Why did net income fall so sharply in Q2 2003?

Net income dropped to $29 million from $169 million mainly because of a $228.5 million pre-tax special charge for workforce reductions and asset write-downs. Higher fuel prices and a stronger Canadian dollar also pressured operating results, while a $98 million foreign exchange gain on long-term debt partially offset the charge.

What is the special charge, and will there be more?

The charge comprises a $105 million labour accrual to eliminate 820 positions (370 in 2003, 330 in 2004, 120 in 2005), a $116 million write-down of the Delaware and Hudson (Northeastern U.S.) network to fair value, and a $7 million write-off of non-beneficial assets. The filing does not indicate further charges, but restructuring payments are expected to continue through 2009 for certain termination benefits.

How did underlying operating performance trend?

Operating income before the special charge fell to $191 million from $219 million, and the operating ratio rose to 79.1% from 76.3%. Freight volumes and intermodal growth were positive, but fuel costs rose 16% and purchased services and insurance costs increased, offsetting the gains.

What is the outlook for the rest of 2003?

Management expects productivity gains and a forecast Canadian grain harvest to mitigate most of the effects of high fuel prices and the stronger Canadian dollar. If those conditions remain stable, results for the second half of 2003 should be in line with the second half of 2002. Management also anticipates a rebound in bulk commodities later in the year.

Why do the reported EPS figures differ from the adjusted figures?

Reported diluted EPS of $0.18 includes the special charge and foreign exchange gains on long-term debt. The adjusted figure of $0.55 excludes both, which management says better reflects ongoing operations. These adjusted measures are non-GAAP, and the company notes they may not be comparable with other companies' measures.

CP 8-K SEC Disclosure — Jul 23, 2003

01—Abstract

Summary

Summary of the 6-K filed July 23, 2003. Cited figures are marked; the original filing is the authoritative source.

Canadian Pacific Railway (CP) reported second-quarter 2003 results showing business growth overshadowed by a $150 million^a after-tax special charge ($228 million pre-tax) and high fuel prices.

Net income fell to $29 million^b ($0.18 diluted EPS) from $169 million ($1.06) a year earlier. Excluding the special charge and foreign exchange gains on long-term debt, income was $87 million ($0.55 per diluted share) versus $111 million ($0.70) in Q2 2002. Freight revenue was essentially flat at $875 million, with intermodal up 11% and volumes rising in five of seven commodity groups, but the operating ratio before the special charge deteriorated to 79.1% from 76.3%.

The special charge reflects a restructuring to align costs with high fuel prices and a stronger Canadian dollar. It includes a plan to eliminate 820 positions by the end of 2005, a $116 million^c write-down of the Northeastern U.S. (Delaware and Hudson) operations to fair value, and a $7 million write-off of non-core investments. Management expects the productivity gains, along with a forecast Canadian grain crop, to offset most of the cost pressures, and guides second-half 2003 results to be roughly in line with second-half 2002.

Management also highlighted plans to rebound bulk volumes and upgrade the intermodal fleet and locomotive capacity. Balance sheet activity included a $350 million^d Medium-Term Note issuance settling July 2, 2003 at a 4.9% coupon, which cost $23.3 million to settle interest rate locks. Year-to-date net income was $131 million ($0.82 diluted), and cash fell to $49.8 million from $284.9 million at year-end 2002.

Net debt to net debt plus equity was 46.8%, and interest coverage before non-recurring items was 2.8x. Note that the filing describes these figures as reported in Canadian dollars, and some metrics are non-GAAP.

02—Key points

Key Highlights

Q2 2003 net income fell 83% to $29 million ($0.18 diluted EPS) from $169 million ($1.06), driven by a $228.5 million pre-tax special charge.
Excluding the special charge and FX gains on long-term debt, Q2 EPS was $0.55 versus $0.70 a year earlier, a 21% decline.
Special charge covers elimination of 820 positions by end-2005, a $116 million write-down of Northeastern U.S. operations, and a $7 million write-off of non-core assets.
Operating ratio before special charge worsened to 79.1% from 76.3%, reflecting fuel expense up 16% and a stronger Canadian dollar that cut U.S.-dollar revenues by $40 million.
Freight revenue was flat at $875 million, with intermodal up 11% on new Port of Vancouver ocean carrier business and freight volumes up in five of seven commodity groups.
Outlook: management expects productivity gains and a forecast Canadian grain crop to offset most high-fuel and currency pressures, with H2 2003 results in line with H2 2002.
Issued $350 million of 4.9% Medium-Term Notes due 2010 settling July 2, 2003, with a $23.3 million cost to settle interest rate locks.

03—Questions

Frequently Asked Questions

Why did net income fall so sharply in Q2 2003?
Net income dropped to $29 million from $169 million mainly because of a $228.5 million pre-tax special charge for workforce reductions and asset write-downs. Higher fuel prices and a stronger Canadian dollar also pressured operating results, while a $98 million foreign exchange gain on long-term debt partially offset the charge.
What is the special charge, and will there be more?
The charge comprises a $105 million labour accrual to eliminate 820 positions (370 in 2003, 330 in 2004, 120 in 2005), a $116 million write-down of the Delaware and Hudson (Northeastern U.S.) network to fair value, and a $7 million write-off of non-beneficial assets. The filing does not indicate further charges, but restructuring payments are expected to continue through 2009 for certain termination benefits.
How did underlying operating performance trend?
Operating income before the special charge fell to $191 million from $219 million, and the operating ratio rose to 79.1% from 76.3%. Freight volumes and intermodal growth were positive, but fuel costs rose 16% and purchased services and insurance costs increased, offsetting the gains.
What is the outlook for the rest of 2003?
Management expects productivity gains and a forecast Canadian grain harvest to mitigate most of the effects of high fuel prices and the stronger Canadian dollar. If those conditions remain stable, results for the second half of 2003 should be in line with the second half of 2002. Management also anticipates a rebound in bulk commodities later in the year.
Why do the reported EPS figures differ from the adjusted figures?
Reported diluted EPS of $0.18 includes the special charge and foreign exchange gains on long-term debt. The adjusted figure of $0.55 excludes both, which management says better reflects ongoing operations. These adjusted measures are non-GAAP, and the company notes they may not be comparable with other companies' measures.

04—Continue

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