CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CPR)

Filing Type: Form 6-K (Report of Foreign Issuer)

Reporting Period: First Quarter ended March 31, 2003

Filing Date: May 21, 2003

CPR operates a 14,000-mile network serving principal centers in Canada and the U.S. Northeast and Midwest. The quarter was characterized by record-high fuel prices and severe winter weather conditions that disrupted operations until mid-March. Despite a significant decline in grain volumes due to drought, total revenues increased slightly year-over-year.

Key Financial Metrics

Non-GAAP Adjusted Income: Excluding non-recurring items and foreign exchange gains/losses on long-term debt, income was $37.7 million (Diluted EPS $0.24) compared to $67.9 million (Diluted EPS $0.43) in Q1 2002.

Material Changes vs. Prior Period

• Revenue Mix: While total revenue grew slightly, freight revenue declined $4.9 million.
  • Intermodal: Strongest growth area, up $18.9 million (9.4%) driven by import-export volumes.
  • Grain: Revenues fell $25.1 million (16.3%) due to drought-reduced crop sizes and traffic diversion to Prince Rupert.
  • Automotive & Fertilizers: Increased $4.7 million and $5.3 million respectively.
• Cost Pressures: Operating expenses rose 8.7%.
  • Fuel: Expense increased $22.0 million (26.3%) due to record prices and higher consumption from severe weather.
  • Purchased Services: Increased $34.3 million (27.3%) due to higher insurance premiums, derailment costs, and operational adjustments to maintain service levels during weather disruptions.
• Foreign Exchange Impact: Net income included a $70.8 million foreign exchange gain on long-term debt due to a strengthening Canadian dollar, compared to a $3.7 million loss in the prior year.
• Productivity: Operating efficiencies declined temporarily due to weather. Average train weights decreased 5.3% to 5,277 tons.

Guidance, Outlook, and Risks

• Outlook: Management anticipates an improved Canadian grain crop, though movement will not begin until the fourth quarter. The primary challenge remains recovering first-quarter slippage while managing unpredictable fuel prices.
• Cost Reduction: CPR announced the elimination of 300 positions in 2003 and other cost-reduction initiatives to offset the difficult first quarter.
• Capital Allocation: Issued US$250 million in long-term debt in March 2003 to repay maturing debt. Investing activities cash usage increased to $182.6 million, primarily for new locomotive purchases.
• Risks and Contingencies:
  • Regulatory: Ongoing U.S. Department of Commerce anti-dumping and countervailing duty investigations on Canadian wheat/durum.
  • Operational: Continued uncertainty regarding fuel prices and potential border security disruptions.
  • Legal/Labor: A labor dispute involving rail traffic controllers in Canada is in conciliation. Environmental remediation liability stands at $111 million.

Investor Verification Checklist

• Non-GAAP Reconciliation: Verify the $70.8 million foreign exchange gain on long-term debt, which significantly inflated GAAP net income compared to the underlying operational performance ($37.7 million adjusted income).
• Fuel Hedging Effectiveness: Assess the impact of the 57% hedge position against record fuel prices and the sustainability of fuel cost management in Q2-Q4.
• Grain Volume Recovery: Monitor the timing and volume of the anticipated improved grain crop movement in Q4 2003.
• Cost Reduction Execution: Track the implementation of the 300 position eliminations and their impact on the operating ratio.
• Regulatory Tariffs: Watch for final determinations on U.S. anti-dumping duties regarding Canadian wheat, which could impact grain revenue.