Why did reported Q4 2003 net income rise 39% when underlying earnings declined?

Reported net income of $175 million includes a $44 million foreign exchange gain on U.S. dollar-denominated long-term debt, which is non-cash and volatile. It also includes favorable tax adjustments. Excluding FX gains on debt and other specified items, net income was $115 million, down from $120 million in Q4 2002, and diluted EPS on that basis was $0.72 versus $0.75.

How did the stronger Canadian dollar affect CP's results in 2003?

The Canadian dollar appreciated about 11% against the U.S. dollar for the full year and 19% year over year in Q4. This reduced 2003 revenue by about $192 million and operating expenses by about $136 million, cutting operating income by $56 million. CP's U.S. dollar debt provides a partial natural hedge, since its cost falls as the Canadian dollar strengthens, but this offset does not fully cover operating impacts.

What drove the 2003 special charge and what does it mean for future costs?

The $228.5 million special charge comprised a $105.5 million accrual for labour restructuring, a $116.1 million writedown of the Northeastern U.S. subsidiary Delaware & Hudson, and a $6.9 million write-down of non-beneficial investments. The workforce reductions are expected to be completed by the end of 2005, with some payments continuing to 2009. Management expects these actions to improve productivity and lower future compensation costs.

Why did operating cash flow fall so much in 2003 and is cash flow under pressure?

Full-year operating cash flow dropped to $326 million from $784 million, primarily because of a voluntary $300 million prepayment into the Canadian defined benefit pension plan, classified as an operating activity. Restructuring payments of $107 million also weighed on cash flow. Cash and short-term investments fell to $134.7 million, but the company funded the shortfall with $700 million of new long-term debt issued during the year. The pension prepayment is a discretionary, one-time item rather than a recurring operating expense.

What are the key risks and watch items for investors from this report?

Key risks include continued currency pressure from a strong Canadian dollar on U.S. dollar revenues and operating margins, fuel cost volatility after a 22% rise in crude prices, and the operating ratio, which worsened to 79.8% before other specified items. Investors should also watch the execution of workforce reductions and productivity gains, the performance of the Delaware & Hudson operations after the writedown, and the outcome of an environmental remediation claim at a U.S. property that management believes will not be material.

CP 8-K SEC Disclosure — Jan 27, 2004

01—Abstract

Summary

Summary of the 6-K filed January 27, 2004. Cited figures are marked; the original filing is the authoritative source.

Canadian Pacific Railway (CP) reported fourth-quarter 2003 net income of $175 million^a, up 39% from $126 million a year earlier, with diluted EPS of $1.10 versus $0.79.

The headline growth is flattered by a $44 million^b foreign exchange gain on U.S. dollar-denominated long-term debt. On a non-GAAP basis that excludes FX on debt and other specified items, income was $115 million versus $120 million, and diluted EPS was $0.72 versus $0.75. Fourth-quarter revenue rose 1.4% to $964 million, and revenue excluding the stronger Canadian dollar grew about 10%, driven by a bulk-commodity recovery (grain, coal, potash, sulphur) and record freight volumes.

Operating ratio before other specified items worsened to 76.6% from 75.0%, reflecting the Canadian dollar's 19% appreciation, which cut operating income by $24 million^c, and higher compensation, depreciation, and fuel costs. For full-year 2003, net income fell 20% to $399 million and diluted EPS dropped to $2.51 from $3.11. Non-GAAP diluted EPS was $2.11 versus $2.56.

The year was hit by a $228.5 million^d special charge for labour restructuring and asset impairment, including a $116 million writedown of the Delaware & Hudson (Northeastern U.S.) operations, and by a 22% rise in crude prices that drove fuel expense up 10%. The Canadian dollar's 11% annual gain reduced operating income by $56 million. Management highlighted record volumes, productivity improvements exiting the year, and a sixth consecutive year leading North American railroads in train-operation safety.

From a balance-sheet and cash-flow perspective, cash fell to $134.7 million from $284.9 million, and full-year operating cash flow dropped to $326 million from $784 million, largely because of a voluntary $300 million prepayment into the Canadian pension plan. Long-term debt rose to $3.35 billion, and the company issued $700 million of new long-term debt during the year.

Net debt to net debt plus equity was 46.8%, and the interest coverage ratio before other specified items was 3.2x. The company also outsourced computing infrastructure to IBM under a seven-year, $200 million agreement that is expected to lower costs over time.

02—Key points

Key Highlights

Q4 2003 net income rose 39% to $175 million ($1.10 diluted EPS), but this was boosted by a $44 million FX gain on U.S. dollar debt; excluding FX and other specified items, earnings declined to $115 million ($0.72 per share) from $120 million ($0.75).
Freight volumes hit a record in Q4, and revenue grew about 10% excluding the Canadian dollar's 19% appreciation; bulk commodities (grain, coal, potash, sulphur) drove an $40 million (11%) increase in bulk revenue.
Full-year 2003 net income fell 20% to $399 million ($2.51 diluted EPS) due to a $228.5 million special charge for labour restructuring and asset impairment (including a $116 million writedown of Delaware & Hudson) and the $28.9 million IBM asset transfer loss.
Operating ratio before other specified items deteriorated to 79.8% for the year from 76.6%, with fuel expense up 10% on a 22% rise in crude prices and the stronger Canadian dollar reducing operating income by $56 million.
Operating cash flow fell sharply to $326 million from $784 million in 2003, partly due to a voluntary $300 million prepayment into the Canadian defined benefit pension plan; cash on hand declined to $134.7 million.
Long-term debt increased to $3.35 billion, including $700 million of new issuance in 2003, while the company's net debt to total capital ratio remained stable at 46.8%.
Management is restructuring labour: 370 jobs eliminated in 2003, with another 330 planned for 2004 and 120 for 2005, and a seven-year $200 million IT outsourcing agreement with IBM is expected to reduce costs over time.

03—Questions

Frequently Asked Questions

Why did reported Q4 2003 net income rise 39% when underlying earnings declined?
Reported net income of $175 million includes a $44 million foreign exchange gain on U.S. dollar-denominated long-term debt, which is non-cash and volatile. It also includes favorable tax adjustments. Excluding FX gains on debt and other specified items, net income was $115 million, down from $120 million in Q4 2002, and diluted EPS on that basis was $0.72 versus $0.75.
How did the stronger Canadian dollar affect CP's results in 2003?
The Canadian dollar appreciated about 11% against the U.S. dollar for the full year and 19% year over year in Q4. This reduced 2003 revenue by about $192 million and operating expenses by about $136 million, cutting operating income by $56 million. CP's U.S. dollar debt provides a partial natural hedge, since its cost falls as the Canadian dollar strengthens, but this offset does not fully cover operating impacts.
What drove the 2003 special charge and what does it mean for future costs?
The $228.5 million special charge comprised a $105.5 million accrual for labour restructuring, a $116.1 million writedown of the Northeastern U.S. subsidiary Delaware & Hudson, and a $6.9 million write-down of non-beneficial investments. The workforce reductions are expected to be completed by the end of 2005, with some payments continuing to 2009. Management expects these actions to improve productivity and lower future compensation costs.
Why did operating cash flow fall so much in 2003 and is cash flow under pressure?
Full-year operating cash flow dropped to $326 million from $784 million, primarily because of a voluntary $300 million prepayment into the Canadian defined benefit pension plan, classified as an operating activity. Restructuring payments of $107 million also weighed on cash flow. Cash and short-term investments fell to $134.7 million, but the company funded the shortfall with $700 million of new long-term debt issued during the year. The pension prepayment is a discretionary, one-time item rather than a recurring operating expense.
What are the key risks and watch items for investors from this report?
Key risks include continued currency pressure from a strong Canadian dollar on U.S. dollar revenues and operating margins, fuel cost volatility after a 22% rise in crude prices, and the operating ratio, which worsened to 79.8% before other specified items. Investors should also watch the execution of workforce reductions and productivity gains, the performance of the Delaware & Hudson operations after the writedown, and the outcome of an environmental remediation claim at a U.S. property that management believes will not be material.

04—Continue

← View all 8-K filings