Why did reported net income rise 146% if the underlying growth was only 23%?

The reported comparison is distorted by two items. Q2 2003 included a $215 million pre-tax special charge (about $141 million after tax) for workforce reductions, an asset write-down and network restructuring, which depressed that period. Q2 2004 also included a $20 million FX loss on long-term debt, versus a $98 million FX gain in Q2 2003. Excluding these items, income grew 23% to $104 million.

Is CPR on track to meet its 2004 earnings guidance?

Management said it still expects diluted EPS growth of 5% to 10% for 2004 (excluding FX on long-term debt and other specified items) over restated 2003 adjusted EPS of $2.07. First-half adjusted diluted EPS was $0.89 versus $0.76 a year earlier, and the guidance assumes a near-normal Canadian grain crop, oil at about US$37 per barrel and an exchange rate of $1.34 per U.S. dollar. Risks include fuel prices and currency moves.

What is driving revenue growth and how is the strong Canadian dollar affecting results?

Growth came mainly from bulk commodities (grain, coal, sulphur and fertilizers), which added $55 million, along with intermodal (up $21 million) and industrial products (up $13 million). The stronger Canadian dollar reduced Q2 revenues by about $22 million and expenses by about $18 million, with virtually no effect on net income excluding FX on debt and special items.

What are the main cost pressures and efficiency initiatives?

Operating expenses rose 8% to $784 million. Compensation and benefits rose $37 million, partly due to higher incentive pay and temporary crew-training costs; depreciation rose $12 million; and purchased services rose $10 million, largely from outsourcing computing infrastructure. Fuel expense rose only about $2.5 million despite a sharp increase in fuel prices, helped by operating efficiencies, a favourable hedge position and an improved fuel surcharge formula. On the efficiency side, the MaxStax intermodal conversion is about 80% complete and targets a 16% productivity gain on intermodal trains.

Did the balance sheet or accounting changes materially affect the picture?

Cash and short-term investments rose to $305 million from $135 million at year-end 2003, while current maturities of long-term debt increased to $270 million from $14 million, which investors should monitor for refinancing needs. Comparative 2003 figures were restated for new Canadian GAAP rules on asset retirement obligations and stock option expensing, which increased Q2 2003 net income by $5 million ($0.04 per share). Management notes that its non-GAAP earnings measures are not standardized and may not be comparable to those of other companies.

CP 8-K SEC Disclosure — Jul 29, 2004

01—Abstract

Summary

Summary of the 6-K filed July 29, 2004. Cited figures are marked; the original filing is the authoritative source.

Canadian Pacific Railway (CPR) reported second-quarter 2004 results that showed strong top-line and earnings growth.

Revenue crossed the $1 billion^a mark at $1,005 million, up 10% from $914 million, led by bulk commodities, intermodal and industrial products. Reported net income rose 146% to $84 million ($0.53 diluted EPS), but this was flattered by a $20 million foreign exchange loss on long-term debt in 2004 versus a $98 million gain in 2003, and by the absence of the 2003 special charge. Excluding those items, income rose 23% to $104 million and diluted EPS rose 23% to $0.65 from $0.53 (the company's non-GAAP measure, which is not standardized under Canadian GAAP).

Operating performance improved meaningfully. Operating income before special items rose 19% to $221 million^b, and the operating ratio improved 1.7 points to 78%. Operating expenses rose 8% to $784 million, driven by compensation (incentive pay and crew training), depreciation and outsourced IT services, while fuel costs were largely offset by efficiencies, a favourable hedge position and a revised fuel surcharge.

Management noted continued progress on the MaxStax intermodal conversion (about 80% complete) and the Norfolk Southern agreement to restructure its northeastern U.S. network. Looking forward, management expects freight volumes to remain robust and reaffirmed its 2004 guidance of 5% to 10% growth in diluted EPS (excluding FX on long-term debt and other specified items) over restated 2003 adjusted EPS of $2.07^c, despite higher fuel prices. Investors should note the balance sheet also shows a rise in current debt maturities to $270 million, and that 2003 comparatives were restated for new asset retirement obligation and stock option expensing rules.

02—Key points

Key Highlights

Q2 2004 revenue topped $1 billion for the first time, reaching $1,005 million, up 10% year over year, with freight revenue of $959 million.
Reported Q2 net income of $84 million ($0.53 diluted EPS), up 146%, though this comparison benefited from the absence of the 2003 $215 million special charge.
Excluding FX on long-term debt and special items, net income rose 23% to $104 million and diluted EPS rose 23% to $0.65 (non-GAAP).
Operating income before special items rose 19% to $221 million; operating ratio improved 1.7 points to 78%.
Bulk commodities drove almost two-thirds of the revenue increase; intermodal revenue rose 9% and industrial products rose 14%.
Reaffirmed 2004 guidance for 5%-10% diluted EPS growth (ex-FX and specified items) over restated 2003 adjusted EPS of $2.07, despite higher fuel prices.
Cash from operations rose to $249 million in Q2 (vs. $101 million), and cash balances increased to $305 million at June 30, 2004.

03—Questions

Frequently Asked Questions

Why did reported net income rise 146% if the underlying growth was only 23%?
The reported comparison is distorted by two items. Q2 2003 included a $215 million pre-tax special charge (about $141 million after tax) for workforce reductions, an asset write-down and network restructuring, which depressed that period. Q2 2004 also included a $20 million FX loss on long-term debt, versus a $98 million FX gain in Q2 2003. Excluding these items, income grew 23% to $104 million.
Is CPR on track to meet its 2004 earnings guidance?
Management said it still expects diluted EPS growth of 5% to 10% for 2004 (excluding FX on long-term debt and other specified items) over restated 2003 adjusted EPS of $2.07. First-half adjusted diluted EPS was $0.89 versus $0.76 a year earlier, and the guidance assumes a near-normal Canadian grain crop, oil at about US$37 per barrel and an exchange rate of $1.34 per U.S. dollar. Risks include fuel prices and currency moves.
What is driving revenue growth and how is the strong Canadian dollar affecting results?
Growth came mainly from bulk commodities (grain, coal, sulphur and fertilizers), which added $55 million, along with intermodal (up $21 million) and industrial products (up $13 million). The stronger Canadian dollar reduced Q2 revenues by about $22 million and expenses by about $18 million, with virtually no effect on net income excluding FX on debt and special items.
What are the main cost pressures and efficiency initiatives?
Operating expenses rose 8% to $784 million. Compensation and benefits rose $37 million, partly due to higher incentive pay and temporary crew-training costs; depreciation rose $12 million; and purchased services rose $10 million, largely from outsourcing computing infrastructure. Fuel expense rose only about $2.5 million despite a sharp increase in fuel prices, helped by operating efficiencies, a favourable hedge position and an improved fuel surcharge formula. On the efficiency side, the MaxStax intermodal conversion is about 80% complete and targets a 16% productivity gain on intermodal trains.
Did the balance sheet or accounting changes materially affect the picture?
Cash and short-term investments rose to $305 million from $135 million at year-end 2003, while current maturities of long-term debt increased to $270 million from $14 million, which investors should monitor for refinancing needs. Comparative 2003 figures were restated for new Canadian GAAP rules on asset retirement obligations and stock option expensing, which increased Q2 2003 net income by $5 million ($0.04 per share). Management notes that its non-GAAP earnings measures are not standardized and may not be comparable to those of other companies.

04—Continue

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