How much of the Q2 2006 net income increase is from underlying operations versus one-time items?

Of the $254.3M increase in net income, roughly $176M came from a one-time reduction in future income tax expense after Canadian federal and provincial tax rate cuts. Favourable FX on long-term debt added about $41M after tax. Excluding these items, income before FX and other specified items rose $20M (about 14%), so the core improvement is real but considerably smaller than the headline figure.

Why did coal and potash volumes decline, and is that expected to reverse?

Coal revenue fell 28% and sulphur/fertilizer revenue fell 10% in Q2, driven by weaker export coal demand and delayed potash shipments to China amid price negotiations, plus stronger Canadian dollar effects. Management said it expects bulk volumes to increase in the second half, and noted that the western Canada track expansion has not yet been fully utilized but is not expected to be a long-term trend.

What is the outlook for taxes, capital spending and free cash flow?

Management expects a normalized 2006 income tax rate of 30% to 32%, and it anticipates cash tax payments will rise in future years as non-capital loss carryforwards are exhausted during 2006. Capital spending is projected at $810M to $825M, and free cash after dividends is expected to exceed $200M in 2006, compared with $92M in 2005, before share repurchases.

What is the impact of the stronger Canadian dollar on CPR?

The Canadian dollar strengthened about 9% against the U.S. dollar in Q2 2006. This reduced freight revenue by roughly $39M and operating income by about $10M in the quarter (about $66M and $17M for the first half). Management estimates that each $0.01 move in the Canadian dollar changes annual operating income by about $3M to $4M, and changes pre-tax FX on U.S. dollar debt by about $10M.

What leadership and governance changes occurred, and do they create risk?

Fred Green became CEO on May 5, 2006, succeeding Robert Ritchie, and John Cleghorn replaced J.E. (Ted) Newall as Chairman. CFO Michael Waites resigned effective April 14, 2006, and Brian Grassby, the Vice-President and Comptroller, is serving as acting CFO. The company has not announced a permanent CFO in this filing, which investors may watch as a point of transition risk.

CP 8-K SEC Disclosure — Jul 25, 2006

01—Abstract

Summary

Summary of the 6-K filed July 25, 2006. Cited figures are marked; the original filing is the authoritative source.

Canadian Pacific Railway (TSX/NYSE: CP) reported second-quarter 2006 net income of $377.5 million^a, up $254.3 million from $123.2 million a year earlier.

Roughly two-thirds of that increase came from a one-time $176 million^b reduction in future income tax expense tied to Canadian federal and provincial corporate tax rate cuts, plus a $58 million favourable swing in foreign exchange on long-term debt. Excluding FX on long-term debt and the tax item, income rose 14% to $160 million, and diluted EPS before those items grew 15% to $1.00. Investors should treat the headline GAAP figure as flattered by non-recurring items; the underlying operating picture is the more meaningful signal.

Operationally, the quarter was mixed. Total revenue rose 2% to $1,131 million^c, with gains in grain, intermodal, automotive and industrial/consumer products offsetting a 28% drop in coal revenue and a 10% decline in sulphur and fertilizers, driven largely by weaker potash demand and a stronger Canadian dollar. Operating expenses rose 2%, mostly from fuel, but the operating ratio improved 40 basis points to a second-quarter best of 75.1%.

First-half net income reached $488.5 million^d and the first-half operating ratio improved 160 basis points to 77.2%. Balance-sheet and capital-return items were supportive. Net debt to net debt plus equity improved to 37.7% from 42.1%, and the company repurchased 1.8 million shares in the quarter at an average of $56.62 under its normal course issuer bid.

Management guided to a normalized 2006 tax rate of 30% to 32%, capital spending of $810 million to $825 million, and free cash of more than $200 million for 2006. Leadership changed during the period, with a new CEO (Fred Green), a new Chairman (John Cleghorn), and an acting CFO after Michael Waites resigned.

02—Key points

Key Highlights

Q2 2006 net income of $377.5M (diluted EPS $2.36) vs. $123.2M (EPS $0.77) in Q2 2005; about $176M of the increase came from a one-time future income tax reduction.
Income before FX on long-term debt and other specified items rose 14% to $160.1M; diluted EPS on that basis rose 15% to $1.00.
Total revenue up 2% to $1,131.0M; coal revenue fell 28% and sulphur/fertilizers fell 10%, offset by growth in grain, intermodal, automotive and industrial/consumer products.
Operating ratio improved 40 bps to 75.1% in Q2 (a Q2 best) and 160 bps to 77.2% for the first half, despite fuel costs rising 10% in the quarter.
Fuel surcharges and hedging recovered more than three-quarters of the fuel price increase.
Net debt-to-capitalization improved to 37.7% from 42.1%; 1.8M shares repurchased in Q2 at an average $56.62.
Guidance: normalized 2006 tax rate of 30–32%, capital spending of $810–825M, and free cash of more than $200M after dividends.

03—Questions

Frequently Asked Questions

How much of the Q2 2006 net income increase is from underlying operations versus one-time items?
Of the $254.3M increase in net income, roughly $176M came from a one-time reduction in future income tax expense after Canadian federal and provincial tax rate cuts. Favourable FX on long-term debt added about $41M after tax. Excluding these items, income before FX and other specified items rose $20M (about 14%), so the core improvement is real but considerably smaller than the headline figure.
Why did coal and potash volumes decline, and is that expected to reverse?
Coal revenue fell 28% and sulphur/fertilizer revenue fell 10% in Q2, driven by weaker export coal demand and delayed potash shipments to China amid price negotiations, plus stronger Canadian dollar effects. Management said it expects bulk volumes to increase in the second half, and noted that the western Canada track expansion has not yet been fully utilized but is not expected to be a long-term trend.
What is the outlook for taxes, capital spending and free cash flow?
Management expects a normalized 2006 income tax rate of 30% to 32%, and it anticipates cash tax payments will rise in future years as non-capital loss carryforwards are exhausted during 2006. Capital spending is projected at $810M to $825M, and free cash after dividends is expected to exceed $200M in 2006, compared with $92M in 2005, before share repurchases.
What is the impact of the stronger Canadian dollar on CPR?
The Canadian dollar strengthened about 9% against the U.S. dollar in Q2 2006. This reduced freight revenue by roughly $39M and operating income by about $10M in the quarter (about $66M and $17M for the first half). Management estimates that each $0.01 move in the Canadian dollar changes annual operating income by about $3M to $4M, and changes pre-tax FX on U.S. dollar debt by about $10M.
What leadership and governance changes occurred, and do they create risk?
Fred Green became CEO on May 5, 2006, succeeding Robert Ritchie, and John Cleghorn replaced J.E. (Ted) Newall as Chairman. CFO Michael Waites resigned effective April 14, 2006, and Brian Grassby, the Vice-President and Comptroller, is serving as acting CFO. The company has not announced a permanent CFO in this filing, which investors may watch as a point of transition risk.

04—Continue

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