Excluding gain on sale of rail line segment, adjusted Q1-2013 net income
was C$519 million, or C$1.22 per diluted share (1)

MONTREAL, April 22, 2013 /CNW Telbec/ – CN (CNR.TO) (CNI) today
reported its financial and operating results for the first quarter
ended March 31, 2013.

First-quarter 2013 highlights

  • First-quarter 2013 net income was C$555 million, or C$1.30 per diluted
    share, compared with net income of C$775 million, or C$1.75 per diluted
    share, for first-quarter 2012.  The first-quarter 2013 results included
    an after-tax gain of C$36 million, or C$0.08 per diluted share, and the
    first quarter of 2012 included an after-tax gain of C$252 million, or
    C$0.57 per diluted share, from the sale of rail line segments in the
    Toronto area to a public transit agency.
  • Q1-2013 adjusted diluted earnings per share (EPS) were C$1.22, an
    increase of three per cent over adjusted diluted EPS of C$1.18 for the
    same period of 2012 (excluding gains on rail line sales in both years). (1)
  • Revenues for the latest quarter increased five per cent to C$2,466
    million, while revenue ton-miles rose three per cent and carloadings
    increased two per cent.
  • Operating income declined two per cent to C$780 million.
  • The operating ratio was 68.4 per cent, a deterioration of 2.2 points
    from the year-earlier performance of 66.2 per cent.
  • The Company utilized C$20 million of free cash flow in first-quarter
    2013, while it generated C$48 million of free cash flow in the
    comparable period of 2012. (1)

Claude Mongeau, president and chief executive officer, said: “CN faced a
number of operational challenges in the first quarter, including
extreme cold and heavy snow in Western Canada, which hampered
operations, congested the network and constrained volume growth. We’ve
turned the corner since then, improving train velocity and reducing
freight car dwell times in yards across the network to restore the
service level expected by our customers.

“CN will emerge stronger from this first-quarter experience. To improve
network resilience, particularly given our expectation of continued
strong volume growth, CN is undertaking several capacity enhancement
projects in its Edmonton-Winnipeg corridor. These and other
productivity initiatives will increase CN’s planned 2013 capital
spending to C$2 billion, an increase of C$100 million over our original
2013 plan.”

2013 financial outlook (2)
CN is maintaining the 2013 financial outlook it issued on Jan. 22, 2013,
except for its revised plan to invest approximately C$2 billion in
capital programs in 2013, compared with the previous plan to invest
C$1.9 billion. Approximately C$1.1 billion of the total expenditure
will be targeted on track infrastructure to maintain a safe and fluid
railway network. In addition, the Company will invest in projects to
support a number of productivity and growth initiatives.

Foreign currency impact on results
Although CN reports its earnings in Canadian dollars, a large portion of
its revenues and expenses is denominated in U.S. dollars. As such, the
Company’s results are affected by exchange-rate fluctuations. There was
minimal impact on CN’s first-quarter 2013 net income on a constant
currency basis. (1)

First-quarter 2013 revenues, traffic volumes and expenses
The five per cent rise in first-quarter revenues was mainly attributable
to freight rate increases and higher freight volumes, due in part to
growth in the North American and Asian economies, partly offset by
operational challenges that constrained volumes.

Revenues increased for petroleum and chemicals (17 per cent), intermodal
(seven per cent), metals and minerals (three per cent), forest products
(two per cent), automotive (two per cent), and grain and fertilizers
(one per cent). Coal revenues declined one per cent.

Carloads increased by two per cent while revenue ton-miles, measuring
the relative weight and distance of rail freight transported by CN,
increased three per cent over the same quarter in 2012.

Rail freight revenue per revenue ton-mile, a measurement of yield
defined as revenue earned on the movement of a ton of freight over one
mile, increased two per cent over the first quarter of 2012, driven by
freight rate increases, partly offset by an increase in the average
length of haul.

Operating expenses increased nine per cent in the first quarter of 2013,
mainly due to higher labor and fringe benefits expense, increased
purchased services and material expense, increased fuel costs, as well
as operational challenges including harsher winter conditions in
Western Canada.

Forward-Looking Statements
Certain information included in this news release constitutes
“forward-looking statements” within the meaning of the United States
Private Securities Litigation Reform Act of 1995 and under Canadian
securities laws. CN cautions that, by their nature, these
forward-looking statements involve risks, uncertainties and
assumptions. The Company cautions that its assumptions may not
materialize and that current economic conditions render such
assumptions, although reasonable at the time they were made, subject to
greater uncertainty. Such forward-looking statements are not guarantees
of future performance and involve known and unknown risks,
uncertainties and other factors which may cause the actual results or
performance of the Company or the rail industry to be materially
different from the outlook or any future results or performance implied
by such statements. To the extent that CN has provided guidance that
are non-GAAP financial measures, the Company may not be able to provide
a reconciliation to the GAAP measures, due to unknown variables and
uncertainty related to future results. Key assumptions used in
determining forward-looking information are set forth below.

Current assumptions
CN is maintaining the 2013 financial outlook it issued on Jan. 22, 2013,
except for its revised plan to invest approximately C$2 billion in
capital programs in 2013, compared with the previous plan to invest
C$1.9 billion. Approximately C$1.1 billion of the total expenditure
will be targeted on track infrastructure to maintain a safe and fluid
railway network. In addition, the Company will invest in projects to
support a number of productivity and growth initiatives.

CN has made a number of economic and market assumptions in preparing its
2013 outlook. The Company is forecasting that North American industrial
production for the year will increase by about two per cent. CN also
expects U.S. housing starts to be in the range of 950,000 units and
U.S. motor vehicles sales to be approximately 15 million units. In
addition, CN is assuming that 2013/2014 grain crop production in both
Canada and the U.S. will be in-line with their respective five-year
averages. With respect to the 2012/2013 crop, production in Canada was
slightly above the five-year average while production in the U.S. was
below the five-year average. With these assumptions, CN assumes carload
growth of three to four per cent, along with continued pricing
improvement above inflation. CN also assumes the Canadian-U.S. exchange
rate to be around parity for 2013 and that the price of crude oil (West
Texas Intermediate) for the year to be in the range of US$90-$100 per
barrel.

Important risk factors that could affect the forward-looking statements
include, but are not limited to, the effects of general economic and
business conditions, industry competition, inflation, currency and
interest rate fluctuations, changes in fuel prices, legislative and/or
regulatory developments, compliance with environmental laws and
regulations, actions by regulators, various events which could disrupt
operations, including natural events such as severe weather, droughts,
floods and earthquakes, labor negotiations and disruptions,
environmental claims, uncertainties of investigations, proceedings or
other types of claims and litigation, risks and liabilities arising
from derailments, and other risks detailed from time to time in reports
filed by CN with securities regulators in Canada and the United States.
Reference should be made to “Management’s Discussion and Analysis” in
CN’s annual and interim reports, Annual Information Form and Form 40-F
filed with Canadian and U.S. securities regulators, available on CN’s
website, for a summary of major risk factors.

CN assumes no obligation to update or revise forward-looking statements
to reflect future events, changes in circumstances, or changes in
beliefs, unless required by applicable Canadian securities laws. In the
event CN does update any forward-looking statement, no inference should
be made that CN will make additional updates with respect to that
statement, related matters, or any other forward-looking statement.

CN – Canadian National Railway Company and its operating railway
subsidiaries – 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, Ala.,
and the key metropolitan areas of Toronto, Buffalo, Chicago, Detroit,
Duluth, Minn./Superior, Wis., Green Bay, Wis., Minneapolis/St. Paul,
Memphis, and Jackson, Miss., with connections to all points in North
America. For more information on CN, visit the Company’s website at www.cn.ca.

 

 

 

 

 

Note 1 – Basis of presentation

In management’s opinion, the accompanying unaudited Interim Consolidated
Financial Statements and Notes thereto, expressed in Canadian dollars,
and prepared in accordance with U.S. generally accepted accounting
principles (U.S. GAAP) for interim financial statements, contain all
adjustments (consisting of normal recurring accruals) necessary to
present fairly Canadian National Railway Company’s (the Company)
financial position as at March 31, 2013, December 31, 2012 and March
31, 2012, and its results of operations, changes in shareholders’
equity and cash flows for the three months ended March 31, 2013 and
2012.

These unaudited Interim Consolidated Financial Statements and Notes
thereto have been prepared using accounting policies consistent with
those used in preparing the Company’s 2012 Annual Consolidated
Financial Statements. While management believes that the disclosures
presented are adequate to make the information not misleading, these
unaudited Interim Consolidated Financial Statements and Notes thereto
should be read in conjunction with the Company’s Interim Management’s
Discussion and Analysis (MDA) and the 2012 Annual Consolidated
Financial Statements and Notes thereto.

Note 2 – Accounting change

In February 2013, the Financial Accounting Standards Board (FASB) issued
Accounting Standards Update (ASU) 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive
Income
. ASU 2013-02 added new disclosure requirements to Accounting Standards
Codification (ASC) 220, Comprehensive Income, for items reclassified out of accumulated other comprehensive income
(AOCI) effective for reporting periods beginning after December 15,
2012. It requires entities to disclose additional information about
amounts reclassified out of AOCI by component including changes in AOCI
balances and significant items reclassified out of AOCI by the
respective line items of net income. The Company has adopted ASU
2013-02 for the reporting period beginning January 1, 2013 and the
prescribed disclosures are presented in Note 11 – Accumulated other
comprehensive income (loss).

Note 3 – Disposal of property

2013 – Disposal of Lakeshore West
On March 19, 2013, the Company entered into an agreement with Metrolinx
to sell a segment of the Oakville subdivision in Oakville and
Burlington, Ontario, together with the rail fixtures and certain
passenger agreements (collectively the “Lakeshore West”), for cash
proceeds of $52 million before transaction costs. Under the agreement,
the Company obtained the perpetual right to operate freight trains over
the Lakeshore West at its then current level of operating activity,
with the possibility of increasing its operating activity for
additional consideration. The transaction resulted in a gain on
disposal of $40 million ($36 million after-tax) that was recorded in
Other income under the full accrual method of accounting for real
estate transactions.

2012 – Disposal of Bala-Oakville
On March 23, 2012, the Company entered into an agreement with Metrolinx
to sell a segment of the Bala and a segment of the Oakville
subdivisions in Toronto, Ontario, together with the rail fixtures and
certain passenger agreements (collectively the “Bala-Oakville”), for
cash proceeds of $311 million before transaction costs. Under the
agreement, the Company obtained the perpetual right to operate freight
trains over the Bala-Oakville at its then current level of operating
activity, with the possibility of increasing its operating activity for
additional consideration. The transaction resulted in a gain on
disposal of $281 million ($252 million after-tax) that was recorded in
Other income under the full accrual method of accounting for real
estate transactions.

Note 4 – Financing activities

Revolving credit facility
The Company has an $800 million revolving credit facility agreement with
a consortium of lenders. The agreement, which contains customary terms
and conditions, allows for an increase in the facility amount, up to a
maximum of $1,300 million, as well as the option to extend the term by
an additional year at each anniversary date, subject to the consent of
individual lenders. The Company exercised such option and on March 22,
2013, the expiry date of the agreement was extended by one year to May
5, 2018. The Company plans to use the credit facility for working
capital and general corporate purposes, including backstopping its
commercial paper program. As at March 31, 2013, the Company had no
outstanding borrowings under its revolving credit facility (nil as at
December 31, 2012).

Commercial paper
The Company has a commercial paper program, which is backed by its
revolving credit facility, enabling it to issue commercial paper up to
a maximum aggregate principal amount of $800 million, or the US dollar
equivalent. As at March 31, 2013, the Company had total borrowings of
$567 million, of which $486 million was denominated in Canadian dollars
and $81 million was denominated in US dollars (US$80 million) presented
in Current portion of long-term debt on the Consolidated Balance Sheet
(nil as at December 31, 2012). The weighted-average interest rate on
these borrowings was 1.01%.

Accounts receivable securitization program
On December 20, 2012, the Company entered into a three-year agreement,
commencing on February 1, 2013, to sell an undivided co-ownership
interest in a revolving pool of accounts receivables to unrelated
trusts for maximum cash proceeds of $450 million. The trusts are
multi-seller trusts and the Company is not the primary beneficiary.
Funding for the acquisition of these assets is customarily through the
issuance of asset-backed commercial paper notes by the unrelated
trusts.

The Company has retained the responsibility for servicing, administering
and collecting the receivables sold. The average servicing period is
approximately one month. Subject to customary indemnifications, each
trust’s recourse is limited to the accounts receivables transferred.

The Company is subject to customary reporting requirements for which
failure to perform could result in termination of the program. In
addition, the program is subject to customary credit rating
requirements, which if not met, could also result in termination of the
program. The Company monitors the reporting requirements and is
currently not aware of any trends, events or conditions that could
cause such termination.

The accounts receivable securitization program provides the Company with
readily available short-term financing for general corporate use. In
the event the program is terminated before its scheduled maturity, the
Company expects to meet its future payment obligations through its
various sources of financing including its revolving credit facility
and commercial paper program, and/or access to capital markets.

The Company accounts for its accounts receivable securitization program
under ASC 860, Transfers and Servicing. Based on the structure of the program, the Company accounts for the
proceeds from the program as a secured borrowing. As such, as at March
31, 2013, the Company recorded $420 million of proceeds received under
the accounts receivable securitization program in the Current portion
of long-term debt on the Consolidated Balance Sheet at a
weighted-average interest rate of 1.16% which is secured by and limited
to $488 million of accounts receivable.

Bilateral letter of credit facilities and Restricted cash and cash
equivalents

The Company has a series of bilateral letter of credit facility
agreements with various banks to support its requirements to post
letters of credit in the ordinary course of business. On March 22,
2013, the expiry date of these agreements was extended by one year to
April 28, 2016. Under these agreements, the Company has the option from
time to time to pledge collateral in the form of cash or cash
equivalents, for a minimum term of one month, equal to at least the
face value of the letters of credit issued. As at March 31, 2013, the
Company had letters of credit drawn of $542 million ($551 million as at
December 31, 2012) from a total committed amount of $559 million ($562
million as at December 31, 2012) by the various banks. As at March 31,
2013, cash and cash equivalents of $512 million ($521 million as at
December 31, 2012) were pledged as collateral and recorded as
Restricted cash and cash equivalents on the Consolidated Balance Sheet.

Share repurchase programs
On October 22, 2012, the Board of Directors of the Company approved a
share repurchase program which allows for the repurchase of up to $1.4
billion in common shares, not to exceed 18.0 million common shares,
between October 29, 2012 and October 28, 2013 pursuant to a normal
course issuer bid at prevailing market prices plus brokerage fees, or
such other prices as may be permitted by the Toronto Stock Exchange.

The following table provides the activity under such share repurchase
program as well as the share repurchase programs of the prior year:

Note 5 – Stock plans

The Company has various stock-based incentive plans for eligible
employees. A description of the Company’s major plans is provided in
Note 10 – Stock plans to the Company’s 2012 Annual Consolidated
Financial Statements. The following table provides total stock-based
compensation expense for awards under all plans, as well as the related
tax benefit recognized in income, for the three months ended March 31,
2013 and 2012.

Cash settled awards
Following approval by the Board of Directors in January 2013, the
Company granted 0.4 million restricted share units (RSUs) to designated
management employees entitling them to receive payout in cash based on
the Company’s share price. The RSUs granted are generally scheduled for
payout after three years (“plan period”) and vest conditionally upon
the attainment of a target relating to return on invested capital over
the plan period.

Payout is conditional upon the attainment of a minimum share price
calculated using the average of the last three months of the plan
period. In addition, commencing at various dates, for senior and
executive management employees (“executive employees”), payout is
conditional on compliance with the conditions of their benefit plans,
award or employment agreements, including but not limited to
non-compete, non-solicitation, and non-disclosure of confidential
information conditions. Current or former executive employees who
breach such conditions of their benefit plans, award or employment
agreements will forfeit the RSU payout. Should the Company reasonably
determine that a current or former executive employee may have violated
the conditions of their benefit plans, award or employment agreement,
the Company may at its discretion change the manner of vesting of the
RSUs to suspend payout on any RSUs pending resolution of such matter.

As at March 31, 2013, 0.1 million RSUs remained authorized for future
issuance under this plan.

In February 2012, the Company’s Board of Directors unanimously voted to
forfeit and cancel the RSU payout of approximately $18 million
otherwise due in February 2012 to its former Chief Executive Officer
(CEO) after determining that the former CEO was likely in breach of his
non-compete and non-disclosure of confidential information conditions
contained in the former CEO’s employment agreement. On February 4,
2013, the Company’s Executive Vice-President and Chief Operating
Officer (COO) resigned to join the Company’s major competitor in
Canada. As a result of the COO’s resignation, compensation amounts
subject to non-compete, non-solicitation and other applicable terms of
his long-term incentive award agreements and related plans, and certain
amounts accumulated under non-registered pension plans and arrangements
were forfeited. In February 2013, the Company entered into confidential
agreements to settle these matters. As a result, in the quarter ended
March 31, 2013, the stock-based compensation liability was reduced by
approximately $20 million.

The following table provides the 2013 activity for all cash settled
awards:

The following table provides valuation and expense information for all
cash settled awards:

Stock option awards
Following approval by the Board of Directors in January 2013, the
Company granted 0.5 million conventional stock options to designated
senior management employees. The stock option plan allows 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
grant. 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
March 31, 2013, 10.1 million common shares remained authorized for
future issuances under this plan. The total number of options
outstanding at March 31, 2013 was 4.2 million.

The following table provides the activity of stock option awards during
2013, and for options outstanding and exercisable at March 31, 2013,
the weighted-average exercise price and the weighted-average years to
expiration. The table also provides the aggregate intrinsic value for
in-the-money stock options, which represents the value that would have
been received by option holders had they exercised their options on
March 31, 2013 at the Company’s closing stock price of $102.10.

The following table provides valuation and expense information for all
stock option awards:

 Note 6 – Pensions and other postretirement benefits

The Company has various 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. Senior and executive management (“executive
employees”) subject to certain minimum service and age requirements,
are also eligible for an additional retirement benefit under their
Special Retirement Stipend Agreements (SRS), the Supplemental Executive
Retirement Plan (SERP) or the Defined Contribution Supplemental
Executive Retirement Plan (DC SERP). Executive employees who breach the
non-compete, non-solicitation and non-disclosure of confidential
information conditions of the SRS, SERP or DC SERP plans or other
employment agreement will forfeit the retirement benefit under these
plans. Should the Company reasonably determine that a current or former
executive employee may have violated the conditions of their SRS, SERP,
or DC SERP plan or other employment agreement, the Company may at its
discretion withhold or suspend payout of the retirement benefit pending
resolution of such matter.

On February 4, 2013, the Company’s COO resigned to join the Company’s
major competitor in Canada. As a result, compensation amounts
accumulated under non-registered pension plans subject to non-compete
and non-solicitation agreements were forfeited. The Company will record
an actuarial gain related to the amounts forfeited upon the completion
of its next actuarial valuation for accounting purposes, as at December
31, 2013.

For the three months ended March 31, 2013 and 2012, the components of
net periodic benefit cost (income) for pensions and other
postretirement benefits were as follows:

Company contributions to its various pension plans are made in
accordance with the applicable legislation in Canada and the United
States (U.S.) and are determined by actuarial valuations. Actuarial
valuations are required on an annual basis both in Canada and the U.S.
The next actuarial valuation for funding purposes for the Company’s
Canadian pension plans, based on a valuation date of December 31, 2012,
will be performed and filed by June 2013 and is expected to identify a
going-concern surplus of approximately $1.4 billion and a solvency
deficit of approximately $2.0 billion calculated using the three-year
average of the Company’s hypothetical windup ratio in accordance with
the Pension Benefit Standards Regulations, 1985. Under Canadian legislation, the solvency deficit is required to be
funded through special solvency payments, for which each annual amount
is equal to one fifth of the solvency deficit, and is re-established at
each valuation date.

Pension contributions made in the first three months of 2013 and 2012 of
$101 million and $553 million, respectively, mainly represent
contributions to the Company’s main pension plan, the CN Pension Plan.
These contributions are for the current service cost as determined
under the Company’s current actuarial valuations. During the first
three months of 2012, the Company made voluntary contributions of $450
million. Voluntary contributions can be treated as a prepayment against
the Company’s required special solvency payments and as at March 31,
2013, the Company had approximately $680 million of accumulated
prepayments which remain available to offset future required solvency
deficit payments. In April 2013, the Company made a voluntary
contribution of $100 million to the CN Pension Plan, increasing the
year-to-date pension contributions to $201 million and its accumulated
prepayments to approximately $780 million. The Company expects to make
total contributions in 2013 of approximately $235 million for all the
Company’s pension plans and to apply approximately $310 million from
its accumulated prepayments to satisfy the remainder of its estimated
2013 required solvency deficit payment.

Additional information relating to the pension plans is provided in Note
11 – Pensions and other postretirement benefits to the Company’s 2012
Annual Consolidated Financial Statements.

Note 7 – Income taxes

The Company recorded income tax expense of $178 million for the three
months ended March 31, 2013, compared to $225 million for the same
period in 2012. Included in the 2013 figures was an income tax recovery
of $16 million resulting from a revision of the apportionment of U.S.
state taxes.

Note 8 – Major commitments and contingencies

A. Commitments
As at March 31, 2013, the Company had commitments to acquire railroad
ties, rail, freight cars, locomotives, and other equipment and
services, as well as outstanding information technology service
contracts and licenses, at an aggregate cost of $648 million ($735
million as at December 31, 2012). The Company also has remaining
estimated commitments in relation to the acquisition of the principal
lines of the former Elgin, Joliet and Eastern Railway Company of
approximately $100 million (US$100 million) to be spent over the next
few years for railroad infrastructure improvements, grade separation
projects, as well as commitments under a series of agreements with
individual communities and a comprehensive voluntary mitigation program
established to address surrounding municipalities’ concerns. The
commitment for the grade separation projects is based on estimated
costs provided by the Surface Transportation Board (STB) at the time of
acquisition and could be subject to adjustment. In addition, remaining
implementation costs associated with the U.S. federal government
legislative requirement to implement positive train control (PTC) by
2015 are estimated to be approximately $180 million (US$180 million).
The Company also has agreements with fuel suppliers to purchase
approximately 95% of its estimated 2013 volume, 77% of its anticipated
2014 volume, 60% of its anticipated 2015 volume, 60% of its anticipated
2016 volume and 24% of its anticipated 2017 volume at market prices
prevailing on the date of the purchase.

B. Contingencies
In the normal course of business, the Company becomes involved in
various legal actions seeking compensatory and occasionally punitive
damages, including actions brought on behalf of various purported
classes of claimants and claims relating to employee and third-party
personal injuries, occupational disease and property damage, arising
out of harm to individuals or property allegedly caused by, but not
limited to, derailments or other accidents.

Canada
Employee injuries are governed by the workers’ compensation legislation
in each province whereby employees may be awarded either a lump sum or
a future stream of payments depending on the nature and severity of the
injury. As such, the provision for employee injury claims is
discounted. In the provinces where the Company is self-insured, costs
related to employee work-related injuries are accounted for based on
actuarially developed estimates of the ultimate cost associated with
such injuries, including compensation, health care and third-party
administration costs. A comprehensive actuarial study is generally
performed at least on a triennial basis. 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.

United States
Personal injury claims by the Company’s employees, including claims
alleging occupational disease and work-related injuries, are subject to
the provisions of the Federal Employers’ Liability Act (FELA).
Employees are compensated under FELA for damages assessed based on a
finding of fault through the U.S. jury system or through individual
settlements. As such, the provision is undiscounted. With limited
exceptions where claims are evaluated on a case-by-case basis, the
Company follows an actuarial-based approach and accrues the expected
cost for personal injury, including asserted and unasserted
occupational disease claims, and property damage claims, based on
actuarial estimates of their ultimate cost. A comprehensive actuarial
study is performed annually.

For employee work-related injuries, including asserted occupational
disease claims, and third-party claims, including grade crossing,
trespasser and property damage claims, the actuarial valuation
considers, among other factors, the Company’s historical patterns of
claims filings and payments. For unasserted occupational disease
claims, the actuarial study includes the projection of the Company’s
experience into the future considering the potentially exposed
population. The Company adjusts its liability based upon management’s
assessment and the results of the study. On an ongoing basis,
management reviews and compares the assumptions inherent in the latest
actuarial study with the current claim experience and, if required,
adjustments to the liability are recorded.

As at March 31, 2013, the Company had aggregate reserves for personal
injury and other claims of $317 million, of which $46 million was
recorded as a current liability ($314 million as at December 31, 2012,
of which $82 million was recorded as a current liability).

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 March 31, 2013, or with respect to
future claims, cannot be reasonably determined. When establishing
provisions for contingent liabilities the Company considers, where a
probable loss estimate cannot be made with reasonable certainty, a
range of potential probable losses for each such matter, and records
the amount it considers the most reasonable estimate within the range.
However, when no amount within the range is a better estimate than any
other amount, the minimum amount in the range is accrued. For matters
where a loss is reasonably possible but not probable, a range of
potential losses cannot be estimated due to various factors which may
include the limited availability of facts, the lack of demand for
specific damages and the fact that proceedings were at an early stage.
Based on information currently available, the Company believes that the
eventual outcome of the actions against the Company will not,
individually or in the aggregate, have a material adverse effect on the
Company’s consolidated financial position. However, due to the inherent
inability to predict with certainty unforeseeable future developments,
there can be no assurance that the ultimate resolution of these actions
will not have a material adverse effect on the Company’s results of
operations, financial position or liquidity in a particular quarter or
fiscal year.

C. Environmental matters
The Company’s operations are subject to numerous federal, provincial,
state, municipal and local environmental laws and regulations in Canada
and the U.S. 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.

Known existing environmental concerns
The Company has identified approximately 300 sites at which it is or may
be liable for remediation costs, in some cases along with other
potentially responsible parties, associated with alleged contamination
and is subject to environmental clean-up and enforcement actions,
including those imposed by the United States Federal Comprehensive
Environmental Response, Compensation and Liability Act of 1980
(CERCLA), also known as the Superfund law, or analogous state laws.
CERCLA and similar state laws, in addition to other similar Canadian
and U.S. laws, generally impose joint and several liability for
clean-up and enforcement costs on current and former owners and
operators of a site, as well as those whose waste is disposed of at the
site, without regard to fault or the legality of the original conduct.
The Company has been notified that it is a potentially responsible
party for study and clean-up costs at approximately 10 sites governed
by the Superfund law (and analogous state laws) for which investigation
and remediation payments are or will be made or are yet to be
determined and, in many instances, is one of several potentially
responsible parties.

The ultimate cost of addressing these known contaminated sites cannot be
definitely established given that the estimated environmental liability
for any given site may vary depending on the nature and extent of the
contamination; the nature of anticipated response actions, taking into
account the available clean-up techniques; evolving regulatory
standards governing environmental liability; and the number of
potentially responsible parties and their financial viability. As a
result, liabilities are recorded based on the results of a four-phase
assessment conducted on a site-by-site basis. A liability is initially
recorded when environmental assessments occur, remedial efforts are
probable, 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. The Company estimates the
costs related to a particular site using cost scenarios established by
external consultants based on the extent of contamination and expected
costs for remedial efforts. In the case of multiple parties, the
Company accrues its allocable share of liability taking into account
the Company’s alleged responsibility, the number of potentially
responsible parties and their ability to pay their respective share of
the liability. Adjustments to initial estimates are recorded as
additional information becomes available.

The Company’s provision for specific environmental sites is undiscounted
and includes costs for remediation and restoration of sites, as well as
monitoring costs. Environmental accruals, which are classified as
Casualty and other in the Consolidated Statement of Income, include
amounts for newly identified sites or contaminants as well as
adjustments to initial estimates. Recoveries of environmental
remediation costs from other parties are recorded as assets when their
receipt is deemed probable.

As at March 31, 2013, the Company had aggregate accruals for
environmental costs of $118 million, of which $32 million was recorded
as a current liability ($123 million as at December 31, 2012, of which
$31 million was recorded as a current liability). The Company
anticipates that the majority of the liability at March 31, 2013 will
be paid out over the next five years. However, some costs may be paid
out over a longer period. The Company expects to partly recover certain
accrued remediation costs associated with alleged contamination and has
recorded a receivable in Intangible and other assets for such
recoverable amounts. Based on the information currently available, the
Company considers its provisions to be adequate.

Unknown existing environmental concerns
While the Company believes that it has identified the costs likely to be
incurred for environmental matters in the next several years based on
known information, the discovery of new facts, future changes in laws,
the possibility of releases of hazardous materials into the environment
and the Company’s ongoing efforts to identify potential environmental
liabilities that may be associated with its properties may result in
the identification of additional environmental liabilities and related
costs. The magnitude of such additional liabilities and the costs of
complying with future environmental laws and containing or remediating
contamination cannot be reasonably estimated due to many factors,
including:

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 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 liabilities or costs, although management believes, based on
current information, that the costs to address environmental matters
will not have a material adverse effect on the Company’s financial
position or liquidity. Costs related to any unknown existing or future
contamination will be accrued in the period in which they become
probable and reasonably estimable.

D. Guarantees and indemnifications
In the normal course of business, the Company, including certain of its
subsidiaries, enters into agreements that may involve providing
guarantees or indemnifications to third parties and others, which may
extend beyond the term of the agreements. These include, but are not
limited to, residual value guarantees on operating leases, standby
letters of credit, surety and other bonds, and indemnifications that
are customary for the type of transaction or for the railway business.

The Company is required to recognize a liability for the fair value of
the obligation undertaken in issuing certain guarantees on the date the
guarantee is issued or modified. In addition, where the Company expects
to make a payment in respect of a guarantee, a liability will be
recognized to the extent that one has not yet been recognized.

(i) 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 2013 and
2021, 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. As at
March 31, 2013, the maximum exposure in respect of these guarantees was
$164 million. There are no recourse provisions to recover any amounts
from third parties.

(ii) Other guarantees
As at March 31, 2013, the Company, including certain of its
subsidiaries, had granted $542 million of irrevocable standby letters
of credit and $12 million of surety and other bonds, issued by highly
rated financial institutions, to third parties to indemnify them in the
event the Company does not perform its contractual obligations. As at
March 31, 2013, the maximum potential liability under these guarantee
instruments was $554 million, of which $489 million related to workers’
compensation and other employee benefit liabilities and $65 million
related to equipment under leases and other liabilities. The letters of
credit were drawn on the Company’s bilateral letter of credit
facilities. The Company had not recorded a liability as at March 31,
2013 with respect to these guarantee instruments as they related to the
Company’s future performance and the Company did not expect to make any
payments under these guarantee instruments. The majority of the
guarantee instruments mature at various dates between 2013 and 2015.

(iii) 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:

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, such exposure cannot be
reasonably determined.

During the period, the Company entered into various indemnification
contracts with third parties for which the maximum exposure for future
payments cannot be reasonably determined. As a result, the Company was
unable to determine the fair value of these guarantees and accordingly,
no liability was recorded. There are no recourse provisions to recover
any amounts from third parties.

Note 9 – Financial instruments

For financial assets and liabilities measured at fair value on a
recurring basis, fair value is the price the Company would receive to
sell an asset or pay to transfer a liability in an orderly transaction
with a market participant at the measurement date. In the absence of
active markets for identical assets or liabilities, such measurements
involve developing assumptions based on market observable data and, in
the absence of such data, internal information that is believed to be
consistent with what market participants would use in a hypothetical
transaction that occurs at the measurement date. Observable inputs
reflect market data obtained from independent sources, while
unobservable inputs reflect the Company’s market assumptions.
Preference is given to observable inputs. These two types of inputs
create the following fair value hierarchy:

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, Restricted cash and cash equivalents,
Accounts receivable, Other current assets, Accounts payable and other:

The carrying amounts approximate fair value because of the short
maturity of these instruments. Cash and cash equivalents and Restricted
cash and cash equivalents include highly liquid investments purchased
three months or less from maturity and are classified as Level 1.
Accounts receivable, Other current assets, and Accounts payable and
other are classified as Level 2 as they may not be priced using quoted
prices, but rather determined from market observable information.

(ii) Intangible and other assets:
Included in Intangible and other assets are equity investments for which
the carrying value approximates the fair value, with the exception of
certain cost investments for which the fair value is estimated based on
the Company’s proportionate share of the underlying net assets.
Intangible and other assets are classified as Level 3 as their fair
value is based on significant unobservable inputs.

(iii) Debt:
The fair value of the Company’s 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. The Company’s
debt is classified as Level 2.

The following table presents the carrying amounts and estimated fair
values of the Company’s financial instruments as at March 31, 2013 and
December 31, 2012 for which the carrying values on the Consolidated
Balance Sheet are different from their fair values:

Note 10 – Earnings per share

The following table provides a reconciliation between basic and diluted
earnings per share:

Basic earnings per share are calculated based on the weighted-average
number of common shares outstanding over each period. Diluted earnings
per share are calculated based on the weighted-average diluted shares
outstanding using the treasury stock method, which assumes that any
proceeds received from the exercise of in-the-money stock options would
be used to purchase common shares at the average market price for the
period. The weighted-average number of stock options that were not
included in the calculation of diluted earnings per share, as their
inclusion would have had an anti-dilutive impact, was 0.1 million for
both the three months ended March 31, 2013 and the corresponding period
in 2012.

Note 11 – Accumulated other comprehensive income (loss)

The following tables provide the components, the change and the
reclassifications out of Accumulated other comprehensive income (loss)
for the three-month periods ending March 31, 2013 and 2012:

 

Statistical data and related productivity measures are based on
estimated data available at such time and are subject to change as more
complete information becomes available, as such certain of the 2012
comparative data and related productivity measures have been restated.

Statistical data and related productivity measures are based on
estimated data available at such time and are subject to change as more
complete information becomes available. 

Adjusted performance measures

For the three months ended March 31, 2013, the Company reported adjusted
net income of $519 million, or $1.22 per diluted share. The adjusted
figures exclude the gain on disposal of a segment of the Oakville
subdivision, together with the rail fixtures and certain passenger
agreements (collectively the “Lakeshore West”), of $40 million, or $36
million after-tax ($0.08 per diluted share). For the three months ended
March 31, 2012, the Company reported adjusted net income of $523
million, or $1.18 per diluted share. The adjusted figures exclude the
gain on disposal of a segment of the Bala and a segment of the Oakville
subdivisions, together with the rail fixtures and certain passenger
agreements (collectively the “Bala-Oakville”), of $281 million, or $252
million after-tax ($0.57 per diluted share).

Management believes that adjusted net income and adjusted earnings per
share are useful measures of performance that can facilitate
period-to-period comparisons, as they exclude items that do not
necessarily arise as part of the normal day-to-day operations of the
Company and could distort the analysis of trends in business
performance. The exclusion of such items in adjusted net income and
adjusted earnings per share does not, however, imply that such items
are necessarily non-recurring. These adjusted measures do not have any
standardized meaning prescribed by GAAP and may, therefore, not be
comparable to similar measures presented by other companies. The reader
is advised to read all information provided in the Company’s 2013
unaudited Interim Consolidated Financial Statements and Notes thereto.
The following table provides a reconciliation of net income and
earnings per share, as reported for the three months ended March 31,
2013 and 2012, to the adjusted performance measures presented herein.

Constant currency

Although CN conducts its business and reports its earnings in Canadian
dollars, a large portion of revenues and expenses is denominated in US
dollars. As such, the Company’s results are affected by exchange-rate
fluctuations.

Financial results at “constant currency” allow results to be viewed
without the impact of fluctuations in foreign currency exchange rates,
thereby facilitating period-to-period comparisons in the analysis of
trends in business performance. Measures at constant currency are
considered non-GAAP measures and do not have any standardized meaning
prescribed by GAAP and may, therefore, not be comparable to similar
measures presented by other companies. Financial results at constant
currency are obtained by translating the current period results
denominated in US dollars at the foreign exchange rates of the
comparable period of the prior year. The average foreign exchange rates
were $1.01 and $1.00 per US$1.00, respectively, for the three months
ended March 31, 2013 and 2012. There was minimal impact on the
Company’s 2013 first quarter net income on a constant currency basis.

Free cash flow

The Company utilized $20 million of free cash flow for the three months
ended March 31, 2013 compared to generated $48 million for the same
period in 2012. Free cash flow does not have any standardized meaning
prescribed by GAAP and may, therefore, not be comparable to similar
measures presented by other companies. The Company believes that free
cash flow is a useful measure of performance as it demonstrates the
Company’s ability to generate cash after the payment of capital
expenditures and dividends. The Company defines free cash flow as the
sum of net cash provided by operating activities, adjusted for changes
in cash and cash equivalents resulting from foreign exchange
fluctuations; and net cash provided by (used in) investing activities,
adjusted for changes in restricted cash and cash equivalents, if any,
the impact of major acquisitions, if any; and the payment of dividends,
calculated as follows:

  

 

SOURCE: CN

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