CNI

Business Context and Reporting Period

Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third quarter and nine months ended September 30, 2005
Business Overview: CN operates a transcontinental railway spanning Canada and mid-America, connecting the Atlantic and Pacific oceans to the Gulf of Mexico. The company serves major ports including Vancouver, Montreal, and New Orleans, and key industrial cities across North America.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Q3 revenues increased 6% and nine-month revenues increased 11%. Growth was driven by freight rate increases (including fuel surcharges), higher volumes in grain/fertilizers, coal, and intermodal segments, and the inclusion of nine months of results from Great Lakes Transportation (GLT) and BC Rail acquisitions.
• Profitability: Net income rose 19% in Q3 and 28% for the nine-month period. The operating ratio improved by 2.1 percentage points in Q3 and 3.2 percentage points for the nine-month period.
• Expense Drivers: Operating expenses increased 2% in Q3 and 6% for the nine-month period. Primary drivers were higher fuel costs (fuel prices averaged $1.79/gallon in Q3 vs. $1.31 in 2004) and higher casualty/other expenses. These were partially offset by favorable currency translation impacts on U.S.-denominated expenses.
• Currency Impact: The stronger Canadian dollar had an unfavorable translation impact of $80 million on Q3 revenues and $220 million on nine-month revenues. Conversely, it provided a favorable $50 million impact on Q3 expenses and $135 million on nine-month expenses.

Outlook, Risks, and Unusual Items

• Management Commentary: CEO E. Hunter Harrison noted record earnings despite headwinds from higher fuel costs, hurricane impacts on the Gulf Coast network, and accidents.
• Unusual Items:
  • Wabamun Lake Derailment: A derailment in Alberta resulted in approximately $28 million in third-quarter expenses (retention under insurance policies). The company expects insurance to cover substantially all expenses above the retention.
  • Hurricanes: Petroleum and chemicals revenues were adversely affected by reduced production in the hurricane-stricken Gulf Coast region.
• Share Repurchases: CN repurchased 4.75 million shares in Q3 for $380 million. A new program approved in July 2005 allows for the repurchase of up to 16.0 million shares through July 2006.
• Risks and Contingencies:
  • Environmental: Aggregate accruals for environmental costs were $156 million. Future liabilities related to remediation cannot be reasonably estimated.
  • Legal: Aggregate reserves for personal injury and other claims were $672 million. Outcomes of pending litigation cannot be predicted with certainty.
  • Derivatives: As of September 30, 2005, CN hedged approximately 47% of remaining 2005 fuel consumption and 17% of 2006 consumption.

Investor Verification Checklist

• Free Cash Flow Definition: Verify the non-GAAP reconciliation of free cash flow ($1.058 billion for 9M), which excludes changes in securitized receivables and adjusts for significant acquisitions.
• Acquisition Integration: Confirm the full-year impact of GLT and BC Rail acquisitions on future operating ratios and synergies, as 2004 comparables only include partial periods.
• Fuel Hedging Strategy: Review the effectiveness of fuel hedges (47% of 2005, 17% of 2006) against rising crude oil prices and the impact on future margins.
• Derailment Liability: Monitor the Wabamun Lake incident for any changes in estimated clean-up costs or insurance recoveries beyond the initial $28 million expense.
• Currency Sensitivity: Assess the ongoing impact of the Canadian dollar's strength on U.S.-denominated revenues versus expenses.