Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Second Quarter and First Half ended June 30, 2003
Business Overview: CN operates a network of approximately 17,500 route miles spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico. The company serves seven business units including petroleum, metals, forest products, coal, grain, intermodal, and automotive.
Key Financial Metrics (U.S. GAAP)
| Metric (in millions, except per share) | Q2 2003 | Q2 2002 | YTD 2003 | YTD 2002 |
|---|---|---|---|---|
| Revenues | $1,463 | $1,551 | $2,959 | $3,060 |
| Operating Income | $437 | $490 | $811 | $896 |
| Net Income | $244 | $280 | $496 | $510 |
| Diluted EPS | $1.26 | $1.39 | $2.53 | $2.54 |
| Operating Ratio | 70.1% | 68.4% | 72.6% | 70.7% |
| Free Cash Flow | $169 | $164 | $350 | $356 |
| Carloadings (thousands) | 1,052 | 1,059 | 2,090 | 2,058 |
Liquidity and Debt: Cash and cash equivalents totaled $130 million as of June 30, 2003. Long-term debt was $4,552 million. The company maintains a $1,000 million revolving credit facility (undrawn) and a commercial paper program with $310 million outstanding.
Material Changes vs. Prior Period
- Currency Impact: The 11% year-over-year appreciation of the Canadian dollar reduced Q2 2003 revenues by approximately $90 million, operating income by $25 million, and net income by $11 million. For the first half, the impact was $135 million on revenues, $40 million on operating income, and $20 million on net income.
- Grain Volumes: Reduced grain traffic due to drought conditions in Western Canada during the previous summer cut revenues by $37 million in Q2 and $80 million for the first half.
- Accounting Change: A cumulative after-tax benefit of $48 million ($75 million pre-tax) was recorded in the first half due to a change in accounting for removal costs of track structure assets (SFAS No. 143). Excluding this, YTD net income was $448 million.
- Expense Management: Operating expenses declined 3% in Q2 and 1% YTD, driven by lower purchased services, labor, and equipment rents, partially offset by higher fuel costs (up 10% in Q2) and casualty expenses.
- Share Repurchases: The company repurchased 8.8 million common shares for $569 million in the first half of 2003.
Guidance, Outlook, and Risks
Outlook: Management is "guardedly optimistic" for the balance of 2003 and into 2004. Improved precipitation levels on the Prairies suggest a good 2003/2004 Canadian grain crop, with volumes expected to improve in the fourth quarter.
Key Risks and Contingencies:
- Labor Negotiations: Agreements covering 97% of the Canadian unionized workforce expire December 31, 2003. Negotiations are expected to commence September 1, 2003. No legal strikes are possible before January 2004.
- Environmental Liabilities: Aggregate accruals for environmental costs were $89 million. Future costs related to remediation cannot be reasonably estimated but could be material.
- Legal Claims: Reserves for personal injury and other claims totaled $610 million. Final outcomes of pending actions cannot be predicted with certainty.
- Competition: Significant competition exists from trucking, barge (particularly for Illinois Central Railroad), and other rail carriers.
Investor Verification Checklist
- Currency Sensitivity: Verify the impact of the Canadian dollar strength on future earnings, as a one-cent change in the exchange rate impacts annual net income by approximately $7 million.
- Grain Crop Recovery: Monitor weather reports and crop forecasts for Western Canada to validate the anticipated Q4 volume recovery.
- Labor Agreement Status: Track the progress of Canadian labor negotiations starting September 2003 to assess strike risk.
- Accounting Policy Impact: Review the long-term effect of the SFAS No. 143 adoption on depreciation and labor expense recognition.
- Capital Expenditures: Confirm adherence to the anticipated $1.1 billion gross capital expenditure budget for 2003.