pensions, an actuarial valuation is required at least on a triennial
basis. However, for the last 15 years, the Company has conducted an annual
actuarial valuation to account for pensions, which uses management assumptions
for the discount rate, the expected long-term rate of return on plan assets and
the rate of compensation increase. The Canadian plans have a measurement date
of December 31 whereas the U.S. plans have a measurement date of September 30.
For pensions and other post-retirement benefits, assumptions are required for,
among others, the discount rate, the expected long-term rate of return on plan
assets, the rate of compensation increase, health care cost trend rates,
mortality rates, employee early retirements, terminations or disability.
Changes in these assumptions result in actuarial gains or losses which in
accordance with SFAS No. 87 and SFAS No. 106, the Company has elected to
amortize over the expected average remaining service life of the employee group
covered by the plans only to the extent that the unrecognized net actuarial
gains and losses are in excess of 10% of the greater of the beginning of year
balances of the projected benefit obligation or market-related value of plan
assets. The future effect on the Company's results of operations is dependent
on economic conditions, employee demographics, mortality rates and investment
performance.
The Company sets its discount rate assumption annually to reflect the rates
available on high-quality, fixed-income debt instruments with a duration of
approximately 11 years, which is expected to match the timing and amount of
expected benefit payments. High quality debt instruments are corporate bonds
with a rating of AA or better. A discount rate of 6.5%, based on bond yields
prevailing at December 31, 2002, was considered appropriate by the Company and
is supported by reports issued by third party advisors. A one-percentage-point
change in the discount rate would not cause a material change in the Company's
net periodic benefit cost.
To develop its expected long-term rate of return assumption used
in the calculation of net periodic benefit cost applicable to the
market-related value of assets, the Company considers both its past experience
and future estimates of long-term investment returns and the expected
composition of the plans' assets. The Company has elected to use a
market-related value of assets, whereby realized and unrealized capital gains
and losses are recognized over a period of five years, while investment and
dividend income are recognized immediately. The Company follows a disciplined
investment strategy, which limits investments in international companies and
prohibits investments in speculative type assets and as such, the Company does
not anticipate the expected average rate of return on plan assets to fluctuate
materially when compared to major capital market indices. During the last ten
years ended December 31, 2002, the CN Pension Plan earned an annual average
rate of return of 9.6%. The actual and market-related value rates of return on
plan assets for the last five years were as follows:
Rates of return 2002 2001 2000 1999 1998
--------------------------------------------------------------------
Actual................ (0.3)% (1.4)% 10.5% 15.0% 12.6%
Market-related value.. 7.4% 10.2% 13.7% 13.8% 10.4%
--------------------------------------------------------------------
For that same period, the Company used a long-term rate of return assumption on
the market-related value of plan assets not exceeding 9% to compute net
periodic benefit cost. However, given the recent performance of its plan assets
and the equity markets in North America, the Company will, effective for 2003,
reduce the expected long-term rate of return on plan assets from 9% to 8% to
reflect management's current view of long-term investment returns. The effect
of this change in management's assumption will be to increase net periodic
benefit cost in 2003 by approximately $50 million.
Based on the fair value of the assets held as at December 31, 2002, the
plan assets are comprised of 1% in cash and short-term investments, 40% in
bonds and mortgages, 50% in Canadian and foreign equities and 9% in real estate
and oil and gas assets. The long-term asset allocation percentages are not
expected to differ materially from the current composition.
The rate of compensation increase of 4% is another significant assumption
in the actuarial model for pension accounting and is determined by the Company
based upon its long-term plans for such increases. For other post-retirement
benefits, the Company reviews external data
U.S. GAAP
44 Canadian National Railway Company
Management's Discussion and Analysis
and its own historical trends for health care costs to determine the health
care cost trend rates. For measurement purposes, the projected health care cost
trend rate was 18% in the current year, and it is assumed that the rate will
decrease gradually to 8% in 2012 and remain at that level thereafter. A
one-percentage-point change in either the rate of compensation increase or the
health care cost trend rate would not cause a material change to the Company's
net periodic benefit cost for both pensions and other post-retirement benefits.
The latest actuarial valuation of the CN Pension Plan was conducted as at
December 31, 2001 and indicated a funding excess. Based on the Pension Plan's
current position, the Company's contributions are expected to be approximately
$75 million in each of 2003, 2004 and 2005. The assumptions discussed above are
not expected to have a significant impact on the cash funding requirements of
the pension plan in 2003.
For pensions, the Company recorded consolidated net periodic benefit income
of $20 million and $13 million in 2002 and 2001, respectively, and net periodic
benefit cost of $6 million in 2000. Consolidated net periodic benefit cost for
other post-retirement benefits was $45 million, $35 million, and $25 million in
2002, 2001, and 2000, respectively. At December 31, 2002, the Company's accrued
benefit cost for post-retirement benefits other than pensions was $284 million
($258 million at December 31, 2001). In addition, at December 31, 2002, the
Company's consolidated pension benefit obligation and accumulated
post-retirement benefit obligation were $11,243 million and $444 million,
respectively ($11,156 million and $309 million at December 31, 2001).
Income taxes
The Company follows the asset and liability method of accounting for income
taxes. Under the asset and liability method, the change in the net deferred
income tax asset or liability is included in the computation of net income.
Deferred income tax assets and liabilities are measured using enacted income
tax rates expected to apply to taxable income in the years in which temporary
differences are expected to be recovered or settled. As a result, a projection
of taxable income is required for those years, as well as an assumption of the
ultimate recovery/settlement period for temporary differences. The projection
of future taxable income is based on management's best estimate and may vary
from actual taxable income. On an annual basis, the Company assesses its need
to establish a valuation allowance for its deferred income tax assets, and if
it is deemed more likely than not that its deferred income tax assets will not
be realized based on its taxable income projections, a valuation allowance is
recorded. As at December 31, 2002, the Company expects that its deferred income
tax assets will be recovered from future taxable income and therefore, has not
set up a valuation allowance. In addition, Canadian and U.S. tax rules and
regulations are subject to interpretation and require judgment by the Company
that may be challenged by the taxation authorities. The Company believes that
its provisions for income taxes are adequate pertaining to any assessments from
the taxation authorities.
The Company's deferred income tax asset is mainly composed of temporary
differences related to accruals for workforce reductions, personal injury and
other claims, environmental, and other post-retirement benefits, and losses and
tax credit carryforwards. The majority of these accruals will be paid out over
the next five years. The Company's deferred income tax liability is mainly
composed of temporary differences related to properties, including purchase
accounting adjustments. Estimating the ultimate settlement period, given that
depreciation rates in effect are based on information as it develops, requires
judgment and management's best estimates. The reversal of timing differences is
expected at future-enacted income tax rates which could change due to fiscal
budget changes and/or changes in income tax laws. As a result, a change in the
timing and the income tax rate at which the components will reverse, could
materially affect deferred income tax expense as recorded in the Company's
results of operations. A one-percentage-point change in the Company's reported
effective income tax rate would have the effect of changing the income tax
expense by $12 million in 2002. In 2001, the Company recorded a reduction of
$90 million to its net deferred income tax liability resulting from the
enactment of lower corporate tax rates in Canada. As a result, for the year
ended December 31, 2001, a deferred income tax recovery of $122 million was
recorded in the Consolidated statement of income and a deferred income tax
expense of $32 million was recorded in Other comprehensive income.
For the year ended December 31, 2002, the Company recorded total income tax
expense of $384 million ($380 million in 2001 and $536 million in 2000) of
which $272 million was for deferred income taxes ($295 million in 2001 and $312
million in 2000). The Company's net deferred income tax liability at December
31, 2002 was $4,704 million ($4,438 million at December 31, 2001).
Business risks
Certain information included in this report may be "forward-looking statements"
within the meaning of the United States Private Securities Litigation Reform
Act of 1995. Such forward-looking statements are not guarantees of future
performance and involve known and unknown risks, uncertainties and other
factors which may cause the outlook, the actual results or performance of the
Company or the rail industry to be materially different from any future results
or performance implied by such statements. Such factors include the factors set
forth below as well as other risks detailed from time to time in reports filed
by the Company with securities regulators in Canada and the United States.
U.S. GAAP
Canadian National Railway Company 45
Management's Discussion and Analysis
Competition
The Company faces significant competition from a variety of carriers, including
Canadian Pacific Railway Company which operates the other major rail system in
Canada, serving most of the same industrial and population centers as the
Company, long distance trucking companies and, in certain markets, major U.S.
railroads and other Canadian and U.S. railroads. Competition is generally based
on the quality and reliability of services provided, price, and the condition
and suitability of carriers' equipment. Competition is particularly intense in
eastern Canada where an extensive highway network and population centers,
located relatively close to one another, have encouraged significant
competition from trucking companies. In addition, much of the freight carried
by the Company consists of commodity goods that are available from other
sources in competitive markets. Factors affecting the competitive position of
suppliers of these commodities, including exchange rates, could materially
adversely affect the demand for goods supplied by the sources served by the
Company and, therefore, the Company's volumes, revenues and profit margins.
To a greater degree than other rail carriers, the Company's subsidiary,
Illinois Central Railroad Company (ICRR), is vulnerable to barge competition
because its main routes are parallel to the Mississippi River system. The use
of barges for some commodities, particularly coal and grain, often represents a
lower cost mode of transportation. Barge competition and barge rates are
affected by navigational interruptions from ice, floods and droughts, which can
cause widely fluctuating barge rates. The ability of ICRR to maintain its
market share of the available freight has traditionally been affected by the
navigational conditions on the river.
In recent years, there has been significant consolidation of rail systems
in the United States. The resulting larger rail systems are able to offer
seamless services in larger market areas and effectively compete with the
Company in certain markets. There can be no assurance that the Company will be
able to compete effectively against current and future competitors in the
railroad industry and that further consolidation within the railroad industry
will not adversely affect the Company's competitive position. No assurance can
be given that competitive pressures will not lead to reduced revenues, profit
margins or both.
Environmental matters
The Company's operations are subject to federal, provincial, state, municipal
and local regulations under environmental laws and regulations concerning,
among other things, emissions into the air; discharges into waters; the
generation, handling, storage, transportation, treatment and disposal of waste,
hazardous substances and other materials; decommissioning of underground and
aboveground storage tanks; and soil and groundwater contamination. A risk of
environmental liability is inherent in railroad and related transportation
operations; real estate ownership, operation or control; and other commercial
activities of the Company with respect to both current and past operations. As
a result, the Company incurs significant compliance and capital costs, on an
ongoing basis, associated with environmental regulatory compliance and clean-up
requirements in its railroad operations and relating to its past and present
ownership, operation or control of real property.
While the Company believes that it has identified the costs likely to be
incurred in the next several years, based on known information, for
environmental matters, the Company's ongoing efforts to identify potential
environmental concerns that may be associated with its properties may lead to
future environmental investigations, which may result in the identification of
additional environmental costs and liabilities.
In the operation of a railroad, it is possible that derailments, explosions
or other accidents may occur that could cause harm to human health or to the
environment. As a result, the Company may incur costs in the future, which may
be material, to address any such harm, including costs relating to the
performance of clean-ups, natural resource damages and compensatory or punitive
damages relating to harm to individuals or property.
The ultimate cost of known contaminated sites cannot be definitely
established, and the estimated environmental liability for any given site may
vary depending on the nature and extent of the contamination, the available
clean-up technique, the Company's share of the costs and evolving regulatory
standards governing environmental liability. Also, additional contaminated
sites yet unknown may be discovered or future operations may result in
accidental releases. For these reasons, there can be no assurance that material
liabilities or costs related to environmental matters will not be incurred in
the future, or will not have a material adverse effect on the Company's
financial position or results of operations in a particular quarter or fiscal
year, or that the Company's liquidity will not be adversely impacted by such
environmental liabilities or costs.
Personal injury and other claims
In the normal course of its operations, the Company becomes involved
in various legal actions, including claims relating to personal injuries,
occupational disease and damage to property. The Company maintains provisions
for such items, which it considers to be adequate for all of its outstanding or
pending claims. The final outcome with respect to actions outstanding or
pending at December 31, 2002, or with respect to future claims, cannot be
predicted with certainty, and therefore there can be no assurance that their
resolution will not have a material adverse effect on the Company's financial
position or results of operations in a particular quarter or fiscal year.
U.S. GAAP
46 Canadian National Railway Company
Management's Discussion and Analysis
Labor negotiations
Canadian workforce
As of January 2003, the Company has labor agreements with bargaining groups
representing substantially its entire Canadian unionized workforce. These
agreements are generally effective until December 31, 2003.
U.S. workforce
The general approach to labor negotiations by U.S. Class 1 railroads is to
bargain on a collective national basis. Grand Trunk Western (GTW), Duluth,
Winnipeg and Pacific (DWP), ICRR, CCP Holdings, Inc. (CCP) and just recently
WC, have bargained on a local basis rather than holding national, industry wide
negotiations because it results in agreements that better address both the
employees' concerns and preferences, and the railways' actual operating
environment. However, local negotiations may not generate federal intervention
in a strike or lockout situation, since a dispute may be localized. The Company
believes the potential mutual benefits of local bargaining outweigh the risks.
As of January 2003, the Company has in place agreements with bargaining
units representing the entire unionized workforce at ICRR, GTW, DWP, and CCP,
and 65% of the unionized workforce at WC. These agreements have various
moratorium provisions, ranging from the end of 2001 to the end of 2005, which
preserve the status quo in respect of given areas during the terms of such
moratoriums. Several of these agreements are currently under renegotiation and
several will open for negotiation in 2003.
Negotiations are ongoing with the bargaining units with which the Company does
not have agreements or settlements. Until new agreements are reached or until
settlements are ratified, the terms and conditions of previous agreements
continue to apply. Although the Company does not anticipate work action related
to these negotiations while they are ongoing, there can be no assurance that
their resolution will not have a material adverse effect on the Company's
financial position or results of operations.
Regulation
The Company's rail operations in Canada are subject to regulation as to (i)
rate setting and network rationalization by the Canadian Transportation Agency
(the Agency) under the Canada Transportation Act (Canada) (the CTA), and (ii)
safety by the federal Minister of Transport under the Railway Safety Act
(Canada) and certain other statutes. The Company's U.S. rail operations are
subject to regulation by the Surface Transportation Board (STB) (the successor
to the Interstate Commerce Commission) and the Federal Railroad Administration.
In addition, the Company is subject to a variety of health, safety, security,
labor, environmental and other regulations, all of which can affect its
competitive position and profitability.
The CTA Review Panel, which was appointed by the federal government to
carry out a comprehensive review of the Canadian transportation legislation,
issued its report to the Minister of Transport at the end of June 2001. The
report was released to the public on July 18, 2001 and contains numerous
recommendations for legislative changes, which, if adopted, would affect all
modes of transportation, including rail. Concurrently, the Minister of
Transport launched a transportation blueprint consultation process, which could
eventually lead to new legislation affecting rail and other transportation
industries. No assurance can be given that any decisions by the federal
government pursuant to the report's recommendations or in connection with the
blueprint consultation process will not materially adversely affect the
Company's financial position or results of operations.
Financial instruments
Although the Company conducts its business and receives revenues primarily in
Canadian dollars, a growing portion of its revenues, expenses, assets and debt
are denominated in U.S. dollars. Thus, the Company's results are affected by
fluctuations in the exchange rate between these currencies. Changes in the
exchange rate between the Canadian dollar and other currencies (including the
U.S. dollar) make the goods transported by the Company more or less competitive
in the world marketplace and thereby affect the Company's revenues and
expenses.
The Company has limited involvement with derivative financial instruments
and does not use them for trading purposes. Collateral or other security to
support financial instruments subject to credit risk is usually not obtained.
However, the credit standing of counterparties or their guarantors is regularly
monitored, and losses due to counterparty non-performance are not anticipated.
To mitigate the effects of fuel price changes on its operating margins and
overall profitability, the Company has a systematic hedging program which calls
for regularly entering into swap positions on crude and heating oil to cover a
target percentage of future fuel consumption up to two years in advance. At
December 31, 2002, the Company has hedged approximately 47% of the estimated
2003 fuel consumption and 25% of the estimated 2004 fuel consumption. This
represents approximately 263 million U.S. gallons at an average price of
U.S.$0.5865 per U.S. gallon.
Realized gains and losses from the Company's fuel hedging activities were a
$3 million gain, a $6 million loss and a $49 million gain for the years ended
December 31, 2002, 2001 and 2000, respectively.
At December 31, 2002, Accumulated other comprehensive income included an
unrealized gain of $30 million, $20 million after tax ($38 million unrealized
loss, $25 million after tax at December 31, 2001), of which $29 million relates
to derivative instruments that will mature within the next year.
U.S. GAAP
Canadian National Railway Company 47
Management's Discusson and Analysis
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; (b) contracts granting
rights to others to use the Company's property, such as leases, licenses and
easements; (c) contracts for the sale of assets; (d) contracts for the
acquisition of services; (e) financing agreements; (f) trust indentures or
fiscal agency agreements or similar agreements relating to debt or equity
securities of the Company and engagement agreements with financial advisors;
(g) transfer agent and registrar agreements in respect of the Company's
securities; and (h) trust agreements establishing trust funds to secure the
payment to certain officers and senior employees of special retirement
compensation arrangements or plans. 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 cannot be
determined with certainty.
Other risks
In any given year, the Company, like other railroads, is susceptible to changes
in the economic conditions of the industries and geographic areas that produce
and consume the freight it transports or the supplies it requires to operate.
In addition, many of the goods and commodities carried by the Company
experience cyclicality in the demand for them. However, many of the bulk
commodities the Company transports move offshore and are impacted more by
global economic conditions than North American economic cycles. The Company's
results of operations can be expected to reflect this cyclicality because of
the significant fixed costs inherent in railroad operations.
Global as well as North American economic conditions, including trade
barriers on certain commodities, may interfere with the free circulation of
goods across Canada and the United States.
Potential terrorist actions can have a direct or indirect impact on the
U.S. transportation infrastructure, including railway infrastructure, and
interfere with the free flow of trade across the two countries. International
conflicts can also have an impact on the Company's markets.
The Company's revenues in 2001 were affected by widespread recessionary
conditions. Although growth rebounded strongly in early 2002, there continues
to be ongoing concern about the sustainability of the recovery due to uncertain
consumer and business confidence. While economic growth is expected to continue
in 2003, the Company remains cautious about business prospects.
Should a major economic slowdown or recession occur in North America or
other key markets, or should major industrial restructuring take place, the
volume of rail shipments carried by the Company is likely to be affected.
In addition to the inherent risks of the business cycle, the Company is
occasionally susceptible to severe weather conditions. For example, in the
first quarter of 1998, a severe ice storm hit eastern Canada, which disrupted
operations and service for the railroad as well as for CN customers. More
recently, severe drought conditions in western Canada significantly reduced
bulk commodity revenues, principally grain. There continues to be widespread
concerns about the impact of crop conditions on grain supplies in the near
term.
Generally accepted accounting principles require the use of historical cost
as the basis of reporting in financial statements. As a result, the cumulative
effect of inflation, which has significantly increased asset replacement costs
for capital-intensive companies such as CN, is not reflected in operating
expenses. Depreciation charges on an inflation-adjusted basis, assuming that
all operating assets are replaced at current price levels, would be
substantially greater than historically reported amounts.
Selected quarterly financial data
Selected quarterly financial data for the eight most recently completed
quarters ending December 31, 2002 is disclosed in Note 23 to the Company's 2002
Consolidated Financial Statements.
Disclosure controls and procedures
The Company's Chief Executive Officer and its Chief Financial Officer, after
evaluating the effectiveness of the Company's "disclosure controls and
procedures" (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c)) as of
January 21, 2003 (the "Evaluation Date") within the 90-day period leading to
and ending on the filing date of this annual report, have concluded that the
Company's disclosure controls and procedures were adequate and effective and
designed to ensure that material information relating to the Company and its
consolidated subsidiaries would have been made known to them. Subsequent to the
Evaluation Date, there were no significant changes in the Company's internal
controls or, to their knowledge, in other factors that could significantly
affect the Company's disclosure controls and procedures.
U.S. GAAP
48 Canadian National Railway Company
Management Report
The accompanying consolidated financial statements of Canadian National Railway
Company and all information in this annual report are the responsibility of
management and have been approved by the Board of Directors.
The financial statements have been prepared by management in conformity
with generally accepted accounting principles in the United States. These
statements include some amounts that are based on best estimates and judgments.
Financial information used elsewhere in the annual report is consistent with
that in the financial statements.
Management of the Company, in furtherance of the integrity and objectivity
of data in the financial statements, has developed and maintains a system of
internal accounting controls and supports an extensive program of internal
audits. Management believes that this system of internal accounting controls
provides reasonable assurance that financial records are reliable and form a
proper basis for preparation of financial statements, and that assets are
properly accounted for and safeguarded.
The Board of Directors carries out its responsibility for the financial
statements in this report principally through its Audit, Finance and Risk
Committee, consisting solely of outside directors. The Audit, Finance and Risk
Committee reviews the Company's consolidated financial statements and annual
report and recommends their approval by the Board of Directors. Also, the
Audit, Finance and Risk Committee meets regularly with the Chief, Internal
Audit, and with the shareholders' auditors.
These consolidated financial statements have been audited by KPMG LLP, who
have been appointed as the sole auditors of the Company by the shareholders.
(signed)
Claude Mongeau
Executive Vice-President and Chief Financial Officer
January 21, 2003
(signed)
Serge Pharand
Vice-President and Corporate Comptroller
January 21, 2003
Auditors' Report
To the Board of Directors of Canadian National Railway Company
We have audited the consolidated balance sheets of Canadian National Railway
Company as at December 31, 2002 and 2001 and the consolidated statements of
income, comprehensive income, changes in shareholders' equity and cash flows
for each of the years in the three-year period ended December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with Canadian and United States
generally accepted auditing standards. Those standards require that we plan and
perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in
all material respects, the financial position of the Company as at December 31,
2002 and 2001, and the results of its operations and its cash flows for each of
the years in the three-year period ended December 31, 2002, in accordance with
generally accepted accounting principles in the United States.
On January 20, 2003, we reported separately to the shareholders of the
Company on consolidated financial statements for the same period, prepared in
accordance with Canadian generally accepted accounting principles.
(signed)
KPMG LLP
Chartered Accountants
Montreal, Canada
January 20, 2003
U.S. GAAP
Canadian National Railway Company 49
Consolidated Statement of Income
Year ended
In millions, except per share data December 31, 2002 2001 2000
-------------------------------------------------------------------------------------
Revenues
Petroleum and chemicals............................. $ 1,102 $ 923 $ 894
Metals and minerals................................. 521 458 392
Forest products..................................... 1,323 1,088 1,008
Coal................................................ 326 338 328
Grain and fertilizers............................... 986 1,161 1,136
Intermodal.......................................... 1,052 969 919
Automotive.......................................... 591 520 559
Other items......................................... 209 195 192
----------------------------
Total revenues......................................... 6,110 5,652 5,428
----------------------------
Operating expenses
Labor and fringe benefits (Note 14)................. 1,837 1,624 1,472
Purchased services and material..................... 778 692 746
Depreciation and amortization (Note 2).............. 584 532 525
Fuel................................................ 459 484 446
Equipment rents..................................... 346 309 285
Casualty and other (Note 2)......................... 637 329 306
----------------------------
Total operating expenses............................... 4,641 3,970 3,780
----------------------------
Operating income....................................... 1,469 1,682 1,648
Interest expense (Note 15)............................. (361) (327) (311)
Other income (Note 16)................................. 76 65 136
----------------------------
Income before income taxes............................. 1,184 1,420 1,473
Income tax expense (Note 17)........................... (384) (380) (536)
----------------------------
Net income............................................. $ 800 $1,040 $ 937
============================
Basic earnings per share (Note 19)..................... $ 4.07 $ 5.41 $ 4.81
Diluted earnings per share (Note 19)................... $ 3.97 $ 5.23 $ 4.67
============================
See accompanying notes to consolidated financial statements.
U.S. GAAP
50 Canadian National Railway
Consolidated Statement of Comprehensive Income
In millions Year ended December 31, 2002 2001 2000
-----------------------------------------------------------------------------------------
Net income .............................................. $ 800 $ 1,040 $ 937
Other comprehensive income (loss) (Note 22):
Unrealized foreign exchange gain (loss) on translation
of U.S. dollar denominated long-term debt designated as
a hedge of the net investment in U.S.subsidiaries .... 51 (202) (91)
Unrealized foreign exchange gain (loss) on translation
of the net investment in foreign operations ........... (40) 308 191
Unrealized holding gain (loss) on investment in
360networks Inc. (Note 6) ............................. (129) 129
Unrealized holding gain (loss) on fuel derivative
instruments (Note 21) ................................. 68 (38)
Minimum pension liability adjustment (Note 13) .......... (20) (17)
------- ------- -------
Other comprehensive income (loss) before income taxes ... 59 (78) 229
Income tax expense on other comprehensive income (loss) . (20) (15) (72)
------- ------- -------
Other comprehensive income (loss) ....................... 39 (93) 157
------- ------- -------
Comprehensive income .................................... $ 839 $ 947 $ 1,094
======= ======= =======
See accompanying notes to consolidated financial statements
U.S. GAAP
Canadian National Railway Company 51
Consolidated Statement of Comprehensive Income
In millions December 31, 2002 2001
------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents......................... $ 25 $ 53
Accounts receivable (Note 4)...................... 722 645
Material and supplies............................. 127 133
Deferred income taxes (Note 17)................... 122 153
Other............................................. 196 180
------- -------
1,192 1,164
Properties (Note 5).................................. 19,681 19,145
Other assets and deferred charges (Note 6)........... 865 914
------- -------
Total assets......................................... $ 21,738 $21,223
======= =======
Liabilities and shareholders' equity
Current liabilities:
Accounts payable and accrued charges (Note 8)..... $ 1,487 $ 1,374
Current portion of long-term debt (Note 10)....... 574 163
Other............................................. 73 132
------- -------
2,134 1,669
Deferred income taxes (Note 17)...................... 4,826 4,591
Other liabilities and deferred credits (Note 9)...... 1,406 1,345
Long-term debt (Note 10)............................. 5,003 5,764
Convertible preferred securities (Note 11)........... - 366
Shareholders' equity:
Common shares (Note 11)........................... 4,785 4,442
Accumulated other comprehensive income (Note 22).. 97 58
Retained earnings................................. 3,487 2,988
------- -------
8,369 7,488
------- -------
Total liabilities and shareholders' equity........... $21,738 $21,223
======= =======
On behalf of the Board:
David G.A. McLean E. Hunter Harrison
Director Director
See accompanying notes to consolidated financial statements.
U.S. GAAP
52 Canadian National Railway Company
Consolidated Statement of Changes in Shareholders' Equity
Issued and Accumulated
outstanding other Total
common Common comprehensive Retained shareholders'
In millions shares shares income (loss) earnings equity
----------------------------------------------------------------------------------------------------------------
Balances December 31, 1999 ................... 202.4 $ 4,597 $ (6) $ 1,531 $ 6,122
Net income ................................... - - - 937 937
Stock options exercised and employee share
plans (Note 11, 12) ....................... 1.2 47 - - 47
Share repurchase program (Note 11) ........... (13.0) (295) - (234) (529)
Other comprehensive income (Note 22) ......... - - 157 - 157
Dividends ($0.70 per share) .................. - - - (136) (136)
----- ------- ------- -------- ---------
Balances December 31, 2000 ................... 190.6 4,349 151 2,098 6,598
Net income ................................... - - - 1,040 1,040
Stock options exercised (Note 11, 12) ........ 2.1 93 - - 93
Other comprehensive loss (Note 22) ........... - - (93) - (93)
Dividends ($0.78 per share) .................. - - - (150) (150)
----- ------- ------- -------- ---------
Balances December 31, 2001 ................... 192.7 4,442 58 2,988 7,488
Net income ................................... - - - 800 800
Stock options exercised (Note 11, 12) ........ 1.8 75 - - 75
Conversion of convertible preferred securities
(Note 11) .................................. 6.0 340 - - 340
Share repurchase program (Note 11) ........... (3.0) (72) - (131) (203)
Other comprehensive income (Note 22) ......... - - 39 - 39
Dividends ($0.86 per share) .................. - - - (170) (170)
Balances December 31, 2002 ................... 197.5 $ 4,785 $ 97 $ 3,487 $ 8,369
===== ======= ======= ======== ========
See accompanying notes to consolidated financial statements.
U.S. GAAP
Canadian National Railway Company 53
Consolidated Statement of Cash Flows
In millions Year ended December 31, 2002 2001 2000
------------------------------------------------------------------------------------------------------------------------
Operating activities
Net income ........................................................................ $ 800 $ 1,040 $ 937
Adjustments to reconcile net income to net cash provided from operating activities:
Depreciation and amortization (Note 18) ........................................ 591 538 533
Deferred income taxes (Note 17) ................................................ 272 295 312
Charge to increase U.S. personal injury and other claims liability (Note 2) .... 281
Workforce reduction charges (Note 14) .......................................... 120 98
Equity in earnings of English Welsh and Scottish Railway (Note 16) ............. (33) (8)
Gain on sale of investments (Note 16) .......................................... (101) (84)
Write-down of investment (Note 16) ............................................. 99
Other changes in:
Accounts receivable ......................................................... (80) 199 80
Material and supplies ....................................................... 11 6
Accounts payable and accrued charges ........................................ (154) (385) (157)
Other net current assets and liabilities .................................... (18) (27) (36)
Other .......................................................................... (167) (138) (85)
------- ------- -------
Cash provided from operating activities .............................................. 1,612 1,621 1,506
Investing activities
Net additions to properties (Note 18) ............................................. (938) (941) (958)
Acquisition of Wisconsin Central Transportation Corporation (Note 3) .............. (1,278)
Other, net ........................................................................ 14 46 (23)
------- ------- -------
Cash used by investing activities .................................................... (924) (2,173) (981)
Dividends paid ....................................................................... (170) (150) (136)
Financing activities
Issuance of long-term debt ........................................................ 3,146 4,015 860
Reduction of long-term debt ....................................................... (3,558) (3,336) (1,038)
Issuance of common shares (Note 11) ............................................... 69 61 28
Repurchase of common shares (Note 11) ............................................. (203) (529)
------- ------- -------
Cash provided from (used by) financing activities .................................... (546) 740 (679)
------- ------- -------
Net increase (decrease) in cash and cash equivalents ................................. (28) 38 (290)
Cash and cash equivalents, beginning of year ......................................... 53 15 305
------- ------- -------
Cash and cash equivalents, end of year ............................................... $ 25 $ 53 $ 15
======= ======= =======
Supplemental cash flow information
Payments for:
Interest (Note 15) ............................................................. $ 398 $ 322 $ 315
Workforce reductions (Note 9) .................................................. 177 169 189
Personal injury and other claims (Note 20) ..................................... 156 149 111
Pensions (Note 13) ............................................................. 92 69 59
Income taxes (Note 17) ......................................................... 65 63 101
======= ======= =======
See accompanying notes to consolidated financial statements.
U.S. GAAP
54 Canadian National Railway Company
Notes to Consolidated Financial Statements
Canadian National Railway Company (CN or the Company), directly and through its
subsidiaries, is engaged in the rail transportation business. CN spans Canada
and mid-America, from the Atlantic and Pacific oceans to the Gulf of Mexico,
serving the ports of Vancouver, Prince Rupert, B.C., Montreal, Halifax, New
Orleans and Mobile, Alabama, and the key cities of Toronto, Buffalo, Chicago,
Detroit, Duluth, Minnesota/Superior, Wisconsin, Green Bay, Wisconsin,
Minneapolis/St. Paul, Memphis, St. Louis and Jackson, Mississippi, with
connections to all points in North America. CN's revenues are derived from the
movement of a diversified and balanced portfolio of goods, including petroleum
and chemicals, grain and fertilizers, coal, metals and minerals, forest
products, intermodal and automotive.
1 Summary of significant accounting policies
These consolidated financial statements are expressed in Canadian dollars,
except where otherwise indicated, and have been prepared in accordance with
accounting principles generally accepted in the United States (U.S. GAAP). The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of revenues and expenses during the period,
the reported amounts of assets and liabilities, and the disclosure of
contingent assets and liabilities at the date of the financial statements. On
an ongoing basis, management reviews its estimates, including those related to
personal injury and other claims, environmental matters, depreciation lives,
pensions and other post-retirement benefits, and income taxes, based upon
currently available information. Actual results could differ from these
estimates.
A. Principles of consolidation
These consolidated financial statements include the accounts of all
subsidiaries, including Wisconsin Central Transportation Corporation (WC) for
which the Company acquired control and consolidated effective October 9, 2001.
The Company's investments in which it has significant influence are accounted
for using the equity method and all other investments are accounted for using
the cost method.
B. Revenues
Freight revenues are recognized on services performed by the Company, based on
the percentage of completed service method. Costs associated with movements are
recognized as the service is performed.
C. Foreign exchange
All of the Company's United States (U.S.) operations are self-sustaining
foreign entit ies with the U.S. dollar as their functional currency. The
Company also has an equity investment in an international affiliate based in
the United Kingdom with the British pound as its functional currency.
Accordingly, the U.S. operations' assets and liabilities and the Company's
foreign equity investment are translated into Canadian dollars at the rate in
effect at the balance sheet date and the revenues and expenses are translated
at average exchange rates during the year. All adjustments resulting from the
translation of the foreign operations are recorded in Other comprehensive
income (Note 22). The Company has designated all U.S. dollar denominated
long-term debt of the parent company as a foreign exchange hedge of its net
investment in U.S. subsidiaries. Accordingly, unrealized foreign exchange gains
and losses, from the dates of designation, on the translation of the U.S.
dollar denominated long-term debt are also included in Other comprehensive
income. (Note 22).
The Company has designated all U.S. dollar denominated long-term debt of
the parent company as a foreign exchange hedge of its net investment in U.S.
subsidiaries. Accordingly, unrealized foreign exchange gains and losses, from
the dates of designation, on the translation of the U.S. dollar denominated
long-term debt are also included in Other comprehensive income.
D. Cash and cash equivalents
Cash and cash equivalents include highly liquid investments purchased three
months or less from maturity and are stated at cost, which approximates market
value.
E. Accounts receivable
Accounts receivable are recorded at cost net of the provision for doubtful
accounts that is based on expected collectibility. Any gains or losses on the
sale of accounts receivable are calculated by comparing the carrying amount of
the accounts receivable sold to the total of the cash proceeds on sale and the
fair value of the retained interest in such receivables on the date of
transfer. Fair values are determined on a discounted cash flow basis. Costs
related to the sale of accounts receivable are recognized in earnings in the
period incurred.
F. Material and supplies
Inventory is valued at weighted-average cost for ties, rails, fuel and new
materials in stores, and at estimated utility or sales value for usable
secondhand, obsolete and scrap materials.
G. Properties
Railroad properties are carried at cost less accumulated depreciation including
asset impairment write-downs. Labor, materials and other costs associated with
the installation of rail, ties, ballast and other track improvements are
capitalized to the extent they meet the Company's minimum threshold for
capitalization. Included in property additions are the costs of developing
computer software for internal use. Maintenance costs are expensed as incurred.
U.S. GAAP
Canadian National Railway Company 55
Notes to Consolidated Financial Statements
1 Summary of significant accounting policies (continued)
The cost of railroad properties, less net salvage value, retired or
disposed of in the normal course of business is charged to accumulated
depreciation, in accordance with the group method of depreciation. The Company
reviews the carrying amounts of properties held and used whenever events or
changes in circumstances indicate that such carrying amounts may not be
recoverable based on future undiscounted cash flows. Assets that are deemed
impaired as a result of such review are recorded at the lower of carrying
amount or fair value. Assets held for sale are measured at the lower of their
carrying amount or fair value, less cost to sell. Losses resulting from
significant line sales are recognized when the asset meets the criteria for
classification as held for sale whereas losses resulting from abandonment are
recognized when the asset ceases to be used. Gains are recognized when they are
realized.
H. Depreciation
The cost of properties, net of asset impairment write-downs, is depreciated on
a straight-line basis over their estimated useful lives as follows:
Asset class Annual rate
----------------------------------------------------------------
Track and roadway........................................... 2%
Rolling stock............................................... 3%
Buildings................................................... 6%
Other....................................................... 4%
----------------------------------------------------------------
The Company follows the group method of depreciation and as such conducts
comprehensive depreciation studies on a periodic basis to assess the
reasonableness of the lives of properties based upon current information and
historical activities. Changes in estimated useful lives are accounted for
prospectively.
I. Pensions
Pension costs are determined using actuarial methods. Net periodic benefit cost
is charged to operations and includes:
(i) the cost of pension benefits provided in exchange for employees' services
rendered during the year,
(ii) the interest cost of pension obligations,
(iii)the amortization of the initial net transition obligation on a
straight-line basis over the expected average remaining service life of
the employee group covered by the plans,
(iv) the amortization of prior service costs and amendments over the expected
average remaining service life of the employee group covered by the plans,
(v) the expected long-term return on pension fund assets, and
(vi) the amortization of cumulative unrecognized net actuarial gains and losses
in excess of 10% of the greater of the beginning of year balances of the
projected benefit obligation or market-related value of plan assets over
the expected average remaining service life of the employee group covered
by the plans.
The pension plans are funded through contributions determined in
accordance with the projected unit credit actuarial cost method.
J. Post-retirement benefits other than pensions
The Company accrues the cost of post-retirement benefits other than pensions
using actuarial methods. These benefits, which are funded by the Company as
they become due, include life insurance programs, medical benefits,
supplemental pension allowances and free rail travel benefits.
The Company amortizes the cumulative unrecognized net actuarial gains and
losses in excess of 10% of the projected benefit obligation at the beginning of
the year, over the expected average remaining service life of the employee
group covered by the plans.
K. Derivative financial instruments
The Company uses derivative financial instruments in the management of its fuel
exposure, and may use them from time to time, in the management of its interest
rate and foreign currency exposures. Derivative instruments are recorded on the
balance sheet at fair value and the changes in fair value are recorded in
earnings or Other comprehensive income depending on the nature and
effectiveness of the hedge transaction. Income and expense related to hedged
derivative financial instruments are recorded in the same category as that
generated by the underlying asset or liability.
L. Personal injury claims
In Canada, the Company accounts for costs related to employee work-related
injuries based on actuarially developed estimates of the ultimate cost
associated with such injuries, including compensation, health care and
administration costs.
In the U.S., the Company accrues the cost for the expected personal injury
claims and existing occupational disease claims, based on actuarial estimates
of their ultimate cost. A liability for unasserted occupational disease claims
is also accrued to the extent they are probable and can be reasonably
estimated.
M. Environmental expenditures
Environmental expenditures that relate to current operations are expensed
unless they relate to an improvement to the property. Expenditures that relate
to an existing condition caused by past operations and which are not expected
to contribute to current or future operations are expensed. Liabilities are
recorded when environmental assessments and/or remedial efforts are likely, and
when the costs, based on a specific plan of action in terms of the technology
to be used and the extent of the corrective action required, can be reasonably
estimated.
U.S. GAAP
56 Canadian National Railway Company
Notes to Consolidated Financial Statements
N. Income taxes
The Company follows the asset and liability method of accounting for income
taxes. Under the asset and liability method, the change in the net deferred tax
asset or liability is included in the computation of net income. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which temporary differences are expected to
be recovered or settled.
O. Stock-based compensation
The Company accounts for stock-based compensation in accordance with Accounting
Principles Board Opinion (APB) 25, "Accounting for Stock Issued to Employees,"
and related interpretations. Accordingly, compensation cost is recorded for the
Company's performance-based stock option awards and no compensation cost is
recorded for the Company's conventional stock option awards. If compensation
cost had been determined based upon fair values at the date of grant for awards
under all plans, consistent with the methods of Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
the Company's pro forma net income and earnings per share would have been as
follows:
Year ended December 31, 2002 2001 2000
-------------------------------------------------------------------------------
Net income, as reported (in millions)... $ 800 $1,040 $ 937
Add (deduct) compensation cost, net of
applicable taxes, determined under:
Intrinsic value method for
performance-based awards (APB 25).. 9 19 3
Fair value method for all
awards (SFAS No. 123).............. (45) (28) (23)
--------------------------------------
Pro forma net income (in millions)...... $ 764 $1,031 $ 917
--------------------------------------
Basic earnings per share, as reported... $4.07 $ 5.41 $4.81
Basic earnings per share, pro forma..... $3.88 $ 5.37 $4.70
Diluted earnings per share, as reported. $3.97 $ 5.23 $4.67
Diluted earnings per share, pro forma... $3.80 $ 5.19 $4.58
-------------------------------------------------------------------------------
These pro forma amounts include compensation cost as calculated using the
Black-Scholes option-pricing model with the following assumptions:
Year ended December 31, 2002 2001 2000
-------------------------------------------------------------------------------
Expected option life (years)........... 7.0 7.0 7.0
Risk-free interest rate................ 5.79% 5.36% 5.38%
Expected stock price volatility........ 30% 30% 30%
Average dividend per share............. $0.86 $0.78 $0.70
-------------------------------------------------------------------------------
Year ended December 31, 2002 2001 2000
-------------------------------------------------------------------------------
Weighted average fair value of
options granted .................... $30.98 $13.79 $12.54
-------------------------------------------------------------------------------
P. Recent accounting pronouncements
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation (FIN) No. 46, "Consolidation of Variable Interest Entities." FIN
No. 46 requires that an enterprise holding other than a voting interest in a
Variable Interest Entity (VIE) could, subject to certain conditions, be
required to consolidate the VIE if the enterprise will absorb a majority of the
VIE's expected losses and/or receive a majority of its expected residual
returns. This interpretation is effective for newly created entities after
January 31, 2003. For pre-existing VIEs, the provisions of the interpretation
are effective for periods beginning after June 15, 2003. The Company does not
expect FIN No. 46 to have a material impact on its financial statements.
In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," which requires that a guarantor disclose and recognize
in its financial statements its obligations relating to guarantees that it has
issued. Liability recognition is required at the inception of the guarantee,
whether or not payment is probable. The disclosure requirements are effective
for periods ending after December 15, 2002, and have been reflected in the
Notes to Consolidated Financial Statements. The recognition and measurement
provisions are effective for guarantees issued or modified after December 31,
2002. The Company will apply the recognition and measurement provisions of FIN
No. 45 on a prospective basis and, as such, does not expect it to have an
initial material impact on its financial statements upon adoption.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which requires that a liability
for costs associated with an exit or disposal activity be recognized when the
liability is incurred. SFAS No. 146 also establishes that the liability should
be initially measured at fair value and subsequently adjusted for changes in
estimated cash flows. SFAS No. 146 is to be applied to exit or disposal
activities initiated after December 31, 2002. The Company will apply SFAS No.
146 on a prospective basis and, as such, does not expect it to have an initial
material impact on its financial statements upon adoption.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which requires an entity to record the fair value of
an asset retirement obligation as a liability in the period in which it incurs
a legal obligation associated with the retirement of tangible long-lived
assets. As a result of the issuance of SFAS No. 143, the Company is reviewing
the accounting policy of its asset replacement program. A change in this policy
will be treated as a change in accounting principle with a cumulative effect
adjustment being recorded in the first quarter of 2003. The statement is
effective for the Company's fiscal year beginning January 1, 2003. The Company
is currently evaluating the impact of this statement on its financial
statements.
U.S. GAAP
Canadian National Railway Company 57
Notes to Consolidated Financial Statements
2 Accounting changes
2002
U.S. personal injury and other claims
In the fourth quarter of 2002, the Company changed its methodology for
estimating its liability for U.S. personal injury and other claims, including
occupational disease claims and claims for property damage, from a case-by-case
approach to an actuarial-based approach. Consequently, the Company recorded a
charge of $281 million ($173 million after tax) to increase its provision for
these claims.
Under the actuarial-based approach, the Company accrues the cost for the
expected personal injury and property damage claims and existing occupational
disease claims, based on actuarial estimates of their ultimate cost. The
Company is unable to estimate the total cost for unasserted occupational
disease claims. However, a liability for unasserted occupational disease claims
is accrued to the extent they are probable and can be reasonably estimated.
Under the case-by-case approach, a liability was recorded only when the
expected loss was both probable and reasonably estimable based on currently
available information. In addition, the Company did not record a liability for
unasserted claims, as such amounts could not be reasonably estimated under the
case-by-case approach.
The Company's U.S. personal injury and other claims expense, including the
above-mentioned charge, was $362 million in 2002. Had the Company continued to
apply the case-by-case approach to its U.S. personal injury and other claims
liability, recognizing the effects of the actual claims experience for existing
and new claims in the fourth quarter, these expenses would have been
approximately $135 million in 2002.
2001
Depreciation
In 2001, the Company conducted a comprehensive depreciation study for its
Canadian properties to assess the reasonableness of the depreciable lives of
properties based on current and historical information. The study revealed that
estimated depreciable lives for certain asset types had increased, and
therefore, those asset lives were extended prospectively. As a result,
depreciation and amortization expense was reduced by $44 million ($28 million
after tax) in 2001.
Derivative financial instruments
On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS No. 138
"Accounting for Certain Derivative Instruments and Certain Hedging Activities."
These statements require that all derivative instruments be recorded on the
balance sheet at their fair value. Changes in fair value of derivatives are
recorded each period in current earnings or Other comprehensive income,
depending on whether or not a derivative is designated as part of a hedge
transaction and, if so, the type of hedge transaction. The initial adoption of
these statements on January 1, 2001 resulted in the recognition of an
unrealized loss of $17 million ($11 million after tax) in Other comprehensive
income. Of that amount, $8 million ($5 million after tax) was recognized in
earnings during 2001. The adoption of these statements did not have a material
impact on net income for 2001 since prior to its adoption, the Company had
already deferred and amortized gains and losses in its results of operations.
Income and expense related to the hedged derivative financial instruments were
recorded in the same category as that generated by the underlying asset or
liability.
3 Acquisition of Wisconsin Central Transportation Corporation
On January 29, 2001, the Company, through an indirect wholly owned subsidiary,
and WC entered into a merger agreement (the Merger) providing for the
acquisition of all of the shares of WC by the Company for an acquisition cost
of $1,301 million (U.S.$833 million). The Merger was approved by the
shareholders of WC at a special meeting held on April 4, 2001. On September 7,
2001, the U.S. Surface Transportation Board rendered a decision, unanimously
approving the Company's acquisition of WC. On October 9, 2001, the Company
completed its acquisition of WC and began a phased integration of the
companies' operations. The acquisition was financed by debt and cash on hand.
The Company accounted for the Merger using the purchase method of
accounting as required by SFAS No. 141 "Business Combinations." As such, the
Company's consolidated financial statements include the assets, liabilities and
results of operations of WC as of October 9, 2001, the date of acquisition. The
Company had estimated, on a preliminary basis, the fair values of the assets
and liabilities acquired based on currently available information. In 2002, the
Company finalized the
U.S. GAAP
58 Canadian National Railway Company
Notes to Consolidated Financial Statements
allocation of the purchase price and adjusted the preliminary fair values of
the assets and liabilities acquired as follows: Current assets decreased by $10
million, Properties increased by $141 million, Other assets and deferred
charges decreased by $98 million, Current liabilities increased by $10 million,
Deferred income taxes increased by $16 million and Other liabilities and
deferred credits increased by $3 million. The increase in Properties and
decrease in Other assets and deferred charges was mainly due to the final
valuation of the Company's foreign equity investment. The remaining adjustments
resulted from additional information obtained for conditions and circumstances
that existed at the time of acquisition.
The following table outlines the final fair values of WC's assets and
liabilities acquired:
In millions
----------------------------------------------------------------
Current assets...........................................$ 165
Properties............................................... 2,576
Other assets and deferred charges........................ 335
------
Total assets acquired.................................... 3,076
======
Current liabilities...................................... 363
Deferred income taxes.................................... 759
Other liabilities and deferred credits................... 181
Long-term debt........................................... 472
------
Total liabilities assumed................................ 1,775
------
Net assets acquired......................................$1,301
======
If the Company had acquired WC on January 1, 2000, based on the historical
amounts reported by WC, net of the difference between the Company's cost to
acquire WC and its net assets, revenues, net income, basic and diluted earnings
per share would have been $6,090 million, $1,090 million, $5.67 per basic share
and $5.48 per diluted share, respectively for the year ended December 31, 2001
and $5,961 million, $971 million, $4.98 per basic share and $4.84 per diluted
share, respectively for 2000. These pro forma figures do not reflect synergies,
and accordingly, do not account for any potential increases in operating
income, any estimated cost savings or facilities consolidation.
4 Accounts receivable
In millions December 31, 2002 2001
-----------------------------------------------------------------------
Freight
Trade.......................................... $321 $309
Accrued........................................ 150 119
Non-freight....................................... 310 298
------------
781 726
Provision for doubtful accounts................... (59) (81)
------------
$722 $645
============
The Company has a five-year revolving agreement, expiring in June 2003, to
sell eligible freight trade receivables up to a maximum of $350 million of
receivables outstanding at any point in time. The Company intends to renew or
replace the program upon expiration. At December 31, 2002, pursuant to the
agreement, $173 million and U.S.$113 million (Cdn$177 million) had been sold on
a limited recourse basis compared to $168 million and U.S.$113 million (Cdn$179
million) at December 31, 2001. Recourse is limited to 10% of receivables sold
and consists of additional freight trade receivables that have been recorded in
Other current assets. The Company has retained the responsibility for
servicing, administering and collecting freight trade receivables sold. Other
income included $9 million in 2002 and $10 million in each of 2001 and 2000 for
costs related to the agreement, which fluctuate with changes in prevailing
interest rates.
No servicing asset or liability has been recorded since the costs of
servicing are compensated by the benefits of the agreement.
The Receivables Purchase Agreement provides for customary indemnification
provisions, which survive for a period of two years following the final
purchase of any receivable, three years from the final collection date or until
statute barred, in the case of taxes. As at December 31, 2002, the Company has
not recorded a liability associated with these indemnifications, for which
there is no monetary limitation, as the Company does not expect to make any
payments pertaining to the indemnifications of this program.
5 Properties
In millions December 31, 2002 December 31, 2001
---------------------------------------------------------------------------------------------------------------------------------
Accumulated Accumulated
Cost depreciation Net Cost depreciation Net
---------------------------------------------------------------------------------------------------------------------------------
Track, roadway and land................... $22,048 $6,265 $15,783 $21,582 $6,230 $15,352
Rolling stock ............................ 4,057 1,506 2,551 3,913 1,456 2,457
Buildings................................. 1,819 880 939 1,715 826 889
Other..................................... 916 508 408 941 494 447
--------------------------------------------------------------------------------------
$28,840 $9,159 $19,681 $28,151 $9,006 $19,145
======================================================================================
Capital leases included in rolling stock.. $ 1,351 $ 233 $ 1,118 $ 1,249 $ 209 $ 1,040
======================================================================================
U.S. GAAP
Canadian National Railway Company 59
Notes to Consolidated Financial Statements
6 Other assets and deferred charges
In millions December 31, 2002 2001
-----------------------------------------------------------------
Investments....................................... $380 $496
Prepaid benefit cost (Note 13).................... 353 251
Deferred receivables.............................. 88 108
Unamortized debt issue costs...................... 41 54
Other............................................. 3 5
------------
$865 $914
============
Investments
As at December 31, 2002, the Company had $368 million ($478 million at December
31, 2001) of investments accounted for under the equity method and $12 million
($18 million at December 31, 2001) of investments accounted for under the cost
method.
Investment in Tranz Rail Holdings Limited (Tranz Rail) and Australian Transport
Network Limited (ATN)
In 2002, the Company sold its interests in Tranz Rail and ATN for aggregate net
proceeds of $69 million, which approximated the carrying value of the
investments. Prior to the sale, the Company had accounted for these investments
as "available for sale" in accordance with the FASB's Emerging Issues Task
Force (EITF) 87-11, "Allocation of Purchase Price to Assets to be Sold."
Investment in English Welsh and Scottish Railway (EWS)
Through its acquisition of WC in 2001, the Company acquired 40.9% of EWS, a
company which provides most of the rail freight services in Great Britain,
operates freight trains through the English Channel tunnel and carries mail for
the Royal Mail. The final fair value of the investment at the date of
acquisition was determined based on the discounted cash flow method and a
multiple of EWS earnings. The Company accounts for its investment in EWS using
the equity method. At December 31, 2002, the excess of the Company's share of
the book value of EWS' net assets over the carrying value of the investment is
being depreciated over the life of its assets and is not significant.
Investment in 360networks Inc.
In June 2001, the Company recorded a charge of $99 million, $71 million after
tax, to write down 100% of its net investment in 360networks Inc. and
subsequently sold all of its shares. In 2000, the Company had recorded a gain
of $84 million, $58 million after tax, related to the exchange of its minority
equity investments in certain joint venture companies for 11.4 million shares
of 360networks Inc. Prior to the write-down, the Company accounted for its
investment in 360networks Inc. in accordance with SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." The shares held were
classified as "available-for-sale securities" whereby the investment was
carried at market value on the balance sheet and the change in the value of the
investment was recorded in Other comprehensive income as an unrealized holding
gain. As a result of the write-down, the Company eliminated all
marked-to-market adjustments related to its investment in 360networks Inc.,
previously recorded in Other comprehensive income.
7 Credit facilities
In December 2002, the Company entered into a U.S.$1,000 million three-year
revolving credit facility and concurrently terminated its previous revolving
credit facilities before their scheduled maturity in March 2003. The credit
facility provides for borrowings at various interest rates, including the
Canadian prime rate, bankers' acceptance rates, the U.S. federal funds
effective rate and the London Interbank Offer Rate, plus applicable margins.
The credit facility agreement contains customary financial covenants, based on
U.S. GAAP, including limitations on debt as a percentage of total
capitalization and maintenance of tangible net worth above pre-defined levels.
Throughout the year, the Company was in compliance with all financial covenants
contained in its outstanding revolving credit agreements. The Company's
commercial paper program is backed by a portion of its revolving credit
facility. As at December 31, 2002, the Company had outstanding commercial paper
of U.S.$136 million (Cdn$214 million) compared to U.S.$213 million (Cdn$339
million) as at December 31, 2001. The Company's borrowings of U.S.$172 million
(Cdn$273 million) outstanding at December 31, 2001 were entirely repaid in the
first quarter of 2002. At December 31, 2002, the Company had borrowings under
its revolving credit facility of U.S.$90 million (Cdn$142 million) at an
average interest rate of 1.77%. Outstanding letters of credit under the
previous facilities were transferred into the current facility. As at December
31, 2002, letters of credit under the revolving credit facility amounted to
$295 million.
8 Accounts payable and accrued charges
In millions December 31, 2002 2001
----------------------------------------------------------------
Trade payables.................................. $ 436 $ 385
Income and other taxes.......................... 251 236
Payroll-related accruals........................ 235 218
Workforce reduction provisions.................. 168 151
Personal injury and other claims (Note 20)...... 136 51
Accrued charges................................. 113 131
Accrued interest................................ 104 141
Accrued operating leases........................ 18 19
Other........................................... 26 42
-------------
$1,487 $1,374
=============
U.S. GAAP
60 Canadian National Railway Company
9 Other liabilities and deferred credits
In millions December 31, 2002 2001
----------------------------------------------------------------
Personal injury and other claims,
net of current portion (Note 20)............. $ 528 $ 379
Workforce reduction provisions,
net of current portion (A)................... 253 340
Accrual for post-retirement benefits
other than pensions (B)...................... 284 258
Environmental reserve, net of current portion... 81 73
Deferred credits and other...................... 260 295
-------------
$1,406 $1,345
=============
A. Workforce reduction provisions (Note 14)
The workforce reduction provisions, which cover employees in both Canada and
the United States, are mainly comprised of payments related to severance, early
retirement incentives and bridging to early retirement, the majority of which
will be disbursed within the next three years. Payments have reduced the
provisions by $177 million for the year ended December 31, 2002 ($169 million
for the year ended December 31, 2001). As at December 31, 2002, the aggregate
provisions, including the current portion, amounted to $421 million ($491
million as at December 31, 2001).
B. Post-retirement benefits other than pensions
(i) Change in benefit obligation
In millions Year ended December 31, 2002 2001
---------------------------------------------------------------
Benefit obligation at beginning of year........... $309 $242
Amendments........................................ 18 25
Actuarial loss.................................... 101 20
Interest cost..................................... 23 19
Service cost...................................... 13 11
Foreign currency changes.......................... (1) 6
Transfer from other plans......................... - 5
Benefits paid..................................... (19) (19)
------------
Benefit obligation at end of year................. $444 $309
============
(ii) Funded status
In millions December 31, 2002 2001
----------------------------------------------------------------
Unfunded benefit obligation at end of year........ $444 $309
Unrecognized net actuarial loss................... (122) (26)
Unrecognized prior service cost................... (38) (25)
------------
Accrued benefit cost for post-retirement
benefits other than pensions................... $284 $258
============
(iii) Components of net periodic benefit cost
In millions Year ended December 31, 2002 2001 2000
----------------------------------------------------------------
Interest cost............................ $23 $19 $15
Service cost............................. 13 11 8
Amortization of prior service cost....... 5 3 1
Recognized net actuarial loss............ 4 2 1
--------------------
Net periodic benefit cost................ $45 $35 $25
====================
(iv) Weighted-average assumptions
December 31, 2002 2001 2000
----------------------------------------------------------------
Discount rate........................... 6.65% 6.97% 6.95%
Rate of compensation increase........... 4.00% 4.00% 4.25%
----------------------------------------------------------------
For measurement purposes, increases in the per capita cost of covered
health care benefits were assumed to be 17% for 2003 and 18% for 2002. It is
assumed that the rate will decrease gradually to 8% in 2012 and remain at that
level thereafter.
A one-percentage-point change in the health care cost trend rate would not
cause a material change in the Company's net periodic benefit cost nor the
post-retirement benefit obligation.
U.S. GAAP
Canadian National Railway Company 61
Notes to Consolidated Financial Statements
10 Long-term debt
Currency
in which December 31,
In millions Maturity payable 2002 2001
---------------------------------------------------------------------------------------------------------------------------------
Debentures and notes: (A)
Canadian National series:
6.63% 10-year notes .........................................................May 15, 2003 U.S.$ $ 236 $ 239
7.00% 10-year notes .........................................................Mar. 15, 2004 U.S.$ 419 422
6.45% Puttable Reset Securities (PURS) (B)...................................July 15, 2006 U.S.$ 394 398
6.38% 10-year notes (C) .....................................................Oct. 15, 2011 U.S.$ 631 636
6.80% 20-year notes (C)......................................................July 15, 2018 U.S.$ 315 318
7.63% 30-year debentures.....................................................May 15, 2023 U.S.$ 236 239
6.90% 30-year notes (C)......................................................July 15, 2028 U.S.$ 749 755
7.38% 30-year debentures (C) ................................................Oct. 15, 2031 U.S.$ 315 318
Illinois Central series:
6.75% 10-year notes..........................................................May 15, 2003 U.S.$ 158 159
7.75% 10-year notes..........................................................May 1, 2005 U.S.$ 158 159
6.98% 12-year notes .........................................................July 12, 2007 U.S.$ 79 80
6.63% 10-year notes..........................................................June 9, 2008 U.S.$ 32 32
5.00% 99-year income debentures..............................................Dec. 1, 2056 U.S.$ 12 12
7.70% 100-year debentures ..................................................Sep. 15, 2096 U.S.$ 197 199
Wisconsin Central series:
6.63% 10-year notes..........................................................April 15, 2008 U.S.$ 236 239
--------------------------------------------------
Total debentures and notes .................................................... 4,167 4,205
Other:
Revolving credit facilities (Note 7) ....................................... U.S.$ 142 273
Commercial paper (D) (Note 7) .............................................. U.S.$ 214 339
Capital lease obligations, amounts owing under equipment agreements
and other (E) ........................................................... Various 1,068 1,125
-------------------------------------------------
Total other ................................................................... 1,424 1,737
-------------------------------------------------
Subtotal....................................................................... 5,591 5,942
Less:
Current portion of long-term debt .......................................... 574 163
Net unamortized discount ................................................... 14 15
-------------------------------------------------
588 178
-------------------------------------------------
$5,003 $5,764
=================================================
A. The Company's debentures and notes are unsecured.
B. The PURS contain imbedded simultaneous put and call options at par. At the
time of issuance, the Company sold the option to call the securities on July
15, 2006 (the reset date). If the call option is exercised, the imbedded put
option is automatically triggered, resulting in the redemption of the original
PURS. The call option holder will then have the right to remarket the
securities at a new coupon rate for an additional 30-year term ending July 15,
2036. The new coupon rate will be determined according to a pre-set mechanism
based on market conditions then prevailing. If the call option is not
exercised, the put option is deemed to have been exercised, resulting in the
redemption of the PURS on July 15, 2006.
C. These debt securities are redeemable, in whole or in part, at the option of
the Company, at any time, at the greater of par and a formula price based on
interest rates prevailing at the time of redemption.
D. The Company has a commercial paper program, which is backed by a portion of
its revolving credit facility, enabling it to issue commercial paper up to a
maximum aggregate principal amount of $600 million, or the U.S. dollar
equivalent. Commercial paper debt is due within one year but has been
classified as long-term debt, reflecting the Company's intent and contractual
ability to refinance the short-term borrowing through subsequent issuances of
commercial paper or drawing down on the revolving credit facility. Interest
rates on commercial paper at December 31, 2002 range from approximately 1.4% to
1.7%.
U.S. GAAP
62 Canadian National Railway Company
Notes to Consolidated Financial Statements
E. Interest rates for the capital leases range from approximately 3.0% to 14.6%
with maturity dates in the years 2003 through 2025. The imputed interest on
these leases amounted to $498 million as at December 31, 2002, and $545 million
as at December 31, 2001.
The equipment agreements are payable by monthly or semi-annual
installments over various periods to 2007 at interest rates ranging from 6.0%
to 6.7%. As at December 31, 2002, the principal amount repayable was $14
million ($19 million as at December 31, 2001). The capital leases, equipment
agreements, and other obligations are secured by properties with a net carrying
amount of $1,136 million as at December 31, 2002 and $1,108 million as at
December 31, 2001.
During 2002, the Company recorded $114 million in assets it acquired
through the exercise of purchase options on existing leases and leases for new
equipment ($91 million in 2001). An equivalent amount was recorded in debt.
F. Long-term debt maturities, including repurchase arrangements and capital
lease repayments on debt outstanding as at December 31, 2002 but excluding
repayments of commercial paper and revolving credit facility of $214 million
and $142 million, respectively, for the next five years and thereafter, are as
follows:
Year In millions
-----------------------------------------------------------------
2003.................................................... $ 574
2004.................................................... 560
2005.................................................... 246
2006.................................................... 438
2007.................................................... 164
2008 and thereafter..................................... 3,239
-----------------------------------------------------------------
G. The aggregate amount of debt payable in U.S. currency as at December 31,
2002 is U.S.$3,164 million (Cdn$4,987 million) and U.S.$3,334 million
(Cdn$5,302 million) as at December 31, 2001.
11 Capital stock and convertible preferred securities
A. Authorized capital stock
The authorized capital stock of the Company is as follows:
o Unlimited number of Common Shares, without par value
o Unlimited number of Class A Preferred Shares, without par value issuable
in series
o Unlimited number of Class B Preferred Shares, without par value issuable
in series
B. Issued and outstanding common shares
During 2002, the Company issued 7.8 million shares of which 1.8 million shares
(2.1 million shares in 2001 and 1.2 million shares in 2000) was related to
stock options exercised and 6.0 million shares was related to the conversion of
the Company's convertible preferred securities. The total number of common
shares issued and outstanding was 197.5 million as at December 31, 2002.
C. Convertible preferred securities ("Securities")
On May 6, 2002, the Company met the conditions required to terminate the
Securities holders' right to convert their Securities into common shares of the
Company, and set the conversion termination date as July 3, 2002. The
conditions were met when the Company's common share price exceeded 120% of the
conversion price of U.S.$38.48 per share for a specified period, and all
accrued interest on the Securities had been paid. On July 3, 2002, Securities
that had not been previously surrendered for conversion were deemed converted,
resulting in the issuance of 6.0 million common shares of the Company.
In 1999, the Company had issued 4.6 million 5.25% Securities due on June
30, 2029, at U.S.$50 per Security. These Securities were subordinated
securities convertible into common shares of CN at the option of the holder at
an original conversion price of U.S.$38.48 per common share, representing an
original conversion rate of 1.2995 common shares for each Security.
D. Share repurchase programs
On October 22, 2002, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 13.0 million common
shares between October 25, 2002 and October 24, 2003 pursuant to a normal
course issuer bid, at prevailing market prices. As at December 31, 2002, $203
million was used to repurchase 3.0 million common shares at an average price of
$67.68 per share.
In 2001, the Board of Directors of the Company approved a share repurchase
program under which the Company did not repurchase any common shares.
In 2000, $529 million was used to repurchase 13.0 million common shares,
the maximum allowed under the program, pursuant to a normal course issuer bid
at an average price of $40.70 per share.
12 Stock plans
The Company has various stock-based incentive plans for eligible employees. A
description of the Company's major plans is provided below:
A. Employee share plan
The Company has an Employee Share Investment Plan (ESIP) giving eligible
employees the opportunity to subscribe for up to 6% 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. Participation at December 31, 2002 was 8,911
employees (9,432 at December 31, 2001). The total number of ESIP shares
purchased on behalf of employees, including the Company's contributions, was
497,459 in 2002, 516,726 in 2001 and 637,531 in 2000, resulting in a pre-tax
charge to income of $9 million, $8 million and $6 million for the years ended
December 31, 2002, 2001 and 2000, respectively.
U.S. GAAP
Canadian National Railway Company 63
Notes to Consolidated Financial Statements
12 Stock plans (continued)
B. Mid-term incentive share unit plan
The Company has a share unit plan, which was approved by the Board of Directors
in 2001, for designated senior management employees entitling them to receive
payout on June 30, 2004 of a combination of common stock of the Company, as to
fifty percent, and cash value, as to the remaining fifty percent.
The share units vest conditionally upon the attainment of targets relating
to the Company's share price during the six-month period ending June 30, 2004.
At December 31, 2002, the total number of share units outstanding was 419,900,
representing a potential maximum compensation cost of $42 million. Due to the
nature of the vesting conditions, no compensation cost was recorded for 2002
and 2001. At December 31, 2002, an additional 45,100 share units remained
authorized for future issuances under this plan.
C. Stock options
The Company has stock option plans for eligible employees to acquire common
shares of the Company upon vesting at a price equal to the market value of the
common shares at the date of granting. The options are exercisable during a
period not exceeding 10 years. The right to exercise options generally accrues
over a period of four years of continuous employment. Options are not generally
exercisable during the first 12 months after the date of grant. At December 31,
2002, an additional 2.6 million common shares remained authorized for future
issuances under these plans.
Options issued by the Company include conventional options, which vest
over a period of time, and performance options, which vest upon the attainment
of Company targets relating to the operating ratio and unlevered return on
investment. The total conventional and performance options outstanding at
December 31, 2002 were 9.1 million and 2.0 million, respectively.
Changes in the Company's stock options are as follows:
Number Weighted-average
of options exercise price
---------------------------------------------------------------------
In millions
--------------------------------------------------------------------
Outstanding at December 31, 1999 (1)...... 8.3 $ 34.88
Granted .................................. 2.2 $ 35.33
Canceled ................................. (0.4) $ 36.23
Exercised................................. (1.2) $ 22.19
---
Outstanding at December 31, 2000 (1)...... 8.9 $ 34.95
Conversion of WC options.................. 1.0 $ 58.63
Granted .................................. 2.4 $ 50.65
Canceled ................................. (0.3) $ 46.01
Exercised................................. (2.1) $ 30.43
---
Outstanding at December 31, 2001 (1) (2).. 9.9 $ 43.62
Granted .................................. 3.2 $ 76.78
Canceled ................................. (0.2) $ 56.98
Exercised................................. (1.8) $ 39.16
---
Outstanding at December 31, 2002 (1) (2).. 11.1 $ 53.50
====
(1) Includes IC converted stock options translated to Canadian dollars using
the foreign exchange rate in effect at the balance sheet date.
(2) Includes WC converted stock options translated to Canadian dollars using
the foreign exchange rate in effect at the balance sheet date.
Stock options outstanding and exercisable as at December 31, 2002 were as
follows:
Options outstanding Options exercisable
---------------------------------------------------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
average average average
Number years to exercise Number exercise
Range of exercise prices of options expiration price of options price
---------------------------------------------------------------------------------------------------------------------------------
In millions In millions
---------------------------------------------------------------------------------------------------------------------------------
$13.50-$23.72 .............................................. 0.1 3 $ 17.23 0.1 $ 17.23
$25.18-$35.01 .............................................. 2.1 6 $ 33.59 1.2 $ 32.48
$35.70-$49.45 .............................................. 3.2 6 $ 44.69 2.7 $ 44.56
$50.02-$69.77 .............................................. 2.5 8 $ 51.43 0.8 $ 52.93
$70.04 and above ........................................... 3.2 9 $ 77.59 0.1 $ 97.09
----- -- ------- --- -------
Balance at December 31, 2002 (1) ........................... 11.1 7 $ 53.50 4.9 $ 44.01
===== ===
(1) Includes IC and WC converted stock options translated to Canadian dollars
using the foreign exchange rate in effect at the balance sheet date.
U.S. GAAP
64 Canadian National Railway Company
Notes to Consolidated Financial Statements
D. Stock-based compensation cost
Compensation cost for performance-based stock option awards under these plans
is determined by the options' intrinsic value in accordance with APB 25,
"Accounting for Stock Issued to Employees," and related interpretations.
Compensation cost recognized for stock-based awards was $9 million, $19 million
and $3 million in 2002, 2001 and 2000, respectively. Disclosures required under
the fair value measurement and recognition method prescribed by SFAS No. 123,
"Accounting for Stock-Based Compensation," are presented in Note 1 - Summary of
significant accounting policies.
13 Pensions
The Company has retirement benefit plans under which substantially all of its
employees are entitled to benefits at retirement age, generally based on
compensation and length of service and/or contributions. The tables that follow
pertain to all such plans. However, the following descriptions relate solely to
the Company's main pension plan, the CN Pension Plan (the Pension Plan). The
Company's other pension plans are not significant.
Description of plan
The Pension Plan is a contributory defined benefit pension plan that covers the
majority of CN employees. It provides for pensions based mainly on years of
service and final average pensionable earnings and is generally applicable from
the first day of employment. Indexation of pensions is provided after
retirement through a gain (loss) sharing mechanism, subject to guaranteed
minimum increases. An independent trust company is the Trustee of the Canadian
National Railways Pension Trust Funds (CN Pension Trust Funds). As Trustee, the
trust company performs certain duties, which include holding legal title to the
assets of the CN Pension Trust Funds and ensuring that the Company, as
Administrator, complies with the provisions of the Pension Plan and the related
legislation.
Funding policy
Employee contributions to the 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, and are
determined by actuarial valuations conducted at least on a triennial basis.
These valuations are made in accordance with legislative requirements and with
the recommendations of the Canadian Institute of Actuaries for the valuation of
pension plans. The latest actuarial valuation of the Pension Plan was conducted
as at December 31, 2001 and indicated a funding excess. Based on the Pension
Plan's current position, the Company's contributions are expected to be
approximately $75 million in each of 2003, 2004 and 2005.
Description of fund assets
The assets of the Pension Plan are accounted for separately in the CN Pension
Trust Funds and consist of cash and short-term investments, bonds, mortgages,
Canadian and foreign equities, real estate, and oil and gas assets. Based on
the fair value of the assets held at December 31, 2002, the plan assets are
comprised of 1% in cash and short-term investments, 40% in bonds and mortgages,
50% in Canadian and foreign equities and 9% in real estate and oil and gas
assets.
(a) Change in benefit obligation
In millions Year ended December 31, 2002 2001
----------------------------------------------------------------
Benefit obligation at beginning of year........ $11,156 $10,855
Interest cost.................................. 714 701
Actuarial (gain) loss.......................... (92) 94
Service cost................................... 99 92
Plan participants' contributions............... 61 73
Foreign currency changes....................... (1) 6
Benefit payments and transfers................. (694) (665)
---------------
Benefit obligation at end of year.............. $11,243 $11,156
===============
(b) Change in plan assets
In millions Year ended December 31, 2002 2001
----------------------------------------------------------------
Fair value of plan assets at beginning of year. $11,763 $12,455
Employer contributions......................... 92 69
Plan participants' contributions............... 61 73
Foreign currency changes....................... (1) 6
Actual return on plan assets................... (39) (175)
Benefit payments and transfers................. (694) (665)
---------------
Fair value of plan assets at end of year....... $11,182 $11,763
===============
(c) Funded status
In millions December 31, 2002 2001
----------------------------------------------------------------
Excess (deficiency) of fair value of plan assets
over benefit obligation at end of year (1).....$ (61) $ 607
Unrecognized net actuarial (gain) loss (1)........ 282 (537)
Unrecognized net transition obligation............ 19 39
Unrecognized prior service cost................... 113 133
-------------
Net amount recognized.............................$ 353 $ 242
=============
(1) Subject to future reduction for gain sharing under the terms of the plan.
(d) Amount recognized in the Consolidated Balance Sheet
In millions December 31, 2002 2001
---------------------------------------------------------------
Prepaid benefit cost (Note 6)..................... $353 $251
Accrued benefit cost.............................. - (9)
Additional minimum pension liability.............. (38) (18)
Intangible asset.................................. 1 1
Accumulated other comprehensive income (Note 22).. 37 17
------------
Net amount recognized............................. $353 $242
============
U.S. GAAP
Canadian National Railway Company 65
Notes to Consolidated Financial Statements
13 Pensions (continued)
(e) Components of net periodic benefit cost
In millions Year ended December 31, 2002 2001 2000
------------------------------------------------------------------
Interest cost........................... $ 714 $ 701 $ 690
Service cost............................ 99 92 70
Amortization of net transition obligation 20 20 19
Amortization of prior service cost...... 20 20 19
Expected return on plan assets.......... (874) (846) (792)
Recognized net actuarial loss........... 1 - -
----------------------
Net periodic benefit cost (income)...... $ (20) $ (13) $ 6
======================
(f) Weighted-average assumptions
December 31, 2002 2001 2000
---------------------------------------------------------------
Discount rate........................... 6.50% 6.50% 6.50%
Rate of compensation increase........... 4.00% 4.00% 4.25%
Expected return on plan assets for
year ending December 31.............. 9.00% 9.00% 9.00%
---------------------------------------------------------------
Effective January 1, 2003, the Company will reduce the expected long-term
rate of return on plan assets from 9% to 8% to reflect management's current
view of long-term investment returns. The effect of this change in management's
assumption will be to increase net periodic benefit cost in 2003 by
approximately $50 million.
As at December 31, 2002, one of the Company's pension plans had an
accumulated benefit obligation of $112 million ($106 million at December 31,
2001) in excess of the fair value of the plan assets of $77 million ($79
million at December 31, 2001) which gave rise to an additional minimum pension
liability. The projected benefit obligation was $116 million at December 31,
2002 ($110 million at December 31, 2001).
The Company has indemnified and held harmless the current trustee and the
former trustee of the Canadian National Railways Pension Trust Funds, and the
respective officers, directors, employees and agents of such trustees, from any
and all taxes, claims, liabilities, damages, costs and expenses arising out of
the performance of their obligations under the relevant trust agreements and
trust deeds, including in respect of their reliance on authorized instructions
of the Company or for failing to act in the absence of authorized instructions.
These indemnifications survive the termination of such agreements or trust
deeds. As at December 31, 2002, the Company has not recorded a liability
associated with these indemnifications, as the Company does not expect to make
any payments pertaining to these indemnifications.
14 Workforce reduction charges
In 2002, the Company announced 1,146 job reductions, in a renewed drive to
improve productivity in all its corporate and operating functions, and recorded
a charge of $120 million, $79 million after tax. In 2001, a charge of $98
million, $62 million after tax, was recorded for the reduction of 690
positions. Reductions relating to these charges were 388 in 2001, 433 in 2002,
with the remainder to be completed by the end of 2003. The charges included
payments for severance, early retirement incentives and bridging to early
retirement, to be made to affected employees.
15 Interest expense
In millions Year ended December 31, 2002 2001 2000
----------------------------------------------------------------
Interest on long-term debt.............. $361 $329 $322
Interest income......................... - (2) (11)
---------------------
$361 $327 $311
=====================
Cash interest payments.................. $398 $322 $315
=====================
16 Other income
In millions Year ended December 31, 2002 2001 2000
----------------------------------------------------------------
Gain on disposal of properties........... $ 41 $ 53 $ 57
Equity in earnings of English Welsh
and Scottish Railway (Note 6)......... 33 8 -
Investment income........................ 18 22 10
Foreign exchange gain.................... 12 7 10
Gain on sale of interest in Detroit
River Tunnel Company (A).............. - 101 -
Write-down of investment
in 360networks Inc. (Note 6).......... - (99) -
Gain on exchange of investment (Note 6).. - - 84
Net real estate costs.................... (15) (20) (22)
Other.................................... (13) (7) (3)
---------------------
$ 76 $ 65 $136
=====================
A. In March 2001, the Company completed the sale of its 50 percent interest in
the Detroit River Tunnel Company (DRT) for proceeds of $112 million and
recorded a gain of $101 million, $73 million after tax. The DRT is a 1.6 mile
rail-only tunnel crossing the Canada-U.S. border between Detroit and Windsor,
Ontario.
U.S. GAAP
66 Canadian National Railway Company
Notes to Consolidated Financial Statements
17 Income taxes
The Company's consolidated effective income tax rate differs from the statutory
Federal tax rate. The reconciliation of income tax expense is as follows:
In millions Year ended December 31, 2002 2001 2000
-----------------------------------------------------------------
Federal tax rate....................... 26.1% 28.1% 29.1%
Income tax expense at the statutory
Federal tax rate....................$ (309) $ (399) $ (429)
Income tax (expense) recovery
resulting from:
Provincial and other taxes.......... (140) (178) (180)
Deferred income tax adjustment
due to rate reductions............ - 122 -
U.S. tax rate differential.......... (1) 3 9
Gain on disposals and dividends..... 6 18 18
Other............................... 60 54 46
------------------------
Income tax expense.....................$ (384) $ (380) $ (536)
========================
Income before income taxes
Canada.............................. $1,101 $1,153 $1,172
U.S................................. 83 267 301
-----------------------
$1,184 $1,420 $1,473
=======================
Current income taxes
Canada..............................$ (130) $ (99) $ (153)
U.S................................. 18 14 (71)
------------------------
$ (112) $ (85) $ (224)
========================
Deferred income taxes
Canada..............................$ (221) $ (173) $ (290)
U.S................................. (51) (122) (22)
------------------------
$ (272) $ (295) $ (312)
========================
Cash payments for income taxes.........$ 65 $ 63 $ 101
========================
Significant components of deferred income tax assets and liabilities are
as follows:
In millions December 31, 2002 2001
---------------------------------------------------------------
Deferred income tax assets
Workforce reduction provisions.................. $ 144 $ 178
Accruals and other reserves..................... 276 182
Post-retirement benefits........................ 99 85
Losses and tax credit carryforwards............. 69 53
--------------
588 498
--------------
Deferred income tax liabilities
Properties and other............................ 5,292 4,936
--------------
Total net deferred income tax liability......... 4,704 4,438
Net current deferred income tax asset........... 122 153
--------------
Net long-term deferred income tax liability $4,826 $4,591
==============
Net deferred income tax liability
Canada....................................... $1,285 $1,050
U.S.......................................... 3,419 3,388
--------------
$4,704 $4,438
=============
The Company expects to realize its deferred income tax assets from the
generation of future taxable income, as the related payments are made and
losses and tax credit carryforwards are utilized.
The Company recognized tax credits of $9 million in 2002 for research and
development expenditures ($35 million in 2001 for investment tax credits) not
previously recognized, which reduced the cost of properties.
18 Segmented information
The Company operates in one business segment with operations and assets in
Canada and the United States.
Information on geographic areas
In millions Year ended December 31, 2002 2001 2000
---------------------------------------------------------------
Revenues:
Canadian rail....................... $3,726 $3,675 $3,650
U.S. rail .......................... 2,384 1,977 1,778
-----------------------
$6,110 $5,652 $5,428
=======================
Operating income:
Canadian rail ...................... $1,163 $1,181 $1,199
U.S. rail .......................... 306 501 449
-----------------------
$1,469 $1,682 $1,648
=======================
Net income:
Canadian rail....................... $ 719 $ 844 $ 695
U.S. rail .......................... 81 196 242
-----------------------
$ 800 $1,040 $ 937
=======================
Depreciation and amortization:
Canadian rail (A)................... $ 343 $ 309 $ 336
U.S. rail .......................... 248 229 197
-----------------------
$ 591 $ 538 $ 533
=======================
Capital expenditures: (B)
Canadian rail (C) .................. $ 717 $ 723 $ 802
U.S. rail .......................... 335 274 310
-----------------------
$1,052 $ 997 $1,112
=======================
In millions December 31, 2002 2001
---------------------------------------------------------------
Identifiable assets:
Canadian rail............................... $ 9,688 $ 9,036
U.S. rail (D)............................... 12,050 12,187
---------------
$21,738 $21,223
===============
(A) Includes $7 million (2001: $6 million, 2000: $8 million) of depreciation
and amortization of properties related to other business activities.
(B) Represents additions to properties that include non-cash capital
expenditures financed through capital lease arrangements.
(C) Includes $4 million (2001: $5 million, 2000: $9 million) of additions to
properties related to other business activities.
(D) Includes equity holdings in foreign investments held by the Company's U.S.
subsidiaries.
U.S. GAAP
Canadian National Railway Company 67
Notes to Consolidated Financial Statements
19 Earnings per share
Year ended December 31, 2002 2001 2000
---------------------------------------------------------------
Basic earnings per share................ $4.07 $5.41 $4.81
Diluted earnings per share.............. $3.97 $5.23 $4.67
======================
The following table provides a reconciliation between basic and diluted
earnings per share:
In millions Year ended December 31, 2002 2001 2000
---------------------------------------------------------------
Net income.............................. $800 $1,040 $937
Income impact on assumed conversion
of preferred securities (Note 11).... 6 12 11
---------------------
$806 $1,052 $948
=====================
Weighted-average shares outstanding..... 196.7 192.1 195.0
Effect of dilutive securities and
stock options ........................ 6.1 8.9 7.8
----------------------
Weighted-average diluted shares
outstanding .......................... 202.8 201.0 202.8
======================
At December 31, 2002, 3.2 million stock options at a weighted- average
exercise price of $77.56 were not included in the calculation of diluted
earnings per share since their inclusion would have had an anti-dilutive
impact.
20 Major commitments and contingencies
A. Leases
The Company has lease commitments for locomotives, freight cars and intermodal
equipment, many of which provide the option to purchase the leased items at
fixed values during or at the end of the lease term. As at December 31, 2002,
the Company's commitments under operating and capital leases are $1,154 million
and $1,407 million, respectively. Annual net minimum payments in each of the
next five years and thereafter, are as follows:
Year In millions Operating Capital
----------------------------------------------------------------
2003 ........................................ $ 212 $ 168
2004 ........................................ 188 153
2005 ........................................ 167 111
2006 ........................................ 139 68
2007 ........................................ 120 123
2008 and thereafter.......................... 328 784
--------------
$1,154 1,407
Less: imputed interest on capital leases at rates
ranging from approximately 3.0% to 14.6%.............. 498
------
Present value of minimum lease payments
at current rate included in debt......................$ 909
======
Rent expense for operating leases was $269 million, $258 million and $219
million for the years ended December 31, 2002, 2001 and 2000, respectively.
Contingent rentals and sublease rentals were not significant.
The Company has guaranteed a portion of the residual values of certain of
its assets under operating leases with expiry dates between 2004 and 2012, for
the benefit of the lessor. If the fair value of the assets, at the end of their
respective lease term, is less than the fair value, as estimated at the
inception of the lease, then the Company must, under certain conditions,
compensate the lessor for the shortfall. The maximum exposure in respect of
these guarantees is $63 million. As at December 31, 2002, the Company has not
recorded a liability associated with these guarantees, as the Company does not
expect to make any payments pertaining to the guarantees of these leases.
B. Other commitments
As at December 31, 2002, the Company had commitments to acquire railroad ties,
rail, freight cars and locomotives at an aggregate cost of $183 million.
Furthermore, as at December 31, 2002, the Company had entered into agreements
with fuel suppliers to purchase approximately 38% of its anticipated 2003
volume and 8% of its anticipated 2004 volume at market prices prevailing on the
date of the purchase.
C. Contingencies
In the normal course of its operations, the Company becomes involved in various
legal actions, including claims relating to personal injuries, occupational
disease and damage to property.
In Canada, employee injuries are governed by the workers' compensation
legislation in each province whereby employees may be awarded either a lump sum
or future stream of payments depending on the nature and severity of the
injury. Accordingly, the Company accounts for costs related to employee
work-related injuries based on actuarially developed estimates of the ultimate
cost associated with such injuries, including compensation, health care and
administration costs. For all other legal actions, the Company maintains, and
regularly updates on a case-by-case basis, provisions for such items when the
expected loss is both probable and can be reasonably estimated based on
currently available information.
In the United States, employee work-related injuries, including
occupational disease claims, are compensated according to the provisions of the
Federal Employers' Liability Act (FELA) and represent a major expense for the
railroad industry. The FELA system, which requires either the finding of fault
through the U.S. jury system or individual settlements, has contributed to the
significant increase in the Company's personal injury expense in recent years.
In view of the Company's growing presence in the United States and the increase
in the number of occupational disease claims over the past few years, an
actuarial study was conducted in 2002, and in the fourth quarter of 2002 the
Company changed its methodology for estimating its liability for U.S. personal
injury and other claims, including occupational disease claims and claims for
property damage, from a case-by-case approach to an actuarial-based approach.
Consequently, and as discussed in Note 2, the Company recorded a charge of $281
million ($173 million after tax) to increase its provision for these claims.
U.S. GAAP
68 Canadian National Railway Company
Notes to Consolidated Financial Statements
Under the actuarial-based approach, the Company accrues the cost for the
expected personal injury and property damage claims and existing occupational
disease claims, based on actuarial estimates of their ultimate cost. The
Company is unable to estimate the total cost for unasserted occupational
disease claims. However, a liability for unasserted occupational disease claims
is accrued to the extent they are probable and can be reasonably estimated.
Under the case-by-case approach, the Company was accruing the cost for
claims as incidents were reported based on currently available information. In
addition, the Company did not record a liability for unasserted claims, as such
amounts could not be reasonably estimated under the case-by-case approach.
The Company's expenses for personal injury and other claims, net of
recoveries, and including the above-mentioned charge, were $393 million in
2002, ($78 million in 2001 and $60 million in 2000) and payments for such items
were $156 million in 2002 ($149 million in 2001 and $111 million in 2000). As
at December 31, 2002, the Company had aggregate reserves for personal injury
and other claims of $664 million ($430 million at December 31, 2001).
Although the Company considers such provisions to be adequate for all its
outstanding and pending claims, the final outcome with respect to actions
outstanding or pending at December 31, 2002, or with respect to future claims,
cannot be predicted with certainty, and therefore there can be no assurance
that their resolution will not have a material adverse effect on the Company's
financial position or results of operations in a particular quarter or fiscal
year.
D. Environmental matters
The Company's operations are subject to federal, provincial, state, municipal
and local regulations under environmental laws and regulations concerning,
among other things, emissions into the air; discharges into waters; the
generation, handling, storage, transportation, treatment and disposal of waste,
hazardous substances, and other materials; decommissioning of underground and
aboveground storage tanks; and soil and groundwater contamination. A risk of
environmental liability is inherent in railroad and related transportation
operations; real estate ownership, operation or control; and other commercial
activities of the Company with respect to both current and past operations. As
a result, the Company incurs significant compliance and capital costs, on an
ongoing basis, associated with environmental regulatory compliance and clean-up
requirements in its railroad operations and relating to its past and present
ownership, operation or control of real property.
While the Company believes that it has identified the costs likely to be
incurred in the next several years, based on known information, for
environmental matters, the Company's ongoing efforts to identify potential
environmental concerns that may be associated with its properties may lead to
future environmental investigations, which may result in the identification of
additional environmental costs and liabilities. The magnitude of such
additional liabilities and the costs of complying with environmental laws and
containing or remediating contamination cannot be reasonably estimated due to:
(i) the lack of specific technical information available with respect to
many sites;
(ii) the absence of any government authority, third-party orders, or claims
with respect to particular sites;
(iii) the potential for new or changed laws and regulations and for
development of new remediation technologies and uncertainty regarding
the timing of the work with respect to particular sites;
(iv) the ability to recover costs from any third parties with respect to
particular sites; and
therefore, the likelihood of any such costs being incurred or whether such
costs would be material to the Company cannot be determined at this time. There
can thus be no assurance that material liabilities or costs related to
environmental matters will not be incurred in the future, or will not have a
material adverse effect on the Company's financial position or results of
operations in a particular quarter or fiscal year, or that the Company's
liquidity will not be adversely impacted by such environmental liabilities or
costs. Although the effect on operating results and liquidity cannot be
reasonably estimated, management believes, based on current information, that
environmental matters will not have a material adverse effect on the Company's
financial condition or competitive position. Costs related to any future
remediation will be accrued in the year in which they become known.
As at December 31, 2002, the Company had aggregate accruals for
environmental costs of $106 million ($112 million as at December 31, 2001).
During 2002, payments of $16 million were applied to the provision for
environmental costs compared to $14 million in 2001 and $11 million in 2000.
The Company anticipates that the majority of the liability at December 31, 2002
will be paid out over the next five years. In addition, related environmental
capital expenditures were $19 million in both 2002 and 2001 and $20 million in
2000. The Company expects to incur capital expenditures relating to
environmental matters of approximately $20 million in each of 2003 and 2004 and
$17 million in 2005.
E. Standby letters of credit
The Company, including certain of its subsidiaries, has granted irrevocable
standby letters of credit, issued by highly rated banks, to third parties to
indemnify them in the event the Company does not perform its contractual
obligations. As at December 31, 2002, the maximum potential liability under
these letters of credit was $403 million of which $334 million was for workers'
compensation and other employee benefits and $69 million was for equipment
under leases and other.
U.S. GAAP
Canadian National Railway Company 69
Notes to Consolidated Financial Statements
20 Major commitments and contingencies (continued)
As at December 31, 2002, the Company has not recorded a liability with
respect to these guarantees, as the Company does not expect to make any
payments in excess of what is recorded on the Company's financial statements
for the aforementioned items. The standby letters of credit mature at various
dates between 2003 and 2007.
F. General indemnifications
In the normal course of business, the Company has provided indemnifi cations,
customary for the type of transaction or for the railway business, in various
agreements with third parties, including indemnification provisions where the
Company would be required to indemnify third parties and others.
Indemnifications are found in various types of contracts with third parties
which include, but are not limited to, (a) contracts granting the Company the
right to use or enter upon property owned by third parties such as leases,
easements, trackage rights and sidetrack agreements; (b) contracts granting
rights to others to use the Company's property, such as leases, licenses and
easements; (c) contracts for the sale of assets; (d) contracts for the
acquisition of services; (e) financing agreements; (f) trust indentures or
fiscal agency agreements or similar agreements relating to debt or equity
securities of the Company and engagement agreements with financial advisors;
(g) transfer agent and registrar agreements in respect of the Company's
securities; and (h) trust agreements establishing trust funds to secure the
payment to certain officers and senior employees of special retirement
compensation arrangements or plans. 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 payment cannot be determined with certainty,
however, may be material.
21 Financial instruments
A. Risk management
The Company has limited involvement with derivative financial instruments in
the management of its fuel, foreign currency and interest rate exposures, and
does not use them for trading purposes.
(i) Credit risk
In the normal course of business, the Company monitors the financial condition
of its customers and reviews the credit history of each new customer.
The Company is exposed to credit risk in the event of non-performance by
counterparties to its derivative financial instruments. Although collateral or
other security to support financial instruments subject to credit risk is
usually not obtained, counterparties are of high credit quality and their
credit standing or that of their guarantor is regularly monitored. As a result,
losses due to counterparty non-performance are not anticipated. The total risk
associated with the Company's counterparties was immaterial at December 31,
2002. The Company believes there are no significant concentrations of credit
risk.
(ii) Fuel
To mitigate the effects of fuel price changes on its operating margins and
overall profitability, the Company has a systematic hedging program which calls
for regularly entering into swap positions on crude and heating oil to cover a
target percentage of future fuel consumption up to two years in advance. The
changes in the fair value of the swap positions are highly correlated to
changes in the price of fuel and therefore, these fuel hedges are being
accounted for as cash flow hedges, whereby the effective portion of the
cumulative change in the market value of the derivative instruments has been
recorded in Accumulated other comprehensive income. The amounts in Accumulated
other comprehensive income will be reclassified into income upon the ultimate
consumption of the hedged fuel. To the extent that the cumulative change in the
fair value of the swap positions does not offset the cumulative change in the
price of fuel, the ineffective portion of the hedge will be recognized into
income immediately. In the event that the fuel hedge is discontinued and the
forecasted purchase of fuel is not expected to occur, the amount in Accumulated
other comprehensive income would be reclassified into income immediately.
Realized gains and losses from the Company's fuel hedging activities
were a $3 million gain, a $6 million loss and a $49 million gain for the years
ended December 31, 2002, 2001 and 2000, respectively. At December 31, 2002, the
Company has hedged approximately 47% of the estimated 2003 fuel consumption and
25% of the estimated 2004 fuel consumption. This represents approximately 263
million U.S. gallons at an average price of U.S.$0.5865 per U.S. gallon.
At December 31, 2002, Accumulated other comprehensive income included an
unrealized gain of $30 million, $20 million after tax ($38 million unrealized
loss, $25 million after tax at December 31, 2001), of which $29 million relates
to derivative instruments that will mature within the next year. The Company
did not recognize any material gains or losses in 2002 and 2001 due to hedge
ineffectiveness as the Company's derivative instruments have been highly
effective in hedging the changes in cash flows associated with forecasted
purchases of diesel fuel.
(iii) Foreign currency
Although the Company conducts its business and receives revenues primarily in
Canadian dollars, a growing portion of its revenues, expenses, assets and debt
are denominated in U.S. dollars. Thus, the Company's results are affected by
fluctuations in the exchange rate between these currencies. Changes in the
exchange rate between the Canadian dollar and other currencies (including the
U.S. dollar) make the goods transported by the Company more or less competitive
in the world marketplace and thereby affect the Company's revenues and
expenses.
For the purpose of minimizing volatility of earnings resulting from the
conversion of U.S. dollar denominated long-term debt into the Canadian dollar,
the Company has designated all U.S. dollar denominated long-term debt of the
parent company as a foreign exchange hedge of
U.S. GAAP
70 Canadian National Railway Company
Notes to Consolidated Financial Statements
its net investment in U.S. subsidiaries. As a result, from the dates of
designation, unrealized foreign exchange gains and losses on the translation of
the Company's U.S. dollar denominated long-term debt are recorded in
Accumulated other comprehensive income.
(iv) Interest rates
From time to time, the Company enters into interest rate swap trans actions for
the purpose of minimizing the volatility in the fair value of certain
fixed-interest long-term debt. In 2002 and 2001, the Company did not enter into
any interest rate swap transactions.
(v) Other
The Company does not currently have any derivative instruments not designated
as hedging instruments.
B. Fair value of financial instruments
Generally accepted accounting principles define the fair value of a financial
instrument as the amount at which the instrument could be exchanged in a
current transaction between willing parties. The Company uses the following
methods and assumptions to estimate the fair value of each class of financial
instruments for which the carrying amounts are included in the Consolidated
Balance Sheet under the following captions:
(i) Cash and cash equivalents, Accounts receivable, Accounts payable and
accrued charges, and Other current liabilities:
The carrying amounts approximate fair value because of the short maturity of
these instruments.
(ii) Other assets and deferred charges:
Investments: The Company has various debt and equity investments for which the
carrying value approximates the fair value, with the exception of a cost
investment for which the fair value was estimated based on the Company's
proportionate share of its net assets.
(iii) Long-term debt:
The fair value of the Company's long-term debt is estimated based on the quoted
market prices for the same or similar debt instruments, as well as discounted
cash flows using current interest rates for debt with similar terms, company
rating, and remaining maturity.
(iv) Convertible preferred securities:
In 2001, the fair value of the Company's convertible preferred securities was
estimated based on the quoted market price.
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments as at December 31, 2002 and 2001
for which the carrying values on the Consolidated Balance Sheet are different
from their fair values:
In millions December 31, 2002 December 31, 2001
-----------------------------------------------------------------------------
Carrying Fair Carrying Fair
amount value amount value
-----------------------------------------------------------------------------
Financial assets
Investments ........................ $ 380 $ 440 $ 496 $ 551
Financial liabilities
Long-term debt
(including current portion) ..... $5,577 $5,738 $5,927 $5,986
Convertible preferred securities ... $ - $ - $ 366 $ 479
-----------------------------------------------------------------------------
22 Other comprehensive income (loss)
A. Components of Other comprehensive income (loss) and the related tax effects
are as follows:
In millions Year ended December 31, 2002
---------------------------------------------------------------------------
Before Income tax Net of
tax (expense) tax
amount recovery amount
---------------------------------------------------------------------------
Unrealized foreign exchange gain on
translation of U.S. dollar denominated
long-term debt designated as a hedge
of the net investment in U.S. subsidiaries ... $ 51 $(17) $ 34
Unrealized foreign exchange loss
on translation of the net investment
in foreign operations ........................ (40) 13 (27)
Unrealized holding gain on fuel
derivative instruments (Note 21) ............. 68 (23) 45
Minimum pension liability
adjustment (Note 13) ......................... (20) 7 (13)
------------------------
Other comprehensive income....................... $ 59 $(20) $ 39
========================
In millions Year ended December 31, 2001
---------------------------------------------------------------------------
Before Income tax Net of
tax (expense) tax
amount recovery amount
---------------------------------------------------------------------------
Unrealized foreign exchange loss on
translation of U.S. dollar denominated
long-term debt designated as a hedge
of the net investment in U.S. subsidiaries ... $(202) $ 71 $(131)
Unrealized foreign exchange gain
on translation of the net investment
in foreign operations ........................ 308 (108) 200
Unrealized holding loss on investment in
360networks Inc. (Note 6) .................... (129) 35 (94)
Unrealized holding loss on fuel
derivative instruments (Note 21) ............. (38) 13 (25)
Minimum pension liability
adjustment (Note 13) ......................... (17) 6 (11)
Deferred income tax (DIT) rate enactment ........ - (32) (32)
------------------------
Other comprehensive loss......................... $ (78) $ (15) $ (93)
========================
U.S. GAAP
Canadian National Railway Company 71
Notes to Consolidated Financial Statements
22 Other comprehensive income (loss) (continued)
In millions Year ended December 31, 2000
--------------------------------------------------------------------------
Before Income tax Net of
tax (expense) tax
amount recovery amount
--------------------------------------------------------------------------
Unrealized foreign exchange loss on
translation of U.S. dollar denominated
long-term debt designated as a hedge
of the net investment in U.S. subsidiaries ... $ (91) $ 34 $ (57
Unrealized foreign exchange gain
on translation of the net investment
in U.S. subsidiaries ......................... 191 (71) 120
Unrealized holding gain on investment in
360networks Inc. (Note 6) .................... 129 (35) 94
------------------------
Other comprehensive income ...................... $ 229 $ (72) $ 157
========================
B. Changes in the balances of each classification within Accumulated other
comprehensive income (loss) are as follows:
In millions
------------------------------------------------------------------------------------------------------------------------------------
Foreign Holding
exchange - gain (loss) Holding gain Minimum Accumulated
Foreign Net investment on 360networks (loss) on fuel pension other
exchange - in foreign Inc. derivative liability DIT rate comprehensive
U.S. $ debt operations investment instruments adjustment enactment income (loss)
--------------------------------------------- ----------- ------------------------------------------------------------------------
Balance at January 1, 2000......... $ (33) $ 27 $ - $ - $ - $ - $ (6)
Period change ..................... (57) 120 94 - - - 157
-----------------------------------------------------------------------------------------------
Balance at December 31, 2000....... (90) 147 94 - - - 151
Period change ..................... (131) 200 (94) (25) (11) (32) (93)
-----------------------------------------------------------------------------------------------
Balance at December 31, 2001....... (221) 347 - (25) (11) (32) 58
Period change ..................... 34 (27) - 45 (13) - 39
-----------------------------------------------------------------------------------------------
Balance at December 31, 2002 ...... $ (187) $320 $ - $ 20 $(24) $(32) $ 97
===============================================================================================
23 Quarterly financial data - unaudited
In millions, except per share data
-----------------------------------------------------------------------------------------------------------------------------------
2002 2001
First Second Third Fourth (1) First Second Third Fourth
-------------------------------------------------------------------------------------
Revenues..................................... $1,509 $1,551 $1,503 $1,547 $1,398 $1,392 $1,325 $1,537
Operating income ............................ $ 406 $ 490 $ 484 $ 89 $ 385 $ 346 $ 430 $ 521
Net income .................................. $ 230 $ 280 $ 268 $ 22 $ 275 $ 217 $ 252 $ 296
Basic earnings per share..................... $ 1.19 $ 1.44 $ 1.34 $ 0.11 $ 1.44 $ 1.13 $ 1.31 $ 1.54
Diluted earnings per share .................. $ 1.15 $ 1.39 $ 1.32 $ 0.11 $ 1.39 $ 1.10 $ 1.27 $ 1.48
Dividend declared per share.................. $0.215 $0.215 $0.215 $0.215 $0.195 $0.195 $0.195 $0.195
=====================================================================================
(1) In the fourth quarter of 2002, the Company recorded a charge of $281
million ($173 million after tax) to increase its liability for U.S.
personal injury and other claims and a charge for workforce reductions of
$120 million ($79 million after tax).
24 Comparative figures
Certain figures, previously reported for 2001 and 2000, have been reclassified
to conform with the basis of presentation adopted in the current year.
U.S. GAAP
72 Canadian National Railway Company
Financial Section (Canadian GAAP)
Contents
Canadian National RailwayCompany The CNPension Plan and the CN 1935 Pension
Plan
----------------------------------------------------- ----------------------------------------------
74 Management's Discussion and Analysis 118 General Review
93 Management Report 119 Trustee's Report
93 Auditors' Report 120 Actuary's Report
94 Consolidated Statement of Income 120 Auditors' Report
95 Consolidated Balance Sheet 121 Consolidated Statement of Net Assets
96 Consolidated Statement of Changes in at Market Value
Shareholders' Equity 122 Consolidated Statement of Changes in
97 Consolidated Statement of Cash Flows Net Assets at Market Value
123 Notes to Consolidated Financial
Statements
Notes to Consolidated Financial Statements
----------------------------------------------------------------------------------------------------------------
98 1 Summary of significant accounting policies
100 2 Accounting changes
102 3 Acquisition of Wisconsin Central Transportation Corporation
102 4 Accounts receivable
103 5 Properties
103 6 Other assets and deferred charges
103 7 Credit facilities
104 8 Accounts payable and accrued charges
104 9 Other liabilities and deferred credits
105 10 Long-term debt
106 11 Capital stock and convertible preferred securities
106 12 Stock plans
108 13 Pensions
109 14 Workforce reduction charges
109 15 Interest expense
109 16 Other income
109 17 Income taxes
110 18 Segmented information
110 19 Earnings per share
111 20 Major commitments and contingencies
113 21 Financial instruments
114 22 Reconciliation of Canadian and United States generally accepted accounting principles
117 23 Quarterly financial data - unaudited
117 24 Comparative figures
Canadian GAAP
Canadian National Railway Company 73
Management's Discussion and Analysis
Management's discussion and analysis (MD&A) relates to the financial condition
and results of operations of Canadian National Railway Company (CN) together
with its wholly owned subsidiaries, including Grand Trunk Corporation (GTC),
Illinois Central Corporation (IC) and Wisconsin Central Transportation
Corporation (WC), the latter from October 9, 2001. As used herein, the word
"Company" means, as the context requires, CN and its subsidiaries. CN's common
shares are listed on the Toronto and New York stock exchanges. Except where
otherwise indicated, all financial information reflected herein is expressed in
Canadian dollars and determined on the basis of Canadian generally accepted
accounting principles (Canadian GAAP). This MD&A should be read in conjunction
with the Company's Consolidated Financial Statements and notes thereto.
Financial results
2002 compared to 2001
On October 9, 2001, the Company completed its acquisition of WC and began a
phased integration of the companies' operations. Accordingly, in the following
discussion, the Company's results include the results of operations of WC,
which were fully integrated into those of the Company in 2002.
The Company recorded consolidated net income of $571 million ($2.87 per
basic share) for the year ended December 31, 2002 compared to $727 million
($3.72 per basic share) for the year ended December 31, 2001. Diluted earnings
per share were $2.82 for the current year compared to $3.62 in 2001. Operating
income was $1,116 million for 2002 compared to $1,366 million in 2001.
The years ended December 31, 2002 and 2001 included items impacting the
comparability of the results of operations. Included in 2002 is a fourth
quarter charge of $281 million, or $173 million after tax, to increase the
Company's provision for U.S. personal injury and other claims, and a charge for
workforce reductions of $120 million, or $79 million after tax. In 2001, the
Company recorded a charge for workforce reductions of $98 million, or $62
million after tax, a charge to write down the Company's net investment in
360networks Inc. of $99 million, or $77 million after tax and a gain of $101
million, or $82 million after tax related to the sale of the Company's 50
percent interest in the Detroit River Tunnel Company (DRT).
Excluding the effects of the items discussed in the preceding paragraph,
adjusted consolidated net income(1) was $823 million ($4.15 per basic share or
$4.07 per diluted share) in 2002 compared to $784 million ($4.02 per basic
share or $3.90 per diluted share) in 2001, an increase of $39 million, or 5%.
Adjusted operating income,(1) which excludes the 2002 charge to increase the
Company's provision for U.S. personal injury and other claims and the 2002 and
2001 workforce reduction charges, increased by $53 million, or 4%, to $1,517
million. The adjusted operating ratio was 75.2% in 2002 compared to 74.1% in
2001, a 1.1-point increase.
(1) The Company's results of operations include items affecting the
comparability of results. Management believes adjusted consolidated net income
and the resulting adjusted performance measures for such items as operating
income, operating ratio, per share data and other statistical measures are
useful measures of performance that facilitate period-to-period comparisons.
These adjusted measures do not have any standardized meaning prescribed by GAAP
and are not necessarily comparable to similar measures presented by other
companies, and therefore, should not be considered in isolation.
Revenues
Revenues for the year ended December 31, 2002 totaled $6,110 million compared
to $5,652 million in 2001. The increase of $458 million, or 8%, was mainly due
to the inclusion of a full year of revenues attributable to the operations of
WC in 2002. In addition, revenue gains were made in petroleum and chemicals,
automotive, intermodal and forest products. These overall increases in revenues
were partly offset by continued weakness in Canadian grain, coal, and metals
and minerals. Revenue ton miles increased by 4% relative to 2001 and freight
revenue per revenue ton mile increased by 4%.
Year ended December 31, 2002 2001 2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------
Freight revenue
Revenues Revenue ton miles per revenue ton mile
-----------------------------------------------------------------------------------------------------
In millions In cents
-----------------------------------------------------------------------------------------------------
Petroleum and chemicals....$1,102 $ 923 30,006 25,243 3.67 3.66
Metals and minerals........ 521 458 13,505 10,777 3.86 4.25
Forest products ........... 1,323 1,088 33,551 29,639 3.94 3.67
Coal ...................... 326 338 14,503 15,566 2.25 2.17
Grain and fertilizers...... 986 1,161 35,773 42,728 2.76 2.72
Intermodal ................ 1,052 969 29,257 26,257 3.60 3.69
Automotive ................ 591 520 3,281 2,885 18.01 18.02
Other items*............... 209 195 - - - -
-------------------------------------------------------------------------
Total .....................$6,110 $5,652 159,876 153,095 3.69 3.56
-------------------------------------------------------------------------
* Principally non-freight revenues derived from third parties.
Canadian GAAP
74 Canadian National Railway Company
Management's Discussion and Analysis
Petroleum and chemicals
Revenues for the year ended December 31, 2002 increased by $179 million, or
19%, over 2001. Growth was mainly due to the inclusion of a full year of
revenues attributable to the operations of WC in 2002, strong sulfur traffic to
the United States and offshore markets and market share gains in various
sectors. The revenue per revenue ton mile remained relatively unchanged for the
year as the effect of the weaker Canadian dollar was offset by an increase in
the average length of haul for non-WC traffic.
[GRAPHIC OMITTED]
Metals and minerals
Revenues for the year ended December 31, 2002 increased by $63 million, or 14%,
over 2001. The increase was mainly due to the inclusion of a full year of
revenues attributable to the operations of WC in 2002, market share gains in
the non-ferrous segment, particularly aluminum, and strong construction
materials traffic. Partly offsetting these gains were the effects of weak steel
markets in the first half of the year, one-time gains in 2001 and reduced
traffic in specific segments due to ongoing customer strikes. Revenue per
revenue ton mile decreased by 9% over 2001 mainly due to an increase in longer
haul traffic and the inclusion of certain lower rated WC traffic.
[GRAPHIC OMITTED]
Forest products
Revenues for the year ended December 31, 2002 increased by $235 million, or
22%, over 2001. Growth was mainly due to the inclusion of a full year of
revenues attributable to the operations of WC in 2002, a strong North American
housing market and improving pulp and paper markets. Also contributing to
growth in the second half of the year were strong lumber shipments from CN's
western lumber producers. The increase in revenue per revenue ton mile of 7%
was mainly due to the effect of the weaker Canadian dollar and the inclusion of
shorter haul WC traffic.
[GRAPHIC OMITTED]
Coal
Revenues for the year ended December 31, 2002 decreased by $12 million, or 4%,
from 2001. The decrease was mainly attributable to weak Canadian coal exports
to offshore markets and reduced demand from power utilities in the first half
of the year. The revenue per revenue ton mile increase of 4% was mainly due to
a decrease in longer haul traffic.
[GRAPHIC OMITTED]
Canadian GAAP
Canadian National Railway Company 75
Management's Discussion and Analysis
Grain and fertilizers
Revenues for the year ended December 31, 2002 decreased by $175 million, or
15%, from 2001. The decrease reflects a significant deterioration in the
Canadian grain crop, a decline in U.S. originated traffic and the loss of a
potash move. Revenue per revenue ton mile increased by 1% mainly as a result of
an increase in regulated grain rates.
[GRAPHIC OMITTED]
Intermodal
Revenues for the year ended December 31, 2002 increased by $83 million, or 9%,
over 2001. Growth in the international segment was driven by market share gains
by steamship lines served by CN. The domestic segment benefited from growing
North American markets, particularly in Canada. Revenue per revenue ton mile
decreased by 2%, mainly due to a higher average fuel surcharge in 2001 and an
increase in the average length of haul.
[GRAPHIC OMITTED]
Automotive
Revenues for the year ended December 31, 2002 increased by $71 million, or 14%,
over 2001. The increase reflects strong motor vehicle production in both Canada
and the United States. Revenue per revenue ton mile remained relatively
unchanged for the year as the effect of the weaker Canadian dollar was offset
by an increase in the average length of haul.
[GRAPHIC OMITTED]
Canadian GAAP
76 Canadian National Railway Company
Management's Discussion and Analysis
Operating expenses
Operating expenses amounted to $4,994 million in 2002 compared to $4,286
million in 2001. The increase was mainly due to the inclusion of a full year of
expenses attributable to the operations of WC in 2002, higher Casualty and
other expenses resulting primarily from the 2002 charge to increase the
Company's provision for U.S. personal injury and other claims, and increased
expenses for labor and fringe benefits that included a higher workforce
reduction charge in 2002 compared to 2001. These increases were partly offset
by lower fuel costs. Operating expenses, excluding the 2002 charge for U.S.
personal injury and other claims and the 2002 and 2001 workforce reduction
charges, amounted to $4,593 million, an increase of $405 million, or 10%, from
2001.(1)
Dollars in millions Year ended December 31, 2002 2001
------------------------------------------------------------------------------------------------------------
% of % of
Amount revenue Amount revenue
------------------------------------------------------------------------------------------------------------
Labor and fringe benefits.................................. $2,051 33.6% $1,810 32.0%
Purchased services and material ........................... 908 14.9% 811 14.4%
Depreciation and amortization ............................. 499 8.1% 463 8.2%
Fuel ...................................................... 459 7.5% 485 8.6%
Equipment rents ........................................... 353 5.8% 314 5.5%
Casualty and other ........................................ 724 11.8% 403 7.1%
------------------------------------------------
Total...................................................... $4,994 $4,286
================================================
Labor and fringe benefits: Labor and fringe benefit expenses in 2002 increased
by $241 million, or 13%, as compared to 2001. The increase was mainly due to
the inclusion of a full year of expenses attributable to the operations of WC
in 2002, a higher workforce reduction charge in 2002, wage increases, and
higher benefit expenses, including health and welfare, particularly in the U.S.
These increases were partly offset by the effects of a reduced workforce in
2002.
In 2002, the Company announced 1,146 job reductions across all corporate
and operating functions in a renewed drive to improve productivity and recorded
a workforce reduction charge of $120 million. Reductions relating to this and
the 2001 workforce reduction charge were 388 in 2001, 433 in 2002, with the
remainder to be completed by the end of 2003. The charges included payments for
severance, early retirement incentives and bridging to early retirement, to be
made to affected employees.
Purchased services and material: These costs increased by $97 million, or 12%,
in 2002 as compared to 2001. The increase was mainly due to the inclusion of a
full year of expenses attributable to the operations of WC in 2002 and higher
expenses for professional services and joint facilities. These increases were
partly offset by reduced expenses for crew transportation and lodging in 2002.
Depreciation and amortization: Depreciation and amortization expense in 2002
increased by $36 million, or 8%, as compared to 2001. The increase was mainly
due to the inclusion of a full year of expenses attributable to the operations
of WC in 2002 and the impact of net capital additions in the current year.
Fuel: Fuel expense in 2002 decreased by $26 million, or 5%, as compared to
2001. The decrease was primarily due to a lower average price of fuel,
partially offset by the inclusion of a full year of expenses attributable to
the operations of WC in 2002.
Equipment rents: These expenses increased by $39 million, or 12%, in 2002 as
compared to 2001. The increase was mainly due to the inclusion of a full year
of expenses attributable to the operations of WC in 2002 and lower car hire
income, partly offset by reduced expenses for long-term operating leases.
Casualty and other: These expenses increased by $321 million, or 80%, in 2002
as compared to 2001. The increase was mainly due to higher expenses for
personal injury and other claims which included a fourth quarter 2002 charge of
$281 million to increase the provision for U.S. personal injury and other
claims, and higher derailment related expenses. Partly offsetting these
increases were lower expenses related to environmental matters and bad debts.
Canadian GAAP
Canadian National Railway Company 77
Management's Discussion and Analysis
Other
Interest expense: Interest expense increased by $41 million to $353 million for
the year ended December 31, 2002 as compared to 2001. The increase was mainly
due to the financing related to the acquisition of WC and the inclusion of a
full year of WC expenses in 2002. Partly offsetting these increases was the
maturity of certain notes in 2001.
Other income: In 2002, the Company recorded other income of $76 million
compared to $65 million in 2001. The increase was mainly due to the inclusion
of a full year of equity in earnings of English Welsh and Scottish Railway
(EWS) in 2002 partly offset by lower gains on disposal of properties. Included
in 2001 was a charge of $99 million to write down the Company's net investment
in 360networks Inc. and a gain of $101 million related to the sale of the
Company's 50 percent interest in DRT.
Income tax expense: The Company recorded income tax expense of $268 million for
the year ended December 31, 2002 compared to $392 million in 2001. The
effective tax rate for the year ended December 31, 2002 decreased to 31.9% from
35.0% in 2001, due mainly to lower income tax rates in Canada.
2001 compared to 2000
The Company recorded consolidated net income of $727 million ($3.72 per basic
share) for the year ended December 31, 2001 compared to $774 million ($3.91 per
basic share) for the year ended December 31, 2000. Diluted earnings per share
were $3.62 for 2001 compared to $3.82 in 2000. The results for 2001 include net
income of $11 million related to the acquisition of WC. Operating income was
$1,366 million for 2001 compared to $1,385 million in 2000. This represents a
decrease of $19 million, or 1%.
The years ended December 31, 2001 and 2000 included items impacting the
comparability of the results of operations. Included in 2001 is a charge for
workforce reductions of $98 million, or $62 million after tax, a charge to
write down the Company's net investment in 360networks Inc. of $99 million, or
$77 million after tax and a gain of $101 million, or $82 million after tax
related to the sale of the Company's 50 percent interest in DRT. In 2000, the
Company recorded a gain of $84 million, or $58 million after tax related to the
exchange of its minority equity investments in certain joint venture companies
for 11.4 million shares of 360networks Inc.
Excluding the effects of the items discussed in the preceding paragraph,
adjusted consolidated net income(1) was $784 million ($4.02 per basic share or
$3.90 per diluted share) in 2001 compared to $716 million ($3.61 per basic
share or $3.54 per diluted share) in 2000. Adjusted operating income,(1) which
excludes the 2001 charge for workforce reductions, increased by $79 million, or
6%, to $1,464 million. The adjusted operating ratio, which excludes the 2001
charge for workforce reductions, improved to 74.1% in 2001 from 74.6% in 2000,
a half-point betterment.
Revenues
Revenues for the year ended December 31, 2001 totaled $5,652 million compared
to $5,446 million in 2000. The increase of $206 million, or 4%, was mainly
attributable to the inclusion of $129 million of WC revenues and to gains in
metals and minerals, intermodal, forest products and grain and fertilizers.
This was partially offset by lower automotive revenues. Revenue ton miles and
freight revenue per revenue ton mile each increased by 2% as compared to 2000.
Year ended December 31, 2001 2000 2001 2000 2001 2000
---------------------------------------------------------------------------------------------------------
Freight revenue
Revenues Revenue ton miles per revenue ton mile
---------------------------------------------------------------------------------------------------------
In millions In cents
---------------------------------------------------------------------------------------------------------
Petroleum and chemicals........ $ 923 $ 894 25,243 24,858 3.66 3.60
Metals and minerals............ 458 392 10,777 9,207 4.25 4.26
Forest products ............... 1,088 1,008 29,639 28,741 3.67 3.51
Coal........................... 338 328 15,566 15,734 2.17 2.08
Grain and fertilizers.......... 1,161 1,136 42,728 42,396 2.72 2.68
Intermodal .................... 969 919 26,257 25,456 3.69 3.61
Automotive .................... 520 559 2,885 3,165 18.02 17.66
Other items*................... 195 210 - - - -
----------------------------------------------
Total .........................$5,652 $5,446 153,095 149,557 3.56 3.50
==============================================
* Principally non-freight revenues derived from third parties.
Canadian GAAP
78 Canadian National Railway Company
Management's Discussion and Analysis
Petroleum and chemicals
Revenues for the year ended December 31, 2001 increased by $29 million, or 3%,
over 2000 of which $22 million resulted from the inclusion of WC revenues.
Excluding WC, growth in 2001 was driven by market share gains and plant
expansions in the petroleum products sector, increased salt traffic, mainly in
the early part of the year, and the weaker Canadian dollar. Significant
weakness in sulfur demand partially offset these increases. The revenue per
revenue ton mile increase of 2% for 2001 was mainly attributable to the effect
of the weaker Canadian dollar.
Metals and minerals
Revenues for the year ended December 31, 2001 increased by $66 million, or 17%,
over 2000 of which $22 million resulted from the inclusion of WC revenues.
Excluding WC, growth in 2001 was driven by strong Canadian aluminum exports to
the United States in line with weaker U.S. production, increased levels of
equipment traffic, market share gains in steel, ores and concentrates, and
increased stone and rock shipments to the United States. Significant weakness
in the steel markets partially offset overall growth. Revenue per revenue ton
mile was essentially flat year over year.
Forest products
Revenues for the year ended December 31, 2001 increased by $80 million, or 8%,
over 2000 of which $55 million resulted from the inclusion of WC revenues.
Excluding WC, growth was driven by market share gains in the panels segment and
the effect of the weaker Canadian dollar. These gains were partially offset by
weakness in the pulp and paper markets due, in part, to a significant reduction
in U.S. paper consumption. The increase in revenue per revenue ton mile of 5%
was mainly due to the effect of the weaker Canadian dollar and the inclusion of
shorter haul WC traffic.
Coal
Revenues for the year ended December 31, 2001 increased by $10 million, or 3%,
over 2000 of which $7 million resulted from the inclusion of WC revenues.
Excluding WC, strong demand for thermal coal in 2001 was partially offset by
reduced shipments of metallurgical coal due to the closure of some Canadian
mines in 2000. The revenue per revenue ton mile increase of 4% was mainly due
to an increase in rates tied to commodity prices and the effect of the weaker
Canadian dollar.
Grain and fertilizers
Revenues for the year ended December 31, 2001 increased by $25 million, or 2%,
over 2000 of which $15 million resulted from the inclusion of WC revenues.
Excluding WC, growth was mainly driven by higher wheat shipments to the United
States, increased market share of U.S. corn and soybean traffic and higher
exports of canola through Vancouver. The 1% increase in revenue per revenue ton
mile was mainly due to a shift to shorter haul traffic and the effect of the
weaker Canadian dollar, partially offset by the introduction of the Canadian
grain revenue cap in August 2000.
Intermodal
Revenues for the year ended December 31, 2001 increased by $50 million, or 5%,
over 2000 of which $7 million resulted from the inclusion of WC revenues.
Excluding WC, growth was driven by market share gains in the international
segment and from new service offerings in the domestic segment. Weaker economic
conditions in the second half of 2001 led to slower growth. Revenue per revenue
ton mile increased by 2% due to rate increases and the effect of the weaker
Canadian dollar, partially offset by a shift to longer haul traffic.
Automotive
Revenues for the year ended December 31, 2001 decreased by $39 million, or 7%,
from 2000. The revenue decline resulted from weakness in North American vehicle
production in 2001 and from one-time gains obtained in 2000 due, in part, to
competitors' service problems. The decline was partially offset by the effect
of the weaker Canadian dollar. The increase in revenue per revenue ton mile of
2% was mainly due to the weaker Canadian dollar partially offset by an increase
in the average length of haul.
Canadian GAAP
Canadian National Railway Company 79
Management's Discussion and Analysis
Operating expenses
Operating expenses amounted to $4,286 million in 2001 compared to $4,061
million in 2000. The increase in 2001 was mainly due to the inclusion of $95
million of WC expenses, higher labor and fringe benefit expenses that included
a charge for workforce reductions of $98 million, increased depreciation and
amortization expense, higher fuel costs, and increased expenses for equipment
rents and casualty and other. Partially offsetting these increases were lower
expenses for purchased services and material. Operating expenses, excluding the
workforce reduction charge, amounted to $4,188 million, an increase of $127
million, or 3%, from 2000.(1)
Dollars in millions Year ended December 31, 2001 2000
---------------------------------------------------------------------------------------------------------
% of % of
Amount revenue Amount revenue
---------------------------------------------------------------------------------------------------------
Labor and fringe benefits.............................. $1,810 32.0% $1,674 30.7%
Purchased services and material ....................... 811 14.4% 858 15.8%
Depreciation and amortization ......................... 463 8.2% 412 7.6%
Fuel .................................................. 485 8.6% 450 8.3%
Equipment rents ....................................... 314 5.5% 291 5.3%
Casualty and other .................................... 403 7.1% 376 6.9%
------------------------------------------------
Total ................................................. $4,286 $4,061
================================================
Labor and fringe benefits: Labor and fringe benefit expenses in 2001 increased
by $136 million, or 8%, as compared to 2000. The increase was mainly
attributable to the workforce reduction charge, the inclusion of WC labor
expense of $46 million, wage increases and the impact of the weaker Canadian
dollar on U.S. denominated expenses. This was partially offset by lower pension
and other benefit related expenses.
The Company recorded a workforce reduction charge of $98 million in the
second quarter of 2001 for the reduction of 690 positions (388 occurred in 2001
and the remainder was completed by the end of 2002). The charge included
payments for severance, early retirement incentives and bridging to early
retirement, to be made to affected employees.
Purchased services and material: These expenses decreased by $47 million, or
5%, in 2001 as compared to 2000. The decrease was mainly due to one-time
consulting and professional fees related to a proposed combination in 2000,
lower contracted services and higher recoveries in 2001 from work performed for
third parties. This was partially offset by higher equipment repair and
maintenance expenses and $15 million resulting from the inclusion of WC
expenses.
Depreciation and amortization: Depreciation and amortization expense in 2001
increased by $51 million, or 12%, as compared to 2000. The increase was mainly
due to net capital additions and the inclusion of WC depreciation of $10
million.
Fuel: Fuel expense in 2001 increased by $35 million, or 8%, as compared to
2000, primarily due to an increase in the average cost of fuel and the
inclusion of $10 million of WC fuel expense.
Equipment rents: These expenses increased by $23 million, or 8%, in 2001 as
compared to 2000. The increase was mainly attributable to lower lease and
offline car hire income and the inclusion of $6 million of WC equipment rents.
This was partially offset by lower private car mileage payments.
Casualty and other: These expenses increased by $27 million, or 7%, in 2001 as
compared to 2000. The increase resulted from higher expenses for occupational
disease claims and environmental matters, higher provincial capital taxes and
the inclusion of $8 million of WC expenses. This was partially offset by lower
expenses for damaged equipment and merchandise claims and provincial sales tax
recoveries in 2001.
Canadian GAAP
80 Canadian National Railway Company
Management's Discussion and Analysis
Other
Interest expense: Interest expense increased by $17 million to $312 million for
the year ended December 31, 2001 as compared to 2000. The increase was mainly
due to the financing related to the acquisition of WC, the inclusion of $4
million of WC interest expense, and the impact of the weaker Canadian dollar on
U.S. denominated interest costs. This was, in part, offset by the refinancing
of a portion of matured debt at lower rates.
Other income: In 2001, the Company recorded other income of $65 million
compared to $126 million in 2000. Included in 2001 is a charge of $99 million
to write down the Company's net investment in 360networks Inc., a gain of $101
million related to the sale of the Company's 50 percent interest in DRT and $11
million of WC other income. The comparative 2000 period included an $84 million
gain related to the 360networks Inc. transaction.
Income tax expense: The Company recorded an income tax expense of $392 million
for the year ended December 31, 2001 compared to $442 million in 2000. The
effective tax rate for the year ended December 31, 2001 decreased to 35.0% from
36.3% in 2000 due mainly to lower tax rates in 2001.
Liquidity and capital resources
The Company's principal source of liquidity is cash generated from operations.
The Company also has the ability to fund liquidity requirements through its
revolving credit facility, the issuance of debt and/or equity, and the sale of
a portion of its accounts receivable through its Accounts receivable
securitization program. In addition, from time to time, the Company's liquidity
requirements can be supplemented by the disposal of surplus properties and the
monetization of assets.
Operating activities: Cash provided from operating activities was $1,173
million for the year ended December 31, 2002 compared to $1,232 million for
2001. Cash generated in 2002 was partially consumed by payments for interest,
workforce reductions and personal injury and other claims of $390 million, $177
million and $156 million, respectively, compared to $307 million, $169 million
and $149 million, respectively in 2001. Pension contributions and payments for
income taxes were $92 million and $65 million, respectively, compared to $69
million and $63 million, respectively in 2001. The Company increased the level
of accounts receivable sold under its Accounts receivable securitization
program by $5 million in 2002 and $133 million in 2001. Payments in 2003 for
workforce reductions are expected to be $168 million while pension
contributions are expected to be approximately $92 million.
Investing activities: Cash used by investing activities in 2002 amounted to
$476 million compared to $1,764 million in 2001. The Company's investing
activities in 2002 included aggregate net proceeds of $69 million from the sale
of its investments in Tranz Rail Holdings Limited and Australian Transport
Network Limited, and $28 million from the sale of IC Terminal Holdings Company.
Investing activities in 2001 included $1,278 million related to the acquisition
of WC as at October 9, 2001 and net proceeds of $112 million from the sale of
DRT. Net capital expenditures for the year ended December 31, 2002 amounted to
$571 million, including $27 million related to WC, a decrease of $34 million
over 2001. Net capital expenditures included expenditures for roadway renewal,
rolling stock, and other capacity and productivity improvements.
The Company anticipates that capital expenditures for 2003 will remain at
approximately the same level as 2002. This will include funds required for
ongoing renewal of the basic plant and other acquisitions and investments
required to improve the Companyoperating efficiency and customer service.
As at December 31, 2002, the Company had commitments to acquire railroad
ties, rail, freight cars and locomotives at an aggregate cost of $183 million.
Dividends: During 2002, the Company paid dividends totaling $179 million to its
shareholders at the quarterly rate of $0.215 per share on the common shares and
5.25% per year on the convertible preferred securities.
Free cash flow
The Company generated $513 million of free cash flow for the year ended
December 31, 2002, compared to $439 million for the same 2001 period, excluding
$1,278 million related to the 2001 acquisition of WC. The Company defines free
cash flow as cash provided from operating activities, excluding increases in
the level of accounts receivable sold under the securitization program ($5
million in 2002, $133 million in 2001), less capital expenditures, other
investing activities and dividends paid.
Financing activities: Cash used by financing activities totaled $546 million
for the year ended December 31, 2002 compared to cash generated of $740 million
in 2001. In 2002, issuances and repayments of long-term debt related
principally to the Company's commercial paper and revolving credit facilities.
In 2001, the Company issued debt securities in two series, U.S.$400 million
(Cdn$629 million) 6.375% Notes due 2011 and U.S.$200 million (Cdn$314 million)
7.375% Debentures due 2031, related to the acquisition of WC.
In 2002, $203 million was used to repurchase common shares under the share
repurchase program. In 2001, the Company also had a share repurchase program,
under which it did not repurchase any common shares.
Canadian GAAP
Canadian National Railway Company 81
Management's Discussion and Analysis
During 2002, the Company recorded $114 million in capital lease
obligations ($91 million in 2001) related to new equipment and the exercise of
purchase options on existing equipment.
The Company has access to various financing arrangements:
Revolving credit facilities
In December 2002, the Company entered into a U.S.$1,000 million three-year
revolving credit facility and concurrently terminated its previous revolving
credit facilities before their scheduled maturity in March 2003. The credit
facility provides for borrowings at various interest rates, plus applicable
margins, and contains customary financial covenants. Throughout the year, the
Company was in compliance with all financial covenants contained in its
outstanding revolving credit agreements. The Company's borrowings of U.S.$172
million (Cdn$273 million) outstanding at December 31, 2001 were entirely repaid
in the first quarter of 2002. At December 31, 2002, the Company had borrowings
under its revolving credit facility of U.S.$90 million (Cdn$142 million) at an
average interest rate of 1.77%. Outstanding letters of credit under the
previous facilities were transferred into the current facility. As at December
31, 2002, letters of credit under the revolving credit facility amounted to
$295 million.
Commercial paper
The Company has a commercial paper program, which is backed by a portion of its
revolving credit facility, enabling it to issue commercial paper up to a
maximum aggregate principal amount of $600 million, or the U.S. dollar
equivalent. Commercial paper debt is due within one year but has been
classified as long-term debt, reflecting the Company's intent and contractual
ability to refinance the short-term borrowing through subsequent issuances of
commercial paper or drawing down on the long-term revolving credit facility. As
at December 31, 2002, the Company had outstanding commercial paper of U.S.$136
million (Cdn$214 million) compared to U.S.$213 million (Cdn$339 million) as at
December 31, 2001.
Shelf registration statement
At December 31, 2002, the Company had U.S.$400 million remaining for issuance
under its shelf registration statement, which expires in August 2003.
Accounts receivable securitization program
The sale of a portion of the Company's accounts receivable is conducted under a
securitization program, which has a $350 million maximum limit and will expire
in June 2003. The program is subject to customary credit rating and reporting
requirements. In the event the program is terminated before its scheduled
maturity, the Company expects to have sufficient liquidity remaining in its
revolving credit facility to meet its payment obligations. The Company intends
to renew or replace the program upon expiration. At December 31, 2002, pursuant
to the agreement, $173 million and U.S.$113 million (Cdn$177 million) had been
sold on a limited recourse basis, an increase of $5 million from the level of
accounts receivable sold at December 31, 2001.
The Receivables Purchase Agreement provides for customary indemnification
provisions, which survive for a period of two years following the final
purchase of any receivable, three years from the final collection date or until
statute barred, in the case of taxes. As at December 31, 2002, the Company has
not recorded a liability associated with these indemnifications, for which
there is no monetary limitation, as the Company does not expect to make any
payments pertaining to the indemnifications of this program. Although there is
no monetary limitation with respect to these indemnifications, the Company
would not expect the amount to exceed the maximum limit under the program.
Canadian GAAP
82 Canadian National Railway Company
Management's Discussion and Analysis
Contractual obligations and commercial commitments
In the normal course of business, the Company incurs contractual obligations
and commercial commitments. The following tables set forth material obligations
and commitments as of December 31, 2002:
Contractual obligations
2008 and
In millions Total 2003 2004 2005 2006 2007 thereafter
---------------------------------------------------------------------------------------------------------------------------------
Debentures and notes........................$4,167 $394 $419 $158 $394 $ 79 $2,723
Capital leases and other(a)................. 1,424 180 141 444 46 90 523
-------------------------------------------------------------------------------------
Long-term debt.............................. 5,591 574 560 602 440 169 3,246
Operating leases............................ 1,154 212 188 167 139 120 328
-------------------------------------------------------------------------------------
Total obligations ..........................$6,745 $786 $748 $769 $579 $289 $3,574
=====================================================================================
Commercial commitments
2008 and
In millions Total 2003 2004 2005 2006 2007 thereafter
---------------------------------------------------------------------------------------------------------------------------------
Standby letters of credit................... $403 $401 $ 1 $- $1 $- $-
Other commercial commitments(b)............. 183 112 71 - - - -
-------------------------------------------------------------------------------------
Total commitments .......................... $586 $513 $72 $- $1 $- $-
=====================================================================================
(a) Excludes $498 million of imputed interest on capital leases at rates
ranging from approximately 3.0% to 14.6%.
(b) Includes commitments for railroad ties, rail, freight cars and
locomotives.
For 2003 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 o bligations, and to fund anticipated capital
expenditures.
Guarantees
Guarantee of residual values of operating leases
The Company has guaranteed a portion of the residual values of certain of its
assets under operating leases with expiry dates between 2004 and 2012, for the
benefit of the lessor. If the fair value of the assets, at the end of their
respective lease term, is less than the fair value, as estimated at the
inception of the lease, then the Company must, under certain conditions,
compensate the lessor for the shortfall. The maximum exposure in respect of
these guarantees is $63 million. As at December 31, 2002, the Company has not
recorded a liability associated with these guarantees, as the Company does not
expect to make any payments pertaining to the guarantees of these leases.
Standby letters of credit
The Company, including certain of its subsidiaries, has granted irrevocable
standby letters of credit, issued by highly rated banks, to third parties to
indemnify them in the event the Company does not perform its contractual
obligations. As at December 31, 2002, the maximum potential liability under
these letters of credit was $403 million of which $334 million was for workers'
compensation and other employee benefits and $69 million was for equipment
under leases and other.
As at December 31, 2002, the Company has not recorded a liability with
respect to these guarantees, as the Company does not expect to make any
payments in excess of what is recorded on the Company's financial statements
for the aforementioned items. The standby letters of credit mature at various
dates between 2003 and 2007.
Indemnifications
CN Pension Plan and CN 1935 Pension Plan
The Company has indemnified and held harmless the current trustee and the
former trustee of the Canadian National Railways Pension Trust Funds, and the
respective officers, directors, employees and agents of such trustees, from any
and all taxes, claims, liabilities, damages, costs and expenses arising out of
the performance of their obligations under the relevant trust agreements and
trust deeds, including in respect of their reliance on authorized instructions
of the Company or for failing to act in the absence of authorized instructions.
These indemnifications survive the termination of such agreements or trust
deeds. As at December 31, 2002, the Company has not recorded a liability
associated with these indem-nifications, as the Company does not expect to make
any payments pertaining to these indemnifications.
Canadian GAAP
Canadian National Railway Company 83
Management's Discussion and Analysis
Share repurchase program
On October 22, 2002, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 13.0 million common
shares between October 25, 2002 and October 24, 2003 pursuant to a normal
course issuer bid, at prevailing market prices. As at December 31, 2002, $203
million was used to repurchase 3.0 million common shares at an average price of
$67.68 per share.
Termination of conversion rights of
5.25% convertible preferred securities ("Securities")
On May 6, 2002, the Company met the conditions required to terminate the
Securities holders' right to convert their Securities into common shares of the
Company, and set the conversion termination date as July 3, 2002. The
conditions were met when the Company's common share price exceeded 120% of the
conversion price of U.S.$38.48 per share for a specified period, and all
accrued interest on the Securities had been paid. On July 3, 2002, Securities
that had not been previously surrendered for conversion were deemed converted,
resulting in the issuance of 6.0 million common shares of the Company.
Acquisition of Wisconsin Central Transportation Corporation
On October 9, 2001, the Company completed its acquisition of WC for an
acquisition cost of $1,301 million (U.S.$833 million) and began a phased
integration of the companies' operations.
The Company accounted for the merger using the purchase method of
accounting as required by the Canadian Institute of Chartered Accountants
(CICA) Handbook Section 1581 "Business Combinations." As such, the Company's
consolidated financial statements include the assets, liabilities and results
of operations of WC as of October 9, 2001, the date of acquisition. The Company
had estimated, on a preliminary basis, the fair values of the assets and
liabilities acquired based on currently available information. In 2002, the
Company finalized the allocation of the purchase price and adjusted the
preliminary fair values of the assets and liabilities acquired as follows:
Current assets decreased by $10 million, Properties increased by $141 million,
Other assets and deferred charges decreased by $98 million, Current liabilities
increased by $10 million, Deferred income taxes increased by $16 million and
Other liabilities and deferred credits increased by $3 million. The increase in
Properties and decrease in Other assets and deferred charges was mainly due to
the final valuation of the Company's foreign equity investment. The remaining
adjustments resulted from additional information obtained for conditions and
circumstances that existed at the time of acquisition. The following table
outlines the final fair values of WC's assets and liabilities acquired:
In millions
----------------------------------------------------------------
Current assets ..........................................$ 165
Properties .............................................. 2,576
Other assets and deferred charges........................ 335
------
Total assets acquired.................................... 3,076
------
Current liabilities ..................................... 363
Deferred income taxes ................................... 759
Other liabilities and deferred credits .................. 181
Long-term debt........................................... 472
------
Total liabilities assumed................................ 1,775
------
Net assets acquired .....................................$1,301
======
Recent accounting pronouncements
In December 2002, the CICA issued Handbook Section 3063 "Impairment of
Long-Lived Assets." Section 3063 provides accounting guidance for the
determination of a long-lived asset impairment as well as recognition,
measurement and disclosure of the impairment. This section is effective for the
Company's fiscal year beginning January 1, 2004. The Company does not expect
Section 3063 to have an initial material impact on its financial statements
upon adoption.
Also in December 2002, the CICA issued Handbook Section 3475 "Disposal of
Long-Lived Assets and Discontinued Operations." Section 3475 provides
accounting guidance for long-lived assets to be disposed of other than by sale,
long-lived assets to be disposed of by sale and presentation and disclosure for
discontinued operations. This section is effective for disposal activities
initiated by the Company on or after May 1, 2003. The Company does not expect
Section 3475 to have an initial material impact on its financial statements
upon adoption.
Canadian GAAP
84 Canadian National Railway Company
Management's Discussion and Analysis
Critical accounting policies
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of revenues and expenses during the period,
the reported amounts of assets and liabilities, and the disclosure of
contingent assets and liabilities at the date of the financial statements. On
an ongoing basis, management reviews its estimates, including those related to
personal injury and other claims, environmental matters, depreciation lives,
pensions and other post-retirement benefits, and income taxes, based upon
currently available information. Actual results could differ from these
estimates. The following accounting policies require management's more
significant judgments and estimates in the preparation of the Company's
consolidated financial statements and as such, are considered to be critical.
The following infor mation should be read in conjunction with the Company's
Consolidated Financial Statements and notes thereto.
Management has discussed the development and selection of the Company's
critical accounting estimates with the Audit, Finance and Risk Committee of the
Company's Board of Directors and the Audit, Finance and Risk Committee has
reviewed the Company's related disclosures herein.
Personal injury and other claims
In the normal course of its operations, the Company becomes involved in various
legal actions, including claims relating to personal injuries, occupational
disease and damage to property.
In Canada, employee injuries are governed by the workers' compensation
legislation in each province whereby employees may be awarded either a lump sum
or future stream of payments depending on the nature and severity of the
injury. Accordingly, the Company accounts for costs related to employee
work-related injuries based on actuarially developed estimates of the ultimate
cost associated with such injuries, including compensation, health care and
administration costs. For all other legal actions, the Company maintains, and
regularly updates on a case-by-case basis, provisions for such items when the
expected loss is both probable and can be reasonably estimated based on
currently available information.
Assumptions used in estimating the ultimate costs for Canadian employee
injury claims consider, among others, the discount rate, the rate of inflation,
wage increases and health care costs. The Company periodically reviews its
assumptions to reflect currently available information. Over the past three
years, the Company has changed certain of these assumptions, which have not had
a material effect on its results of operations. For all other legal claims in
Canada, estimates are based on case history, trends and judgment.
In the United States, employee work-related injuries, including
occupational disease claims, are compensated according to the provisions of the
Federal Employers' Liability Act (FELA) and represent a major expense for the
railroad industry. The FELA system, which requires either the finding of fault
through the U.S. jury system or individual settlements, has contributed to the
significant increase in the Company's personal injury expense in recent years.
In view of the Company's growing presence in the United States and the increase
in the number of occupational disease claims over the past few years, an
actuarial study was conducted in 2002, and in the fourth quarter of 2002 the
Company changed its methodology for estimating its liability for U.S. personal
injury and other claims, including occupational disease claims and claims for
property damage, from a case-by-case approach to an actuarial-based approach.
Consequently, and as discussed in Note 2 to the Consolidated Financial
Statements, the Company recorded a charge of $281 million ($173 million after
tax) to increase its provision for these claims.
Under the actuarial-based approach, the Company accrues the cost for the
expected personal injury and property damage claims and existing occupational
disease claims, based on actuarial estimates of their ultimate cost. The
Company is unable to estimate the total cost for unasserted occupational
disease claims. However, a liability for unasserted occupational disease claims
is accrued to the extent they are probable and can be reasonably estimated.
Under the case-by-case approach, the Company was accruing the cost for
claims as incidents were reported based on currently available information. In
addition, the Company did not record a liability for unasserted claims, as such
amounts could not be reasonably estimated under the case-by-case approach.
For the U.S. personal injury and other claims liability, historical claim
data is used to formulate assumptions relating to the expected number of claims
and average cost per claim (severity) for each year. Changes in any one of
these assumptions could materially affect Casualty and other expense as
reported in the Company's results of operations. For example, a 5% change in
the number of claims or severity would have the effect of changing the
provision by approximately $25 million and the annual expense by approximately
$5 million.
The Company's expenses for personal injury and other claims, net of
recoveries, and including the above-mentioned charge, were $393 million in 2002
($78 million in 2001 and $60 million in 2000) and payments for such items were
$156 million in 2002 ($149 million in 2001 and $111 million in 2000). As at
December 31, 2002, the Company had aggregate reserves for personal injury and
other claims of $664 million ($430 million at December 31, 2001).
Canadian GAAP
Canadian National Railway Company 85
Management's Discussion and Analysis
Environmental matters
Regulatory compliance
A risk of environmental liability is inherent in railroad and related
transportation operations; real estate ownership, operation or control; and
other commercial activities of the Company with respect to both current and
past operations. As a result, the Company incurs significant compliance and
capital costs, on an ongoing basis, associated with environmental regulatory
compliance and clean-up requirements in its railroad operations and relating to
its past and present ownership, operation or control of real property.
Environmental expenditures that relate to current operations are expensed
unless they relate to an improvement to the property. Expenditures that relate
to an existing condition caused by past operations and which are not expected
to contribute to current or future operations are expensed.
Known existing environmental concerns
The ultimate cost of known contaminated sites cannot be definitely established,
and the estimated environmental liability for any given site may vary depending
on the nature and extent of the contamination, the available clean-up
technique, the Company's share of the costs and evolving regulatory standards
governing environmental liability. As a result, liabilities are recorded based
on the results of a four-phase environmental assessment conducted on a
site-by-site basis. A liability is initially recorded at the completion of the
second phase and adjusted, if necessary, upon completion of the third and/or
fourth phase depending on the facts, as they become known.
The initial phase entails an overview of the pertinent site and includes
obtaining and reviewing historical data. At the end of the second phase, the
presence or absence of contamination is confirmed for those sites identified as
a concern in the initial phase. Upon completion of phase three, the extent of
the contamination is determined and if necessary, options are developed to
monitor, contain or remediate the contamination. In the final phase, the
remediation or containment program is put in operation.
Cost scenarios are established by external consultants based on extent of
contamination and expected costs for remedial efforts. The Company uses these
scenarios to estimate the costs related to a particular site. At December 31,
2002, most of the Company's properties not acquired through recent acquisitions
are approaching phase four and therefore costs related to such sites may change
based on information as it becomes available. For properties acquired through
recent acquisitions, the Company obtained assessments from both external and
internal consultants and a liability has been accrued based on such
assessments. These estimates may change based on information as it becomes
available.
Unknown existing environmental concerns
The Company's ongoing efforts to identify potential environmental concerns that
may be associated with its properties may lead to future environmental
investigations, which may result in the identification of additional
environmental costs and liabilities. The magnitude of such additional
liabilities and costs cannot be reasonably estimated due to:
(i) the lack of specific technical information available with respect to
many sites;
(ii) the absence of any government authority, third-party orders, or claims
with respect to particular sites;
(iii) the potential for new or changed laws and regulations and for
development of new remediation technologies and uncertainty regarding
the timing of the work with respect to particular sites;
(iv) the ability to recover costs from any third parties with respect to
particular sites;
and as such, costs related to future remediation will be accrued in the year
they become known.
Future occurrences
In the operation of a railroad, it is possible that derailments, explosions or
other accidents may occur that could cause harm to human health or to the
environment. As a result, the Company may incur costs in the future, which may
be material, to address any such harm, including costs relating to the
performance of clean-ups, natural resource damages and compensatory or punitive
damages relating to harm to individuals or property.
The Company's expenses relating to environmental matters, net of recoveries,
have not been significant in the past three years. Payments for such items were
$16 million in 2002 ($14 million in 2001 and $11 million in 2000). As at
December 31, 2002, the Company had aggregate accruals for environmental costs
of $106 million ($112 million at December 31, 2001). The Company anticipates
that the majority of the liability will be paid out over the next five years.
Canadian GAAP
86 Canadian National Railway Company
Management's Discussion and Analysis
Depreciation lives
Railroad properties are carried at cost less accumulated depreciation including
asset impairment write-downs. The Company follows the group method of
depreciation and, as such, depreciates the cost of railroad properties, less
net salvage value, on a straight-line basis over their estimated useful lives.
In addition, under the group method of depreciation, the cost of railroad
properties, less net salvage value, retired or disposed of in the normal course
of business, is charged to accumulated depreciation.
Assessing the reasonableness of the estimated useful lives of properties
requires judgment and is based on currently available information, including
periodic depreciation studies conducted by the Company. The Company's U.S.
properties are subject to comprehensive depreciation studies conducted by
external consultants as required by the Surface Transportation Board (STB).
Depreciation studies for Canadian properties are not required by regulation and
are therefore conducted internally. Studies are performed on specific asset
groups on a periodic basis. The studies consider, among others, the analysis of
historical retirement data using recognized life analysis techniques, and the
forecasting of asset life characteristics. Changes in circumstances, such as
technological advances, changes to the Company's business strategy, changes in
the Company's capital strategy or changes in regulations can result in the
actual useful lives differing from the Company's estimates.
A change in the remaining useful life of a group of assets, or their
estimated net salvage, will affect the depreciation rate used to amortize the
group of assets and thus affect depreciation expense as reported in the
Company's results of operations. A change of one year in the composite useful
life of the Company's fixed asset base would impact annual depreciation expense
by approximately $12 million.
Depreciation studies are a means of ensuring that the assumptions used to
estimate the useful lives of particular asset groups are still valid and where
they are not, they serve as the basis to establish the new depreciation rates
to be used on a prospective basis. In 2001, the Company conducted a
comprehensive study for its Canadian properties, which did not have an impact
on depreciation expense as the benefit of increased lives was offset by
deficiencies in certain accumulated depreciation balances. The study conducted
in 2000 for the Company's U.S. properties did not have an impact on
depreciation expense.
In 2002, the Company recorded total depreciation and amortization expense
of $506 million ($469 million in 2001 and $421 million in 2000). At December
31, 2002, the Company had Properties of $16,898 million, net of accumulated
depreciation of $6,285 million ($16,723 million in 2001, net of accumulated
depreciation of $6,070 million).
Pensions and other post-retirement benefits
The Company accounts for pension and other post-retirement benefits as required
by CICA Handbook Section 3461 "Employee Future Benefits." Under this accounting
standard, assumptions are made regarding the valuation of benefit obligations
and performance of plan assets. Deferred recognition of differences between
actual results and those assumed is a guiding principle of these standards.
This approach allows for a gradual recognition of changes in benefit
obligations and plan performance over the expected average remaining service
life of the employee group covered by the plans. The following description
pertaining to pensions relate generally to the Company's main pension plan, the
CN Pension Plan. The Company's other pension plans are not significant.
For pensions, an actuarial valuation is required at least on a triennial
basis. However, for the last 15 years, the Company has conducted an annual
actuarial valuation to account for pensions, which uses management assumptions
for the discount rate, the expected long-term rate of return on plan assets and
the rate of compensation increase. The Canadian plans have a measurement date
of December 31 whereas the U.S. plans have a measurement date of September 30.
For pensions and other post-retirement benefits, assumptions are required for,
among others, the discount rate, the expected long-term rate of return on plan
assets, the rate of compensation increase, health care cost trend rates,
mortality rates, employee early retirements, terminations or disability.
Changes in these assumptions result in actuarial gains or losses which in
accordance with Section 3461, the Company has elected to amortize over the
expected average remaining service life of the employee group covered by the
plans only to the extent that the unrecognized net actuarial gains and losses
are in excess of 10% of the greater of the beginning of year balances of the
projected benefit obligation or market-related value of plan assets. The future
effect on the Company's results of operations is dependent on economic
conditions, employee demographics, mortality rates and investment performance.
The Company sets its discount rate assumption annually to reflect the
rates available on high-quality, fixed-income debt instruments with a duration
of approximately 11 years, which is expected to match the timing and amount of
expected benefit payments. High quality debt instruments are corporate bonds
with a rating of AA or better. A discount rate of 6.5%, based on bond yields
prevailing at December 31, 2002, was considered appropriate by the Company and
is supported by reports issued by third party advisors. A one-percentage-point
change in the discount rate would not cause a material change in the Company's
net periodic benefit cost.
Canadian GAAP
Canadian National Railway Company 87
Management's Discussion and Analysis
To develop its expected long-term rate of return assumption used in the
calculation of net periodic benefit cost applicable to the market-related value
of assets, the Company considers both its past experience and future estimates
of long-term investment returns and the expected composition of the plans'
assets. The Company has elected to use a market-related value of assets,
whereby realized and unrealized capital gains and losses are recognized over a
period of five years, while investment and dividend income are recognized
immediately. The Company follows a disciplined investment strategy, which
limits investments in international companies and prohibits investments in
speculative type assets and as such, the Company does not anticipate the
expected average rate of return on plan assets to fluctuate materially when
compared to major capital market indices. During the last ten years ended
December 31, 2002, the CN Pension Plan earned an annual average rate of return
of 9.6%. The actual and market-related value rates of return on plan assets for
the last five years were as follows:
Rates of return 2002 2001 2000 1999 1998
-----------------------------------------------------------------
Actual................ (0.3)% (1.4)% 10.5% 15.0% 12.6%
Market-related value.. 7.4 % 10.2% 13.7% 13.8% 10.4%
========================================
For that same period, the Company used a long-term rate of return assumption on
the market-related value of plan assets not exceeding 9% to compute net
periodic benefit cost. However, given the recent performance of its plan assets
and the equity markets in North America, the Company will, effective for 2003,
reduce the expected long-term rate of return on plan assets from 9% to 8% to
reflect management's current view of long-term investment returns. The effect
of this change in management's assumption will be to increase net periodic
benefit cost in 2003 by approximately $50 million.
Based on the fair value of the assets held as at December 31, 2002, the
plan assets are comprised of 1% in cash and short-term investments, 40% in
bonds and mortgages, 50% in Canadian and foreign equities and 9% in real estate
and oil and gas assets. The long-term asset allocation percentages are not
expected to differ materially from the current composition.
The rate of compensation increase of 4% is another significant assumption
in the actuarial model for pension accounting and is determined by the Company
based upon its long-term plans for such increases. For other post-retirement
benefits, the Company reviews external data and its own historical trends for
health care costs to determine the health care cost trend rates. For
measurement purposes, the projected health care cost trend rate was 18% in the
current year, and it is assumed that the rate will decrease gradually to 8% in
2012 and remain at that level thereafter. A one-percentage-point change in
either the rate of compensation increase or the health care cost trend rate
would not cause a material change to the Company's net periodic benefit cost
for both pensions and other post-retirement benefits.
The latest actuarial valuation of the CN Pension Plan was conducted as at
December 31, 2001 and indicated a funding excess. Based on the Pension Plan's
current position, the Company's contributions are expected to be approximately
$75 million in each of 2003, 2004 and 2005. The assumptions discussed above are
not expected to have a significant impact on the cash funding requirements of
the pension plan in 2003.
For pensions, the Company recorded consolidated net periodic benefit
income of $20 million and $13 million in 2002 and 2001, respectively, and net
periodic benefit cost of $6 million in 2000. Consolidated net periodic benefit
cost for other post-retirement benefits was $45 million, $35 million, and $25
million in 2002, 2001, and 2000, respectively. At December 31, 2002, the
Company's accrued benefit cost for post-retirement benefits other than pensions
was $284 million ($258 million at December 31, 2001). In addition, at December
31, 2002, the Company's consolidated pension benefit obligation and accumulated
post-retirement benefit obligation were $11,243 million and $444 million,
respectively ($11,156 million and $309 million at December 31, 2001).
Canadian GAAP
88 Canadian National Railway Company
Management's Discussion and Analysis
Income taxes
The Company follows the asset and liability method of accounting for income
taxes. Under the asset and liability method, the change in the net deferred
income tax asset or liability is included in the computation of net income.
Deferred income tax assets and liabilities are measured using substantively
enacted income tax rates expected to apply to taxable income in the years in
which temporary differences are expected to be recovered or settled. As a
result, a projection of taxable income is required for those years, as well as
an assumption of the ultimate recovery/settlement period for temporary
differences. The projection of future taxable income is based on management's
best estimate and may vary from actual taxable income. On an annual basis, the
Company assesses its need to establish a valuation allowance for its deferred
income tax assets, and if it is deemed more likely than not that its deferred
income tax assets will not be realized based on its taxable income projections,
a valuation allowance is recorded. As at December 31, 2002, the Company expects
that its deferred income tax assets will be recovered from future taxable
income and therefore, has not set up a valuation allowance. In addition,
Canadian and U.S. tax rules and regulations are subject to interpretation and
require judgment by the Company that may be challenged by the taxation
authorities. The Company believes that its provisions for income taxes are
adequate pertaining to any assessments from the taxation authorities.
The Company's deferred income tax asset is mainly composed of temporary
differences related to accruals for workforce reductions, personal injury and
other claims, environmental, and other post-retirement benefits, and losses and
tax credit carryforwards. The majority of these accruals will be paid out over
the next five years. The Company's deferred income tax liability is mainly
composed of temporary differences related to properties, including purchase
accounting adjustments. Estimating the ultimate settlement period, given that
depreciation rates in effect are based on information as it develops, requires
judgment and management's best estimates. The reversal of timing differences is
expected at future substantively enacted income tax rates which could change
due to fiscal budget changes and/or changes in income tax laws. As a result, a
change in the timing and the income tax rate at which the components will
reverse, could materially affect deferred income tax expense as recorded in the
Company's results of operations. A one- percentage-point change in the
Company's reported effective income tax rate would have the effect of changing
the income tax expense by $8 million in 2002. For the year ended December 31,
2002, the Company recorded total income tax expense of $268 million ($392
million in 2001 and $442 million in 2000) of which $156 million was for
deferred income taxes ($307 million in 2001 and $218 million in 2000). The
Company's net deferred income tax liability at December 31, 2002 was $3,703
million ($3,576 million at December 31, 2001).
Business risks
Certain information included in this report may be "forward-looking statements"
within the meaning of the United States Private Securities Litigation Reform
Act of 1995. Such forward-looking statements are not guarantees of future
performance and involve known and unknown risks, uncertainties and other
factors which may cause the outlook, the actual results or performance of the
Company or the rail industry to be materially different from any future results
or performance implied by such statements. Such factors include the factors set
forth below as well as other risks detailed from time to time in reports filed
by the Company with securities regulators in Canada and the United States.
Competition
The Company faces significant competition from a variety of carriers, including
Canadian Pacific Railway Company which operates the other major rail system in
Canada, serving most of the same industrial and population centers as the
Company, long distance trucking companies and, in certain markets, major U.S.
railroads and other Canadian and U.S. railroads. Competition is generally based
on the quality and reliability of services provided, price, and the condition
and suitability of carriers' equipment. Competition is particularly intense in
eastern Canada where an extensive highway network and population centers,
located relatively close to one another, have encouraged significant
competition from trucking companies. In addition, much of the freight carried
by the Company consists of commodity goods that are available from other
sources in competitive markets. Factors affecting the competitive position of
suppliers of these commodities, including exchange rates, could materially
adversely affect the demand for goods supplied by the sources served by the
Company and, therefore, the Company's volumes, revenues and profit margins.
To a greater degree than other rail carriers, the Company's subsidiary,
Illinois Central Railroad Company (ICRR), is vulnerable to barge competition
because its main routes are parallel to the Mississippi River system. The use
of barges for some commodities, particularly coal and grain, often represents a
lower cost mode of transportation. Barge competition and barge rates are
affected by navigational interruptions from ice, floods and droughts, which can
cause widely fluctuating barge rates. The ability of ICRR to maintain its
market share of the available freight has traditionally been affected by the
navigational conditions on the river.
Canadian GAAP
Canadian National Railway Company 89
Management's Discussion and Analysis
In recent years, there has been significant consolidation of rail systems
in the United States. The resulting larger rail systems are able to offer
seamless services in larger market areas and effectively compete with the
Company in certain markets. There can be no assurance that the Company will be
able to compete effectively against current and future competitors in the
railroad industry and that further consolidation within the railroad industry
will not adversely affect the Company's competitive position. No assurance can
be given that competitive pressures will not lead to reduced revenues, profit
margins or both.
Environmental matters
The Company's operations are subject to federal, provincial, state, municipal
and local regulations under environmental laws and regulations concerning,
among other things, emissions into the air; discharges into waters; the
generation, handling, storage, transportation, treatment and disposal of waste,
hazardous substances and other materials; decommissioning of underground and
aboveground storage tanks; and soil and groundwater contamination. A risk of
environmental liability is inherent in railroad and related transportation
operations; real estate ownership, operation or control; and other commercial
activities of the Company with respect to both current and past operations. As
a result, the Company incurs significant compliance and capital costs, on an
ongoing basis, associated with environmental regulatory compliance and clean-up
requirements in its railroad operations and relating to its past and present
ownership, operation or control of real property.
While the Company believes that it has identified the costs likely to be
incurred in the next several years, based on known information, for
environmental matters, the Company's ongoing efforts to identify potential
environmental concerns that may be associated with its properties may lead to
future environmental investigations, which may result in the identification of
additional environmental costs and liabilities.
In the operation of a railroad, it is possible that derailments,
explosions or other accidents may occur that could cause harm to human health
or to the environment. As a result, the Company may incur costs in the future,
which may be material, to address any such harm, including costs relating to
the performance of clean-ups, natural resource damages and compensatory or
punitive damages relating to harm to individuals or property.
The ultimate cost of known contaminated sites cannot be definitely
established, and the estimated environmental liability for any given site may
vary depending on the nature and extent of the contamination, the available
clean-up technique, the Company's share of the costs and evolving regulatory
standards governing environmental liability. Also, additional contaminated
sites yet unknown may be discovered or future operations may result in
accidental releases. For these reasons, there can be no assurance that material
liabilities or costs related to environmental matters will not be incurred in
the future, or will not have a material adverse effect on the Company's
financial position or results of operations in a particular quarter or fiscal
year, or that the Company's liquidity will not be adversely impacted by such
environmental liabilities or costs.
Personal injury and other claims
In the normal course of its operations, the Company becomes involved in various
legal actions, including claims relating to personal injuries, occupational
disease and damage to property. The Company maintains provisions for such
items, which it considers to be adequate for all of its outstanding or pending
claims. The final outcome with respect to actions outstanding or pending at
December 31, 2002, or with respect to future claims, cannot be predicted with
certainty, and therefore there can be no assurance that their resolution will
not have a material adverse effect on the Company's financial position or
results of operations in a particular quarter or fiscal year.
Labor negotiations
Canadian workforce
As of January 2003, the Company has labor agreements with bargaining groups
representing substantially its entire Canadian unionized workforce. These
agreements are generally effective until December 31, 2003.
U.S. workforce
The general approach to labor negotiations by U.S. Class 1 railroads is to
bargain on a collective national basis. Grand Trunk Western (GTW), Duluth,
Winnipeg and Pacific (DWP), ICRR, CCP Holdings, Inc. (CCP) and just recently
WC, have bargained on a local basis rather than holding national, industry wide
negotiations because it results in agreements that better address both the
employees' concerns and preferences, and the railways' actual operating
environment. However, local negotiations may not generate federal intervention
in a strike or lockout situation, since a dispute may be localized. The Company
believes the potential mutual benefits of local bargaining outweigh the risks.
Canadian GAAP
90 Canadian National Railway Company
Management's Discussion and Analysis
As of January 2003, the Company has in place agreements with bargaining
units representing the entire unionized workforce at ICRR, GTW, DWP, and CCP,
and 65% of the unionized workforce at WC. These agreements have various
moratorium provisions, ranging from the end of 2001 to the end of 2005, which
preserve the status quo in respect of given areas during the terms of such
moratoriums. Several of these agreements are currently under renegotiation and
several will open for negotiation in 2003.
Negotiations are ongoing with the bargaining units with which the Company does
not have agreements or settlements. Until new agreements are reached or until
settlements are ratified, the terms and conditions of previous agreements
continue to apply. Although the Company does not anticipate work action related
to these negotiations while they are ongoing, there can be no assurance that
their resolution will not have a material adverse effect on the Company's
financial position or results of operations.
Regulation
The Company's rail operations in Canada are subject to regulation as to (i)
rate setting and network rationalization by the Canadian Transportation Agency
(the Agency) under the Canada Transportation Act (Canada) (the CTA), and (ii)
safety by the federal Minister of Transport under the Railway Safety Act
(Canada) and certain other statutes. The Company's U.S. rail operations are
subject to regulation by the Surface Transportation Board (STB) (the successor
to the Interstate Commerce Commission) and the Federal Railroad Administration.
In addition, the Company is subject to a variety of health, safety, security,
labor, environmental and other regulations, all of which can affect its
competitive position and profitability.
The CTA Review Panel, which was appointed by the federal government to
carry out a comprehensive review of the Canadian transportation legislation,
issued its report to the Minister of Transport at the end of June 2001. The
report was released to the public on July 18, 2001 and contains numerous
recommendations for legislative changes, which, if adopted, would affect all
modes of transportation, including rail. Concurrently, the Minister of
Transport launched a transportation blueprint consultation process, which could
eventually lead to new legislation affecting rail and other transportation
industries. No assurance can be given that any decisions by the federal
government pursuant to the report's recommendations or in connection with the
blueprint consultation process will not materially adversely affect the
Company's financial position or results of operations.
Financial instruments
Although the Company conducts its business and receives revenues primarily in
Canadian dollars, a growing portion of its revenues, expenses, assets and debt
are denominated in U.S. dollars. Thus, the Company's results are affected by
fluctuations in the exchange rate between these currencies. Changes in the
exchange rate between the Canadian dollar and other currencies (including the
U.S. dollar) make the goods transported by the Company more or less competitive
in the world marketplace and thereby affect the Company's revenues and
expenses.
The Company has limited involvement with derivative financial instruments
and does not use them for trading purposes. Collateral or other security to
support financial instruments subject to credit risk is usually not obtained.
However, the credit standing of counterparties or their guarantors is regularly
monitored, and losses due to counterparty non-performance are not anticipated.
To mitigate the effects of fuel price changes on its operating margins and
overall profitability, the Company has a systematic hedging program which calls
for regularly entering into swap positions on crude and heating oil to cover a
target percentage of future fuel consumption up to two years in advance. At
December 31, 2002, the Company has hedged approximately 47% of the estimated
2003 fuel consumption and 25% of the estimated 2004 fuel consumption. This
represents approximately 263 million U.S. gallons at an average price of
U.S.$0.5865 per U.S. gallon.
Realized gains and losses from the Company's fuel hedging activities were
a $3 million gain, a $6 million loss and a $49 million gain for the years ended
December 31, 2002, 2001 and 2000, respectively. As a result of fuel hedging
activities, the Company had an unrealized gain of $30 million at December 31,
2002 compared to an unrealized loss of $38 million at December 31, 2001.
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; (b) contracts granting
rights to others to use the Company's property, such as leases, licenses and
easements; (c) contracts for the sale of assets; (d) contracts for the
acquisition of services; (e) financing agreements; (f) trust indentures or
fiscal agency agreements or similar agreements relating to debt or equity
securities of the Company and engagement agreements with financial advisors;
(g) transfer agent and
Canadian GAAP
Canadian National Railway Company 91
Management's Discussion and Analysis
registrar agreements in respect of the Company's securities; and (h) trust
agreements establishing trust funds to secure the payment to certain officers
and senior employees of special retirement compensation arrangements or plans.
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 cannot be determined with certainty.
Other risks
In any given year, the Company, like other railroads, is susceptible to changes
in the economic conditions of the industries and geographic areas that produce
and consume the freight it transports or the supplies it requires to operate.
In addition, many of the goods and commodities carried by the Company
experience cyclicality in the demand for them. However, many of the bulk
commodities the Company transports move offshore and are impacted more by
global economic conditions than North American economic cycles. The Company's
results of operations can be expected to reflect this cyclicality because of
the significant fixed costs inherent in railroad operations.
Global as well as North American economic conditions, including trade
barriers on certain commodities, may interfere with the free circulation of
goods across Canada and the United States.
Potential terrorist actions can have a direct or indirect impact on the
U.S. transportation infrastructure, including railway infrastructure, and
interfere with the free flow of trade across the two countries. International
conflicts can also have an impact on the Company's markets.
The Company's revenues in 2001 were affected by widespread recessionary
conditions. Although growth rebounded strongly in early 2002, there continues
to be ongoing concern about the sustainability of the recovery due to uncertain
consumer and business confidence. While economic growth is expected to continue
in 2003, the Company remains cautious about business prospects.
Should a major economic slowdown or recession occur in North America or
other key markets, or should major industrial restructuring take place, the
volume of rail shipments carried by the Company is likely to be affected.
In addition to the inherent risks of the business cycle, the Company is
occasionally susceptible to severe weather conditions. For example, in the
first quarter of 1998, a severe ice storm hit eastern Canada, which disrupted
operations and service for the railroad as well as for CN customers. More
recently, severe drought conditions in western Canada significantly reduced
bulk commodity revenues, principally grain. There continues to be widespread
concerns about the impact of crop conditions on grain supplies in the near
term.
Generally accepted accounting principles require the use of historical
cost as the basis of reporting in financial statements. As a result, the
cumulative effect of inflation, which has significantly increased asset
replacement costs for capital-intensive companies such as CN, is not reflected
in operating expenses. Depreciation charges on an inflation-adjusted basis,
assuming that all operating assets are replaced at current price levels, would
be substantially greater than historically reported amounts.
Selected quarterly financial data
Selected quarterly financial data for the eight most recently completed
quarters ending December 31, 2002 is disclosed in Note 23 to the Company's 2002
Consolidated Financial Statements.
Disclosure controls and procedures
The Company's Chief Executive Officer and its Chief Financial Officer, after
evaluating the effectiveness of the Company's "disclosure controls and
procedures" (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c)) as of
January 21, 2003 (the "Evaluation Date") within the 90-day period leading to
and ending on the filing date of this annual report, have concluded that the
Company's disclosure controls and procedures were adequate and effective and
designed to ensure that material information relating to the Company and its
consolidated subsidiaries would have been made known to them. Subsequent to the
Evaluation Date, there were no significant changes in the Company's internal
controls or, to their knowledge, in other factors that could significantly
affect the Company's disclosure controls and procedures.
Canadian GAAP
92 Canadian National Railway Company
Management Report
The accompanying consolidated financial statements of Canadian National Railway
Company and all information in this annual report are the responsibility of
management and have been approved by the Board of Directors.
The financial statements have been prepared by management in conformity
with generally accepted accounting principles in Canada. These statements
include some amounts that are based on best estimates and judgments. Financial
information used elsewhere in the annual report is consistent with that in the
financial statements.
Management of the Company, in furtherance of the integrity and objectivity
of data in the financial statements, has developed and maintains a system of
internal accounting controls and supports an extensive program of internal
audits. Management believes that this system of internal accounting controls
provides reasonable assurance that financial records are reliable and form a
proper basis for preparation of financial statements, and that assets are
properly accounted for and safeguarded.
The Board of Directors carries out its responsibility for the financial
statements in this report principally through its Audit, Finance and Risk
Committee, consisting solely of outside directors. The Audit, Finance and Risk
Committee reviews the Company's consolidated financial statements and annual
report and recommends their approval by the Board of Directors. Also, the
Audit, Finance and Risk Committee meets regularly with the Chief, Internal
Audit, and with the shareholders' auditors.
These consolidated financial statements have been audited by KPMG LLP, who
have been appointed as the sole auditors of the Company by the shareholders.
(signed)
Claude Mongeau
Executive Vice-President and Chief Financial Officer
January 21, 2003
(signed)
Serge Pharand
Vice-President and Corporate Comptroller
January 21, 2003
Auditors' Report
To the shareholders of Canadian National Railway Company
We have audited the consolidated balance sheets of Canadian National Railway
Company as at December 31, 2002 and 2001 and the consolidated statements of
income, changes in shareholders' equity and cash flows for each of the years in
the three-year period ended December 31, 2002. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with Canadian and United States
generally accepted auditing standards. Those standards require that we plan and
perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in
all material respects, the financial position of the Company as at December 31,
2002 and 2001, and the results of its operations and its cash flows for each of
the years in the three-year period ended December 31, 2002, in accordance with
Canadian generally accepted accounting principles.
On January 20, 2003, we reported separately to the Board of Directors of
the Company on consolidated financial statements for the same period, prepared
in accordance with United States generally accepted accounting principles.
(signed)
KPMG llp
Chartered Accountants
Montreal, Canada
January 20, 2003
Canadian GAAP
Canadian National Railway Company 93
Consolidated Statement of Income
In millions, except per share data Year ended December 31,
2002 2001 2000
---------------------------------------------------------------------------------------------
Revenues
Petroleum and chemicals............................. $1,102 $ 923 $ 894
Metals and minerals................................. 521 458 392
Forest products..................................... 1,323 1,088 1,008
Coal................................................ 326 338 328
Grain and fertilizers............................... 986 1,161 1,136
Intermodal.......................................... 1,052 969 919
Automotive.......................................... 591 520 559
Other items......................................... 209 195 210
-----------------------------------
Total revenues......................................... 6,110 5,652 5,446
-----------------------------------
Operating expenses
Labor and fringe benefits (Note 14)................. 2,051 1,810 1,674
Purchased services and material..................... 908 811 858
Depreciation and amortization....................... 499 463 412
Fuel................................................ 459 485 450
Equipment rents..................................... 353 314 291
Casualty and other (Note 2)......................... 724 403 376
-----------------------------------
Total operating expenses............................... 4,994 4,286 4,061
-----------------------------------
Operating income....................................... 1,116 1,366 1,385
Interest expense (Note 15)............................. (353) (312) (295)
Other income (Note 16)................................. 76 65 126
-----------------------------------
Income before income taxes............................. 839 1,119 1,216
Income tax expense (Note 17)........................... (268) (392) (442)
-----------------------------------
Net income............................................. $ 571 $ 727 $ 774
===================================
Basic earnings per share (Note 19) .................... $ 2.87 $ 3.72 $ 3.91
Diluted earnings per share (Note 19)................... $ 2.82 $ 3.62 $ 3.82
===================================
See accompanying notes to consolidated statements.
Canadian GAAP
94 Canadian National Railway Company
Consolidated Statement of Income
In millions December 31, 2002 2001
-------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents............................................ $ 25 $ 53
Accounts receivable (Note 4)......................................... 722 645
Material and supplies................................................ 127 133
Deferred income taxes (Note 17)...................................... 122 153
Other................................................................ 167 180
---------------------
1,163 1,164
Properties (Note 5)..................................................... 16,898 16,723
Other assets and deferred charges (Note 6).............................. 863 901
---------------------
Total assets............................................................ $18,924 $18,788
=====================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable and accrued charges (Note 8)........................ $ 1,487 $ 1,374
Current portion of long-term debt (Note 10).......................... 574 163
Other................................................................ 73 101
---------------------
2,134 1,638
Deferred income taxes (Note 17)......................................... 3,825 3,729
Other liabilities and deferred credits (Note 9)......................... 1,335 1,296
Long-term debt (Note 10)................................................ 5,003 5,764
Shareholders' equity:
Common shares (Note 11).............................................. 3,558 3,209
Convertible preferred securities (Note 11)........................... - 327
Contributed surplus.................................................. 175 178
Currency translation................................................. 132 133
Retained earnings.................................................... 2,762 2,514
---------------------
6,627 6,361
---------------------
Total liabilities and shareholders' equity.............................. $18,924 $18,788
=====================
On behalf of the Board:
David G.A. McLean E. Hunter Harrison
Director Director
See accompanying notes to consolidated statements.
Canadian GAAP
Canadian National Railway Company 95
Consolidated Statement of Income
Issued and
Issued and outstanding
outstanding convertible Convertible Total
common preferred Common preferred Contributed Currency Retained shareholders'
In millions shares securities shares securities surplus translation earnings equity
----------------------------------------------------------------------------------------------------------------------------------
Balances December 31, 1999........ 202.4 4.6 $3,311 $327 $190 $ (9) $1,626 $5,445
Net income........................ - - - - - - 774 774
Stock options exercised
(Note 11, 12) .................. 1.2 - 26 - - - - 26
Share repurchase program
(Note 11) ...................... (13.0) - (213) - (12) - (304) (529)
Currency translation.............. - - - - - 70 - 70
Dividends ($0.70 per share)....... - - - - - - (136) (136)
Dividends on convertible
preferred securities........... - - - - - - (11) (11)
------------------ ------------------------------------------------------------------
Balances December 31, 2000........ 190.6 4.6 3,124 327 178 61 1,949 5,639
Net income........................ - - - - - - 727 727
Stock options exercised
(Note 11, 12) ................. 2.1 - 85 - - - - 85
Currency translation.............. - - - - - 72 - 72
Dividends ($0.78 per share)....... - - - - - - (150) (150)
Dividends on convertible
preferred securities........... - - - - - - (12) (12)
------------------ ------------------------------------------------------------------
Balances December 31, 2001........ 192.7 4.6 3,209 327 178 133 2,514 6,361
Net income........................ - - - - - - 571 571
Stock options exercised
(Note 11, 12) .................. 1.8 - 75 - - - - 75
Conversion of convertible
preferred securities
(Note 11) ...................... 6.0 (4.6) 327 (327) - - - -
Share repurchase program
(Note 11) ...................... (3.0) - (53) - (3) - (147) (203)
Currency translation.............. - - - - - (1) - (1)
Dividends ($0.86 per share)....... - - - - - - (170) (170)
Dividends on convertible
preferred securities........... - - - - - - (6) (6)
------------------ ------------------------------------------------------------------
Balances December 31, 2002........ 197.5 - $3,558 $ - $175 $132 $2,762 $6,627
================== ==================================================================
See accompanying notes to consolidated statements.
Canadian GAAP
96 Canadian National Railway Company
Consolidated Statement of Income
In millions Year ended December 31, 2002 2001 2000
----------------------------------------------------------------------------------------------------------------------------------
Operating activities
Net income............................................................................. $ 571 $ 727 $ 774
Adjustments to reconcile net income to net cash provided from operating activities:
Depreciation and amortization (Note 18)............................................. 506 469 421
Deferred income taxes (Note 17)..................................................... 156 307 218
Charge to increase U.S. personal injury and other claims liability (Note 2)......... 281 - -
Workforce reduction charges (Note 14)............................................... 120 98 -
Equity in earnings of English Welsh and Scottish Railway (Note 16).................. (33) (8) -
Gain on sale of investments (Note 16)............................................... - (101) (84)
Write-down of investment (Note 16).................................................. - 99 -
Other changes in:
Accounts receivable.............................................................. (80) 197 71
Material and supplies............................................................ - 11 7
Accounts payable and accrued charges............................................. (154) (378) (168)
Other net current assets and liabilities......................................... (18) (26) (39)
Other............................................................................... (176) (163) (72)
-------------------------------------
Cash provided from operating activities................................................... 1,173 1,232 1,128
Investing activities
Net additions to properties (Note 18).................................................. (571) (605) (607)
Acquisition of Wisconsin Central Transportation Corporation (Note 3)................... - (1,278) -
Other, net............................................................................. 95 119 21
-------------------------------------
Cash used by investing activities......................................................... (476) (1,764) (586)
Dividends paid............................................................................ (179) (174) (149)
Financing activities
Issuance of long-term debt............................................................. 3,146 4,015 860
Reduction of long-term debt............................................................ (3,558) (3,336) (1,038)
Issuance of common shares (Note 11).................................................... 69 61 26
Repurchase of common shares (Note 11).................................................. (203) - (529)
-------------------------------------
Cash provided from (used by) financing activities......................................... (546) 740 (681)
-------------------------------------
Net increase (decrease) in cash and cash equivalents...................................... (28) 34 (288)
Cash and cash equivalents, beginning of year.............................................. 53 19 307
-------------------------------------
Cash and cash equivalents, end of year.................................................... $ 25 $ 53 $ 19
-------------------------------------
Supplemental cash flow information Payments for:
Interest (Note 15).................................................................. $ 390 $ 307 $ 299
Workforce reductions (Note 9)....................................................... 177 169 189
Personal injury and other claims (Note 20).......................................... 156 149 111
Pensions (Note 13).................................................................. 92 69 59
Income taxes (Note 17).............................................................. 65 63 101
=====================================
See accompanying notes to consolidated statements.
Canadian GAAP
Canadian National Railway Company 97
Notes to Consolidated Financial Statements
Canadian National Railway Company (CN or the Company), directly and through its
subsidiaries, is engaged in the rail transportation business. CN spans Canada
and mid-America, from the Atlantic and Pacific oceans to the Gulf of Mexico,
serving the ports of Vancouver, Prince Rupert, B.C., Montreal, Halifax, New
Orleans and Mobile, Alabama, and the key cities of Toronto, Buffalo, Chicago,
Detroit, Duluth, Minnesota/Superior, Wisconsin, Green Bay, Wisconsin,
Minneapolis/St. Paul, Memphis, St. Louis and Jackson, Mississippi, with
connections to all points in North America. CN's revenues are derived from the
movement of a diversified and balanced portfolio of goods, including petroleum
and chemicals, grain and fertilizers, coal, metals and minerals, forest
products, intermodal and automotive.
1 Summary of significant accounting policies
These consolidated financial statements are expressed in Canadian dollars,
except where otherwise indicated, and have been prepared in accordance with
accounting principles generally accepted in Canada (Canadian GAAP). Significant
differences between the accounting principles applied in the accompanying
financial statements and those under United States generally accepted
accounting principles (U.S. GAAP) are quantified and explained in Note 22 to
the financial statements. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of revenues and
expenses during the period, the reported amounts of assets and liabilities, and
the disclosure of contingent assets and liabilities at the date of the
financial statements. On an ongoing basis, management reviews its estimates,
including those related to personal injury and other claims, environmental
matters, depreciation lives, pensions and other post-retirement benefits, and
income taxes, based upon currently available information. Actual results could
differ from these estimates.
A. Principles of consolidation
These consolidated financial statements include the accounts of all
subsidiaries, including Wisconsin Central Transportation Corporation (WC) for
which the Company acquired control and consolidated effective October 9, 2001.
The Company's investments in which it has significant influence are accounted
for using the equity method and all other investments are accounted for using
the cost method.
B. Revenues
Freight revenues are recognized on services performed by the Company, based on
the percentage of completed service method. Costs associated with movements are
recognized as the service is performed.
C. Foreign exchange
All of the Company's United States (U.S.) operations are self-sustaining
foreign entities with the U.S. dollar as their functional currency. The Company
also has an equity investment in an international affiliate based in the United
Kingdom with the British pound as its functional currency. Accordingly, the
U.S. operations' assets and liabilities and the Company's foreign equity
investment are translated into Canadian dollars at the rate in effect at the
balance sheet date and the revenues and expenses are translated at average
exchange rates during the year. All adjustments resulting from the translation
of the foreign operations are recorded in Currency translation, which forms
part of Shareholders' equity.
The Company has designated all U.S. dollar denominated long- term debt of
the parent company as a foreign exchange hedge of its net investment in U.S.
subsidiaries. Accordingly, unrealized foreign exchange gains and losses, from
the dates of designation, on the translation of the U.S. dollar denominated
long-term debt are also included in Currency translation.
D. Cash and cash equivalents
Cash and cash equivalents include highly liquid investments purchased three
months or less from maturity and are stated at cost, which approximates market
value.
E. Accounts receivable
Accounts receivable are recorded at cost net of the provision for doubtful
accounts that is based on expected collectibility. Any gains or losses on the
sale of accounts receivable are calculated by comparing the carrying amount of
the accounts receivable sold to the total of the cash proceeds on sale and the
fair value of the retained interest in such receivables on the date of
transfer. Fair values are determined on a discounted cash flow basis. Costs
related to the sale of accounts receivable are recognized in earnings in the
period incurred.
F. Material and supplies
Inventory is valued at weighted-average cost for ties, rails, fuel and new
materials in stores, and at estimated utility or sales value for usable
secondhand, obsolete and scrap materials.
G. Properties
Railroad properties are carried at cost less accumulated depreciation including
asset impairment write-downs. All costs of materials associated with the
installation of rail, ties, ballast and other track improvements are
capitalized to the extent they meet the Company's minimum threshold for
capitalization. The related labor and overhead costs are also capitalized for
the installation of new, non-replacement track. All other labor and overhead
costs and maintenance costs are expensed as incurred. Related interest costs
are charged to expense. Included in property additions are the costs of
developing computer software for internal use.
See accompanying notes to consolidated statements.
Canadian GAAP
98 Canadian National Railway Company
Notes to Consolidated Financial Statements
The cost of railroad properties, less net salvage value, retired or
disposed of in the normal course of business is charged to accumulated
depreciation, in accordance with the group method of depreciation. The Company
reviews the carrying amounts of properties whenever events or changes in
circumstances indicate that such carrying amounts may not be recoverable based
on future undiscounted cash flows or estimated net realizable value. Assets
that are deemed impaired as a result of such review are recorded at the lower
of carrying amount or net recoverable amount.
H. Depreciation
The cost of properties, net of asset impairment write-downs, is depreciated on
a straight-line basis over their estimated useful lives as follows:
Asset class Annual rate
----------------------------------------------------------------
Track and roadway........................................... 2%
Rolling stock............................................... 3%
Buildings................................................... 6%
Other....................................................... 4%
----------------------------------------------------------------
The Company follows the group method of depreciation and as such conducts
comprehensive depreciation studies on a periodic basis to assess the
reasonableness of the lives of properties based upon current information and
historical activities. Such a study was conducted in 2001 for the Company's
Canadian properties. The study did not have a significant effect on
depreciation expense as the benefit of increased asset lives was offset by
deficiencies in certain accumulated depreciation balances. Changes in estimated
useful lives are accounted for prospectively.
I. Pensions
Pension costs are determined using actuarial methods. Net periodic benefit cost
is charged to operations and includes:
(i) the cost of pension benefits provided in exchange for employees'
services rendered during the year,
(ii) the interest cost of pension obligations,
(iii) the amortization of the initial net transition obligation on a
straight-line basis over the expected average remaining service life of
the employee group covered by the plans,
(iv) the amortization of prior service costs and amendments over the expected
average remaining service life of the employee group covered by the
plans,
(v) the expected long-term return on pension fund assets, and
(vi) the amortization of cumulative unrecognized net actuarial gains and
losses in excess of 10% of the greater of the beginning of year balances
of the projected benefit obligation or market-related value of plan
assets over the expected average remaining service life of the employee
group covered by the plans.
The pension plans are funded through contributions determined in
accordance with the projected unit credit actuarial cost method.
J. Post-retirement benefits other than pensions
The Company accrues the cost of post-retirement benefits other than pensions
using actuarial methods. These benefits, which are funded by the Company as
they become due, include life insurance programs, medical benefits,
supplemental pension allowances and free rail travel benefits.
The Company amortizes the cumulative unrecognized net actuarial gains and
losses in excess of 10% of the projected benefit obligation at the beginning of
the year, over the expected average remaining service life of the employee
group covered by the plans.
K. Derivative financial instruments
The Company uses derivative financial instruments in the management of its fuel
exposure, and may use them from time to time, in the management of its interest
rate and foreign currency exposures. Gains or losses on such instruments
entered into for the purpose of hedging financial risk exposures are deferred
and amortized in the results of operations over the life of the hedged asset or
liability or over the term of the derivative financial instrument. Income and
expense related to hedged derivative financial instruments are recorded in the
same category as that generated by the underlying asset or liability.
L. Personal injury claims
In Canada, the Company accounts for costs related to employee work-related
injuries based on actuarially developed estimates of the ultimate cost
associated with such injuries, including compensation, health care and
administration costs.
In the U.S., the Company accrues the cost for the expected personal injury
claims and existing occupational disease claims, based on actuarial estimates
of their ultimate cost. A liability for unasserted occupational disease claims
is also accrued to the extent they are probable and can be reasonably
estimated.
See accompanying notes to consolidated statements.
Canadian GAAP
Canadian National Railway Company 99
Notes to Consolidated Financial Statements
1 Summary of significant account policies (continued)
M. Environmental expenditures
Environmental expenditures that relate to current operations are expensed
unless they relate to an improvement to the property. Expenditures that relate
to an existing condition caused by past operations and which are not expected
to contribute to current or future operations are expensed. Liabilities are
recorded when environmental assessments and/or remedial efforts are likely, and
when the costs, based on a specific plan of action in terms of the technology
to be used and the extent of the corrective action required, can be reasonably
estimated.
N. Income taxes
The Company follows the asset and liability method of accounting for income
taxes. Under the asset and liability method, the change in the net deferred tax
asset or liability is included in the computation of net income. Deferred tax
assets and liabilities are measured using substantively enacted tax rates
expected to apply to taxable income in the years in which temporary differences
are expected to be recovered or settled.
O. Stock-based compensation
The Company accounts for stock-based compensation in accordance with the
Canadian Institute of Chartered Accountants (CICA) Handbook Section 3870
"Stock-Based Compensation and Other Stock-Based Payments," as explained in Note
2 - Accounting changes. Accordingly, compensation cost is recorded for the
Company's performance-based stock option awards under the intrinsic value
method and recognized over the vesting period. No compensation cost is recorded
for the Company's conventional stock option awards.
P. Recent accounting pronouncements
In December 2002, the CICA issued Handbook Section 3063 "Impairment of
Long-Lived Assets." Section 3063 provides accounting guidance for the
determination of a long-lived asset impairment as well as recognition,
measurement and disclosure of the impairment. This section is effective for the
Company's fiscal year beginning January 1, 2004. The Company does not expect
Section 3063 to have an initial material impact on its financial statements
upon adoption.
Also in December 2002, the CICA issued Handbook Section 3475 "Disposal of
Long-Lived Assets and Discontinued Operations." Section 3475 provides
accounting guidance for long-lived assets to be disposed of other than by sale,
long-lived assets to be disposed of by sale and presentation and disclosure for
discontinued operations. This section is effective for disposal activities
initiated by the Company on or after May 1, 2003. The Company does not expect
Section 3475 to have an initial material impact on its financial statements
upon adoption.
2 Accounting changes
2002
U.S. personal injury and other claims
In the fourth quarter of 2002, the Company changed its methodology for
estimating its liability for U.S. personal injury and other claims, including
occupational disease claims and claims for property damage, from a case-by-case
approach to an actuarial-based approach. Consequently, the Company recorded a
charge of $281 million ($173 million after tax) to increase its provision for
these claims.
Under the actuarial-based approach, the Company accrues the cost for the
expected personal injury and property damage claims and existing occupational
disease claims, based on actuarial estimates of their ultimate cost. The
Company is unable to estimate the total cost for unasserted occupational
disease claims. However, a liability for unasserted occupational disease claims
is accrued to the extent they are probable and can be reasonably estimated.
Under the case-by-case approach, a liability was recorded only when the
expected loss was both probable and reasonably estimable based on currently
available information. In addition, the Company did not record a liability for
unasserted claims, as such amounts could not be reasonably estimated under the
case-by-case approach.
The Company's U.S. personal injury and other claims expense, including the
above-mentioned charge, was $362 million in 2002. Had the Company continued to
apply the case-by-case approach to its U.S. personal injury and other claims
liability, recognizing the effects of the actual claims experience for existing
and new claims in the fourth quarter, these expenses would have been
approximately $135 million in 2002.
Stock-based compensation
Effective January 1, 2002, the Company adopted the CICA Handbook Section 3870
"Stock-Based Compensation and Other Stock-Based Payments." The new
recommendations require the use of a fair value based approach of accounting
for all non-employee and certain employee stock-based awards, such as direct
awards of stock, awards that call for settlement in cash or other assets, or
stock appreciation rights that call for settlement through the issuance of
equity instruments. For all other employee stock-based awards, such as stock
option awards, the recommendations encourage but do not require that the fair
value based approach be used, though require additional disclosure including
net income and earnings per share, as if the fair value based accounting method
had been used to account for these awards.
Canadian GAAP
100 Canadian National Railway Company
Notes to Consolidated Financial Statements
The Company has elected to prospectively apply the intrinsic value based
method of accounting to its awards of conventional and performance-based
employee stock options granted on or after January 1, 2002. These options are
granted at an exercise price equal to the market value of the common shares at
the date of granting and, as such, compensation cost is not recognized for
conventional-based options since both the number of shares to which an
individual is entitled and the exercise price are known at the date of
granting. Compensation cost attributable to performance-based employee stock
option awards, granted on or after January 1, 2002, is measured at intrinsic
value and recognized over the vesting period. Changes in intrinsic value
between the grant date and the measurement date result in a change in the
measure of compensation cost. For the year ended December 31, 2002, no
compensation cost was recognized as no performance-based employee stock option
awards were granted. In prior periods, the Company did not record compensation
cost related to employee stock option grants and, any consideration paid by
employees on the exercise of stock options was recorded as share capital.
In accordance with the new recommendations, the Company accounts for its
direct awards of stock to employees, which are issued through the mid-term
incentive share unit plan, using the fair value based approach to awards
granted on or after January 1, 2002. The mid-term incentive share unit plan
entitles employees to receive payout of a combination of common stock of the
Company (equity settled portion), as to 50 percent, and cash value (cash
settled portion), as to the remaining 50 percent.
The new recommendations will not be applied to the equity settled portion
of this award granted prior to January 1, 2002 since the new recommendations
require prospective application for such awards.
Compensation cost for the cash settled portion of this award is measured
at fair value, which in all respects is equivalent to intrinsic value since the
compensation cost stemming from the award must be finally measured at intrinsic
value, and is recognized over the vesting period. Changes in intrinsic value
between the grant date and the measurement date result in a change in the
measure of compensation cost. The new recommendations require retroactive
application, without restatement, of the Company's grants outstanding at
January 1, 2002 that call for settlement in cash. Had the new recommendations
been retroactively applied to the cash settled portion, there would have been
no impact on prior periods' financial statements, since no compensation cost
was, or would have been recognized for prior periods, due to the nature of the
vesting conditions.
For the year ended December 31, 2002, the Company granted 3.2 million
conventional options. For the year ended December 31, 2002, 1.8 million of
previously issued stock options were exercised.
If compensation cost had been determined as if the fair value based
accounting approach had been used for all awards granted for the year ended
December 31, 2002, the Company's net income and earnings per share would have
been as follows:
Year ended December 31, 2002
---------------------------------------------------------------
Net income (in millions)..................................$ 553
Basic earnings per share..................................$2.78
Diluted earnings per share................................$2.73
---------------------------------------------------------------
As permitted by the new recommendations, these amounts exclude the effect
of awards granted prior to January 1, 2002 and include the calculation of
compensation cost using the Black-Scholes option-pricing model with the
following assumptions:
Year ended December 31, 2002
---------------------------------------------------------------
Expected option life (years)............................. 7.0
Risk-free interest rate.................................. 5.79%
Expected stock price volatility.......................... 30%
Average dividend per share...............................$ 0.86
---------------------------------------------------------------
Year ended December 31, 2002
---------------------------------------------------------------
Weighted average fair value of options granted...........$30.98
---------------------------------------------------------------
2001
Foreign currency translation
In 2001, the Company early adopted the CICA amended recommendations of Section
1650 "Foreign Currency Translation." The amended section eliminates the
deferral and amortization of unrealized translation gains or losses on foreign
currency denominated monetary items that have a fixed or ascertainable life
extending beyond the end of a fiscal year. Translation gains or losses on the
above items are now recognized in net income immediately. As required by the
amended section, the Company retroactively restated all prior period financial
statements presented. The cumulative effect of the adoption of the amended
section of $93 million ($62 million after tax) has been reflected as a charge
to opening retained earnings of 1999. The effect on net income for 2001 and
2000 was an increase of $1 million and $2 million, respectively.
2000
Earnings per share
In 2000, the Company early adopted the CICA recommendations related to the
presentation of earnings per share. The standard essentially harmonizes
Canadian and U.S. standards, specifically in the areas of presenting earnings
per share information, computing diluted earnings per share and disclosure
requirements. The new standard requires restatement of prior year comparative
information.
Canadian GAAP
Canadian National Railway Company 101
Notes to Consolidated Financial Statements
3 Acquisition of Wisconsin Central Transportation Corporation
On January 29, 2001, the Company, through an indirect wholly owned subsidiary,
and WC entered into a merger agreement (the Merger) providing for the
acquisition of all of the shares of WC by the Company for an acquisition cost
of $1,301 million (U.S.$833 million). The Merger was approved by the
shareholders of WC at a special meeting held on April 4, 2001. On September 7,
2001, the U.S. Surface Transportation Board rendered a decision, unanimously
approving the Company's acquisition of WC. On October 9, 2001, the Company
completed its acquisition of WC and began a phased integration of the
companies' operations. The acquisition was financed by debt and cash on hand.
The Company accounted for the Merger using the purchase method of
accounting as required by CICA Handbook Section 1581 "Business Combinations."
As such, the Company's consolidated financial statements include the assets,
liabilities and results of operations of WC as of October 9, 2001, the date of
acquisition. The Company had estimated, on a preliminary basis, the fair values
of the assets and liabilities acquired based on currently available
information. In 2002, the Company finalized the allocation of the purchase
price and adjusted the preliminary fair values of the assets and liabilities
acquired as follows: Current assets decreased by $10 million, Properties
increased by $141 million, Other assets and deferred charges decreased by $98
million, Current liabilities increased by $10 million, Deferred income taxes
increased by $16 million and Other liabilities and deferred credits increased
by $3 million. The increase in Properties and decrease in Other assets and
deferred charges was mainly due to the final valuation of the Company's foreign
equity investment. The remaining adjustments resulted from additional
information obtained for conditions and circumstances that existed at the time
of acquisition.
The following table outlines the final fair values of WC's assets and
liabilities acquired:
In millions
---------------------------------------------------------------
Current assets...........................................$ 165
Properties............................................... 2,576
Other assets and deferred charges........................ 335
------
Total assets acquired.................................... 3,076
------
Current liabilities...................................... 363
Deferred income taxes.................................... 759
Other liabilities and deferred credits................... 181
Long-term debt........................................... 472
------
Total liabilities assumed................................ 1,775
------
Net assets acquired......................................$1,301
======
4 Accounts receivable
In millions December 31, 2002 2001
---------------------------------------------------------------
Freight
Trade.......................................... $321 $309
Accrued........................................ 150 119
Non-freight ...................................... 310 298
------------
781 726
Provision for doubtful accounts .................. (59) (81)
------------
$722 $645
============
The Company has a five-year revolving agreement, expiring in June 2003, to
sell eligible freight trade receivables up to a maximum of $350 million of
receivables outstanding at any point in time. The Company intends to renew or
replace the program upon expiration. At December 31, 2002, pursuant to the
agreement, $173 million and U.S.$113 million (Cdn$177 million) had been sold on
a limited recourse basis compared to $168 million and U.S.$113 million (Cdn$179
million) at December 31, 2001. Recourse is limited to 10% of receivables sold
and consists of additional freight trade receivables that have been recorded in
Other current assets. The Company has retained the responsibility for
servicing, administering and collecting freight trade receivables sold. Other
income included $9 million in 2002 and $10 million in each of 2001 and 2000 for
costs related to the agreement, which fluctuate with changes in prevailing
interest rates.
No servicing asset or liability has been recorded since the costs of
servicing are compensated by the benefits of the agreement.
The Receivables Purchase Agreement provides for customary indemnification
provisions, which survive for a period of two years following the final
purchase of any receivable, three years from the final collection date or until
statute barred, in the case of taxes. As at December 31, 2002, the Company has
not recorded a liability associated with these indemnifications, for which
there is no monetary limitation, as the Company does not expect to make any
payments pertaining to the indemnifications of this program.
Canadian GAAP
102 Canadian National Railway Company
Notes to Consolidated Financial Statements
5 Properties
In millions December 31, 2002 December 31, 2001
---------------------------------------------------------------------------------------------------------------------------------
Accumulated Accumulated
Cost depreciation Net Cost depreciation Net
---------------------------------------------------------------------------------------------------------------------------------
Track, roadway and land....................$16,727 $3,604 $13,123 $16,549 $3,510 $13,039
Rolling stock.............................. 3,841 1,392 2,449 3,703 1,336 2,367
Buildings.................................. 1,723 778 945 1,622 721 901
Other...................................... 892 511 381 919 503 416
--------------------------------------------------------------------------------------
$23,183 $6,285 $16,898 $22,793 $6,070 $16,723
======================================================================================
Capital leases included in rolling stock...$ 1,348 $ 244 $ 1,104 $ 1,246 $ 218 $ 1,028
======================================================================================
6 Other assets and deferred charges
In millions December 31, 2002 2001
---------------------------------------------------------------
Investments....................................... $380 $496
Prepaid benefit cost (Note 13) ................... 353 251
Deferred receivables ............................. 88 108
Unamortized debt issue costs ..................... 41 42
Other ............................................ 1 4
------------
$863 $901
============
Investments
As at December 31, 2002, the Company had $368 million ($478 million at December
31, 2001) of investments accounted for under the equity method and $12 million
($18 million at December 31, 2001) of investments accounted for under the cost
method.
Investment in Tranz Rail Holdings Limited (Tranz Rail) and Australian Transport
Network Limited (ATN)
In 2002, the Company sold its interests in Tranz Rail and ATN for aggregate net
proceeds of $69 million, which approximated the carrying value of the
investments. Prior to the sale, the Company had accounted for these investments
as "available for sale."
Investment in English Welsh and Scottish Railway (EWS)
Through its acquisition of WC in 2001, the Company acquired 40.9% of EWS, a
company which provides most of the rail freight services in Great Britain,
operates freight trains through the English Channel tunnel and carries mail for
the Royal Mail. The final fair value of the investment at the date of
acquisition was determined based on the discounted cash flow method and a
multiple of EWS earnings. The Company accounts for its investment in EWS using
the equity method. At December 31, 2002, the excess of the Company's share of
the book value of EWS' net assets over the carrying value of the investment is
being depreciated over the life of its assets and is not significant.
Investment in 360networks Inc.
In June 2001, the Company recorded a charge of $99 million, $77 million after
tax, to write down 100% of its net investment in 360networks Inc. and
subsequently sold all of its shares. In 2000, the Company had recorded a gain
of $84 million, $58 million after tax, related to the exchange of its minority
equity investments in certain joint venture companies for 11.4 million shares
of 360networks Inc.
7 Credit facilities
In December 2002, the Company entered into a U.S.$1,000 million three-year
revolving credit facility and concurrently terminated its previous revolving
credit facilities before their scheduled maturity in March 2003. The credit
facility provides for borrowings at various interest rates, including the
Canadian prime rate, bankers' acceptance rates, the U.S. federal funds
effective rate and the London Interbank Offer Rate, plus applicable margins.
The credit facility agreement contains customary financial covenants, based on
U.S. GAAP, including limitations on debt as a percentage of total
capitalization and maintenance of tangible net worth above pre-defined levels.
Throughout the year, the Company was in compliance with all financial covenants
contained in its outstanding revolving credit agreements. The Company's
commercial paper program is backed by a portion of its revolving credit
facility. As at December 31, 2002, the Company had outstanding commercial paper
of U.S.$136 million (Cdn$214 million) compared to U.S.$213 million (Cdn$339
million) as at December 31, 2001. The Company's borrowings of U.S.$172 million
(Cdn$273 million) outstanding at December 31, 2001 were entirely repaid in the
first quarter of 2002. At December 31, 2002, the Company had borrowings under
its revolving credit facility of U.S.$90 million (Cdn$142 million) at an
average interest rate of 1.77%. Outstanding letters of credit under the
previous facilities were transferred into the current facility. As at December
31, 2002, letters of credit under the revolving credit facility amounted to
$295 million.
Canadian GAAP
Canadian National Railway Company 103
Notes to Consolidated Financial Statements
8 Accounts payable and accrued charges
In millions December 31, 2002 2001
---------------------------------------------------------------
Trade payables.................................. $ 436 $385
Income and other taxes.......................... 251 236
Payroll-related accruals........................ 235 218
Workforce reduction provisions.................. 168 151
Personal injury and other claims (Note 20)...... 136 51
Accrued charges................................. 113 131
Accrued interest................................ 104 141
Accrued operating leases........................ 18 19
Other........................................... 26 42
--------------
$1,487 $1,374
==============
9 Other liabilities and deferred credits
In millions December 31, 2002 2001
---------------------------------------------------------------
Personal injury and other claims,
net of current portion (Note 20)............. $528 $379
Workforce reduction provisions,
net of current portion (A)................... 253 340
Accrual for post-retirement benefits
other than pensions (B)...................... 284 258
Environmental reserve, net of current portion... 81 73
Deferred credits and other...................... 189 246
--------------
$1,335 $1,296
==============
A. Workforce reduction provisions (Note 14)
The workforce reduction provisions, which cover employees in both Canada and
the United States, are mainly comprised of payments related to severance, early
retirement incentives and bridging to early retirement, the majority of which
will be disbursed within the next three years. Payments have reduced the
provisions by $177 million for the year ended December 31, 2002 ($169 million
for the year ended December 31, 2001). As at December 31, 2002, the aggregate
provisions, including the current portion, amounted to $421 million ($491
million as at December 31, 2001).
B. Post-retirement benefits other than pensions
(i) Change in benefit obligation
In millions Year ended December 31, 2002 2001
---------------------------------------------------------------
Benefit obligation at beginning of year........... $309 $242
Amendments........................................ 18 25
Actuarial loss.................................... 101 20
Interest cost..................................... 23 19
Service cost...................................... 13 11
Foreign currency changes.......................... (1) 6
Transfer from other plans......................... - 5
Benefits paid..................................... (19) (19)
------------
Benefit obligation at end of year................. $444 $309
============
(ii) Funded status
In millions December 31, 2002 2001
---------------------------------------------------------------
Unfunded benefit obligation at end of year........ $444 $309
Unrecognized net actuarial loss................... (122) (26)
Unrecognized prior service cost................... (38) (25)
------------
Accrued benefit cost for post-retirement
benefits other than pensions................... $284 $258
============
(iii) Components of net periodic benefit cost
In millions Year ended December 31, 2002 2001 2000
---------------------------------------------------------------
Interest cost............................ $23 $19 $15
Service cost............................. 13 11 8
Amortization of prior service cost....... 5 3 1
Recognized net actuarial loss............ 4 2 1
--------------------
Net periodic benefit cost................ $45 $35 $25
====================
(iv) Weighted-average assumptions
December 31, 2002 2001 2000
---------------------------------------------------------------
Discount rate........................... 6.65% 6.97% 6.95%
Rate of compensation increase........... 4.00% 4.00% 4.25%
---------------------------------------------------------------
For measurement purposes, increases in the per capita cost of covered
health care benefits were assumed to be 17% for 2003 and 18% for 2002. It is
assumed that the rate will decrease gradually to 8% in 2012 and remain at that
level thereafter.
A one-percentage-point change in the health care cost trend rate would not
cause a material change in the Company's net periodic benefit cost nor the
post-retirement benefit obligation.
Canadian GAAP
104 Canadian National Railway Company
Notes to Consolidated Financial Statements
10 Long-term debt
Currency
in which December 31,
In millions Maturity payable 2002 2001
---------------------------------------------------------------------------------------------------------------------------------
Debentures and notes: (A)
Canadian National series:
6.63%10-year notes .........................................................May 15, 2003 U.S.$ $ 236 $ 239
7.00%10-year notes .........................................................Mar. 15, 2004 U.S.$ 419 422
6.45%Puttable Reset Securities (PURS) (B)...................................July 15, 2006 U.S.$ 394 398
6.38%10-year notes (C) .....................................................Oct. 15, 2011 U.S.$ 631 636
6.80%20-year notes (C)......................................................July 15, 2018 U.S.$ 315 318
7.63%30-year debentures.....................................................May 15, 2023 U.S.$ 236 239
6.90%30-year notes (C)......................................................July 15, 2028 U.S.$ 749 755
7.38%30-year debentures (C) ................................................Oct. 15, 2031 U.S.$ 315 318
Illinois Central series:
6.75%10-year notes..........................................................May 15, 2003 U.S.$ 158 159
7.75%10-year notes..........................................................May 1, 2005 U.S.$ 158 159
6.98%12-year notes .........................................................July 12, 2007 U.S.$ 79 80
6.63%10-year notes..........................................................June 9, 2008 U.S.$ 32 32
5.00%99-year income debentures..............................................Dec. 1, 2056 U.S.$ 12 12
7.70% 00-year debentures ...................................................Sep. 15, 2096 U.S.$ 197 199
Wisconsin Central series:
6.63% 10-year notes.........................................................April 15, 2008 U.S.$ 236 239
--------------------------------------------------
Total debentures and notes .................................................... 4,167 4,205
Other:
Revolving credit facilities (Note 7) ....................................... U.S.$ 142 273
Commercial paper (D) (Note 7) .............................................. U.S.$ 214 339
Capital lease obligations, amounts owing under equipment
agreements and other (E) ................................................. Various 1,068 1,125
--------------------------------------------------
Total other ................................................................... 1,424 1,737
--------------------------------------------------
Subtotal....................................................................... 5,591 5,942
Less:
Current portion of long-term debt .......................................... 574 163
Net unamortized discount ................................................... 14 15
--------------------------------------------------
588 178
--------------------------------------------------
$5,003 $5,764
==================================================
A. The Company's debentures and notes are unsecured.
B. The PURS contain imbedded simultaneous put and call options at par. At the
time of issuance, the Company sold the option to call the securities on July
15, 2006 (the reset date). If the call option is exercised, the imbedded put
option is automatically triggered, resulting in the redemption of the original
PURS. The call option holder will then have the right to remarket the
securities at a new coupon rate for an additional 30-year term ending July 15,
2036. The new coupon rate will be determined according to a pre-set mechanism
based on market conditions then prevailing. If the call option is not
exercised, the put option is deemed to have been exercised, resulting in the
redemption of the PURS on July 15, 2006.
C. These debt securities are redeemable, in whole or in part, at the option of
the Company, at any time, at the greater of par and a formula price based on
interest rates prevailing at the time of redemption.
D. The Company has a commercial paper program, which is backed by a portion of
its revolving credit facility, enabling it to issue commercial paper up to a
maximum aggregate principal amount of $600 million, or the U.S. dollar
equivalent. Commercial paper debt is due within one year but has been
classified as long-term debt, reflecting the Company's intent and contractual
ability to refinance the short-term borrowing through subsequent issuances of
commercial paper or drawing down on the revolving credit facility. Interest
rates on commercial paper at December 31, 2002 range from approximately 1.4% to
1.7%.
Canadian GAAP
Canadian National Railway Company 105
Notes to Consolidated Financial Statements
10 Long-term debt (continued)
E. Interest rates for the capital leases range from approximately 3.0% to 14.6%
with maturity dates in the years 2003 through 2025. The imputed interest on
these leases amounted to $498 million as at December 31, 2002, and $545 million
as at December 31, 2001.
The equipment agreements are payable by monthly or semi-annual
installments over various periods to 2007 at interest rates ranging from 6.0%
to 6.7%. As at December 31, 2002, the principal amount repayable was $14
million ($19 million as at December 31, 2001). The capital leases, equipment
agreements, and other obligations are secured by properties with a net carrying
amount of $1,122 million as at December 31, 2002 and $1,096 million as at
December 31, 2001.
During 2002, the Company recorded $114 million in assets it acquired
through the exercise of purchase options on existing leases and leases for new
equipment ($91 million in 2001). An equivalent amount was recorded in debt.
F. Long-term debt maturities, including repurchase arrangements and capital
lease repayments on debt outstanding as at December 31, 2002 but excluding
repayments of commercial paper and revolving credit facility of $214 million
and $142 million, respectively, for the next five years and thereafter, are as
follows:
Year In millions
----------------------------------------------------------------
2003.................................................... $ 574
2004.................................................... 560
2005.................................................... 246
2006.................................................... 438
2007.................................................... 164
2008 and thereafter..................................... 3,239
----------------------------------------------------------------
G. The aggregate amount of debt payable in U.S. currency as at December 31,
2002 is U.S.$3,164 million (Cdn$4,987 million) and U.S.$3,334 million
(Cdn$5,302 million) as at December 31, 2001.
11 Capital stock and convertible preferred securities
A. Authorized capital stock
The authorized capital stock of the Company is as follows:
o Unlimited number of Common Shares, without par value
o Unlimited number of Class A Preferred Shares, without par value issuable
in series
o Unlimited number of Class B Preferred Shares, without par value issuable
in series
B. Issued and outstanding common shares
During 2002, the Company issued 7.8 million shares of which 1.8 million shares
(2.1 million shares in 2001 and 1.2 million shares in 2000) was related to
stock options exercised and 6.0 million shares was related to the conversion of
the Company's convertible preferred securities. The total number of common
shares issued and outstanding was 197.5 million as at December 31, 2002.
C. Convertible preferred securities ("Securities")
On May 6, 2002, the Company met the conditions required to terminate the
Securities holders' right to convert their Securities into common shares of the
Company, and set the conversion termination date as July 3, 2002. The
conditions were met when the Company's common share price exceeded 120% of the
conversion price of U.S.$38.48 per share for a specified period, and all
accrued interest on the Securities had been paid. On July 3, 2002, Securities
that had not been previously surrendered for conversion were deemed converted,
resulting in the issuance of 6.0 million common shares of the Company.
In 1999, the Company had issued 4.6 million 5.25% Securities due on June
30, 2029, at U.S.$50 per Security. These Securities were subordinated
securities convertible into common shares of CN at the option of the holder at
an original conversion price of U.S.$38.48 per common share, representing an
original conversion rate of 1.2995 common shares for each Security.
D. Share repurchase programs
On October 22, 2002, the Board of Directors of the Company approved a share
repurchase program which allows for the repurchase of up to 13.0 million common
shares between October 25, 2002 and October 24, 2003 pursuant to a normal
course issuer bid, at prevailing market prices. As at December 31, 2002, $203
million was used to repurchase 3.0 million common shares at an average price of
$67.68 per share.
In 2001, the Board of Directors of the Company approved a share repurchase
program under which the Company did not repurchase any common shares.
In 2000, $529 million was used to repurchase 13.0 million common shares,
the maximum allowed under the program, pursuant to a normal course issuer bid
at an average price of $40.70 per share.
12 Stock plans
The Company has various stock-based incentive plans for eligible employees. A
description of the Company's major plans is provided below:
A. Employee share plan
The Company has an Employee Share Investment Plan (ESIP) giving eligible
employees the opportunity to subscribe for up to 6% 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. Participation at December 31, 2002 was 8,911
employees (9,432 at December 31, 2001). The total number of ESIP shares
purchased on behalf of employees, including the Company's contributions, was
497,459 in 2002, 516,726 in 2001 and 637,531 in 2000, resulting in a pre-tax
charge to income of $9 million, $8 million and $6 million for the years ended
December 31, 2002, 2001 and 2000, respectively.
Canadian GAAP
106 Canadian National Railway Company
Notes to Consolidated Financial Statements
B. Mid-term incentive share unit plan
The Company has a share unit plan, which was approved by the Board of Directors
in 2001, for designated senior management employees entitling them to receive
payout on June 30, 2004 of a combination of common stock of the Company, as to
fifty percent, and cash value, as to the remaining fifty percent.
The share units vest conditionally upon the attainment of targets relating
to the Company's share price during the six-month period ending June 30, 2004.
At December 31, 2002, the total number of share units outstanding was 419,900,
representing a potential maximum compensation cost of $21 million. Due to the
nature of the vesting conditions, no compensation cost was recorded for 2002
and 2001. At December 31, 2002, an additional 45,100 share units remained
authorized for future issuances under this plan.
C. Stock options
The Company has stock option plans for eligible employees to acquire common
shares of the Company upon vesting at a price equal to the market value of the
common shares at the date of granting. The options are exercisable during a
period not exceeding 10 years. The right to exercise options generally accrues
over a period of four years of continuous employment. Options are not generally
exercisable during the first 12 months after the date of grant. At December 31,
2002, an additional 2.6 million common shares remained authorized for future
issuances under these plans. Options issued by the Company include conventional
options, which vest over a period of time, and performance options, which vest
upon the attainment of Company targets relating to the operating ratio and
unlevered return on investment. The total conventional and performance options
outstanding at December 31, 2002 were 9.1 million and 2.0 million,
respectively. Changes in the Company's stock options are as follows:
Number Weighted-average
of options exercise price
----------------------------------------------------------------
In millions
----------------------------------------------------------------
Outstanding at December 31, 1999 (1)...... 8.3 $ 34.88
Granted .................................. 2.2 $ 35.33
Canceled .................................(0.4) $ 36.23
Exercised.................................(1.2) $ 22.19
----------------------
Outstanding at December 31, 2000 (1)...... 8.9 $ 34.95
Conversion of WCoptions................... 1.0 $ 58.63
Granted .................................. 2.4 $ 50.65
Canceled .................................(0.3) $ 46.01
Exercised.................................(2.1) $ 30.43
----------------------
Outstanding at December 31, 2001 (1) (2).. 9.9 $ 43.62
Granted .................................. 3.2 $ 76.78
Canceled .................................(0.2) $ 56.98
Exercised.................................(1.8) $ 39.16
----------------------
Outstanding at December 31, 2002 (1) (2)..11.1 $53.50
----------------------
(1) Includes IC converted stock options translated to Canadian dollars using
the foreign exchange rate in effect at the balance sheet date.
(2) Includes WC converted stock options translated to Canadian dollars using
the foreign exchange rate in effect at the balance sheet date.
Stock options outstanding and exercisable as at December 31, 2002 were as
follows:
Options outstanding Options exercisable
---------------------------------------------------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
average average average
Number years to exercise Number exercise
Range of exercise prices of options expiration price of options price
---------------------------------------------------------------------------------------------------------------------------------
In millions In millions
---------------------------------------------------------------------------------------------------------------------------------
$13.50-$23.72 .............................................. 0.1 3 $ 17.23 0.1 $ 17.23
$25.18-$35.01 .............................................. 2.1 6 $ 33.59 1.2 $ 32.48
$35.70-$49.45 .............................................. 3.2 6 $ 44.69 2.7 $ 44.56
$50.02-$69.77 .............................................. 2.5 8 $ 51.43 0.8 $ 52.93
$70.04 and above ........................................... 3.2 9 $ 77.59 0.1 $ 97.09
----- ----
Balance at December 31, 2002 (1) ........................... 11.1 7 $ 53.50 4.9 $44.01
===== ====
(1) Includes IC and WC converted stock options translated to Canadian dollars
using the foreign exchange rate in effect at the balance sheet date.
D. Stock-based compensation cost
Compensation cost for performance-based stock option awards under these plans
is determined by the options' intrinsic value in accordance with the CICA
Handbook Section 3870 "Stock-Based Compensation and Other Stock-Based
Payments." No compensation cost was recognized for stock-based awards in 2002.
Disclosures required under the fair value based accounting approach are
presented in Note 2 - Accounting changes.
Canadian GAAP
Canadian National Railway Company 107
Notes to Consolidated Financial Statements
13 Pensions
The Company has retirement benefit plans under which substantially all of its
employees are entitled to benefits at retirement age, generally based on
compensation and length of service and/or contributions. The tables that follow
pertain to all such plans. However, the following descriptions relate solely to
the Company's main pension plan, the CN Pension Plan (the Pension Plan). The
Company's other pension plans are not significant.
Description of plan
The Pension Plan is a contributory defined benefit pension plan that covers the
majority of CN employees. It provides for pensions based mainly on years of
service and final average pensionable earnings and is generally applicable from
the first day of employment. Indexation of pensions is provided after
retirement through a gain (loss) sharing mechanism, subject to guaranteed
minimum increases. An independent trust company is the Trustee of the Canadian
National Railways Pension Trust Funds (CN Pension Trust Funds). As Trustee, the
trust company performs certain duties, which include holding legal title to the
assets of the CN Pension Trust Funds and ensuring that the Company, as
Administrator, complies with the provisions of the Pension Plan and the related
legislation.
Funding policy
Employee contributions to the 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, and are
determined by actuarial valuations conducted at least on a triennial basis.
These valuations are made in accordance with legislative requirements and with
the recommendations of the Canadian Institute of Actuaries for the valuation of
pension plans. The latest actuarial valuation of the Pension Plan was conducted
as at December 31, 2001 and indicated a funding excess. Based on the Pension
Plan's current position, the Company's contributions are expected to be
approximately $75 million in each of 2003, 2004 and 2005.
Description of fund assets
The assets of the Pension Plan are accounted for separately in the CN Pension
Trust Funds and consist of cash and short-term investments, bonds, mortgages,
Canadian and foreign equities, real estate, and oil and gas assets. Based on
the fair value of the assets held at December 31, 2002, the plan assets are
comprised of 1% in cash and short-term investments, 40% in bonds and mortgages,
50% in Canadian and foreign equities and 9% in real estate and oil and gas
assets.
(a) Change in benefit obligation
In millions Year ended December 31, 2002 2001
---------------------------------------------------------------
Benefit obligation at beginning of year........ $11,156 $10,855
Interest cost.................................. 714 701
Actuarial (gain) loss.......................... (92) 94
Service cost................................... 99 92
Plan participants' contributions............... 61 73
Foreign currency changes....................... (1) 6
Benefit payments and transfers................. (694) (665)
---------------
Benefit obligation at end of year.............. $11,243 $11,156
===============
(b) Change in plan assets
In millions Year ended December 31, 2002 2001
---------------------------------------------------------------
Fair value of plan assets at beginning of year. $11,763 $12,455
Employer contributions......................... 92 69
Plan participants' contributions............... 61 73
Foreign currency changes....................... (1) 6
Actual return on plan assets................... (39) (175)
Benefit payments and transfers................. (694) (665)
---------------
Fair value of plan assets at end of year....... $11,182 $11,763
===============
(c) Funded status
In millions December 31, 2002 2001
---------------------------------------------------------------
Excess (deficiency) of fair value of plan assets
over benefit obligation at end of year (1).....$ (61) $ 607
Unrecognized net actuarial (gain) loss (1)........ 282 (537)
Unrecognized net transition obligation............ 19 39
Unrecognized prior service cost................... 113 133
---------------
Net amount recognized............................. $353 $ 242
===============
(1) Subject to future reduction for gain sharing under the terms of the plan.
(d) Amount recognized in the Consolidated Balance Sheet
In millions December 31, 2002 2001
----------------------------------------------------------------
Prepaid benefit cost (Note 6)..................... $353 $251
Accrued benefit cost.............................. - (9)
---------------
Net amount recognized............................. $353 $242
===============
(e) Components of net periodic benefit cost
In millions Year ended December 31, 2002 2001 2000
----------------------------------------------------------------
Interest cost........................... $ 714 $ 701 $ 690
Service cost............................ 99 92 70
Amortization of net transition
obligation ........................... 20 20 19
Amortization of prior service cost...... 20 20 19
Expected return on plan assets.......... (874) (846) (792)
Recognized net actuarial loss........... 1 - -
------------------------
Net periodic benefit cost (income)......$ (20) $ (13) $ 6
=======================
Canadian GAAP
108 Canadian National Railway Company
Notes to Consolidated Financial Statements
(f) Weighted-average assumptions
December 31, 2002 2001 2000
----------------------------------------------------------------
Discount rate.......................... 6.50% 6.50% 6.50%
Rate of compensation increase.......... 4.00% 4.00% 4.25%
Expected return on plan assets for
year ending December 31............. 9.00% 9.00% 9.00%
----------------------------------------------------------------
Effective January 1, 2003, the Company will reduce the expected long-term
rate of return on plan assets from 9% to 8% to reflect management's current
view of long-term investment returns. The effect of this change in management's
assumption will be to increase net periodic benefit cost in 2003 by
approximately $50 million.
The Company has indemnified and held harmless the current trustee and the
former trustee of the Canadian National Railways Pension Trust Funds, and the
respective officers, directors, employees and agents of such trustees, from any
and all taxes, claims, liabilities, damages, costs and expenses arising out of
the performance of their obligations under the relevant trust agreements and
trust deeds, including in respect of their reliance on authorized instructions
of the Company or for failing to act in the absence of authorized instructions.
These indemnifications survive the termination of such agreements or trust
deeds. As at December 31, 2002, the Company has not recorded a liability
associated with these indemnifications, as the Company does not expect to make
any payments pertaining to these indemnifications.
14 Workforce reduction charges
In 2002, the Company announced 1,146 job reductions, in a renewed drive to
improve productivity in all its corporate and operating functions, and recorded
a charge of $120 million, $79 million after tax. In 2001, a charge of $98
million, $62 million after tax, was recorded for the reduction of 690
positions. Reductions relating to these charges were 388 in 2001, 433 in 2002,
with the remainder to be completed by the end of 2003. The charges included
payments for severance, early retirement incentives and bridging to early
retirement, to be made to affected employees.
15 Interest expense
In millions Year ended December 31, 2002 2001 2000
----------------------------------------------------------------
Interest on long-term debt.............. $353 $314 $306
Interest income......................... - (2) (11)
---------------------
$353 $312 $295
=====================
Cash interest payments.................. $390 $307 $299
=====================
16 Other income
In millions Year ended December 31, 2002 2001 2000
---------------------------------------------------------------
Gain on disposal of properties........... $ 41 $ 53 $ 57
Equity in earnings of English Welsh
and Scottish Railway (Note 6)......... 33 8 -
Investment income........................ 18 22 -
Foreign exchange gain.................... 12 7 10
Gain on sale of interest in Detroit River
Tunnel Company (A).................... - 101 -
Write-down of investment
in 360networks Inc. (Note 6).......... - (99) -
Gain on exchange of investment (Note 6).. - - 84
Net real estate costs.................... (15) (20) (22)
Other.................................... (13) (7) (3)
---------------------
$ 76 $ 65 $126
=====================
A. In March 2001, the Company completed the sale of its 50 percent interest in
the Detroit River Tunnel Company (DRT) for proceeds of $112 million and
recorded a gain of $101 million, $82 million after tax. The DRT is a 1.6 mile
rail-only tunnel crossing the Canada-U.S. border between Detroit and Windsor,
Ontario.
17 Income taxes
The Company's consolidated effective income tax rate differs from the statutory
Federal tax rate. The reconciliation of income tax expense is as follows:
In millions Year ended December 31, 2002 2001 2000
---------------------------------------------------------------
Federal tax rate....................... 26.1% 28.1% 29.1%
Income tax expense at the statutory
Federal tax rate.................... $(219) $ (314) $ (353)
Income tax (expense) recovery
resulting from:
Provincial and other taxes.......... (97) (134) (148)
Deferred income tax adjustment
due to rate reductions............ - - (4)
U.S. tax rate differential.......... 1 1 7
Gain on disposals and dividends..... 6 27 20
Other............................... 41 28 36
-----------------------
Income tax expense..................... $ (268) $ (392) $ (442)
=======================
Income before income taxes
Canada.............................. $ 900 $ 955 $ 999
U.S................................. (61) 164 217
-----------------------
$ 839 $1,119 $1,216
=======================
Current income taxes
Canada.............................. $ (130) $ (99) $ (153)
U.S................................. 18 14 (71)
-----------------------
$ (112) $ (85) $ (224)
=======================
Deferred income taxes
Canada.............................. $ (161) $ (226) $ (228)
U.S................................. 5 (81) 10
-----------------------
$ (156) $ (307) $ (218)
=======================
Cash payments for income taxes......... $ 65 $ 63 $ 101
=======================
Canadian GAAP
Canadian National Railway Company 109
Notes to Consolidated Financial Statements
17 Income taxes (continued)
Significant components of deferred income tax assets and liabilities are
as follows:
In millions December 31, 2002 2001
---------------------------------------------------------------
Deferred income tax assets
Workforce reduction provisions.................. $ 144 $ 178
Accruals and other reserves..................... 263 182
Post-retirement benefits........................ 99 85
Losses and tax credit carryforwards............. 69 53
--------------
575 498
--------------
Deferred income tax liabilities
Properties and other............................ 4,278 4,074
--------------
Total net deferred income tax liability......... 3,703 3,576
Net current deferred income tax asset........... 122 153
--------------
Net long-term deferred income tax liability..... $3,825 $3,729
==============
Net deferred income tax liability
Canada....................................... $ 436 $ 291
U.S.......................................... 3,267 3,285
--------------
$3,703 $3,576
==============
The Company expects to realize its deferred income tax assets from the
generation of future taxable income, as the related payments are made and
losses and tax credits carryforwards are utilized.
The Company recognized tax credits of $9 million in 2002 for research and
development expenditures ($35 million in 2001 for investment tax credits) not
previously recognized, which reduced the cost of properties.
18 Segmented information
The Company operates in one business segment with operations and assets in
Canada and the United States.
Information on geographic areas
In millions Year ended December 31, 2002 2001 2000
---------------------------------------------------------------
Revenues:
Canadian rail....................... $3,726 $3,675 $3,668
U.S. rail........................... 2,384 1,977 1,778
-----------------------
$6,110 $5,652 $5,446
=======================
Operating income:
Canadian rail ...................... $ 954 $ 966 $1,025
U.S. rail .......................... 162 400 360
-----------------------
$1,116 $1,366 $1,385
=======================
Net income:
Canadian rail ...................... $ 577 $ 591 $ 589
U.S. rail .......................... (6) 136 185
-----------------------
$ 571 $ 727 $ 774
=======================
In millions Year ended December 31, 2002 2001 2000
---------------------------------------------------------------
Depreciation and amortization:
Canadian rail (A) .................. $ 278 $ 255 $ 232
U.S. rail .......................... 228 214 189
-----------------------
$ 506 $ 469 $ 421
=======================
Capital expenditures: (B)
Canadian rail (C) .................. $ 491 $ 484 $ 541
U.S. rail .......................... 194 177 215
---------------------------------------------------------------
$ 685 $ 661 $ 756
=======================
In millions December 31, 2002 2001
---------------------------------------------------------------
Identifiable assets:
Canadian rail............................... $ 7,402 $ 6,987
U.S. rail (D)............................... 11,522 11,801
-----------------------
$18,924 $18,788
=======================
(A) Includes $7 million (2001: $6 million, 2000: $9 million) of depreciation
and amortization of properties related to other business activities.
(B) Represents additions to properties that include non-cash capital
expenditures financed through capital lease arrangements.
(C) Includes $4 million (2001: $5 million, 2000: $9 million) of additions to
properties related to other business activities.
(D) Includes equity holdings in foreign investments held by the Company's U.S.
subsidiaries.
19 Earnings per share
The 2000 comparative figures have been restated to conform to the new
accounting standard as explained in Note 2. The amended CICA Section 1650
"Foreign Currency Translation" requires restatement of prior years' income and,
as such, earnings per basic and diluted share for 2000 have increased by $0.01,
respectively.
Year ended December 31, 2002 2001 2000
----------------------------------------------------------------
Basic earnings per share................ $2.87 $3.72 $3.91
Diluted earnings per share.............. $2.82 $3.62 $3.82
======================
The following table provides a reconciliation between basic and diluted
earnings per share:
In millions Year ended December 31, 2002 2001 2000
----------------------------------------------------------------
Net income.............................. $571 $727 $774
Dividends on convertible preferred
securities (Note 11)................. 6 12 11
----------------------
$565 $715 $763
======================
Weighted-average shares outstanding..... 196.7 192.1 195.0
Effect of dilutive securities and
stock options ....................... 6.1 8.9 7.8
======================
Weighted-average diluted shares
outstanding ......................... 202.8 201.0 202.8
======================
At December 31, 2002, 3.2 million stock options at a weighted- average
exercise price of $77.56 were not included in the calculation of diluted
earnings per share since their inclusion would have had an anti-dilutive
impact.
Canadian GAAP
110 Canadian National Railway Company
Notes to Consolidated Financial Statements
20 Major commitments and contingencies
A. Leases
The Company has lease commitments for locomotives, freight cars and intermodal
equipment, many of which provide the option to purchase the leased items at
fixed values during or at the end of the lease term. As at December 31, 2002,
the Company's commitments under operating and capital leases are $1,154 million
and $1,407 million, respectively. Annual net minimum payments in each of the
next five years and thereafter, are as follows:
Year In millions Operating Capital
--------------------------------------------------------------------------
2003 ........................................ $ 212 $ 168
2004 ........................................ 188 153
2005 ........................................ 167 111
2006 ........................................ 139 68
2007 ........................................ 120 123
2008 and thereafter.......................... 328 784
--------------------
$1,154 1,407
Less: imputed interest on capital leases at rates
ranging from approximately 3.0% to 14.6%.................... 498
------
Present value of minimum lease payments
at current rate included in debt............................ $ 909
======
Rent expense for operating leases was $269 million, $258 million and $219
million for the years ended December 31, 2002, 2001 and 2000, respectively.
Contingent rentals and sublease rentals were not significant.
The Company has guaranteed a portion of the residual values of certain of
its assets under operating leases with expiry dates between 2004 and 2012, for
the benefit of the lessor. If the fair value of the assets, at the end of their
respective lease term, is less than the fair value, as estimated at the
inception of the lease, then the Company must, under certain conditions,
compensate the lessor for the shortfall. The maximum exposure in respect of
these guarantees is $63 million. As at December 31, 2002, the Company has not
recorded a liability associated with these guarantees, as the Company does not
expect to make any payments pertaining to the guarantees of these leases.
B. Other commitments
As at December 31, 2002, the Company had commitments to acquire railroad ties,
rail, freight cars and locomotives at an aggregate cost of $183 million.
Furthermore, as at December 31, 2002, the Company had entered into agreements
with fuel suppliers to purchase approximately 38% of its anticipated 2003
volume and 8% of its anticipated 2004 volume at market prices prevailing on the
date of the purchase.
C. Contingencies
In the normal course of its operations, the Company becomes involved in various
legal actions, including claims relating to personal injuries, occupational
disease and damage to property.
In Canada, employee injuries are governed by the workers' compensation
legislation in each province whereby employees may be awarded either a lump sum
or future stream of payments depending on the nature and severity of the
injury. Accordingly, the Company accounts for costs related to employee
work-related injuries based on actuarially developed estimates of the ultimate
cost associated with such injuries, including compensation, health care and
administration costs. For all other legal actions, the Company maintains, and
regularly updates on a case-by-case basis, provisions for such items when the
expected loss is both probable and can be reasonably estimated based on
currently available information.
In the United States, employee work-related injuries, including
occupational disease claims, are compensated according to the provisions of the
Federal Employers' Liability Act (FELA) and represent a major expense for the
railroad industry. The FELA system, which requires either the finding of fault
through the U.S. jury system or individual settlements, has contributed to the
significant increase in the Company's personal injury expense in recent years.
In view of the Company's growing presence in the United States and the increase
in the number of occupational disease claims over the past few years, an
actuarial study was conducted in 2002, and in the fourth quarter of 2002 the
Company changed its methodology for estimating its liability for U.S. personal
injury and other claims, including occupational disease claims and claims for
property damage, from a case-by-case approach to an actuarial-based approach.
Consequently, and as discussed in Note 2, the Company recorded a charge of $281
million ($173 million after tax) to increase its provision for these claims.
Under the actuarial-based approach, the Company accrues the cost for the
expected personal injury and property damage claims and existing occupational
disease claims, based on actuarial estimates of their ultimate cost. The
Company is unable to estimate the total cost for unasserted occupational
disease claims. However, a liability for unasserted occupational disease claims
is accrued to the extent they are probable and can be reasonably estimated.
Under the case-by-case approach, the Company was accruing the cost for
claims as incidents were reported based on currently available information. In
addition, the Company did not record a liability for unasserted claims, as such
amounts could not be reasonably estimated under the case-by-case approach.
The Company's expenses for personal injury and other claims, net of
recoveries, and including the above-mentioned charge, were $393 million in
2002, ($78 million in 2001 and $60 million in 2000) and payments for such items
were $156 million in 2002 ($149 million in 2001 and $111 million in 2000). As
at December 31, 2002, the Company had aggregate reserves for personal injury
and other claims of $664 million ($430 million at December 31, 2001).
Although the Company considers such provisions to be adequate for all its
outstanding and pending claims, the final outcome with respect to actions
outstanding or pending at December 31, 2002, or with respect to future claims,
cannot be predicted with certainty, and therefore there can be no assurance
that their resolution will not have a material adverse effect on the Company's
financial position or results of operations in a particular quarter or fiscal
year.
Canadian GAAP
Canadian National Railway Company 111
Notes to Consolidated Financial Statements
20 Major commitments and contingencies (continued)
D. Environmental matters
The Company's operations are subject to federal, provincial, state, municipal
and local regulations under environmental laws and regulations concerning,
among other things, emissions into the air; discharges into waters; the
generation, handling, storage, transportation, treatment and disposal of waste,
hazardous substances, and other materials; decommissioning of underground and
aboveground storage tanks; and soil and groundwater contamination. A risk of
environmental liability is inherent in railroad and related transportation
operations; real estate ownership, operation or control; and other commercial
activities of the Company with respect to both current and past operations. As
a result, the Company incurs significant compliance and capital costs, on an
ongoing basis, associated with environmental regulatory compliance and clean-up
requirements in its railroad operations and relating to its past and present
ownership, operation or control of real property.
While the Company believes that it has identified the costs likely to be
incurred in the next several years, based on known information, for
environmental matters, the Company's ongoing efforts to identify potential
environmental concerns that may be associated with its properties may lead to
future environmental investigations, which may result in the identification of
additional environmental costs and liabilities. The magnitude of such
additional liabilities and the costs of complying with environmental laws and
containing or remediating contamination cannot be reasonably estimated due to:
(i) the lack of specific technical information available with respect
to many sites;
(ii) the absence of any government authority, third-party orders, or
claims with respect to particular sites;
(iii) the potential for new or changed laws and regulations and for
development of new remediation technologies and uncertainty
regarding the timing of the work with respect to particular
sites;
(iv) the ability to recover costs from any third parties with respect
to particular sites; and
therefore, the likelihood of any such costs being incurred or whether such
costs would be material to the Company cannot be determined at this time. There
can thus be no assurance that material liabilities or costs related to
environmental matters will not be incurred in the future, or will not have a
material adverse effect on the Company's financial position or results of
operations in a particular quarter or fiscal year, or that the Company's
liquidity will not be adversely impacted by such environmental liabilities or
costs. Although the effect on operating results and liquidity cannot be
reasonably estimated, management believes, based on current information, that
environmental matters will not have a material adverse effect on the Company's
financial condition or competitive position. Costs related to any future
remediation will be accrued in the year in which they become known.
As at December 31, 2002, the Company had aggregate accruals for
environmental costs of $106 million ($112 million as at December 31, 2001).
During 2002, payments of $16 million were applied to the provision for
environmental costs compared to $14 million in 2001 and $11 million in 2000.
The Company anticipates that the majority of the liability at December 31, 2002
will be paid out over the next five years.
In addition, related environmental capital expenditures were $19 million
in both 2002 and 2001 and $20 million in 2000. The Company expects to incur
capital expenditures relating to environmental matters of approximately $20
million in each of 2003 and 2004 and $17 million in 2005.
E. Standby letters of credit
The Company, including certain of its subsidiaries, has granted irrevocable
standby letters of credit, issued by highly rated banks, to third parties to
indemnify them in the event the Company does not perform its contractual
obligations. As at December 31, 2002, the maximum potential liability under
these letters of credit was $403 million of which $334 million was for workers'
compensation and other employee benefits and $69 million was for equipment
under leases and other.
As at December 31, 2002, the Company has not recorded a liability with
respect to these guarantees, as the Company does not expect to make any
payments in excess of what is recorded on the Company's financial statements
for the aforementioned items. The standby letters of credit mature at various
dates between 2003 and 2007.
F. 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; (b) contracts granting
rights to others to use the Company's property, such as leases, licenses and
easements; (c) contracts for the sale of assets; (d) contracts for the
acquisition of services; (e) financing agreements; (f) trust indentures or
fiscal agency agreements or similar agreements relating to debt or equity
securities of the Company and engagement agreements with financial advisors;
(g) transfer agent and registrar agreements in respect of the Company's
securities; and (h) trust agreements establishing trust funds to secure the
payment to certain officers and senior employees of special retirement
compensation arrangements or plans. 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 payment cannot be determined with certainty,
however, may be material.
Canadian GAAP
112 Canadian National Railway Company
Notes to Consolidated Financial Statements
21 Financial instruments
A. Risk management
The Company has limited involvement with derivative financial instruments in
the management of its fuel, foreign currency and interest rate exposures, and
does not use them for trading purposes.
(i) Credit risk
In the normal course of business, the Company monitors the financial condition
of its customers and reviews the credit history of each new customer.
The Company is exposed to credit risk in the event of non-performance by
counterparties to its derivative financial instruments. Although collateral or
other security to support financial instruments subject to credit risk is
usually not obtained, counterparties are of high credit quality and their
credit standing or that of their guarantor is regularly monitored. As a result,
losses due to counterparty non-performance are not anticipated. The total risk
associated with the Company's counterparties was immaterial at December 31,
2002. The Company believes there are no significant concentrations of credit
risk.
(ii) Fuel
To mitigate the effects of fuel price changes on its operating margins and
overall profitability, the Company has a systematic hedging program which calls
for regularly entering into swap positions on crude and heating oil to cover a
target percentage of future fuel consumption up to two years in advance.
Realized gains and losses from the Company's fuel hedging activities were
a $3 million gain, a $6 million loss and a $49 million gain for the years ended
December 31, 2002, 2001 and 2000, respectively. At December 31, 2002, the
Company has hedged approximately 47% of the estimated 2003 fuel consumption and
25% of the estimated 2004 fuel consumption. This represents approximately 263
million U.S. gallons at an average price of U.S.$0.5865 per U.S. gallon.
Unrecognized gains and losses from the Company's fuel hedging activities were a
$30 million gain, a $38 million loss and a $17 million loss as at December 31,
2002, 2001 and 2000, respectively.
(iii) Foreign currency
Although the Company conducts its business and receives revenues primarily in
Canadian dollars, a growing portion of its revenues, expenses, assets and debt
are denominated in U.S. dollars. Thus, the Company's results are affected by
fluctuations in the exchange rate between these currencies. Changes in the
exchange rate between the Canadian dollar and other currencies (including the
U.S. dollar) make the goods transported by the Company more or less competitive
in the world marketplace and thereby affect the Company's revenues and
expenses.
For the purpose of minimizing volatility of earnings resulting from the
conversion of U.S. dollar denominated long-term debt into the Canadian dollar,
the Company has designated all U.S. dollar denominated long-term debt of the
parent company as a foreign exchange hedge of its net investment in U.S.
subsidiaries. As a result, from the dates of designation, unrealized foreign
exchange gains and losses on the translation of the Company's U.S. dollar
denominated long-term debt are recorded in Currency translation, which forms
part of Shareholders' equity.
(iv) Interest rates
From time to time, the Company enters into interest rate swap transactions for
the purpose of minimizing the volatility in the fair value of certain
fixed-interest long-term debt. In 2002 and 2001, the Company did not enter into
any interest rate swap transactions.
(v) Other
The Company does not currently have any derivative instruments not designated
as hedging instruments.
B. Fair value of financial instruments
Generally accepted accounting principles define the fair value of a financial
instrument as the amount at which the instrument could be exchanged in a
current transaction between willing parties. The Company uses the following
methods and assumptions to estimate the fair value of each class of financial
instruments for which the carrying amounts are included in the Consolidated
Balance Sheet under the following captions:
(i) Cash and cash equivalents, Accounts receivable, Accounts payable and
accrued charges, and Other current liabilities:
The carrying amounts approximate fair value because of the short maturity of
these instruments.
(ii) Other assets and deferred charges:
Investments: The Company has various debt and equity investments for which the
carrying value approximates the fair value, with the exception of a cost
investment for which the fair value was estimated based on the Company's
proportionate share of its net assets.
(iii) Long-term debt:
The fair value of the Company's long-term debt is estimated based on the quoted
market prices for the same or similar debt instruments, as well as discounted
cash flows using current interest rates for debt with similar terms, company
rating, and remaining maturity.
(iv) Convertible preferred securities:
In 2001, the fair value of the Company's convertible preferred securities was
estimated based on the quoted market price.
Canadian GAAP
Canadian National Railway Company 113
Notes to Consolidated Financial Statements
21 Financial instruments (continued)
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments as at December 31, 2002 and 2001
for which the carrying values on the Consolidated Balance Sheet are different
from the fair values:
In millions December 31, 2002 December 31, 2001
--------------------------------------------------------------------------------
Carrying Fair Carrying Fair
amount value amount value
--------------------------------------------------------------------------------
Financial assets
Investments....................... $ 380 $ 440 $ 496 $ 551
Financial liabilities
Long-term debt
(including current portion).... $5,577 $5,738 $5,927 $5,986
Other
Convertible preferred securities.. $ - $ - $ 327 $ 479
--------------------------------------------------------------------------------
22 Reconciliation of Canadian and United States generally accepted accounting
principles
The consolidated financial statements of Canadian National Railway Company are
expressed in Canadian dollars and are prepared in accordance with Canadian GAAP
which conform, in all material respects, with U.S. GAAP except as described
below:
A. Reconciliation of net income
The application of U.S. GAAP would have the following effects on the net income
as reported:
In millions Year ended December 31, 2002 2001 2000
-------------------------------------------------------------------------
Net income - Canadian GAAP .................... $ 571 $727 $774
Adjustments in respect of:
Property capitalization,
net of depreciation ..................... 363 339 278
Interest on convertible preferred
securities .............................. (9) (19) (18)
Stock-based compensation cost .............. (9) (19) (3)
Income tax rate reductions ................. - 122 (4)
Income tax expense on current year
U.S. GAAP adjustments .................... (116) (110) (90)
----------------------
Net income - U.S. GAAP ........................ $ 800 $1,040 $937
======================
(i) Property capitalization
Under Canadian GAAP, the Company capitalizes only the material component of
track replacement costs, to the extent it meets the Company's minimum threshold
for capitalization, whereas under U.S. GAAP the labor, material and related
overheads are capitalized. Furthermore, the Company capitalizes under U.S. GAAP
all major expenditures for work that extends the useful life and/or improves
the functionality of bridges and other structures and freight cars.
(ii) Stock-based compensation
As explained in Note 2, effective January 1, 2002, the Company adopted the CICA
recommendations related to the accounting for stock-based compensation and
other stock-based payments. The Company has elected to prospectively apply the
recommendations to its awards of conventional and performance-based employee
stock options granted on or after January 1, 2002. Compensation cost
attributable to performance-based employee stock option awards granted before
such date continues to be a reconciling difference.
(iii) Convertible preferred securities
As explained in Note 11, the Convertible preferred securities (Securities) were
converted into common shares of the Company on July 3, 2002. Prior to such
date, the Securities were treated as equity under Canadian GAAP, whereas under
U.S. GAAP they were treated as debt. Consequently, the interest on the
Securities until July 3, 2002 was treated as a dividend for Canadian GAAP but
as interest expense for U.S. GAAP.
(iv) Foreign exchange
In 2001, the Company early adopted the CICA amended recommendations of Section
1650 "Foreign Currency Translation," which essentially harmonizes Canadian and
U.S. accounting standards by eliminating the deferral and amortization of
unrealized translation gains or losses on foreign currency denominated monetary
items that have a fixed or ascertainable life extending beyond the end of a
fiscal year and recognizing them into net income immediately. As required by
the amended section, the Company has retroactively restated all prior period
financial statements presented.
(v) Income tax expense
In 2001, under U.S. GAAP, the Company recorded a reduction to its net deferred
income tax liability resulting from the enactment of lower corporate tax rates
in Canada. As a result, a deferred income tax recovery of $122 million was
recorded in the Consolidated statement of income and a deferred income tax
expense of $32 million was recorded in Other comprehensive income. For Canadian
GAAP purposes, there was no adjustment in 2001 as the impact resulting from
lower corporate tax rates was accounted for in 2000 when the rates were
substantively enacted. For the year ended December 31, 2000, the Canadian GAAP
adjustment was a $4 million expense as the deferred tax position under Canadian
GAAP was different.
Canadian GAAP
114 Canadian National Railway Company
Notes to Consolidated Financial Statements
B. Earnings per share
In 2000, the Company early adopted the CICA recommendations related to the
presentation of earnings per share. Although the standard essentially
harmonizes Canadian and U.S. standards, the earnings per share calculations
continue to differ due to differences in the earnings figures.
(i) Basic earnings per share
Year ended December 31, 2002 2001 2000
---------------------------------------------------------------------
Net income - U.S. GAAP ..................... $4.07 $5.41 $4.81
Weighted-average number of common shares
outstanding (millions) - U.S. GAAP ...... 196.7 192.1 195.0
-----------------------
(ii) Diluted earnings per share
Year ended December 31, 2002 2001 2000
---------------------------------------------------------------------
Net income - U.S. GAAP ..................... $3.97 $5.23 $4.67
Weighted-average number of common shares
outstanding (millions) - U.S. GAAP ...... 202.8 201.0 202.8
------------------------
C. Reconciliation of significant balance sheet items
(i) Shareholders' equity
As permitted under Canadian GAAP, the Company eliminated its accumulated
deficit of $811 million as of June 30, 1995 through a reduction of the capital
stock in the amount of $1,300 million, and created a contributed surplus of
$489 million. Such a reorganization within Shareholders' equity is not
permitted under U.S. GAAP.
Under Canadian GAAP, the dividend in kind declared in 1995 (with respect
to land transfers) and other capital transactions were deducted from
Contributed surplus. For U.S. GAAP purposes, these amounts would have been
deducted from Retained earnings.
Under Canadian GAAP, costs related to the sale of shares have been
deducted from Contributed surplus. For U.S. GAAP purposes, these amounts would
have been deducted from Capital stock.
Under Canadian GAAP, the excess in cost over the stated value resulting
from the repurchase of shares was allocated first to Capital stock, then to
Contributed surplus and finally to Retained earnings. Under U.S. GAAP, the
excess would have been allocated to Capital stock followed by Retained
earnings.
For Canadian and U.S. GAAP purposes, the Company designated all U.S.
dollar denominated long-term debt of the parent company as a foreign exchange
hedge of its net investment in U.S. subsidiaries. Under Canadian GAAP, the
resulting net unrealized foreign exchange gain, from the date of designation,
has been included in Currency translation. For U.S. GAAP purposes, the
resulting net unrealized foreign exchange gain has been included as part of
Accumulated other comprehensive income, a separate component of Shareholders'
equity, as required under Statement of Financial Accounting Standards (SFAS)
No. 130, "Reporting Comprehensive Income."
(ii) Minimum pension liability adjustment
In 2002 and 2001, one of the Company's pension plans had an accumulated benefit
obligation in excess of the fair value of the plan assets. Under U.S. GAAP,
this gave rise to an additional minimum pension liability. An intangible asset
was recognized up to the amount of the unrecognized prior service cost and the
difference has been recorded in Accumulated other comprehensive income, a
separate component of Shareholders' equity. There are no requirements under
Canadian GAAP to record a minimum pension liability adjustment.
(iii) Derivative instruments
On January 1, 2001, under U.S. GAAP, the Company adopted SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities," as amended by
SFAS No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging
Activities." In accordance with these statements, the Company has recorded in
its balance sheet the fair value of derivative instruments used to hedge a
portion of the Company's fuel requirements. Changes in the market value of
these derivative instruments have been recorded in Accumulated other
comprehensive income, a separate component of Shareholders' equity. There are
no similar requirements under Canadian GAAP.
(iv) Convertible preferred securities
As explained in Note 11, the Convertible preferred securities (Securities) were
converted into common shares of the Company on July 3, 2002. Prior to such
date, the Securities were treated as equity under Canadian GAAP, whereas under
U.S. GAAP they were treated as debt. Consequently, the initial costs related to
the issuance of the Securities, net of amortization, which were previously
deferred and amortized for U.S. GAAP, have since been reclassified to equity.
Canadian GAAP
Canadian National Railway Company 115
Notes to Consolidated Financial Statements
22 Reconciliations of Canadian and United States generally
accepted accounting principles (continued)
(v) The application of U.S. GAAP would have a significant effect on the
following balance sheet items as reported:
In millions December 31, 2002 2001
----------------------------------------------------------------
Current assets - Canadian GAAP................. $ 1,163 $ 1,164
Fuel derivative instruments.................... 29 -
----------------
Current assets - U.S. GAAP..................... $ 1,192 $ 1,164
===============
Properties - Canadian GAAP..................... $16,898 $16,723
Property capitalization, net of depreciation... 2,783 2,422
----------------
Properties - U.S. GAAP......................... $19,681 $19,145
===============
Other assets and deferred charges -
Canadian GAAP ............................... $ 863 $ 901
Fuel derivative instruments.................... 1 -
Intangible asset............................... 1 1
Debt issue costs............................... - 12
----------------
Other assets and deferred charges - U.S. GAAP.. $ 865 $ 914
===============
Current liabilities - Canadian GAAP............ $ 2,134 $ 1,638
Fuel derivative instruments.................... - 31
----------------
Current liabilities - U.S. GAAP................ $ 2,134 $ 1,669
===============
Deferred income tax liability -
Canadian GAAP ............................... $ 3,825 $ 3,729
Cumulative effect of prior years'
adjustments to income ....................... 955 845
Income taxes on current year U.S.
GAAP adjustments ............................ 116 110
Income taxes on translation of U.S. to
Canadian GAAP adjustments................... 16 13
Income taxes on minimum pension liability
adjustment .................................. (13) (6)
Income taxes on fuel derivative instruments.... 10 (13)
Income tax rate reductions..................... (86) (86)
Other.......................................... 3 (1)
----------------
Deferred income tax liability - U.S. GAAP...... $ 4,826 $ 4,591
===============
Other liabilities and deferred credits -
Canadian GAAP .............................. $ 1,335 $ 1,296
Stock-based compensation....................... 33 24
Minimum pension liability adjustment........... 38 18
Fuel derivative instruments.................... - 7
----------------
Other liabilities and deferred credits
- U.S. GAAP $ 1,406 $ 1,345
===============
Capital stock - Canadian GAAP.................. $ 3,558 $ 3,209
Capital reorganization......................... 1,300 1,300
Stock-based compensation....................... 49 48
Foreign exchange loss on convertible
preferred securities ........................ 12 -
Costs related to the sale of shares............ (33) (33)
Share repurchase program....................... (101) (82)
----------------
Capital stock - U.S. GAAP...................... $ 4,785 $ 4,442
===============
In millions December 31, 2002 2001
----------------------------------------------------------------
Convertible preferred securities -
Canadian GAAP ............................... $ - $ 327
Debt issue costs............................... - 12
Foreign exchange loss on convertible
preferred securities ........................ - 27
----------------
Convertible preferred securities
(classified as debt) - U.S. GAAP............ $ - $ 366
===============
Contributed surplus - Canadian GAAP............ $ 175 $ 178
Dividend in kind with respect to land
transfers ................................... 248 248
Costs related to the sale of shares............ 33 33
Other transactions and related
income tax effect........................... 18 18
Share repurchase program....................... 15 12
Capital reorganization......................... (489) (489)
----------------
Contributed surplus - U.S. GAAP................ $ - $ -
===============
Currency translation - Canadian GAAP........... $ 132 $ 133
Unrealized foreign exchange gain (loss)
on U.S. to Canadian GAAP adjustments,
net of applicable taxes..................... 1 (7)
Fuel derivative instruments,
net of applicable taxes..................... 20 (25)
Income tax rate reductions..................... (32) (32)
Minimum pension liability adjustment,
net of applicable taxes..................... (24) (11)
----------------
Accumulated other comprehensive
income - U.S. GAAP.......................... $ 97 $ 58
===============
Retained earnings - Canadian GAAP.............. $ 2,762 $ 2,514
Cumulative effect of prior years'
adjustments to income....................... 1,449 1,136
Current year adjustments to net income......... 229 313
Share repurchase program....................... 86 70
Cumulative dividend on convertible
preferred securities........................ 38 32
Capital reorganization......................... (811) (811)
Dividend in kind with respect to
land transfers.............................. (248) (248)
Other transactions and related
income tax effect........................... (18) (18)
----------------
Retained earnings - U.S. GAAP.................. $ 3,487 $ 2,988
===============
Canadian GAAP
116 Canadian National Railway Company
Notes to Consolidated Financial Statements
23 Quarterly financial data -- unaudited
In millions, except per share data
---------------------------------------------------------------------------------------------------------------------------------
2002 2001
First Second Third Fourth (1) First Second Third Fourth
---------------------------------------------------------------------------------------------------------------------------------
Revenues..................................... $1,509 $1,551 $1,503 $1,547 $1,398 $1,392 $1,325 $1,537
Operating income ............................ $ 372 $ 385 $ 362 $ (3) $ 362 $ 245 $ 331 $ 428
Net income .................................. $ 211 $ 212 $ 187 $ (39) $ 271 $ 40 $ 178 $ 238
Basic earnings per share .................... $ 1.08 $ 1.08 $ 0.93 $ (0.20) $ 1.40 $ 0.19 $ 0.91 $ 1.22
Diluted earnings per share .................. $ 1.04 $ 1.04 $ 0.92 $ (0.19) $ 1.36 $ 0.19 $ 0.88 $ 1.18
Dividend declared per share ................. $0.215 $0.215 $0.215 $ 0.215 $0.195 $0.195 $0.195 $0.195
===================================================================================
(1) In the fourth quarter of 2002, the Company recorded a charge of $281
million ($173 million after tax) to increase its liability for U.S.
personal injury and other claims and a charge for workforce reductions of
$120 million ($79 million after tax).
24 Comparative figures
Certain figures, previously reported for 2001 and 2000, have been reclassified
to conform with the basis of presentation adopted in the current year.
Canadian GAAP
Canadian National Railway Company 117
The CN Pension Plan and the CN 1935 Pension Plan
General review
Trustee
Effective January 1, 2002, CIBC Mellon Trust Company (CIBC Mellon) was
appointed as Trustee of the Canadian National Railways Pension Trust Funds (CN
Pension Trust Funds, or Funds), replacing Montreal Trust Company of Canada. As
Trustee, CIBC Mellon performs certain duties which include holding legal title
to the assets of the Funds and providing a certificate confirming that Canadian
National Railway Company (CN), as Administrator, complied with the provisions
of the CN Pension Plan, the CN 1935 Pension Plan and the Pension Benefits
Standards Act, 1985 and its regulations. The checks and direct deposit payments
in respect of these plans were issued in the name of the CN Pension Trust Funds
from bank accounts in the name of CIBC Mellon, Trustee of the CN Pension Trust
Funds.
Administration of the pension plans
Overall accountability for the pension and benefit administration is the
responsibility of CN. Mercer Human Resource Consulting, an employee benefits
consulting firm, performs agreed-on pension and benefit administration services
on behalf of CN.
Pension benefits
A. Pension improvements
The following pension improvements are effective January 1, 2002 and are based
on recommendations made by the Pension Committee in 2001 and approved by CN's
Board of Directors:
o The pension formula was increased from 1.6%/2.0% to 1.7%/2.0% for active
members on January 1, 2002, for each year of pensionable service from
January 1, 1966 for the CN Pension Plan only.
o The eligibility requirements to qualify for indexation were shortened from
age 60 and at least five complete calendar years since retirement to age
59 and at least four complete calendar years since retirement.
o Pensions were indexed at 75% of inflation rather than 60% of inflation for
the year 2002. Retirees and survivors who met the eligibility requirements
saw their 2002 pension increase by 2.25% instead of 1.8% on the first
$3,000 of basic monthly pension. This was a lifetime pension benefit
increase.
o A special improvement to pensions was paid to eligible retirees and
surviving spouses entitled to indexation on January 1, 2002, based on the
number of years that such retirees were on pension and their pensionable
service at the time of retirement. This was a lifetime pension benefit
increase.
In addition to these improvements, the CN Pension Plan was amended to
provide for a reduction in the basic employee contribution rates, subject to
certain conditions, from 5.48%/6.98% to 4.3%/6.3%, effective January 1, 2002.
This improvement reflected an agreement that CN reached with five of its six
unions on the implementation of an employee-paid Long Term Disability (LTD)
plan for unionized employees active on January 1, 2002 and thereafter. The
remaining union had established an employee-paid LTD plan in 1999 and the
members of such union also benefited from the contribution reductions, subject
to the same conditions applicable to the other unionized members. Disability
pensions under the CN Pension Plan will be reduced to reflect the benefit
payable under such employee-paid LTD plans.
The non-unionized employees also benefited from the contribution
reductions and the full cost of this reduction was charged to the Non-Unionized
Employees' Improvement Account as they have been covered by a CN-paid LTD plan
under the CN Flex Benefit Program for many years.
In 2002, CN's Board of Directors approved the recommendation made by the
Pension Committee to index pensions at 75% of inflation rather than 60% of
inflation for the year 2003. Therefore, retirees and survivors who meet the
eligibility requirements will see their 2003 pension increase by 1.275% instead
of 1.02% on the first $3,250 of basic monthly pension. This is a lifetime
pension benefit increase.
B. Indexation agreement and escalation account
As a result of the indexation agreement negotiated with the railway unions in
1989 and improvements to such agreement negotiated in 1992 and 1998,
approximately 41,500 retirees and surviving spouses received permanent pension
increases in 2002. These increases amounted to 2.25% on the first $3,000 of
basic CN monthly pension, with a guaranteed minimum monthly pension increase of
$9.00 for eligible retirees and $4.50 for eligible surviving spouses.
Under this indexation agreement, effective January 1, 1989, 50% of the
experience gains or losses related to pensioners are accounted for separately
in the Escalation Account. Net experience gains are used to pay for indexation
of pensions above the minimum up to the maximum annual amount. The maximum
annual indexation for eligible retirees and survivors is 60% (75% for the 2002
and 2003 indexation) of the increase in the Consumer Price Index (CPI) to a
maximum increase in CPI of 6%, with an annual limit on the amount of pension
which can be indexed.
The Pension Committee may recommend additional benefits for pensioners,
financed through the Escalation Account, if the balance in the account exceeds
a certain threshold. These additional benefits are subject to approval by CN's
Board of Directors. Such additional benefits were granted on January 1, 2002 as
indicated under section A. Pension improvements. In 2002, CN's Board of
Directors approved the Pension Committee's recommendation to increase maximum
indexation for 2003 only, effective January 1, 2003 as indicated under section
A. Pension improvements. The value of such improvements was charged to the
Escalation Account in the current valuation.
118 The CN Pension Plan and the CN 1935 Pension Plan
The CN Pension Plan and the CN 1935 Pension Plan
C. Improvement accounts
Effective January 1, 1998, the unions and CN agreed to share the experience
gains (losses) resulting from investment earnings related to active unionized
members of the CN Pension Plan, based on the same concept as the indexation
agreement. Under this agreement, annual calculations determine the amount of
experience gains or losses to be credited (debited) to an account referred to
as the Unionized Employees' Improvement Account. The balance of such account,
if positive, may be used to improve benefits of unionized active members or
reduce their contributions, as recommended by the Pension Committee and
approved by CN's Board of Directors. The improvement account concept was also
extended to non-unionized members and separate accounts were created for
unionized and non-unionized members.
The increase in the pension formula on January 1, 2002 as described under
section A. Pension improvements was financed through the Improvement Accounts
as of January 1, 2002.
Annual pension statements
As required by the Pension Benefits Standards Act, 1985 and to keep employees
who are members of the CN Pension Plan and the CN 1935 Pension Plan updated
annually on their personal entitlement, personalized pension statements were
prepared as at December 31, 2001 and distributed by June 2002.
Services to pensioners
A. Direct deposit:
The Direct Deposit System (DDS) is available to all retirees and survivors.
Under this system, the monthly pension benefit is deposited directly into the
individual's personal account. An itemized pension pay stub is sent to that
individual initially, each January and whenever the gross or net amount
changes. About 40,700 pensioners used this service in 2002.
B. Toll-free help lines:
Approximately 45,400 calls were handled in 2002 through the central toll-free
help line (1-800-361-0739). Staff handling the toll-free telephone line have
ready access to records and information required for quick, efficient and
accurate responses to most callers' needs - in both of Canada's official
languages.
Trustee's report
To the Administrator and the Members of the CN Pension Plan
and the CN 1935 Pension Plan
We, CIBC Mellon Trust Company, are the Trustee of the Canadian National
Railways Pension Trust Funds ("CN Pension Trust Funds").
As Trustee, we have appointed KPMG LLP to examine the systems, procedures
and internal controls used in respect to the custody, investment and
administration of the assets of the CN Pension Trust Funds, the administration
of the CN Pension Plan and the CN 1935 Pension Plan ("1935 Plan"), and the
performance of the Canadian National Railway Company ("CN") as Administrator of
the CN Pension Plan and the 1935 Plan for the year ended December 31, 2002.
Our examination included such tests and procedures as were considered
necessary in the circumstances taking into consideration the requirements of
the Trust Deeds and our experience in the Canadian pension industry.
In our opinion, based on the reasonable, but not absolute, degree of
assurance obtained from the examination performed, the aforementioned systems,
procedures and internal controls used by CN as Administrator, operated
effectively during the year ended December 31, 2002 and complied with the
objectives of the Pension Benefits Standards Act, 1985 and its Regulations.
(signed)
CIBC Mellon Trust Company
Trustee of the Canadian National Railways
Pension Trust Funds
Toronto, January 20, 2003
The CN Pension Plan and the CN 1935 Pension Plan 119
The CN Pension Plan and the CN 1935 Pension Plan
Actuary's report
To the Board of Directors of
Canadian National Railway Company
We have conducted actuarial valuations for funding purposes as at December 31,
2001 for the CN Pension Plan and the CN 1935 Pension Plan.
As at December 31, 2001, these valuations revealed a consolidated
actuarial liability of $10,486 million, a consolidated surplus of $482 million
and a current service cost net of plan members' contributions of $87 million in
2002. The next actuarial valuations will be conducted as at December 31, 2004,
at the latest.
In my opinion, for the purposes of the valuations,
o the data on which these valuations were based were sufficient and
reliable,
o the assumptions are, in aggregate, appropriate, and
o the methods employed in the valuations are appropriate.
We have also conducted actuarial valuations for accounting purposes as at
December 31, 2001 for the CN Pension Plan and the CN 1935 Pension Plan.
These valuations were made in accordance with the requirements of Section
3461 of the Handbook of the Canadian Institute of Chartered Accountants (CICA).
They revealed a consolidated actuarial liability of $10,933 million.
The difference between the results of the actuarial valuations conducted
for funding purposes and those conducted for accounting purposes is mainly due
to the CICA Section 3461 requirement to use an interest rate inherent in the
amount at which the actuarial liability could be settled at the date of
valuation.
Both valuations have been prepared and, my opinions given, in accordance
with accepted actuarial practice.
(signed)
Bernard Morency
Fellow of the Canadian Institute of Actuaries
Mercer Human Resource Consulting Limited
Montreal, January 21, 2003
Auditors' report
To the Board of Directors of
Canadian National Railway Company
We have audited the consolidated statement of net assets of the CN Pension Plan
and the CN 1935 Pension Plan as at December 31, 2002 and the consolidated
statement of changes in net assets for the year then ended. These financial
statements are the responsibility of the Administrator. Our responsibility is
to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with Canadian generally accepted
auditing standards. Those standards require that we plan and perform an audit
to obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by the Administrator, as well as evaluating the overall
financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in
all material respects, the net assets of the CN Pension Plan and the CN 1935
Pension Plan as at December 31, 2002 and the changes in their net assets for
the year then ended in accordance with Canadian generally accepted accounting
principles.
(signed)
KPMG LLP
Chartered Accountants
Montreal, Canada
January 20, 2003
120 The CN Pension Plan and the CN 1935 Pension Plan
Consolidated Statement of Net Assets at Market Value
In millions As at December 31, 2002 2001
-------------------------------------------------------------------------------
Bonds ............................................... $ 4,096 $ 3,733
Mortgages ........................................... 319 272
Real estate ......................................... 318 271
Oil and gas ......................................... 657 468
Equities ............................................ 5,565 6,033
Cash and short-term investments ..................... 143 890
---------------------
11,098 11,667
Receivable from Canadian National Railway Company ... 4 5
Net other liabilities ............................... (9) (1)
---------------------
$ 11,093 $ 11,671
======== ========
On behalf of the Board:
David G.A. McLean E. Hunter Harrison
Director Director
See accompanying notes to consolidated financial statements.
The CN Pension Plan and the CN 1935 Pension Plan 121
Consolidated Statement of Changes in Net Assets at Market Value
In millions Year ended December 31, 2002 2001
------------------------------------------------------------------------------------------------
Net assets at market value, beginning of year ........................... $ 11,671 $ 12,356
--------------------
Investment income
Bonds ........................................................... 240 238
Mortgages ....................................................... 23 18
Real estate ..................................................... 10 11
Oil and gas ..................................................... 52 48
Equities ........................................................ 84 88
Short-term investments .......................................... 14 20
--------------------
423 423
Less administrative expenses ............................................ (19) (18)
--------------------
Investment income before net gain (loss) on sale of investments ......... 404 405
Net gain (loss) on sale of investments .................................. (167) 486
--------------------
Total investment income ................................................. 237 891
--------------------
Unrealized depreciation in value of investments ......................... (268) (1,060)
--------------------
Contributions
Employees ....................................................... 61 73
Company ......................................................... 74 69
--------------------
Total contributions ..................................................... 135 142
--------------------
Disbursements for members
Pension benefits paid ........................................... (645) (618)
Refunds ......................................................... (37) (43)
--------------------
Total disbursements for members ......................................... (682) (661)
--------------------
Transfers ............................................................... - 3
--------------------
Net decrease ............................................................ (578) (685)
--------------------
Net assets at market value, end of year ................................. $ 11,093 $ 11,671
====================
See accompanying notes to consolidated financial statements.
122 The CN Pension Plan and the CN 1935 Pension Plan
Notes to Consolidated Financial Statements
1 Description of plans
These consolidated financial statements cover two pension plans, the CN Pension
Plan and the CN 1935 Pension Plan (CN Plans), and include the accounts of the
Canadian National Railways Pension Trust Funds and its wholly owned companies.
All references in these financial statements to the "Company" refer to Canadian
National Railway Company, which is the Administrator of the CN Plans. The CN
1935 Pension Plan is for a closed group of members and represents less than 1%
of the pension obligation of the plans. Therefore, the following is a
summarized description of the CN Pension Plan only. Please refer to the rules
of the CN Pension Plan for additional information.
A. General
The CN Pension Plan (the Plan) is a contributory defined benefit pension plan
generally applicable for employees from the first day of employment. Under this
Plan, employees contribute between 4.3% and 4.7% (5.48% and 5.88% prior to
January 1, 2002) of earnings up to the Year's Maximum Pensionable Earnings
(YMPE) under the Canada or Quebec Pension Plan and between 6.3% and 6.7% (6.98%
and 7.38% prior to January 1, 2002) of earnings in excess of the YMPE up to a
maximum of $4,989 in 2002. Participants are not required to make contributions
after 35 years of pensionable service. Company contributions are determined on
the basis of actuarial valuations done at least on a triennial basis in
accordance with the requirements of the Pension Benefits Standards Act, 1985
and Regulations thereunder.
B. Pensions
Pensions are based on the employee's average pensionable earnings for the best
five consecutive calendar years or the last 60 months of employment at the rate
of 2% for each year of pensionable service prior to January 1, 1966, 1.7% for
each year of pensionable service thereafter up to the average YMPE over the
last 60 months and 2% of the excess of such average pensionable earnings over
the average YMPE. The maximum annual pension payable is $1,715 multiplied by
the pensionable service of the member. Pensionable service is limited to 35
years.
C. Retirement age
The normal retirement age is 65. However, with the Company's consent, employees
who are at least 55 years of age and have 85 points (age plus years of
pensionable service) are entitled to an early retirement pension without
reduction. Employees with less than 85 points can retire anytime from age 55
with a reduction in their pension of 0.5% for each month (6% per year) between
their date of retirement and their 65th birthday.
D. Disability pensions
A member with 10 years of pensionable service who is declared either unfit to
perform his/her usual employment with the Company due to a permanent disability
which occurred prior to 1992, or totally and permanently disabled due to a
disability which occurred after 1991, may, subject to certain conditions, apply
for an immediate reduced or unreduced pension. Any declarations in respect of a
member's disability are the responsibility of CN's Chief Medical Officer. The
disability pension may be adjusted to take into account benefits payable under
a long-term disability plan or under a Workers' Compensation Act of any
province.
E. Pre-retirement survivors' pensions and death refunds
A survivor's pension is payable to the eligible spouse of a member who had a
minimum of two years of plan membership upon his/her death. Otherwise, a death
refund is payable to the spouse, or, if there is no spouse, to the estate of
the member.
F. Post-retirement survivors' pensions and estate settlements
Upon the death of a retiree who had an eligible spouse at retirement, either
55% or 60% of the basic pension of the retiree is payable to that spouse during
his/her lifetime depending on the option elected at retirement. The survivor's
pension is guaranteed for the first 10 years after retirement. If the retiree
and the surviving spouse, if any, die in the first 10 years after retirement,
the survivor's pension will be payable to the estate of the retiree until the
10-year period is over.
G. Termination benefits
Upon termination of service, a member is entitled to either his/her
contributions with interest or to the value of his/her benefits accrued under
the Plan or to a deferred pension or a combination of the above, depending on
his/her age, pensionable service and years of membership at termination.
H. Income taxes
The Plan is registered under the Income Tax Act and Regulations. Contributions
to the Plan are tax deductible to the Company and investment income of the
Canadian National Railways Pension Trust Funds is not taxable in Canada.
Investment income from some foreign countries is subject to withholding taxes,
which are either fully or partially recovered.
The CN Pension Plan and the CN 1935 Pension Plan 123
Notes to Consolidated Financial Statements
2 Summary of significant accounting policies
A. Basis of presentation
These consolidated financial statements are prepared on a market value basis,
in accordance with generally accepted accounting principles in Canada for
pension plans. Management is required to make estimates and assumptions that
affect the reported amounts at the date of the financial statements. Actual
results could differ from these estimates. These financial statements present
the aggregate financial position of the CN Plans as a separate financial
reporting entity independent of the sponsor and plan members, and are prepared
to assist plan members and others in reviewing the activities of the CN Plans
for the year and as such, do not portray the funding requirements of the CN
Plans nor the benefit security of individual members.
B. Investments
Investment transactions are recorded at the point when the risks and rewards of
ownership are transferred. Publicly traded securities are recorded on the trade
date.
Investments are stated at market value which is determined using publicly
quoted prices where available. When such prices are not available, market
values are estimated on the basis of the present value of estimated future net
cash flows, the market value of comparable assets, or the breakup value of
underlying assets.
Market values of investments are determined as follows:
(i) Bonds are valued using the closing market price as at December 31.
(ii) Mortgages are valued using current market yields of financial instruments
of similar maturity and at appropriate spreads from instruments of
comparable quality.
(iii) Real estate consists of land and buildings. Land is valued using the
market value of comparable assets, and buildings are valued using the
present value of estimated future net cash flows and the market value of
comparable assets. Independent valuations of land and buildings are
performed triennially.
(iv) Oil and gas reserves are valued using the present value of estimated
future net cash flows, which are based on projected production, prices,
and costs. Land is valued using the market value of comparable assets.
Trust units and equities are valued using the closing market price as at
December 31.
(v) Equities are valued using the closing market price as at December 31.
(vi) Short-term investments and other assets are valued at cost, which
approximates market value.
(vii) Listed derivative financial instruments are valued using the market
settlement price as at December 31. Unlisted derivative financial
instruments are valued using the present value of future net cash flows
determined by using closing market levels and interest rates for
instruments of similar maturity and credit risk.
The change in market value has been segregated in the Consolidated
Statement of Changes in Net Assets at Market Value between net gain (loss) on
sale of investments during the year and the unrealized appreciation
(depreciation) in value of investments, which represents the balance of the
change in market value of investments for the year.
C. Income recognition
Dividends are accrued on the ex-dividend date; income from other investments is
accrued as earned. Gains or losses realized on the sale of investments are
recognized on the dates of sales, are calculated based on the average cost of
the assets and are included in the Consolidated Statement of Changes in Net
Assets at Market Value as a net gain (loss) on sale of investments.
D. Foreign exchange
Assets and liabilities denominated in foreign currencies are translated using
current rates as at December 31 or at the forward foreign exchange contract
rates for investments that are hedged. Foreign dividends and interest income
are translated at the rates prevailing when accrued.
Unrealized foreign exchange gains and losses on investments incurred
during the year are included in unrealized appreciation (depreciation) in value
of investments. The net gain (loss) on sale of investments denominated in
foreign currencies includes the foreign exchange gain or loss realized on the
transaction.
E. Contributions
Contributions from employees are recorded in the period in which the Company
makes payroll deductions. The contributions from the Company, as determined by
the latest actuarial valuations, are recorded using the accrual method.
F. Transfers
Transfers to/from other funds are accounted for in the period in which the
value of the transfers can be reasonably estimated.
124 The CN Pension Plan and the CN 1935 Pension Plan
Notes to Consolidated Financial Statements
3 Investments
Investments consist of securities, assets or financial instruments where the CN
Plans' original intention is to hold to maturity or until market conditions
render alternative investments more attractive. Significant terms and
conditions related to investments as at December 31 are as follows:
Market risk
Market risk is the risk that the value of an investment will fluctuate
as a result of changes in market prices whether those changes are caused by
factors specific to the individual investment or its issuer, or factors
affecting all securities traded in the market. The CN Plans' policy is to
invest in a diversified portfolio of investments, based on criteria established
in the Statement of Investment Policies and Procedures, and may include the use
of derivative financial instruments to mitigate the impact of market risk.
Equities are diversified by issuer and by industry. The most significant
allocations to individual issuers or industry sectors are limited to 4.2% and
15.2%, (3.5% and 17.7% in 2001) respectively.
Foreign currency risk
Foreign currency exposure arises from investments denominated in currencies
other than the Canadian dollar. Fluctuations in foreign currency rates can
result in a positive or negative impact on the fair value of the CN Plans'
investments. The CN Plans' exposure to currencies, as a proportion of total
assets and after taking into account the effect of foreign currency derivatives
positions, is as follows:
As at December 31, 2002 2001
-------------------------------------------------------------------------------
Canada ....................................................... 78% 73%
United States of America ..................................... 11% 18%
Euro zone .................................................... 3% 4%
United Kingdom ............................................... 2% 2%
Japan ........................................................ 2% 1%
Other ........................................................ 4% 2%
-------------
Total ........................................................ 100% 100%
=============
Interest rate risk
Interestrate risk represents the risk that the market value of the CN Plans'
investments will fluctuate 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 CN Plans.
The term to maturity of interest rate sensitive investments, based on
contractual repricing dates, is as follows:
In millions, except percentage data As at December 31, 2002 2001
-----------------------------------------------------------------------------------------------------------------------------------
Term to maturity
------------------------------ Average Average
Within 1 1 to 5 Over 5 effective effective
year years years Total yield Total yield
-----------------------------------------------------------------------------------------------------------------------------------
Short-term investments .............................. $ 132 $ - $ - $ 132 2.78% $ 881 2.51%
Bonds ............................................... 34 1,637 2,425 4,096 4.59% 3,733 5.06%
Mortgages ........................................... - 76 243 319 5.44% 272 6.47%
----------------------------------------------------------------------------
Total ............................................... $ 166 $ 1,713 $ 2,668 $ 4,547 4.60% $ 4,886 4.68%
============================================================================
Credit risk
Credit risk arises from the potential for an investee to fail or a counterparty
to default on its contractual obligations to the CN Plans.
In accordance with formally established policies, the CN Plans manage
credit risk by dealing with counterparties considered to be of high credit
quality, utilizing an internal credit limit monitoring process as well as
credit mitigation techniques such as master netting and collateral agreements.
Short-term investments consist primarily of securities issued by Canadian
chartered banks. Seventy-eight percent (90% in 2001) of Bonds are issued or
guaranteed by Canadian or U.S. governments and 18% (9% in 2001) by
corporations. Mortgages are secured by real estate.
At year-end, the CN Plans' most significant exposures were with Canadian
governments which issued or guaranteed $3,200 million ($3,181 million in 2001)
of securities held by the CN Plans. Excluding the above, the remainder of
assets are diversified with no other issuer accounting for more than 2.1% (3.3%
in 2001) of total net assets. Credit risk resulting from the use by the CN
Plans of derivative financial instruments is addressed in Note 4.
The CN Pension Plan and the CN 1935 Pension Plan 125
Notes to Consolidated Financial Statements
4 Derivative financial instruments
From time to time, the CN Plans use derivative financial instruments
(derivatives) for asset mix management purposes or to hedge their exposures to
foreign currency, interest rate or market risks of the portfolio or anticipated
transactions. Derivatives are financial instruments whose value is derived from
interest rates, foreign exchange rates, equity or commodity prices. 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. Derivatives include forwards, futures, swaps and options. Types of
contracts used by the CN Plans include:
o Swaps, which are contractual agreements between two parties to exchange
fixed and/or floating rate payments based on a notional value.
o Forwards and futures, which are contractual agreements to either buy or
sell a specified currency or financial instrument at a specific price and
date in the future. Forwards are customized contracts transacted in the
over-the-counter market. Futures are standardized contracts traded on
regulated exchanges and are subject to daily cash margining.
The credit risk of derivative instruments is limited to the cost of
replacing, at current fair value, all contracts which have a positive value.
Credit risk on futures contracts is considered minimal as the counterparty to a
futures contract is a public exchange, contracts are marked-to- market and
margin receivables and payables are settled in cash daily.
The following table summarizes the derivatives portfolio of the CN Plans
and the related credit exposure:
As at December 31, 2002 2001
------------------------------------------------------------------------------------------------------------------------
Fair value (2) Fair value (2)
Notional ------------------- Notional -------------------
In millions value (1) Assets Liabilities value (1) Assets Liabilities
------------------------------------------------------------------------------------------------------------------------
Interest rate:
Swap contracts ...................... $ 50 $ 0.7 $ - $ 41 $ - $ 0.2
Futures contracts ................... 765 - - 294 - -
Foreign exchange:
Forward contracts ................... 1,209 1.7 7.5 867 15.1 7.2
Swap contracts ...................... - - - 65 - 7.7
Equity and commodity:
Futures contracts ................... 4 - - 9 - -
---------------------------------------------------------------------
Total ....................................... $2,028 2.4 $ 7.5 $1,276 15.1 $ 15.1
---------------------------------------------------------------------
Effect of master netting
and collateral
agreements ............................... (0.2) (2.0)
---------------------------------------------------------------------
Net credit risk
(replacement cost) ....................... $ 2.2 $ 13.1
=====================================================================
(1) Notional value represents the amount to which a rate or price is applied
in order to calculate the exchange of cash flows under a derivative
contract.
(2) The fair values of all derivative contracts are included in the market
value of the assets of the CN Plans.
5 Funding policy
In respect of the CN Plans, the contributions by the Company are determined in
accordance with the requirements of the Pension Benefits Standards Act, 1985
and Regulations thereunder, and are based on the projected unit credit
actuarial cost method, with projection of salaries where future salary changes
affect the amount of the projected benefits. In the case of the CN 1935 Pension
Plan, the Company makes money purchase contributions in accordance with the
rules of the plan.
The latest actuarial valuations of the CN Plans were prepared by Mercer
Human Resource Consulting Limited as at December 31, 2001 and were submitted to
the Superintendent of Financial Institutions and to the Canada Customs and
Revenue Agency. In these actuarial valuations, the principal assumptions
adopted by the CN Plans' actuary are members' mortality, disability,
retirement, termination of employment, merit and periodic increases in
earnings, as well as a long-term rate of return of 7.0% (7.25% at the previous
valuation) per annum on investments. Future increases in members' earnings have
been projected using economic assumptions consistent with this long-term rate
of return.
6 Transfers
In 2002, the accounts include a provision for the amounts to be remitted
to/from other funds to cover transfers of members of CN Plans to other pension
plans and transfers of members of other plans to the CN Plans.
7 Consolidated actuarial pension obligation and asset value
The actuarial valuations as at December 31, 2001 revealed a consolidated
actuarial liability of $10,933 million and a consolidated actuarial asset value
of $10,968 million. The results of these valuations were then used to estimate
the corresponding figures as at December 31, 2002, which approximate $11,127
million and $11,212 million, respectively, as at that date. The principal
components of the change in the pension obligations are the interest accrued on
benefits ($706 million in 2002 and $693 million in 2001), benefit payments and
transfers ($683 million in 2002 and $655 million in 2001), benefits accrued
during the year ($157 million in 2002 and $163 million in 2001), and actuarial
loss ($14 million in 2002 and $10 million in 2001). The consolidated actuarial
liability was calculated in accordance with the Canadian Institute of Chartered
Accountants (CICA) Handbook Section 3461 using a discount rate of 6.5% as at
December 31, 2002 and December 31, 2001. The consolidated actuarial asset value
is based on a market-related method, which recognizes the change in market
value over a period of five years using the straight-line method.
126 The CN Pension Plan and the CN 1935 Pension Plan
2002 President's Awards for Excellence
Representing a diverse number of functions and locations, and demonstrating an
unprecedented ability to work together at all levels, a record number of
employees received CN's President's Awards for Excellence in 2002. From across
the entire system in both Canada and the United States, they excelled in their
efforts to come up with innovative solutions, focus on results, and make a
difference at CN and in their communities.
Category: Safety
-------------------------------------------------------------------------------
L.I.F.E. team - Richard Dare, Benton - Illinois; Scott Lipe - Carbondale,
Illinois; Brad Sanders - Centralia, Illinois; Arthur Rapp - Champaign,
Illinois; Cathy Cortez, Charles Webster - Chicago, Illinois; Barry Kracht -
Duquoin, Illinois; Charles Scholes - Effingham, Illinois; Terry Mason, Michael
Mowen - Harvey, Illinois; Paul Adams, Erik Anderson, Larry Anderson, Carol
Brinkman, Ronald Ester, David Hall, Bob Keane, Pat Post, Gordon Sharp, David
Sprankle - Homewood, Illinois; Kenny Monke - Mattoon, Illinois; Doyle Cowles,
Steven Craig, Brian Ott, Joseph Rubino - Waterloo, Iowa; Walter Carlton III,
Gary Devall - Baton Rouge, Louisiana; Frank Elkins Jr. - New Orleans,
Louisiana; Jeffrey Roberts - Detroit, Michigan; Terry Tindol - Battle Creek,
Michigan; John Geary Jr., William Lustig, Ray Townley - Flat Rock, Michigan;
Larry Bancroft, Jim McMahon, Ron Merrow - Pontiac, Michigan; David Hayslip,
Robbie Harman - Troy, Michigan; William Chesteen - Grenada, Mississippi; Winky
Freeman, Johney Grayson Jr., Randy Harris, Michael Strange - Jackson,
Mississippi; Bennie Punchard - McComb, Mississippi; Joseph Baroni, Tarie Smith,
Michael Wells - Memphis, Tennessee
This 47-member union/management team takes its name - L.I.F.E. (for Live
Injury-Free Everyday) - to heart, demonstrating an unwavering commitment to
railroad safety, a top priority at CN. Representing all occupations, they
revised the existing safety rule books from different organizations within CN's
U.S. operations and developed an innovative safety initiative that moves away
from more traditional approaches to implementing railroad safety processes and
procedures. Their original solution uses a number of creative methods such as
peer coaching.
-------------------------------------------------------------------------------
Norman J. Witzell - Surrey, British Columbia
Constable Witzell is a man with a mission: spreading CN's message of rail
safety to every corner of British Columbia. He goes above and beyond the normal
call of duty and leaves nothing out in fulfilling his role as Community
Services Officer, which he conducts based on a comprehensive action plan.
Category: New Business Opportunities
-------------------------------------------------------------------------------
Air Canada Jet Fuel team - Patrice Dery - Charny, Quebec; Mike A. Corr, Dave
Howett - Concord, Ontario; Ron L. Borden - Mississauga, Ontario; Janet A.
Drysdale, Carmino Russo - Montreal, Quebec
These team members put their heads together to come up with a non-traditional
and innovative approach to improving customer service. The result was a much
quicker turnaround time for transporting jet fuel for Air Canada.
-------------------------------------------------------------------------------
NSC Minerals - Marc Arnaud, Tim Cowieson, Barry Pellerin - Saskatoon,
Saskatchewan; Greg Kendall, Gary Parbery - Winnipeg, Manitoba
A "cold call" from a Transportation officer was the initiative that got the
ball rolling with NSC Minerals. With follow-up efforts from these team members,
it led to bringing the company on board as an important new customer and
transportation partner. The results: significant benefits to CN annually.
Category: Customer Focus
-------------------------------------------------------------------------------
Judy Amato - Flat Rock, Michigan
Judy's passion for customer service is what prompted her client, Ford, to
nominate her for the President's Award. In fact, Judy's contribution has helped
both Ford and CN. One of her many client-focused initiatives helped Ford save
on costs by using rail instead of trucking.
-------------------------------------------------------------------------------
White Pine Team - Douglas Webster - Chicago, Illinois; Jeff Brazeau, Joseph
Dennis, Jim Firkus, James Waitanek - Ironwood, Michigan; Brad Koenig - Fond du
Lac, Wisconsin; Jack Bratanich, Kenneth Feucht, Albert Hoecherl, Gerard Jiskra,
Lyle Nelson, Randy Nichols, Brent Ogle, Wayne Phetteplace, Brian Tucci, Duane
Webster - Ladysmith, Wisconsin; Dan Hampston, Ronald Lake, Fred Nafey, John
Wickersham - Mellen, Wisconsin; William Lange, James Mabie Sr. - Prentice,
Wisconsin; Gary Bright - South Range, Wisconsin; Frederick Bandt, Brad Dupee,
Thomas Helton, Gary Hoffman, Richard Hoffman, James Peterson, Corey Quante,
Brian Retzlaff - Stevens Point, Wisconsin
This team jumped into action during an emergency last April. It was their quick
thinking and combined efforts that prevented White Pine Copper Refinery from
having to shut down when it was threatened by flooding. The consequences of the
measures they took were impressive: White Pine avoided substantial losses in
delayed deliveries and lost production.
Category: People Leadership
-------------------------------------------------------------------------------
Denny Duncan - Mattoon, Illinois
Denny is a true role model for his staff. A dedicated manager who takes pride
in his work, he is a good listener who is open to innovation, comments and
suggestions. Even in extreme weather conditions, the teams he leads complete
their work on schedule and under budget. And safety is always a priority in
Denny's book; his bridge gangs have not had one reported injury since he took
over in 1999.
Category: Cost Effectiveness
-------------------------------------------------------------------------------
Research and Development team - Helga Audet, Hani Bazerghi, Carla D'Alessandro,
Deanna Derocher, Stephen Desabrais, John Edwards, Claude Essiembre, Linda
Feudi, Greg Hickson, Stella Karnis, Farveh Momayezzadeh, Bob S. Moore, Susan
Parker, Anshu Pathak, Dan Toy, Bob White, Walter Zanelli - Montreal, Quebec;
Timothy Keegan - Edmonton, Alberta
Using creativity, this cross-functional team contributed to improving CN's
bottom line. They worked together to access Canadian federal and provincial R&D
tax incentives arising from CN's investments in innovation in the areas of
Systems, Transportation, Engineering, Environment and Safety. The new process
they introduced is generating substantial benefits for CN now and into the
future.
Category: Operational Breakthrough
-------------------------------------------------------------------------------
B&S Gang no. 70 - Doug Bainbridge, Jeff Beaudry, Mike Faubert, Rick Fortier,
Don Hicks, Luc Labonte, Liduino Medeiros, Ken Payne, Todd Schell, Ernie Simard,
Hank Vanstraten, Robert Zadow - Capreol, Ontario
Working together, the members of this team - from field supervisor to the cook
on the gang - proved that a revolutionary new procedure results in significant
savings. They delivered exceptional performance in the execution of an
innovative new method of bridge stringer replacement that completely transforms
the traditionally labor-intensive, time-consuming task.
-------------------------------------------------------------------------------
WC/BLE Labor Negotiating Team - Jack Gibbins - Chicago, Illinois; Roger
MacDougall - Rosemont, Illinois; Jeff Bochman - Fond du Lac, Wisconsin; John
Reynolds - Green Bay, Wisconsin; Bill Grimstad, Allan Rothwell, Ed Terbell -
Stevens Point, Wisconsin
IC/BLE Labor Negotiating Team - Myron Becker - Chicago, Illinois; Thomas J.
Goodwine - Homewood, Illinois; John P. Kay - Jackson, Mississippi; John Koonce
- Memphis, Tennessee
These teams are responsible for a breakthrough in labor/management relations in
the United States. The new agreements reached between Wisconsin Central and the
Brotherhood of Locomotive Engineers (BLE) and between Illinois Central and the
BLE simplify and modernize both the language of the contracts and the nature of
the employment relationship between employees and the company, and improve the
employees' quality of life.
Category: Bravery/Exceptional Community Service
-------------------------------------------------------------------------------
James Jones - Detroit, Michigan (now retired and living in Myrtle Beach, South
Carolina)
James was honored for an act of bravery that saved a woman's life. He came to
the rescue of the elderly and handicapped senior who was trapped in a burning
car in a gas station. It was thanks to his heroic act that the woman survived
the life-threatening ordeal.
-------------------------------------------------------------------------------
Operation Lifesaver - Tom Bozyk, Sandra Hamm, Tom Hosfield, Rick Small, Ron B.
Smith, Cynthia Stotz - Winnipeg, Manitoba; Don Marquis - Fort Frances, Ontario;
Gerald Koopman - North Battleford, Saskatchewan; Hugh Beechy, Greg Smerchynski
- Regina, Saskatchewan
This team performs an important community service through Operation Lifesaver,
a program to which they are totally dedicated. Their commitment to this rail
industry initiative translates into increased awareness of the dangers of
highway/railroad crossings and trespassing on railroad property. Team members
work closely together using as many different and imaginative means as possible
to get this important message out to their communities.
Category: Diversity
-------------------------------------------------------------------------------
Brent Ballingall - Kamloops, British Columbia
Brent demonstrated his commitment to diversity by taking it upon himself to
actively participate in several initiatives for Aboriginal peoples. He attended
conferences and workshops, took part in the development of an Aboriginal/CN
database on native sites, and was involved in CN's contribution to the
construction of the Skeetchestn Pow-Wow arbor.
-------------------------------------------------------------------------------
Judy MacKenzie - Edmonton, Alberta
Judy was singled out for championing diversity in recruiting for seasonal track
opportunities. In addition to advertising through TMP Worldwide recruitment
services, she directly contacted the employment offices of several local
Aboriginal bands. Her actions resulted in the hiring of 55 people, a third of
whom represent diverse groups.
Canadian National Railway Company 127
[PHOTO OMITTED]
CAPTION: Left to right: David G.A. McLean, E. Hunter Harrison, Gilbert H.
Lamphere, V. Maureen Kempston Darkes, James K. Gray, Cedric E. Ritchie
Board of Directors (As of December 31, 2002)
David G.A. McLean, O.B.C., LL.D.
Chairman of the Board
Canadian National Railway Company
Chairman and
Chief Executive Officer
The McLean Group
Committees: 2*, 3, 4, 5, 6, 7
E. Hunter Harrison
President and
Chief Executive Officer
Canadian National Railway Company
Committees: 3, 7
Gilbert H. Lamphere
Private Investor and
Former Chairman of the Board
Illinois Central Corporation
Committees: 1, 4, 5, 7
V. Maureen Kempston Darkes,
O.C., D.Comm., LL.D.
Group Vice-President
General Motors Corporation
and President GM Latin America,
Africa and Middle East
Committees: 2, 5, 7
James K. Gray, O.C., A.O.E., LL.D.
Corporate Director and
Former Chairman and
Chief Executive Officer
Canadian Hunter Exploration Ltd.
Committees: 1, 2, 4, 7
Cedric E. Ritchie, O.C., LL.D.
Corporate Director and
Former Chairman and
Chief Executive Officer
The Bank of Nova Scotia
Committees: 1, 2, 5, 6, 7
Paul M. Tellier resigned from the Board of Directors on December 31, 2002.
128 Canadian National Railway Company
[PHOTO OMITTED]
CAPTION: Left to right: Robert Pace, Michael R. Armellino, Edward C. Lumley,
Denis Losier, Gordon D. Giffin, Purdy Crawford, Edith E. Holiday, J.V. Raymond
Cyr
Robert Pace
President and
Chief Executive Officer
The Pace Group
Committees: 1*, 2, 6, 7
Michael R. Armellino
Retired Partner
The Goldman Sachs Group
Committees: 1, 2, 4, 6, 7*
The Honorable
Edward C. Lumley, P.C., LL.D.
Vice-Chairman
BMO Nesbitt Burns
Committees: 4, 5, 6*, 7
Denis Losier
President and
Chief Executive Officer
Assumption Life
Committees: 1, 4, 5, 7
Ambassador Gordon D. Giffin
Senior Partner
McKenna Long & Aldridge
Committees: 1, 2, 7
Purdy Crawford, O.C., Q.C., LL.D.
Chairman
AT&T Canada Corp.
Counsel
Osler, Hoskin & Harcourt
Committees: 2, 5*, 6, 7
Edith E. Holiday
Corporate Director and Trustee,
Former General Counsel,
United States Treasury Department
and Secretary of the Cabinet
The White House
Committees: 1, 6, 7
J.V. Raymond Cyr, O.C., LL.D.
Chairman
PolyValor Inc.
Committees: 1, 4*, 5, 6, 7
Committees:
1 Audit, finance and risk 2 Corporate governance and nominating 3 Donations
4 Environment, safety and security 5 Human resources and compensation
6 Investment 7 Strategic planning
*denotes chairman of the committee
Canadian National Railway Company 129
Executive Officers of the Company
David G.A. McLean
Chairman of the Board
E. Hunter Harrison
President and
Chief Executive Officer
Tullio Cedraschi
President and
Chief Executive Officer
CN Investment Division
Les Dakens
Senior Vice-President
People
Sean Finn
Senior Vice-President
Public Affairs,
Chief Legal Officer and
Corporate Secretary
James M. Foote
Executive Vice-President
Sales and Marketing
Keith L. Heller
Senior Vice-President
Eastern Canada Division
Jack T. McBain
Senior Vice-President
Operations
Claude Mongeau
Executive Vice-President and
Chief Financial Officer
Robert E. Noorigian
Vice-President
Investor Relations
130 Canadian National Railway Company
Shareholder and investor information
Annual meeting
The annual meeting of shareholders will be held
at 10:30 am on Tuesday, April 15, 2003,
at the Sheraton Center, Montreal, QC
Annual information form
The annual information form may be obtained by writing to:
The Corporate Secretary
Canadian National Railway Company
935 de La Gauchetiere Street West
Montreal, Quebec H3B 2M9
Transfer agent and registrar
Computershare Trust Company of Canada
Offices in:
Montreal, QC; Toronto, ON; Calgary, AB; Vancouver, BC
Telephone: 1-800-332-0095
Fax: 1-888-453-0330
Web: www.computershare.com
Co-transfer agent and co-registrar
Computershare Trust Company of New York
88 Pine Street, 19th Floor
Wall Street Plaza, New York, NY 10005
Telephone: (212) 701-7600 or 1-800-245-7630
U.S. cash dividends
Shareholders wishing to receive dividends in U.S. dollars may
obtain detailed information by communicating with:
Computershare Trust Company of Canada
Telephone: 1-800-332-0095
Stock exchanges
Canadian National common shares are listed on the
Toronto and New York stock exchanges.
Ticker symbols:
CNR (Toronto Stock Exchange)
CNI (New York Stock Exchange)
Investor relations
Robert Noorigian
Vice-President, Investor Relations
Telephone: (514) 399-0052 or 1-800-319-9929
Shareholder services
Shareholders having inquiries concerning their shares
or wishing to obtain information about CN should contact:
Computershare Trust Company of Canada
Shareholder Services
100 University Avenue, 9th Floor
Toronto, Ontario M5J 2Y1
Telephone: 1-800-332-0095
Fax: 1-888-453-0330
Email: caregistryinfo@computershare.com
Head office
Canadian National Railway Company
935 de La Gauchetiere Street West
Montreal, Quebec H3B 2M9
P.O. Box 8100
Montreal, Quebec H3C 3N4
Additional copies of this report are La version francaise du present rapport
available from: est disponible a l'adresse suivante :
CN Public Affairs Affaires publiques CN
935 de La Gauchetiere Street West 935, rue de La Gauchetiere Ouest
Montreal, Quebec H3B 2M9 Montreal (Quebec) H3B 2M9
Telephone:1-888-888-5909 Telephone : 1 888 888-5909
Fax: (204) 987-9310 Telecopieur : (204) 987-9310
Email: cn@wpg.faneuil.com Courriel : cn@wpg.faneuil.com
[GRAPHIC OMITTED]
CN 935 de La Gauchetiere Street West, Montreal, Quebec H3B 2M9 www.cn.ca
Item
4
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Computershare
Trust Company of Canada
9th Floor, 100 University Avenue
Toronto, Ontario M5J 2Y1
www.computershare.com
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Holder Account Number
Dear Shareholder:
On behalf of the Board of
Directors and Management of Canadian National Railway Company (CN), we cordially
invite you to attend the annual meeting of shareholders that will be held this
year in the Ballroom at Le Centre Sheraton, 1201 René-Lévesque Boulevard
West, Montréal, Quebec, on Tuesday, April 15, 2003, at 10:30 a.m., Eastern
Time.
The agenda and related documentation
are attached. In addition to these items, we will discuss the significant changes
underway in the Company as well as its coming challenges. You will have the opportunity
to meet your directors and the senior officers of CN.
Your participation in the
affairs of the Company is important to us. If you are unable to attend in person,
we encourage you to complete and return the enclosed proxy form in the envelope
provided for this purpose so that your views can be represented. Also, it is possible
for you to vote over the Internet by following the instructions on the enclosed
proxy form. Even if you plan to attend the meeting, you may find it convenient
to express your views in advance by completing and returning the proxy form or
by voting over the Internet.
If your shares are not registered
in your name but are held in the name of a nominee, you may wish to consult the
information on page 3 of the accompanying management proxy circular with respect
to how to vote your shares.
A live Internet broadcast
of the meeting will be available on our website at www.cn.ca. Should you decide
to attend the meeting, please bring this letter with you to facilitate registration.
We look forward to seeing
you at the meeting.
Sincerely,
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E. HUNTER HARRISON
President and Chief Executive Officer
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DAVID G.A.
MCLEAN
Chairman of the Board
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000UAC
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