CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CPR)

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

Reporting Period: Third quarter and nine months ended September 30, 2003

Filing Date: November 6, 2003

CPR is a transcontinental carrier operating in Canada and the U.S. The reporting period reflects steady growth in freight volumes, driven by grain, sulphur, fertilizers, and intermodal traffic. However, financial results were significantly impacted by a 13% year-over-year appreciation in the Canadian dollar, which reduced U.S. dollar-denominated revenues and expenses when converted to Canadian dollars.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Volatility: Q3 2003 net income increased 45% to $95 million compared to Q3 2002, primarily due to a significant reduction in foreign exchange losses on long-term debt ($4 million loss in 2003 vs. $47 million loss in 2002). Conversely, YTD net income declined 39% to $226 million, driven by a $228 million special charge and foreign exchange headwinds on revenues.
• Foreign Exchange Impact: The stronger Canadian dollar reduced Q3 revenues by $53 million and operating income by $17 million. YTD revenue reduction was $112 million.
• Special Charge: A non-recurring charge of $228.5 million ($150 million after tax) was recorded in Q2 2003. This included $105 million for labor restructuring (eliminating 820 jobs by 2005) and a $116 million write-down of under-performing assets in the Northeastern U.S. (Delaware & Hudson Railway).
• Volume Growth: Despite revenue declines, freight volumes increased 5% in Q3 and 4% YTD. Grain, sulphur, and intermodal volumes were key growth drivers, while automotive and coal volumes declined.
• Cost Management: Fuel expenses remained flat in Q3 despite a 15% increase in crude prices, attributed to hedging programs and improved efficiency. YTD fuel expenses rose 14% due to higher prices and severe winter conditions.

Guidance, Outlook, and Risks

• Outlook: Management anticipates a rebound in the fourth quarter, driven by a larger grain crop moving off the prairies and a recovery in coal volumes. The company has accelerated track work and added locomotives and freight cars to support this growth.
• Productivity: Employee productivity increased 5% on a workload basis. The company successfully managed a seven-week strike by traffic controllers and implemented a new freight yard management system pilot.
• Key Risks:
  • Currency Fluctuations: Continued volatility in the Canadian/U.S. dollar exchange rate poses a risk to reported revenues and expenses.
  • Commodity Prices: Persistently high fuel prices and uncertainty in global oil markets.
  • Regulatory & Security: New border security measures (VACIS systems) and potential changes to the Canada Transportation Act.
  • Labour Relations: Collective agreements with maintenance and steel workers expire December 31, 2003; negotiations are ongoing.
  • Environmental Liabilities: Accruals for environmental remediation totaled $100 million as of September 30, 2003.

Investor Verification Checklist

• Non-GAAP Reconciliation: Verify the reconciliation of "Income excluding non-recurring items and FX on LTD" to GAAP Net Income, as management relies heavily on these adjusted figures to demonstrate operational performance.
• Special Charge Cash Flow: Confirm the timing and magnitude of cash outflows related to the $228 million restructuring charge, which is expected to be paid out through 2009.
• Foreign Exchange Sensitivity: Assess the company's exposure to the Canadian dollar, as a 13% appreciation in Q3 significantly masked underlying volume growth.
• Asset Impairment: Review the details of the $116 million write-down of the Delaware & Hudson Railway assets to understand the long-term impact on the Northeastern U.S. network.
• Debt Structure: Note the issuance of $350 million in medium-term notes in Q3 2003 and the associated interest rate swap agreements.