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, 2006 (First Quarter)
Release Date: April 20, 2006
Accounting Basis: U.S. Generally Accepted Accounting Principles (U.S. GAAP)

CN operates a railroad network spanning Canada and mid-America. The company reported a solid first-quarter performance characterized by productivity improvements, a 2% increase in revenue ton-miles, and a record operating ratio.

Key Financial Metrics

Debt and Liquidity: Total debt (current + long-term) was C$5,262 million at March 31, 2006. The debt-to-total capitalization ratio was 36.4%. The company maintained a C$1,000 million revolving credit facility and a C$500 million accounts receivable securitization program.

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 8% to C$1,847 million, driven by freight rate increases (including fuel surcharges) and a positive traffic mix. This growth occurred despite a C$55 million unfavorable translation impact from a stronger Canadian dollar.
• Expense Management: Operating expenses rose 4% to C$1,222 million. The primary driver was a 22% increase in fuel costs (average price rose to $1.88/gallon). Labor costs decreased slightly (2%), while purchased services and depreciation increased.
• Commodity Performance: All seven commodity groups saw revenue gains. Intermodal (+12%) and Coal (+10%) led the growth. Forest products (+8%) and Grain/Fertilizers (+8%) also performed well, though pulp/paper shipments declined.
• Productivity: The operating ratio improved to a record 66.2%, a 3.0 percentage point improvement over the prior year, reflecting cost control and efficiency gains.

Guidance, Outlook, and Risks

Management Commentary: CEO E. Hunter Harrison highlighted strong free cash flow generation and continued productivity improvements. The company noted that results were achieved despite higher fuel costs and currency headwinds.

Forward-Looking Statements: The filing contains forward-looking statements assuming positive economic trends in North America and Asia will continue. Management cautions that actual results could differ materially.

Risks and Contingencies:

• Legal and Claims: Aggregate reserves for personal injury and other claims were C$659 million. The company notes that final outcomes cannot be predicted with certainty.
• Environmental: Aggregate accruals for environmental costs were C$128 million. Future liabilities related to remediation and compliance cannot be reasonably estimated but could be material.
• Guarantees: The company has outstanding guarantees, including standby letters of credit and residual value guarantees on leases, with a maximum potential liability of C$468 million (excluding lease residual guarantees of C$80 million).
• Accounting Changes: The company adopted SFAS No. 123(R) on January 1, 2006, requiring the expensing of stock-based compensation. This increased stock-based compensation expense by C$5 million and decreased net income by C$3 million for the quarter.

Investor Verification Checklist

• Fuel Hedging Exposure: Verify the extent of remaining fuel hedge positions (covering ~11% of remaining 2006 consumption) and the impact of rising crude oil prices on future margins.
• Currency Sensitivity: Assess the impact of the stronger Canadian dollar on U.S. dollar-denominated revenues (C$55 million negative impact in Q1) and expenses (C$35 million positive impact).
• Share Repurchases: Confirm the status of the 32.0 million share repurchase program; C$370 million was spent in Q1 2006 to repurchase 7.0 million shares.
• Stock Split Adjustment: Ensure all per-share data is reviewed in the context of the two-for-one stock split effected on February 28, 2006.
• Environmental Liabilities: Review the C$128 million accrual for environmental costs and the disclosure regarding the inability to estimate future remediation costs.