FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Report of Foreign Issuer
 
Pursuant to Rule 13a-16 or 15d-16
of the Securities Exchange Act of 1934
 
For the month of October, 2007
 
Commission File Number: 001-02413
 
Canadian National Railway Company
(Translation of registrant’s name into English)
 
935 de la Gauchetiere Street West
Montreal, Quebec
Canada H3B 2M9

(Address of principal executive offices)
 
Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F:
 
Form 20-F           Form 40-F    X  

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1):
 
Yes           No    X  

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7):
 
Yes           No    X  

Indicate by check mark whether by furnishing the information contained in this Form, the Registrant is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934:
 
Yes           No    X  

If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): N/A


 
 
Canadian National Railway Company

Table of Contents
 
Item
 
1. Press Release dated October 22, 2007 entitled, "CN reports Q3-2007 net income of C$485 million, or C$0.96 per diluted share, including C$0.03 per share benefit from favorable tax adjustments".
 
 
 
 

 
Item 1
 
 
North America’s Railroad

 
NEWS RELEASE

CN reports Q3-2007 net income of C$485 million,
or C$0.96 per diluted share, including C$0.03 per share
benefit from favorable tax adjustments

Results reflect weak forest products
revenues, challenging C$/US$ exchange rate environment

MONTREAL, Oct. 22, 2007 CN (TSX:CNR)(NYSE:CNI) today reported its financial and operating results for the three-month and nine-month periods ended Sept. 30, 2007.

Key third-quarter 2007 statistics
 
·  
Diluted earnings per share of C$0.96, including a C$0.03 per share benefit from favorable tax adjustments, increased two per cent from the year-earlier period.
·  
Net income of C$485 million, including a C$14-million benefit from favorable tax adjustments, declined two per cent from net income for the same quarter of 2006.
·  
Revenues remained essentially flat at C$2,023 million, with several commodity groups helping to offset significant weakness in forest products.
·  
Operating income declined nine per cent to C$768 million, while CN’s operating ratio increased by 3.5 points to 62.0 per cent.
 
E. Hunter Harrison, president and chief executive officer, said: “CN’s third-quarter results are a solid achievement given the challenges we faced during the period. Revenues in our forest products segment – CN’s largest commodity group by revenue – declined 13 per cent as a result of weak market conditions and mill closures, the impact of a stronger Canadian dollar and lower fuel surcharge revenues.
 
“The stronger Canadian dollar not only affected forest products but also our other businesses. Clearly, few of us expected that the Canadian dollar would surge beyond parity with the U.S. dollar during the quarter. Despite these challenges, we are fortunate to have a diversified portfolio of businesses and we were able to register volume and revenue growth in Canadian coal, grain and fertilizers, petroleum and chemicals, and automotive.
 

 
“In the near term, CN anticipates continued weak market conditions in a number of segments, particularly forest products and construction materials. In addition, we will continue to confront the financial impact of the Canadian dollar/U.S. dollar exchange rate and its effect on our customers. However, as a result of anticipated gains from the closing of our Central Station Complex and English Welsh and Scottish Railway transactions during the fourth quarter, CN expects to achieve full-year 2007 diluted earnings per share growth of about five per cent. Excluding these transaction gains, 2007 adjusted diluted earnings per share are expected to be flat versus 2006.”

Third-quarter results

Net income for the third quarter of 2007 was C$485 million, including a C$14-million benefit from favorable tax adjustments related to the enactment of corporate tax rate changes in Canada and net capital losses arising from a reorganization of certain subsidiaries, compared with net income of C$497 million for the comparable period of 2006.
 
Diluted earnings per share for the latest quarter were C$0.96, including a C$0.03 per share benefit from favorable tax adjustments, compared with C$0.94 per diluted share for the same quarter of 2006.
 
Third-quarter revenues of C$2,023 million were relatively flat, largely on account of the unfavorable translation impact of a stronger Canadian dollar on U.S. dollar-denominated revenues, lower fuel surcharge revenues resulting from a decrease in the applicable year-over-year oil prices, and weaknesses in specific markets, particularly forest products. These decreases were partly offset by freight rate increases, an overall improvement in traffic mix, driven primarily by extended routings, and volume growth in Canadian coal, grain and fertilizers, petroleum and chemicals, and automotive traffic.
 
Revenue ton-miles, a measurement of the relative weight and distance of rail freight transported by the Company, declined one per cent during third-quarter 2007 versus the comparable period of 2006. Total 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, declined one per cent over the same period in 2006.
 
Operating expenses for the third quarter increased six per cent to C$1,255 million, mainly due to increased labor and fringe benefits, fuel, equipment rents, and casualty and other expenses, which were partly offset by the translation impact of the stronger Canadian dollar.
 
The operating ratio, defined as operating expenses as a percentage of revenues, was 62.0 per cent during the quarter, compared with 58.5 per cent for the third quarter of 2006, a 3.5-point increase.


2

 
Nine-month 2007 results

Net income for the first nine months of 2007 was C$1,325 million, or C$2.59 per diluted share, including deferred income tax recoveries of C$44 million (C$0.09 per diluted share) resulting from the enactment of lower corporate tax rates in Canada and net capital losses arising from a reorganization of certain subsidiaries.
 
Year-earlier net income was C$1,588 million, or C$2.95 per diluted share, including a deferred income tax recovery of C$250 million (C$0.46 per diluted share).
 
Revenues for the first nine months of 2007 were relatively flat at C$5,956 million, as freight rate increases and an overall improvement in traffic mix were largely offset by the impact of the first-quarter United Transportation Union (UTU) strike and adverse weather conditions, operational challenges, primarily in western Canada, the translation impact of a stronger Canadian dollar on U.S. dollar-denominated revenues, lower fuel surcharge revenues as a result of a decrease in the applicable year-over-year oil prices, and weakness in specific markets, particularly forest products.
 
Revenue ton-miles for the first nine months of 2007 declined two per cent from the comparable period of 2006, while total rail freight revenue per ton-mile increased two per cent.
 
For the first nine months of 2007, operating expenses increased four per cent to C$3,816 million, mainly due to increased fuel, equipment rents and purchased services and material expenses, which were partly offset by the translation impact of a stronger Canadian dollar and lower casualty and other expenses. The nine-month operating ratio was 64.1 per cent, a 2.5-point increase.
 
In addition to the adverse weather conditions in the first quarter and operational challenges in the second quarter, the Company’s results in the first nine months of 2007 included the impact of a first-quarter 2007 strike by 2,800 members of the UTU in Canada for which the Company estimates that the impact on first-quarter 2007 operating income and net income approximated C$50 million and C$35 million, respectively (C$0.07 per diluted share).
 
The financial results in this press release were determined on the basis of U.S. generally accepted accounting principles (U.S. GAAP).
 
Please see discussion and reconciliation of non-GAAP adjusted performance measures in the attached supplementary schedule, Non-GAAP Measures.
 
This news release contains forward-looking statements. CN cautions that, by their nature, forward-looking statements involve risk, uncertainties and assumptions, and while there may be a risk of recession in the U.S. economy, the Company’s assumption is that positive economic conditions in North America and globally will continue, which assumption may not materialize, and that its results could differ materially from those expressed or implied in such statements. Important factors that could cause such differences include, but are not limited to, industry competition, legislative and/or regulatory developments, compliance with environmental laws and regulations, various events which could disrupt operations, including natural events such as severe weather, droughts, floods and earthquakes, the effects of adverse general economic and business conditions, inflation, currency fluctuations, changes in fuel prices, labor disruptions, environmental claims, investigations or proceedings, other types of claims and litigation, 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 CN’s most recent Form 40-F filed with the United States Securities and Exchange Commission, its Annual Information Form filed with the Canadian securities regulators, and its 2006 Annual Consolidated Financial Statements and Notes thereto and Management’s Discussion and Analysis (MD&A), for a summary of major risks.

 
3


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, St. Louis, 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.

- 30 -

Contacts:
   
Media
 
Investment Community
Mark Hallman
 
Robert Noorigian
Director
 
Vice-President
Communications, Media & Eastern Region
 
Investor Relations
(905) 669-3384
 
(514) 399-0052


4


CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF INCOME (U.S. GAAP) 

(In millions, except per share data)
 
   
Three months ended    
September 30
 
Nine months ended    
September 30
   
2007
   
2006
   
2007
   
2006
 
   
   (Unaudited)       
                                 
Revenues
  $
2,023
    $
2,032
    $
5,956
    $
5,929
 
                                 
Operating expenses
                               
Labor and fringe benefits
   
446
     
420
     
1,361
     
1,349
 
Purchased services and material
   
247
     
250
     
786
     
756
 
Depreciation and amortization
   
165
     
157
     
504
     
483
 
Fuel
   
251
     
235
     
719
     
665
 
Equipment rents
   
59
     
49
     
187
     
135
 
Casualty and other
   
87
     
77
     
259
     
267
 
Total operating expenses
   
1,255
     
1,188
     
3,816
     
3,655
 
                                 
Operating income
   
768
     
844
     
2,140
     
2,274
 
                                 
Interest expense
    (78 )     (82 )     (251 )     (232 )
                                 
Other income (loss)
   
2
      (10 )    
7
      (16 )
                                 
Income before income taxes
   
692
     
752
     
1,896
     
2,026
 
                                 
Income tax expense (Note 8)
    (207 )     (255 )     (571 )     (438 )
                                 
Net income
  $
485
    $
497
    $
1,325
    $
1,588
 
                                 
Earnings per share (Note 9)
                               
                                 
Basic
  $
0.97
    $
0.95
    $
2.62
    $
3.00
 
                                 
Diluted
  $
0.96
    $
0.94
    $
2.59
    $
2.95
 
                                 
Weighted-average number of shares
                               
                                 
Basic
   
499.7
     
522.5
     
505.0
     
529.5
 
                                 
Diluted
   
506.4
     
530.2
     
512.1
     
538.0
 
See accompanying notes to unaudited consolidated financial statements.
 
5


CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED BALANCE SHEET (U.S. GAAP) 

(In millions)

   
September 30
   
December 31
   
September 30
 
   
2007
   
2006
   
2006
 
   
(Unaudited)
         
(Unaudited)
 
Assets
                 
                   
Current assets:
                 
Cash and cash equivalents
  $
214
    $
179
    $
56
 
Accounts receivable
   
641
     
692
     
1,035
 
Material and supplies
   
206
     
189
     
205
 
Deferred income taxes (Notes 2, 8)
   
69
     
84
     
80
 
Other
   
316
     
192
     
107
 
     
1,446
     
1,336
     
1,483
 
                         
Properties
   
19,883
     
21,053
     
20,216
 
Intangible and other assets
   
1,576
     
1,615
     
976
 
                         
Total assets
  $
22,905
    $
24,004
    $
22,675
 
                         
Liabilities and shareholders' equity
                       
                         
Current liabilities:
                       
Accounts payable and accrued charges
  $
1,205
    $
1,823
    $
1,671
 
Current portion of long-term debt (Note 4)
   
293
     
218
     
151
 
Other
   
56
     
73
     
69
 
     
1,554
     
2,114
     
1,891
 
                         
Deferred income taxes (Notes 2, 8)
   
4,940
     
5,215
     
4,884
 
Other liabilities and deferred credits
   
1,410
     
1,465
     
1,474
 
Long-term debt (Note 4)
   
5,342
     
5,386
     
5,164
 
 
                       
Shareholders' equity:
                       
Common shares
   
4,359
     
4,459
     
4,476
 
Accumulated other comprehensive loss
    (257 )     (44 )     (520 )
Retained earnings
   
5,557
     
5,409
     
5,306
 
     
9,659
     
9,824
     
9,262
 
                         
Total liabilities and shareholders' equity
  $
22,905
    $
24,004
    $
22,675
 
See accompanying notes to unaudited consolidated financial statements.
 
6


CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (U.S. GAAP)

(In millions)

   
Three months ended
September 30
   
Nine months ended
September 30
 
   
2007
   
2006
   
2007
   
2006
 
   
(Unaudited)
 
Common shares (1)
                       
                                 
Balance, beginning of period
  $
4,417
    $
4,543
    $
4,459
    $
4,580
 
Stock options exercised and other
   
16
     
8
     
83
     
90
 
Share repurchase programs (Note 4)
    (74 )     (75 )     (183 )     (194 )
Balance, end of period
  $
4,359
    $
4,476
    $
4,359
    $
4,476
 
                                 
Accumulated other comprehensive loss
                               
                                 
Balance, beginning of period
  $ (180 )   $ (521 )   $ (44 )   $ (222 )
                                 
Other comprehensive income (loss):
                               
                                 
Unrealized foreign exchange gain (loss) on:
                               
Translation of the net investment in foreign operations
    (381 )    
50
      (914 )     (214 )
Translation of U.S. dollar-denominated long-term debt
                               
designated as a hedge of the net investment in U.S. subsidiaries
   
328
      (44 )    
766
     
163
 
                                 
Pension and other postretirement benefit plans:
                               
Amortization of:
                               
Prior service cost (Note 6)
   
5
     
-
     
16
     
-
 
Net actuarial loss (Note 6)
   
13
     
-
     
38
     
-
 
                                 
Derivative instruments:
                               
Decrease in unrealized holding gains on fuel
                               
derivative instruments
   
-
      (10 )    
-
      (57 )
Other comprehensive loss before income taxes
    (35 )     (4 )     (94 )     (108 )
                                 
Income tax recovery (expense)
    (42 )    
5
      (119 )     (190 )
Other comprehensive income (loss)
    (77 )    
1
      (213 )     (298 )
Balance, end of period
  $ (257 )   $ (520 )   $ (257 )   $ (520 )
                                 
Retained earnings
                               
                                 
Balance, beginning of period
  $
5,554
    $
5,212
    $
5,409
    $
4,891
 
                                 
Adoption of new accounting pronouncements (Note 2)
   
-
     
-
     
95
     
-
 
                                 
Restated balance, beginning of period
   
5,554
     
5,212
     
5,504
     
4,891
 
                                 
Net income
   
485
     
497
     
1,325
     
1,588
 
Share repurchase programs (Note 4)
    (378 )     (318 )     (956 )     (916 )
Dividends
    (104 )     (85 )     (316 )     (257 )
Balance, end of period
  $
5,557
    $
5,306
    $
5,557
    $
5,306
 
See accompanying notes to unaudited consolidated financial statements.

(1)
During the three and nine months ended September 30, 2007, the Company issued 0.5 million and 2.9 million common shares, respectively, as a result of stock options exercised. At September 30, 2007, the Company had 494.5 million common shares outstanding.
 
7


CANADIAN NATIONAL RAILWAY COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (U.S. GAAP) 

(In millions)
 
   
Three months ended
September 30
   
Nine months ended
September 30
 
   
2007
   
2006
   
2007
   
2006
 
         
(Unaudited)
       
Operating activities
                       
                                 
Net income
  $
485
    $
497
    $
1,325
    $
1,588
 
Adjustments to reconcile net income to net cash provided from
                               
operating activities:
                               
Depreciation and amortization
   
165
     
159
     
506
     
486
 
Deferred income taxes
   
75
     
74
     
125
      (20 )
Other changes in:
                               
Accounts receivable
    (252 )     (71 )     (38 )     (420 )
Material and supplies
    (6 )    
30
      (26 )     (54 )
Accounts payable and accrued charges
    (65 )    
134
      (471 )    
149
 
Other net current assets and liabilities
   
42
     
9
     
51
     
92
 
Other
    (14 )    
22
      (40 )    
57
 
Cash provided from operating activities
   
430
     
854
     
1,432
     
1,878
 
                                 
Investing activities
                               
                                 
Property additions
    (350 )     (384 )     (897 )     (826 )
Other, net
   
14
     
6
     
26
      (39 )
Cash used by investing activities
    (336 )     (378 )     (871 )     (865 )
                                 
Financing activities
                               
                                 
Issuance of long-term debt
   
1,841
     
-
     
3,325
     
3,125
 
Reduction of long-term debt
    (1,420 )     (153 )     (2,469 )     (2,855 )
Issuance of common shares due to exercise of stock options
                               
  and related excess tax benefits realized
   
14
     
4
     
73
     
78
 
Repurchase of common shares
    (452 )     (393 )     (1,139 )     (1,110 )
Dividends paid
    (104 )     (85 )     (316 )     (257 )
Cash used by financing activities
    (121 )     (627 )     (526 )     (1,019 )
                                 
Net increase (decrease) in cash and cash equivalents
    (27 )     (151 )    
35
      (6 )
                                 
Cash and cash equivalents, beginning of period
   
241
     
207
     
179
     
62
 
Cash and cash equivalents, end of period
  $
214
    $
56
    $
214
    $
56
 
                                 
Supplemental cash flow information
                               
Net cash receipts from customers and other
  $
1,770
    $
1,949
    $
5,930
    $
5,521
 
Net cash payments for:
                               
Employee services, suppliers and other expenses
    (1,106 )     (924 )     (3,387 )     (3,097 )
Interest
    (86 )     (86 )     (273 )     (227 )
Workforce reductions
    (8 )     (10 )     (24 )     (37 )
Personal injury and other claims
    (12 )     (18 )     (58 )     (60 )
Pensions
    (27 )     (21 )     (50 )     (46 )
Income taxes
    (101 )     (36 )     (706 )     (176 )
Cash provided from operating activities
  $
430
    $
854
    $
1,432
    $
1,878
 
See accompanying notes to unaudited consolidated financial statements.
 
8


CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP)

 
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 September 30, 2007, December 31, 2006, and September 30, 2006, and its results of operations, changes in shareholders’ equity and cash flows for the three and nine months ended September 30, 2007 and 2006.
 
These unaudited Interim Consolidated Financial Statements and Notes thereto have been prepared using accounting policies consistent with those used in preparing the Company’s 2006 Annual Consolidated Financial Statements, except for accounting for income taxes and pensions and other postretirement benefits as explained in Note 2 – Adoption of new accounting pronouncements. 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 (MD&A) and Annual Consolidated Financial Statements and Notes thereto.
 
Certain of the comparative figures have been reclassified in order to be consistent with the 2007 presentation as discussed herein. As a result of the Company's expansion of its existing non-rail transportation services, in combination with its rail service, the Company has become primarily responsible for the fulfillment of the transportation of goods involving non-rail activities.  In order to be consistent with other non-rail transportation services, the Company reclassified certain operating expenses incurred for non-rail transportation services, which were previously netted with their related revenues, to reflect the gross reporting of revenues where appropriate.  This change had no impact on the Company's operating income and net income, as both revenues and operating expenses were increased by $92 million and $225 million in the three and nine months ended September 30, 2007, respectively, and $51 million and $155 million, respectively, for the same periods in 2006.

 
Note 2 – Adoption of new accounting pronouncements

Income taxes
On January 1, 2007, the Company adopted Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes,” which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  This Interpretation also provides guidance on derecognition, classification, interest and penalties, disclosure, and transition. The application of FIN No. 48 on January 1, 2007 had the effect of decreasing the net deferred income tax liability and increasing Retained earnings by $98 million.
 
At January 1, 2007, the total amount of unrecognized tax benefits was $80 million, of which $36 million related to accrued interest and penalties. The total amount of the gross unrecognized tax benefits was $140 million, before considering tax treaties and other arrangements between taxation authorities. If recognized, all of the unrecognized tax benefits would affect the effective tax rate. The amount of unrecognized tax benefits did not significantly change as at September 30, 2007.
 
The Company recognizes interest accrued and penalties related to unrecognized tax benefits in Income tax expense in the Company’s Consolidated Statement of Income. The amount of interest and penalties expense for the three and nine months ended September 30, 2007 was not significant.
 
In Canada, the federal income tax returns filed for the years 2002 to 2006 and the provincial income tax returns filed for the years 1998 to 2006 remain subject to examination by the taxation authorities. In the U.S., the income tax returns filed for the years 2004 to 2006 remain subject to examination by the taxation authorities.
 
Pensions and other postretirement benefits
On January 1, 2007, pursuant to Statement of Financial Accounting Standards (SFAS) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R),” the Company early adopted the requirement to measure the defined benefit plan assets and the projected benefit obligation as of the date of the fiscal year-end statement of financial position for its U.S. plans. The Company elected to use the 15-month transition method, which allows for the extrapolation of net periodic benefit cost based on the September 30, 2006 measurement date to the fiscal year-end date of
 
9

 
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP) 


December 31, 2007. As a result, the Company recorded a reduction of $3 million to Retained earnings at January 1, 2007, which represents the net periodic benefit cost attributable to the period between the early measurement date of September 30, 2006 and January 1, 2007 (the date of adoption).
 
 
Note 3 – Agreement to acquire Elgin, Joliet and Eastern Railway Company (EJ&E)
 
In September 2007, the Company entered into an agreement with the U.S. Steel Corporation (U.S. Steel) for the acquisition of the key operations of EJ&E for a purchase price of approximately U.S.$300 million. Under the terms of the agreement, the Company will acquire substantially all of the railroad assets and equipment of EJ&E, except those that support the Gary Works site in Northwest Indiana and the steelmaking operations of U.S. Steel. The acquisition will be financed by debt and cash on hand.
 
 In accordance with the terms of the agreement, the Company’s obligation to consummate the acquisition is subject to the Company having obtained from the U.S. Surface Transportation Board (STB) a final, unappealable decision that approves the acquisition or exempts it from regulation and does not impose on the parties conditions that would significantly and adversely affect the anticipated economic benefits of the acquisition to the Company.
 
 The Company believes that if its application to acquire EJ&E is approved by the STB as filed, the transaction should close by mid-2008. If the transaction is approved, the Company will account for the acquisition using the purchase method of accounting.
 
 
Note 4 – Financing activities

Shelf prospectus and registration statement
In September 2007, the Company issued U.S.$250 million (Cdn$250 million) of 5.85% Notes due 2017 and U.S.$300 million (Cdn$300 million) of 6.375% Debentures due 2037, the total remaining amount under its shelf registration statement filed in May 2006. The Company used the net proceeds of U.S.$544 million to repay a portion of its commercial paper outstanding and to reduce its accounts receivable securitization program.
 
Revolving credit facility
As at September 30, 2007, the Company had letters of credit drawn on its U.S.$1 billion revolving credit facility of $58 million ($308 million as at December 31, 2006). The Company also had total borrowings under its commercial paper program of $377 million, of which $136 million was denominated in Canadian dollars and $241 million was denominated in U.S. dollars (U.S.$242 million). The weighted-average interest rate on these borrowings was 5.43%. The Company had no commercial paper outstanding as at December 31, 2006.
 
Accounts receivable securitization
The Company has a five-year agreement, expiring in May 2011, to sell an undivided co-ownership interest of up to a maximum of $600 million in a revolving pool of freight receivables to an unrelated trust.
At September 30, 2007, the Company had sold receivables that resulted in proceeds of $406 million under this program ($393 million at December 31, 2006). The retained interest in the receivables was approximately 10% of this amount and is recorded in Other current assets. At September 30, 2007, the servicing asset and liability were not significant.
 
Share repurchase programs
On July 23, 2007, the Board of Directors of the Company approved a new share repurchase program which allows for the repurchase of up to 33.0 million common shares between July 26, 2007 and July 25, 2008 pursuant to a normal course issuer bid, at prevailing market prices or such other price as may be permitted by the Toronto Stock Exchange.
 
In the third quarter of 2007, under this current share repurchase program, the Company repurchased 8.3 million common shares for $452 million, at a weighted-average price of $54.46 per share.
 
10


CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP) 


In the second quarter of 2007, the Company completed its 28.0 million share repurchase program, which began on July 25, 2006, repurchasing a total of 28.0 million common shares for $1,453 million, at a weighted-average price of $51.88 per share.  Of this amount, 12.5 million common shares were repurchased in 2007 for $687 million, at a weighted-average price of $54.93 per share.

 
Note 5 – Stock plans

The Company has various stock-based incentive plans for eligible employees. A description of the plans is provided in Note 12 – Stock plans, to the Company’s 2006 Annual Consolidated Financial Statements. For the three and nine months ended September 30, 2007, the Company recorded total compensation expense for awards under all plans of $39 million and $112 million, respectively, and $7 million and $48 million, respectively, for the same periods in 2006. The total tax benefit recognized in income in relation to stock-based compensation expense for the three and nine months ended September 30, 2007, was $12 million and $33 million, respectively, and $1 million and $12 million, respectively, for the same periods in 2006.
 
Cash settled award
Following approval by the Board of Directors in January 2007, the Company granted 0.7 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 by the Company are generally scheduled for payout in cash after three years (“plan period”) and vest upon the attainment of targets relating to return on invested capital over the plan period and the Company’s share price during the last three months of the plan period. As at September 30, 2007, 0.1 million RSUs remained authorized for future issuance under this plan.

The following table provides the activity for all cash settled awards in 2007:

               
Vision 2008 Share Unit
   
Voluntary Incentive
 
   
RSUs
   
Plan (Vision)
   
Deferral Plan (VIDP)
 
In millions
 
Nonvested
   
Vested
   
Nonvested
   
Vested
   
Nonvested
   
Vested
 
                                                 
Outstanding at December 31, 2006
   
2.0
     
-
     
0.8
     
-
     
0.3
     
1.9
 
Granted
   
0.7
     
-
     
-
     
-
     
-
     
-
 
Forfeited
   
-
     
-
     
-
     
-
     
-
     
-
 
Vested during period
    (0.2 )    
0.2
     
-
     
-
      (0.1 )    
0.1
 
Payout
   
-
      (0.1 )    
-
     
-
     
-
      (0.2 )
Conversion into VIDP
   
-
      (0.1 )    
-
     
-
     
-
     
0.1
 
Outstanding at September 30, 2007
   
2.5
     
-
     
0.8
     
-
     
0.2
     
1.9
 
 
11


CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP) 


The following table provides valuation and expense information for all cash settled awards:
 
In millions, unless otherwise indicated  
RSUs (1)
   
Vision (1)
   
VIDP (2)
   
Total
 
Year of grant  
2007
   
2006
   
2005
   
2004
   
2005
   
2003
onwards
       
                                           
Stock-based compensation expense
                                         
recognized over requisite service
period
                                         
Nine months ended September 30, 2007
  $
17
    $
19
    $
19
    $
5
    $
13
    $
30
    $
103
 
Nine months ended September 30, 2006
 
N/A
    $
8
    $
12
    $
5
    $
6
    $
5
    $
36
 
                                                         
Liability outstanding
                                                       
September 30, 2007
  $
17
    $
40
    $
53
    $
4
    $
20
    $
115
    $
249
 
December 31, 2006
 
N/A
    $
21
    $
34
    $
8
    $
8
    $
99
    $
170
 
                                                         
Fair value per unit
                                                       
September 30, 2007
  $
48.31
    $
53.97
    $
56.56
    $
56.76
    $
37.20
    $
56.76
   
N/A
 
                                                         
Fair value of awards vested during period
                                                       
Nine months ended September 30, 2007
  $
-
    $
-
    $
-
    $
5
    $
-
    $
3
    $
8
 
Nine months ended September 30, 2006
 
N/A
    $
-
    $
-
    $
-
    $
-
    $
2
    $
2
 
                                                         
Nonvested awards at September 30, 2007
                                                       
Unrecognized compensation cost
  $
15
    $
14
    $
5
    $
5
    $
9
    $
10
    $
58
 
Remaining recognition period (years)
   
2.25
     
1.25
     
0.25
     
1.25
     
1.25
     
3.25
   
N/A
 
                                                         
Assumptions (3)
                                                       
Stock price ($)
  $
56.76
    $
56.76
    $
56.76
    $
56.76
    $
56.76
    $
56.76
   
N/A
 
Expected stock price volatility (4)
    20%       20%       21%    
N/A
      20%    
N/A
   
N/A
 
Expected term (years) (5)
   
2.25
     
1.25
     
0.25
   
N/A
     
1.25
   
N/A
   
N/A
 
Risk-free interest rate (6)
    4.07%       4.20%       4.20%    
N/A
      4.13%    
N/A
   
N/A
 
Dividend rate ($) (7)
  $
0.84
    $
0.84
    $
0.84
   
N/A
    $
0.84
   
N/A
   
N/A
 

(1)
Compensation cost is based on the fair value of the awards at period-end using the lattice-based valuation model that uses the assumptions as presented herein, except for time-vested RSUs.
 
(2)
Compensation cost is based on intrinsic value.
 
(3)
Assumptions used to determine fair value are at period-end.
 
(4)
Based on the historical volatility of the Company's stock over a period commensurate with the expected term of the award.
 
(5)
Represents the remaining period of time that awards are expected to be outstanding.
 
(6)
Based on the implied yield available on zero-coupon government issues with an equivalent term commensurate with the expected term of the awards.
 
(7)
Based on the annualized dividend rate.

Stock option award
Following approval by the Board of Directors in January 2007, the Company granted 0.9 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 September 30, 2007, 14.4 million common shares remained authorized for future issuances under this plan.  The total number of options outstanding at September 30, 2007, including conventional, performance, and performance-accelerated options, was 10.7 million, 0.6 million and 3.5 million, respectively.
 
12


CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP) 


The following table provides the activity of stock option awards in 2007:

         
Options outstanding
       
   
Number
   
Weighted-average
   
Weighted-average
   
Aggregate
 
   
of options
   
exercise price
   
years to expiration
   
intrinsic value
 
   
In millions
               
In millions
 
Outstanding at December 31, 2006 (1)
   
16.9
   
$
23.29
             
Granted
   
0.9
   
$
52.79
             
Forfeited
    (0.1 )  
$
36.92
             
Exercised
    (2.9 )  
$
20.25
             
Outstanding at September 30, 2007 (1)
   
14.8
   
$
24.52
     
4.8
   
$
477
 
Exercisable at September 30, 2007 (1)
   
12.5
   
$
21.15
     
4.2
   
$
446
 
(1)
Stock options with a U.S. dollar exercise price have been translated to Canadian dollars using the foreign exchange rate in effect at the balance sheet date.

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

In millions, unless otherwise indicated
                             
Year of grant
 
2007
   
2006
   
2005
   
Prior to 2005
   
Total
 
                               
Stock-based compensation expense
                             
recognized over requisite service period (1)
                             
Nine months ended September 30, 2007
  $
6
    $
1
    $
2
    $
-
    $
9
 
Nine months ended September 30, 2006
 
N/A
    $
7
    $
2
    $
3
    $
12
 
                                         
Fair value per unit
                                       
At grant date ($)
  $
13.36
    $
13.80
    $
9.19
    $
8.61
   
N/A
 
                                         
Fair value of awards vested during period
                                       
Nine months ended September 30, 2007
  $
-
    $
4
    $
3
    $
-
    $
7
 
Nine months ended September 30, 2006
 
N/A
    $
-
    $
3
    $
34
    $
37
 
                                         
Nonvested awards at September 30, 2007
                                       
Unrecognized compensation cost
  $
5
    $
5
    $
4
    $
-
    $
14
 
Remaining recognition period (years)
   
3.4
     
2.4
     
1.3
     
-
   
N/A
 
                                         
Assumptions (1)
                                       
Grant price ($)
  $
52.79
    $
51.51
    $
36.33
    $
23.59
   
N/A
 
Expected stock price volatility (2)
    24%       25%       25%       30%    
N/A
 
Expected term (years) (3)
   
5.2
     
5.2
     
5.2
     
6.2
   
N/A
 
Risk-free interest rate (4)
    4.12%       4.04%       3.50%      
5.13%
   
N/A
 
Dividend rate ($) (5)
  $
0.84
    $
0.65
    $
0.50
    $
0.30
   
N/A
 

(1)
Compensation cost is based on the grant date fair value using the Black-Scholes option-pricing model that uses the assumptions at the grant date.
 
(2)
Based on the historical volatility of the Company's stock over a period commensurate with the expected term of the award.
 
(3)
Represents the period of time that awards are expected to be outstanding. The Company uses historical data to estimate option exercise and employee termination, and groups of employees that have similar historical exercise behavior are considered separately.
 
(4)
Based on the implied yield available on zero-coupon government issues with an equivalent term commensurate with the expected term of the awards.
 
(5)
Based on the annualized dividend rate.
 
13


CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP)

 
Note 6 – Pensions and other postretirement benefits

For the three and nine months ended September 30, 2007 and 2006, the components of net periodic benefit cost for pensions and other postretirement benefits were as follows:

(a) Components of net periodic benefit cost for pensions

   
Three months ended
   
Nine months ended
 
   
September 30
   
September 30
 
In millions
 
2007
   
2006
   
2007
   
2006
 
Service cost
  $
38
    $
29
    $
114
    $
109
 
Interest cost
   
186
     
180
     
557
     
538
 
Expected return on plan assets
    (234 )     (227 )     (703 )     (680 )
Amortization of prior service cost
   
5
     
5
     
15
     
14
 
Amortization of net actuarial loss
   
13
     
22
     
40
     
68
 
Net periodic benefit cost
  $
8
    $
9
    $
23
    $
49
 
                                 
(b) Components of net periodic benefit cost for postretirement benefits
                               
                                 
   
Three months ended
   
Nine months ended
 
   
September 30
   
September 30
 
In millions
 
2007
   
2006
   
2007
   
2006
 
Service cost
  $
1
    $
1
    $
3
    $
3
 
Interest cost
   
4
     
3
     
11
     
11
 
Curtailment
   
-
     
-
      (3 )    
-
 
Amortization of prior service cost
   
-
     
-
     
1
     
-
 
Recognized net actuarial gain
   
-
     
-
      (2 )     (4 )
Net periodic benefit cost
  $
5
    $
4
    $
10
    $
10
 

For the 2007 funding year, the Company expects to make total contributions of approximately $90 million for all its defined benefit plans, of which $50 million was disbursed as at September 30, 2007.
 
 
Note 7 – Major commitments and contingencies

A. Commitments
As at September 30, 2007, 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 $815 million ($773 million at December 31, 2006). The Company also has agreements with fuel suppliers to purchase approximately 75% of the estimated remaining 2007 volume, 52% of its anticipated 2008 volume, 31% of its anticipated 2009 volume, 13% of its anticipated 2010 volume, and approximately 18% of its anticipated 2011 to 2015 volumes, at market prices prevailing on the date of the purchase.
 
B. Contingencies
In the normal course of its operations, the Company becomes involved in various legal actions, including claims relating to personal injuries, occupational disease and damage to property.

Canada
Employee injuries are governed by the workers’ compensation legislation in each province whereby employees may be awarded either a lump sum or future stream of payments depending on the nature and severity of the injury. Accordingly, the Company accounts for costs related to employee work-related injuries based on actuarially developed estimates of the ultimate cost associated with such injuries, including compensation, health care and third-party administration costs. For all other legal actions, the Company maintains,

14

 
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP) 


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
Employee work-related injuries, including occupational disease claims, are compensated according to the provisions of the Federal Employers’ Liability Act (FELA), which requires either the finding of fault through the U.S. jury system or individual settlements, and represent a major liability for the railroad industry. The Company follows an actuarial-based approach and accrues the expected cost for personal injury and property damage claims and asserted and unasserted occupational disease claims, based on actuarial estimates of their ultimate cost.  A comprehensive actuarial study is conducted on an annual basis, in the fourth quarter, by an independent actuarial firm for occupational disease claims, while an actuarial study is conducted on a semi-annual basis for non-occupational disease claims. In the second quarter of 2007, the Company recorded a net reduction to its provision for U.S. personal injuries and other claims pursuant to the results of the latest actuarial 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 September 30, 2007, the Company had aggregate reserves for personal injury and other claims of $500 million, of which $103 million was recorded as a current liability ($602 million, of which $115 million was recorded as a current liability at December 31, 2006). 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 September 30, 2007, or with respect to future claims, cannot be predicted with certainty, and therefore there can be no assurance that their resolution will not have a material adverse effect on the Company’s financial position or results of operations 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 United States 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. As a result, the Company incurs significant compliance and capital costs, on an ongoing basis, associated with environmental regulatory compliance and clean-up requirements in its railroad operations and relating to its past and present ownership, operation or control of real property.
 
 The Company is subject to environmental clean-up and enforcement actions.  In particular, the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), also known as the Superfund law, as well as similar state laws generally impose joint and several liability for clean-up and enforcement costs on current and former owners and operators of a 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 21 sites governed by the Superfund law (and other similar federal and 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.
 
 While the Company believes that it has identified the costs likely to be incurred in the next several years, based on known information, for environmental matters, the Company’s ongoing efforts to identify potential environmental concerns that may be associated with its properties may lead to future environmental investigations, which may result in the identification of additional environmental costs and liabilities. The magnitude of such additional liabilities and the costs of complying with environmental laws and containing or remediating contamination cannot be reasonably estimated due to:

(i)
the lack of specific technical information available with respect to many sites;
(ii)
the absence of any government authority, third-party orders, or claims with respect to particular sites;
(iii)
the potential for new or changed laws and regulations and for development of new remediation technologies and uncertainty regarding the timing of the work with respect to particular sites;
(iv)
the ability to recover costs from any third parties with respect to particular sites; and
 
15


CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP) 


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 material 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 environmental liabilities or costs. Although the effect on operating results and liquidity cannot be reasonably estimated, management believes, based on current information, that environmental matters will not have a material adverse effect on the Company’s financial condition or competitive position. Costs related to any future remediation will be accrued in the year in which they become known.
 
As at September 30, 2007, the Company had aggregate accruals for environmental costs of $109 million, of which $18 million was recorded as a current liability ($131 million, of which $25 million was recorded as a current liability as at December 31, 2006).
 
D. Guarantees and indemnifications
In the normal course of business, the Company enters into agreements that may involve providing certain guarantees or indemnifications to third parties and others, which may extend beyond the term of the agreement. These include, but are not limited to, residual value guarantees on operating leases, standby letters of credit and 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 2007 and 2017, 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. At September 30, 2007, the maximum exposure in respect of these guarantees was $141 million. There are no recourse provisions to recover any amounts from third parties.

(ii) Other guarantees
The Company has granted irrevocable standby letters of credit and 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 September 30, 2007, the maximum potential liability under these guarantees was $459 million, of which $384 million was for workers’ compensation and other employee benefits and $75 million was for equipment under leases and other. During 2007, the Company has granted guarantees for which no liability has been recorded, as the majority relates to the Company’s future performance.
 
As at September 30, 2007 the Company had not recorded any additional liability with respect to these guarantees, as the Company does not expect to make any additional payments associated with these guarantees.  The majority of the guarantee instruments mature at various dates between 2007 and 2010.
 
(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, (a) contracts granting the Company the right to use or enter upon property owned by third parties such as leases, easements, trackage rights and sidetrack agreements; (b) contracts granting rights to others to use the Company’s property, such as leases, licenses and easements; (c) contracts for the sale of assets and securitization of accounts receivable; (d) contracts for the acquisition of services; (e) financing agreements; (f) trust indentures, fiscal agency agreements, underwriting agreements or similar agreements relating to debt or equity securities of the Company and engagement agreements with financial advisors; (g) transfer agent and registrar agreements in respect of the Company’s securities; (h) trust and other agreements relating to pension plans and other plans, including those establishing trust funds to secure payment to certain officers and senior employees of special retirement compensation arrangements; (i) pension transfer agreements; (j) master agreements with financial institutions governing derivative transactions; and (k) settlement agreements with insurance companies or other third parties whereby such insurer or third party has
 
16

 
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP) 


been indemnified for any present or future claims relating to insurance policies, incidents or events covered by the settlement agreements. 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 determined with certainty.
 
The Company has entered into various indemnification contracts with third parties for which the maximum exposure for future payments cannot be determined with certainty. 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 8 – Income taxes

In the third quarter of 2007, the enactment of a new Michigan income-based business tax to replace the single business tax was shortly followed by the enactment of an additional bill, which allows for future deductions equal to the net taxable temporary differences existing at the beginning of 2008. Therefore, there was no impact on the deferred income tax liability.
 
For the three and nine months ended September 30, 2007, the Company recorded deferred income tax recoveries of $14 million and $44 million, respectively, in the Consolidated Statement of Income, for the enactment of corporate income tax rate changes in Canada and net capital losses arising from a reorganization of certain subsidiaries.
 
For the nine months ended September 30, 2006, the Company recorded a deferred income tax recovery of $250 million in the Consolidated Statement of Income, resulting primarily from the enactment of lower corporate income tax rates in Canada.

 
Note 9 – Earnings per share
 
The following table provides a reconciliation between basic and diluted earnings per share:

   
Three months ended
   
Nine months ended
 
   
September 30
   
September 30
 
In millions, except per share data
 
2007
   
2006
   
2007
   
2006
 
                                 
Net income
  $
485
    $
497
    $
1,325
    $
1,588
 
                                 
Weighted-average shares outstanding
   
499.7
     
522.5
     
505.0
     
529.5
 
Effect of stock options
   
6.7
     
7.7
     
7.1
     
8.5
 
Weighted-average diluted shares outstanding
   
506.4
     
530.2
     
512.1
     
538.0
 
                                 
Basic earnings per share
  $
0.97
    $
0.95
    $
2.62
    $
3.00
 
Diluted earnings per share
  $
0.96
    $
0.94
    $
2.59
    $
2.95
 

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 nil and 0.1 million for the three and nine months ended September 30, 2007, respectively, and 0.2 million, respectively, for the corresponding periods in 2006.
 
17

 
CANADIAN NATIONAL RAILWAY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (U.S. GAAP) 


Note 10 - Investment in English Welsh and Scottish Railway (EWS)