CNI

Business Context and Reporting Period

Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Three months ended March 31, 2003 (First Quarter 2003)
Filing Date: May 1, 2003
Business Overview: CN operates a rail network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico. The company transports a diversified portfolio of goods including intermodal, petroleum, chemicals, metals, minerals, forest products, coal, grain, and automotive.

Key Financial Metrics (U.S. GAAP)

Material Changes vs. Prior Period

• Accounting Change Impact: Reported net income increased 9.6% to $252 million, driven primarily by a one-time cumulative after-tax benefit of $48 million ($24 cents per share) resulting from the adoption of SFAS No. 143 regarding asset retirement obligations. Excluding this benefit, net income decreased 11% to $204 million.
• Revenue Performance: Total revenues declined 1% to $1,496 million. This was due to an 11% drop in bulk commodities (grain and fertilizers) and weakness in automotive and forest products. These declines were offset by growth in Intermodal (+13%), Petroleum and Chemicals (+6%), and Metals and Minerals (+3%).
• Expense Management: Operating expenses rose 2% to $1,122 million. Increases were driven by a 13% rise in fuel costs, higher casualty expenses, and costs associated with severe winter weather (the second coldest Canadian winter in 20 years). Equipment rents decreased 11%.
• Operating Ratio: The operating ratio worsened by 1.9 percentage points to 75.0%, reflecting the combination of lower revenues and higher operating expenses.
• Capital Allocation: The company repurchased 5.8 million common shares for $362 million and paid dividends of $49 million.

Guidance, Outlook, and Risks

• Management Outlook: Management remains cautious regarding economic prospects for the remainder of 2003, citing slowed economic growth and hesitant consumer spending in the United States. Capital expenditures for 2003 are expected to remain at approximately the same level as 2002.
• Weather and Operational Risks: Severe winter conditions caused congestion and additional maintenance expenses. The company notes ongoing susceptibility to severe weather and crop conditions affecting grain supplies.
• Labor Negotiations: Labor agreements covering 97% of the Canadian unionized workforce expire on December 31, 2003. While the company is optimistic about renewals without disruption, strikes or lockouts remain a risk after January 2004. U.S. workforce negotiations are ongoing on a local basis.
• Environmental and Legal Contingencies: The company maintains reserves of $637 million for personal injury and other claims and $97 million for environmental costs. Management believes these are adequate but notes that future liabilities cannot be predicted with certainty.
• Competition: Significant competition exists from Canadian Pacific Railway, trucking companies, and barge traffic (particularly for the Illinois Central subsidiary along the Mississippi River).

Investor Verification Checklist

• Adjusted Earnings: Verify the sustainability of earnings by analyzing the $204 million "adjusted" net income figure, excluding the $48 million one-time accounting benefit.
• Grain Volume Trends: Monitor the 13% decline in grain and fertilizer revenues to assess the impact of crop conditions and export demand on future bulk commodity performance.
• Fuel Hedging Effectiveness: Review the fuel hedging program details (47% of 2003 consumption hedged) to understand exposure to future fuel price volatility given the 13% increase in fuel expenses.
• Labor Agreement Status: Track the progress of Canadian labor negotiations expiring in late 2003 to evaluate potential operational disruption risks.
• Share Repurchase Program: Confirm the remaining capacity of the share repurchase program (approved for up to 13.0 million shares; 8.8 million repurchased to date) and its impact on future cash flow.