CP Canadian Pacific Kansas City Limited

Company adjusts guidance CALGARY, April 22 /PRNewswire-FirstCall/ -- Canadian Pacific Railway Limited (TSX/NYSE: CP) announced its first-quarter results today. Net income in the first quarter was $91 million, a decrease of 29 per cent from $129 million in 2007, and diluted earnings per share was $0.59, a decrease of $0.23 from $0.82 in the first quarter of 2007. Diluted earnings per share, excluding the effects of foreign exchange gains and losses on long-term debt and other specified items, decreased $0.03 as there was a favourable change in provincial tax rates which partially offset the impacts of severe winter operating conditions and the increase in fuel costs. However, foreign exchange gains and losses and other specified items, discussed below, reduced earnings by a further $0.20. SUMMARY OF FIRST-QUARTER 2008 COMPARED WITH FIRST-QUARTER 2007 - Total revenues rose three per cent to $1.15 billion from $1.12 billion - Income before foreign exchange gains and losses on long-term debt and other specified items decreased five per cent to $116 million from $123 million - Adjusted diluted earnings per share decreased to $0.75 from $0.78 - Operating ratio was 82.7 per cent compared with 79.5 per cent "The first quarter brought many challenges as we continued to face remarkable year-over-year increases in both fuel prices and the Canadian dollar," said Fred Green, President and CEO. "At the same time, we had a difficult winter with prolonged cold spells and record snowfall which affected the entire supply chain and resulted in very tough operating conditions throughout the central and eastern parts of our network. Although our busy western corridor remained fluid, the winter weather had a significant impact on our overall ability to move traffic efficiently." "The team will continue to focus on execution excellence and we intend to exploit all opportunities to improve efficiency including cost management, yield improvement and other strategic initiatives. Despite the tough first-quarter and continuing headwinds, our goal is still to deliver positive earnings growth in 2008." Freight revenues increased 10 per cent in the quarter, as global demand for bulk products remained solid, but the foreign exchange impact of a stronger Canadian dollar reduced this growth to three per cent. Grain, coal and sulphur and fertilizers all saw growth in the six to seven percent range. Industrial and consumer products increased 10 per cent over first-quarter 2007, built on a foundation of continued strength in Alberta. Intermodal revenues were also up four per cent. These gains were offset, in part, by decreases in forest products and automotive of 19 per cent and 12 per cent respectively, reflecting a weaker US economy. Operating expenses in the quarter increased 13 per cent, but the positive foreign exchange impact of a stronger Canadian dollar reduced the increase to seven per cent. The majority of this increase was due to higher fuel costs and less efficient operations resulting from the challenging winter operating conditions. 2008 OUTLOOK "We faced a tough first quarter with substantial headwinds, and as we look to the balance of the year, we anticipate the continuing effects of a slowing North American economy on our business. Although demand remains strong for our bulk portfolio, we expect to see an impact on our intermodal business, and further deterioration of our merchandise business. We also expect high fuel prices, including the price of WTI and refining margins, will continue," said Mike Lambert, CFO. "As a result, we are reducing our earnings guidance for 2008 and due to the ongoing economic uncertainty we are also widening the range of our guidance. We now expect that diluted earnings per share (before foreign exchange gains and losses on long-term debt and other specified items) will be in the range of $4.40 to $4.60, a change from $4.65 to $4.80." The 2008 estimate assumes an average currency exchange rate of the U.S. dollar at par with the Canadian dollar. Crude oil prices are expected to average US $98 per barrel, while crack spread is expected to increase an average of US $7 per barrel in 2008 compared with 2007 with an estimated all-in fuel price of US $3.35 per US gallon for the year. WTI is updated from US $87 per barrel. CP expects to grow total revenue by four to six per cent in 2008, unchanged from previous assumptions as volume declines will be offset by fuel recovery. Total operating expenses are expected to increase by six to eight per cent, revised from the original assumption of three to five per cent due principally to higher fuel cost. CP expects its tax rate to be in the 27 per cent to 29 per cent range, a change from the original outlook of 29 per cent to 31 per cent as a result of decreasing Canadian tax rates. CP expects free cash to be approximately $200 million, adjusted downwards from the original outlook of in excess of $250 million in 2008, resulting from the expected decline in Operating Income. The 2008 outlook includes the projected earnings of the Dakota Minnesota & Eastern Railroad (DM&E) on an equity accounting basis for the full year. FOREIGN EXCHANGE GAINS AND LOSSES ON LONG-TERM DEBT AND OTHER SPECIFIED ITEMS CP had a foreign exchange loss on long-term debt of $16 million ($11 million after tax) in the first quarter of 2008, compared with a foreign exchange gain on long-term debt of $9 million ($6 million after tax) in the first quarter of 2007. At March 31, 2008 CP held investments in Canadian Non-Bank Asset Backed Commercial Paper (ABCP) with an original cost of approximately $144 million. In the third-quarter of 2007, CP adjusted the estimated fair value of the investment and took a charge of $21 million ($15 million after tax) and classified the investments as long-term investments. In recognition of current credit market conditions impacting these investments, CP has further adjusted the estimated fair value of the investments and taken an additional charge in the first-quarter of 2008 of $21 million ($15 million after tax). Continuing uncertainties regarding the value of the assets which underlie the ABCP, the amount and timing of cash flows and the outcome of the restructuring process could give rise to a material change in the value of the Company's investments in ABCP which would impact the Company's near-term earnings. Presentation of non-GAAP earnings CP presents non-GAAP earnings in this news release to provide a basis for evaluating underlying earnings and liquidity trends in its business that can be compared with prior periods' results of operations. These non-GAAP earnings exclude foreign currency translation impacts on long-term debt, which can be volatile and short term, and other specified items, which are not among CP's normal ongoing revenues and operating expenses. The impact of volatile short-term rate fluctuations on foreign-denominated debt is only realized when long-term debt matures or is settled. A reconciliation of income, excluding foreign exchange gains and losses on long-term debt and other specified items, to net income as presented in the financial statements is detailed in the attached Summary of Rail Data. Diluted EPS, excluding foreign exchange gains and losses on long-term debt and other specified items, is also referred to in this news release as "adjusted diluted EPS". Free cash is calculated as cash provided by operating activities, less cash used in investing activities and dividends paid, and adjusted for the acquisition cost of DM&E. Free cash is adjusted for the DM&E acquisition, as it is not indicative of normal day-to-day investments in the Company's asset base. Earnings that exclude the foreign exchange currency translation impact on long-term debt and other specified items, and free cash after dividends, as described in this news release, have no standardized meanings and are not defined by Canadian generally accepted accounting principles and, therefore, are unlikely to be comparable to similar measures presented by other companies. Other specified items are material transactions that may include, but are not limited to, restructuring and asset impairment charges, gains and losses on non-routine sales of assets, unusual income tax adjustments, and other items that do not typify normal business activities. Note on forward-looking information This news release contains certain forward-looking statements relating but not limited to our operations, anticipated financial performance and business prospects. Undue reliance should not be placed on forward-looking information as actual results may differ materially. By its nature, CP's forward-looking information involves numerous assumptions, inherent risks and uncertainties, including but not limited to the following factors: changes in business strategies; general North American and global economic and business conditions; risks in agricultural production such as weather conditions and insect populations; the availability and price of energy commodities; the effects of competition and pricing pressures; industry capacity; shifts in market demand; changes in laws and regulations, including regulation of rates; changes in taxes and tax rates; potential increases in maintenance and operating costs; uncertainties of litigation; labour disputes; risks and liabilities arising from derailments; timing of completion of capital and maintenance projects; currency and interest rate fluctuations; effects of changes in market conditions on the financial position of pension plans and investments; and various events that could disrupt operations, including severe weather conditions, security threats and governmental response to them, and technological changes. There are factors that could cause actual results to differ from those described in the forward-looking statements contained in this news release. These more specific factors are identified and discussed in the Outlook section and elsewhere in this news release with the particular forward-looking statement in question. CP undertakes no obligation to update publicly or otherwise revise any forward-looking information, whether as a result of new information, future events or otherwise except as required by law. Canadian Pacific, through the ingenuity of its employees located across Canada and in the United States, remains committed to being the safest, most fluid railway in North America. Our people are the key to delivering innovative transportation solutions to our customers and to ensuring the safe operation of our trains through the more than 900 communities where we operate. Our combined ingenuity makes CP a better place to work, rail a better way to ship, and North America a better place to live. Come and visit us at http://www.cpr.ca/ to see how we can put our ingenuity to work for you. Canadian Pacific is proud to be the official rail freight services provider for the Vancouver 2010 Olympic and Paralympic Winter Games. STATEMENT OF CONSOLIDATED INCOME (in millions, except per share data) For the three months ended March 31 2008 2007 -------------------------- (unaudited) Revenues Freight $ 1,124.4 $ 1,090.9 Other 22.5 25.0 -------------------------- 1,146.9 1,115.9 Operating expenses Compensation and benefits 328.3 332.5 Fuel 230.2 171.2 Materials 65.5 62.4 Equipment rents 45.9 55.5 Depreciation and amortization 119.9 118.6 Purchased services and other 158.9 146.4 -------------------------- 948.7 886.6 -------------------------- Operating income 198.2 229.3 Other charges (Note 4) 6.7 4.8 Equity income in Dakota, Minnesota & Eastern Railroad Corporation (Note 9) (11.0) Change in estimated fair value of Canadian third party asset-backed commercial paper (Note 9) 21.3 - Foreign exchange losses (gains) on long-term debt 16.3 (8.6) Interest expense (Note 5) 59.9 46.8 Income tax expense (Note 6) 14.2 57.7 -------------------------- Net income $ 90.8 $ 128.6 -------------------------- -------------------------- Basic earnings per share (Note 7) $ 0.59 $ 0.83 -------------------------- -------------------------- Diluted earnings per share (Note 7) $ 0.59 $ 0.82 -------------------------- -------------------------- See notes to interim consolidated financial statements. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (in millions) For the three months ended March 31 2008 2007 -------------------------- (unaudited) Comprehensive income Net income $ 90.8 $ 128.6 Other comprehensive income Net change in foreign currency translation adjustments, net of hedging activities 3.3 (0.3) Net change in gains on derivatives designated as cash flow hedges (8.8) (3.2) -------------------------- Other comprehensive loss before income taxes (5.5) (3.5) Income tax recovery 8.0 0.7 -------------------------- Other comprehensive income (loss) (Note 11) 2.5 (2.8) -------------------------- Comprehensive income $ 93.3 $ 125.8 -------------------------- -------------------------- See notes to interim consolidated financial statements. CONSOLIDATED BALANCE SHEET (in millions) March 31 December 31 2008 2007 -------------------------- (unaudited) Assets Current assets Cash and cash equivalents $ 71.3 $ 378.1 Accounts receivable and other current assets 585.2 542.8 Materials and supplies 176.7 179.5 Future income taxes 70.6 67.3 -------------------------- 903.8 1,167.7 Investments (Note 9) 1,719.0 1,668.6 Net properties 9,360.4 9,293.1 Other assets and deferred charges 1,392.0 1,235.6 -------------------------- Total assets $ 13,375.2 $ 13,365.0 -------------------------- -------------------------- Liabilities and shareholders' equity Current liabilities Short-term borrowing $ 66.7 $ 229.7 Accounts payable and accrued liabilities 995.5 980.8 Income and other taxes payable 50.9 68.8 Dividends payable 38.0 34.5 Long-term debt maturing within one year 31.1 31.0 -------------------------- 1,182.2 1,344.8 Deferred liabilities 690.4 714.6 Long-term debt 4,267.6 4,146.2 Future income taxes 1,703.9 1,701.5 Shareholders' equity Share capital (Note 10) 1,210.4 1,188.6 Contributed surplus 38.5 42.4 Accumulated other comprehensive income (Note 11) 42.1 39.6 Retained income 4,240.1 4,187.3 -------------------------- 5,531.1 5,457.9 -------------------------- Total liabilities and shareholders' equity $ 13,375.2 $ 13,365.0 -------------------------- -------------------------- Commitments and contingencies (Note 17). See notes to interim consolidated financial statements. STATEMENT OF CONSOLIDATED CASH FLOWS (in millions) For the three months ended March 31 2008 2007 -------------------------- (unaudited) Operating activities Net income $ 90.8 $ 128.6 Add (deduct) items not affecting cash: Depreciation and amortization 119.9 118.6 Future income taxes (4.5) 38.5 Change in estimated fair value of Canadian third party asset-backed commercial paper (Note 9) 21.3 - Foreign exchange losses (gains) on long-term debt 16.3 (8.6) Amortization of deferred charges 2.5 3.1 Equity income, net of cash received (9.4) - Restructuring and environmental remediation payments (Note 8) (13.7) (13.2) Other operating activities, net (25.5) (2.7) Change in non-cash working capital balances related to operations (37.7) (36.6) -------------------------- Cash provided by operating activities 160.0 227.7 -------------------------- Investing activities Additions to properties (127.4) (204.2) Additions to investments and other assets (Note 13) (134.7) (0.3) Additions to investment in Dakota, Minnesota & Eastern Railroad Corporation (Note 9) (6.3) - Net (cost) proceeds from disposal of transportation properties (2.5) 8.9 -------------------------- Cash used in investing activities (270.9) (195.6) -------------------------- Financing activities Dividends paid (34.5) (29.1) Issuance of CP Common Shares 12.2 10.1 Purchase of CP Common Shares - (16.1) Net (decrease) increase in short-term borrowing (163.0) 77.7 Repayment of long-term debt (10.6) (173.4) -------------------------- Cash used in financing activities (195.9) (130.8) -------------------------- Cash position Decrease in cash and cash equivalents (306.8) (98.7) Cash and cash equivalents at beginning of period 378.1 124.3 -------------------------- Cash and cash equivalents at end of period $ 71.3 $ 25.6 -------------------------- -------------------------- See notes to interim consolidated financial statements. CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (in millions) For the three months ended March 31 2008 2007 -------------------------- (unaudited) Share capital Balance, beginning of period $ 1,188.6 $ 1,175.7 Shares issued under stock option plans 21.8 12.3 Shares purchased - (5.1) -------------------------- Balance, end of period 1,210.4 1,182.9 -------------------------- Contributed surplus Balance, beginning of period 42.4 32.3 Stock compensation expense 4.5 5.2 Stock compensation expense related to shares issued under stock option plans (8.4) (0.4) -------------------------- Balance, end of period 38.5 37.1 -------------------------- Accumulated other comprehensive income Balance, beginning of period 39.6 80.4 Other comprehensive income (loss) (Note 11) 2.5 (2.8) -------------------------- Balance, end of period 42.1 77.6 -------------------------- Retained income Balance, beginning of period 4,187.3 3,586.1 Net income for the period 90.8 128.6 Shares purchased - (38.0) Dividends (38.0) (35.0) -------------------------- Balance, end of period 4,240.1 3,641.7 -------------------------- Total accumulated other comprehensive income and retained income 4,282.2 3,719.3 -------------------------- -------------------------- Shareholders' equity, end of period $ 5,531.1 $ 4,939.3 -------------------------- -------------------------- See notes to interim consolidated financial statements. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2008 (unaudited) 1 Basis of presentation These unaudited interim consolidated financial statements and notes have been prepared using accounting policies that are consistent with the policies used in preparing Canadian Pacific Railway Limited's ("CP", "the Company" or "Canadian Pacific Railway") 2007 annual consolidated financial statements, except as discussed below and in Note 2 for the adoption of new accounting standards. They do not include all disclosures required under Generally Accepted Accounting Principles for annual financial statements and should be read in conjunction with the annual consolidated financial statements. CP's operations can be affected by seasonal fluctuations such as changes in customer demand and weather-related issues. This seasonality could impact quarter-over-quarter comparisons. 2 New accounting changes Financial Instrument and Capital Disclosures The CICA has issued the following accounting standards effective for fiscal years beginning on or after January 1, 2008: Section 3862 "Financial Instruments - Disclosures", Section 3863 "Financial Instruments - Presentation", and Section 1535 "Capital Disclosures". Section 3862 "Financial Instruments - Disclosures" and Section 3863 "Financial Instruments - Presentation" replace Section 3861 "Financial Instruments - Disclosure and Presentation", revising disclosures related to financial instruments, including hedging instruments, and carrying forward unchanged presentation requirements. Section 1535 "Capital Disclosures" requires the Company to provide disclosures about the Company's capital and how it is managed. The adoption of these new accounting standards did not impact the amounts reported in the Company's financial statements; however, it did result in expanded note disclosure (see Note 12 and Note 18). Inventories Effective January 1, 2008, the CICA has issued accounting standard Section 3031 "Inventories". Section 3031 "Inventories" provides guidance on the method of determining the cost of the Company's materials and supplies. The new accounting standard specifies that inventories are to be valued at the lower of cost and net realizable value. The standard requires the reversal of previously recorded write downs to realizable value when there is clear evidence that net realizable value has increased. The adoption of Section 3031 "Inventories" did not impact the Company's financial statements. 3 Future accounting changes In February 2008, the CICA issued accounting standard Section 3064 "Goodwill and intangible assets", replacing accounting standard Section 3062 "Goodwill and other intangible assets" and accounting standard Section 3450 "Research and development costs". The new Section will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2008. Accordingly, the Company will adopt the new standards for its fiscal year beginning January 1, 2009. Section 3064 establishes standards for the recognition, measurement, presentation and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous Section 3062. The Company is currently evaluating the impact of the adoption of this new Section. 4 Other charges For the three months ended March 31 (in millions) 2008 2007 -------------------------- Amortization of discount on accruals recorded at present value $ 1.5 $ 2.0 Other exchange losses 1.3 (0.5) Loss on sale of accounts receivable 1.6 1.3 Losses (gains) on non-hedging derivative instruments - (0.3) Other 2.3 2.3 -------------------------- Total other (income) charges $ 6.7 $ 4.8 -------------------------- -------------------------- 5 Interest expense For the three months ended March 31 (in millions) 2008 2007 -------------------------- Interest expense $ 64.7 $ 48.8 Interest income (4.8) (2.0) -------------------------- Total interest expense $ 59.9 $ 46.8 -------------------------- -------------------------- 6 Income taxes During the three months ended March 31, 2008, legislation was substantively enacted to reduce provincial income tax rates. As a result of these changes, the Company recorded a $10.6 million benefit in future tax liability and income tax expense for the three months ended March 31, 2008, related to the revaluation of its future income tax balances as at December 31, 2007. Cash taxes paid for the quarter ended March 31, 2008, was $44.8 million (quarter ended March 31, 2007 - cash taxes paid was $9.2 million). 7 Earnings per share At March 31, 2008, the number of shares outstanding was 153.6 million (March 31, 2007 - 155.2 million). Basic earnings per share have been calculated using net income for the period divided by the weighted average number of CP shares outstanding during the period. Diluted earnings per share have been calculated using the treasury stock method, which gives effect to the dilutive value of outstanding options. The number of shares used in earnings per share calculations is reconciled as follows: For the three months ended March 31 (in millions) 2008 2007 -------------------------- Weighted average shares outstanding 153.5 155.5 Dilutive effect of stock options 1.3 1.9 -------------------------- Weighted average diluted shares outstanding 154.8 157.4 -------------------------- -------------------------- (in dollars) Basic earnings per share 0.59 0.83 Diluted earnings per share 0.59 0.82 8 Restructuring and environmental remediation At March 31, 2008, the provision for restructuring and environmental remediation was $225.0 million (December 31, 2007 - $234.0 million). This provision primarily includes labour liabilities for restructuring plans. Payments are expected to continue in diminishing amounts until 2025. The environmental remediation liability includes the cost of a multi-year soil remediation program. Set out below is a reconciliation of CP's liabilities associated with restructuring and environmental remediation programs: Three months ended March 31, 2008 Opening Amorti- Closing Balance zation Foreign Balance Jan. 1 of Exchange Mar. 31 (in millions) 2008 Accrued Payments Discount Impact 2008 ------------------------------------------------------ Labour liability for terminations and severances $ 129.2 - (12.3) 1.1 0.9 $ 118.9 Other non-labour liabilities for exit plans 0.8 - (0.2) - - 0.6 ------------------------------------------------------ Total restructuring liability 130.0 - (12.5) 1.1 0.9 119.5 ------------------------------------------------------ Environmental remediation program 104.0 0.9 (1.2) - 1.8 105.5 ------------------------------------------------------ Total restructuring and environmental remediation liability $ 234.0 0.9 (13.7) 1.1 2.7 $ 225.0 ------------------------------------------------------ ------------------------------------------------------ Three months ended March 31, 2007 Opening Amorti- Closing Balance zation Foreign Balance Jan. 1 of Exchange Mar. 31 (in millions) 2007 Accrued Payments Discount Impact 2007 ------------------------------------------------------ Labour liability for terminations and severances $ 187.4 - (12.5) 1.5 (0.3) 176.1 Other non-labour liabilities for exit plans 1.4 - (0.1) - - 1.3 ------------------------------------------------------ Total restructuring liability 188.8 - (12.6) 1.5 (0.3) 177.4 ------------------------------------------------------ Environmental remediation program 120.2 0.2 (0.6) - (0.6) 119.2 ------------------------------------------------------ Total restructuring and environmental remediation liability $ 309.0 0.2 (13.2) 1.5 (0.9) 296.6 ------------------------------------------------------ ------------------------------------------------------ Amortization of Discount is charged to income as "Other Charges", "Compensation and Benefits" and "Purchased Services and Other" as applicable. New accruals and adjustments to previous accruals are reflected in "Compensation and Benefits" and "Purchased Services and Other" as applicable. 9 Investments Dakota, Minnesota & Eastern Railroad Corporation ("DM&E") Effective October 4, 2007, the Company acquired all of the issued and outstanding shares of DM&E. The Company is currently accounting for the purchase by the equity method until such time as the acquisition has been approved by the United States Surface Transportation Board ("STB"). The purchase price was $1.499 billion cash payment, including a $6 million post closing adjustment in the first quarter of 2008, and transaction costs of $20 million incurred to March 31, 2008. Future contingent payment of up to approximately US$1.05 billion may become payable upon achievement of certain milestones. The equity income from the Company's investment in DM&E, which is recorded net of tax, was $11.0 million during the three months ended March 31, 2008, and is recorded in "Other income and charges" on the Statement of Consolidated Income. The difference between cost and the underlying net book value of DM&E at the date of acquisition was US$983.5 million. For the three months ended March 31, 2008 the equity income from the Company's investment in DM&E was reduced by $3.4 million to recognize additional depreciation expense based on the assigned cost using fair values at that date of acquisition and $0.4 million to recognize amortization of the fair value of intangible assets acquired. Canadian Third Party Asset-backed Commercial Paper ("ABCP") At March 31, 2008, the Company held ABCP issued by a number of trusts with an original cost of $143.6 million. At the dates the Company acquired these investments they were rated R1 (High) by DBRS Limited ("DBRS"), the highest credit rating issued for commercial paper, and backed by R1 (High) rated assets and liquidity agreements. These investments matured during the third quarter of 2007 but, as a result of liquidity issues in the ABCP market, did not settle on maturity. As a result, the Company has classified its ABCP as long-term investments after initially classifying them as Cash and cash equivalents. On August 16, 2007, an announcement was made by a group representing banks, asset providers and major investors on an agreement in principle to a long-term proposal and interim agreement to convert the ABCP into long-term floating rate notes maturing no earlier than the scheduled maturity of the underlying assets. On September 6, 2007, a pan-Canadian restructuring committee consisting of major investors was formed. The committee was created to propose a solution to the liquidity problem affecting the ABCP and has retained legal and financial advisors to oversee the proposed restructuring process. The ABCP in which the Company has invested has not traded in an active market since mid-August 2007 and there are currently no market quotations available. On March 17, 2008, a court order was obtained through which the restructuring of the ABCP is expected to occur under the protection of the Companies' Creditors Arrangement Act. It is expected that a vote to approve the restructuring will occur on April 25, 2008. This approval will be requested on the basis of all ABCP investments being a single class for the purpose of voting. The restructuring must obtain a majority of votes by number of investors and a two-thirds majority by value of holding. Should these thresholds be reached it is likely the restructuring will be approved by the Court and implemented by the end of May 2008. On March 20, 2008, the pan-Canadian restructuring committee issued an Information Statement containing details about the proposed restructuring. Based on this and other public information it is estimated that, of the $143.6 million of ABCP in which the Company has invested: - $12.5 million is represented by traditional securitized assets and the Company will, on restructuring, receive replacement TA Tracking long-term floating rate notes with a maturity of approximately eight and one half years. As the underlying assets are primarily comprised of cash and Canadian Lines of Credit which are subject to an offer to repurchase at par value, the Company has assumed that these notes will be repaid in full significantly in advance of maturity; - $117.8 million is represented by a combination of leveraged collateralized debt, synthetic assets and traditional securitized assets and the Company will, on restructuring, receive replacement senior Class A-1 and Class A-2 and subordinated Class B and Class C long-term floating rate notes with maturities of approximately eight years and nine months. The Company expects to receive replacement notes with par values as follows: Class A-1: $61.4 million Class A-2: $45.0 million Class B: $7.9 million Class C: $3.5 million The replacement senior notes are expected to obtain a AA rating while the replacement subordinated notes are likely to be unrated; and - $13.3 million is represented by assets that have an exposure to US mortgages and sub-prime mortgages. On restructuring, the Company is likely to receive IA Tracking long-term floating rate notes with maturities of approximately between five years and three months and eight years and seven months. These notes may be rated, although at this time the pan-Canadian restructuring committee has provided no indication of the rating these notes may receive. The valuation technique used by the Company to estimate the fair value of its investment in ABCP at March 31, 2008, incorporates probability weighted discounted cash flows considering the best available public information regarding market conditions and other factors that a market participant would consider for such investments. The assumptions used in determining the estimated fair value reflect the details included in the Information Statement issued by the pan-Canadian restructuring committee and the risks associated with the long-term floating rate notes. The interest rates and maturities of the various long-term floating rate notes, discount rates and credit losses modelled are: Probability weighted average interest rate 3.6 per cent Weighted average discount rate 7.1 per cent Maturity of long-term floating rate notes five to nine years Credit losses rated notes(1): nil to 15 percent unrated notes(2): 15 to 100 percent (1) TA Tracking, Class A-1 and Class A-2 senior notes and IA Tracking notes. (2) Class B and Class C subordinated notes. Interest rates and credit losses vary by each of the different replacement long-term floating rate notes to be issued as each has different credit ratings and risks. Interest rates and credit losses also vary by the different probable cash flow scenarios that have been modelled. Discount rates vary dependent upon the credit rating of the replacement long-term floating rate notes. Discount rates have been estimated using the Government of Canada benchmark rates plus expected spreads for similarly rated instruments with similar maturities and structure. An increase in the estimated discount rates of one percent would reduce the estimated fair value of the Company's investment in ABCP by approximtely $5 million. Maturities vary by different replacement long-term floating rate notes as a result of the expected maturity of the underlying assets. One of the cash flow scenarios modelled is a liquidation scenario whereby, if the restructuring is not successfully completed, recovery of the Company's investment is through the liquidation of the underlying assets of the ABCP trusts. In addition, while the likelihood is remote, there remains a possibility that a liquidation scenario may occur even with a successful approval of the restructuring plan. In addition, assumptions have also been made as to the amount of restructuring costs that the Company will bear. Based on additional information that became available during the first quarter of 2008, the probability weighted discounted cash flows resulted in an estimated fair value of the Company's ABCP of $100.8 million at March 31, 2008. This was a reduction from the estimated fair value at December 31, 2007 of $122.1 million. As a result, a further $21.3 million before tax ($15.0 million after tax) was recorded as a charge to income in the first quarter of 2008. This represents 15 percent of the original value, bringing the total write-down to a total of approximately 30 percent of the original value. Continuing uncertainties regarding the value of the assets which underlie the ABCP, the amount and timing of cash flows and the outcome of the restructuring process could give rise to a further material change in the value of the Company's investment in ABCP which could impact the Company's near term earnings. 10 Shareholders' equity An analysis of Common Share balances is as follows: For the three months ended March 31 (millions of shares) 2008 2007 -------------------------- Share capital, beginning of period 153.3 155.5 Shares issued under stock option plans 0.3 0.4 Shares purchased - (0.7) -------------------------- Share capital, end of period 153.6 155.2 -------------------------- -------------------------- For the three months ended March 31, 2008, there were no shares purchased (2007 - 0.7 million shares were purchased at an average price per share of $63.85). Purchases are made at the market price on the day of purchase, with consideration allocated to share capital up to the average carrying amount of the shares, and any excess allocated to retained earnings. When shares are purchased, it takes three days before the transaction is settled and the shares are cancelled. The cost of shares purchased in a given month and settled in the following month is accrued in the month of purchase. 11 Other comprehensive income and accumulated other comprehensive income Components of other comprehensive income and the related tax effects are as follows: For the three months ended March 31 (in millions) 2008 Before Income tax Net of tax (expense) tax amount recovery amount ----------------------------- Unrealized foreign exchange loss on translation of U.S. dollar-denominated long-term debt designated as a hedge of the net investment in U.S. subsidiaries $ (43.0) $ 5.8 $ (37.2) Unrealized foreign exchange gain on translation of the net investment in U.S. subsidiaries 46.3 - 46.3 Realized gain on cash flow hedges settled in the period (3.0) 0.8 (2.2) Decrease in unrealized holding gains on cash flow hedges (5.7) 1.4 (4.3) Realized gain on cash flow hedges settled in prior periods (0.1) - (0.1) ----------------------------- Other comprehensive income (loss) $ (5.5) $ 8.0 $ 2.5 ----------------------------- ----------------------------- For the three months ended March 31 (in millions) 2007 Before Income tax Net of tax (expense) tax amount recovery amount ----------------------------- Unrealized foreign exchange gain on translation of U.S. dollar-denominated long-term debt designated as a hedge of the net investment in U.S. subsidiaries $ 3.9 $ (0.6) $ 3.3 Unrealized foreign exchange loss on translation of the net investment in U.S. subsidiaries (4.2) - (4.2) Realized gain on cash flow hedges settled in the period (3.3) 1.3 (2.0) Increase in unrealized holding gains on cash flow hedges 0.1 - 0.1 ----------------------------- Other comprehensive loss $ (3.5) $ 0.7 $ (2.8) ----------------------------- ----------------------------- Changes in the balances of each classification within Accumulated other comprehensive income are as follows: Three months ended March 31, 2008 Opening Closing Balance, Balance, Jan. 1, Period Mar. 31, (in millions) 2008 change 2008 ----------------------------- Foreign exchange gain on U.S. dollar debt designated as a hedge of the net investment in U.S. subsidiaries $ 296.6 $ (37.2) $ 259.4 Foreign exchange loss on net investment in U.S. subsidiaries (246.9) 46.3 (200.6) Unrealized effective gains on cash flow hedges (6.2) (6.5) (12.7) Deferred loss on settled hedge instruments (3.9) (0.1) (4.0) ----------------------------- Accumulated other comprehensive income $ 39.6 $ 2.5 $ 42.1 ----------------------------- ----------------------------- Three months ended March 31, 2007 Opening Closing Balance, Balance, Jan. 1, Period Mar. 31, (in millions) 2007 change 2007 ----------------------------- Foreign exchange gain on U.S. dollar debt designated as a hedge of the net investment in U.S. subsidiaries $ 235.3 $ 3.3 $ 238.6 Foreign exchange loss on net investment in U.S. subsidiaries (168.5) (4.2) (172.7) Unrealized effective gains of cash flow hedges 18.9 (1.9) 17.0 Deferred loss on settled hedge instruments (5.3) - (5.3) ----------------------------- Accumulated other comprehensive income $ 80.4 $ (2.8) $ 77.6 ----------------------------- ----------------------------- During the next twelve months, the Company expects $11.3 million of unrealized holding gains on derivative instruments to be realized and recognized in the Statement of Consolidated Income. Existing derivative instruments designated as cash flow hedges will be fully matured by December 31, 2009. 12 Financial instruments The fair value of a financial instrument is the amount of consideration that would be agreed upon in an arm's length transaction between willing parties. The Company uses the following methods and assumptions to estimate fair value of each class of financial instruments for which carrying amounts are included in the Consolidated Balance Sheet as follows: Loans and receivables --------------------- Accounts receivable and other current assets - The carrying amounts approximate fair value because of the short maturity of these instruments. Investments - Long-term receivable balances are carried at amortized cost based on an initial fair value as determined at the time using discounted cash flow analysis and observable market based inputs. Financial liabilities --------------------- Accounts payable and accrued liabilities, short-term borrowings, and deferred liabilities - The carrying amounts approximate fair value because of the short maturity of these instruments. Long-term debt - The carrying amount of long-term debt is at amortized cost based on an initial fair value as determined at the time using the quoted market prices for the same or similar debt instruments. Available for sale ------------------ Investments - Certain equity investments which are recorded on a cost basis have a carrying value that equals cost as fair value cannot be reliably established as there are no quoted prices in an active market for these investments. Held for trading ---------------- Derivative instruments that are designated as hedging instruments are measured at fair value determined using the quoted market prices for the same or similar instruments. Derivative instruments that are not designated in hedging relationships are classified as held for trading and measured at fair value determined by using quoted market prices for similar instruments and changes in fair values of such derivatives are recognized in net income as they arise. Cash and cash equivalents - The carrying amounts approximate fair value because of the short maturity of these instruments. Investments - Canadian third party asset-backed commercial paper (ABCP) is carried at fair value, which has been determined using valuation techniques that incorporate probability weighted discounted future cash flows reflecting market conditions and other factors that a market participant would consider (see Note 9). The table below reconciles carrying value positions of the Company's financial instruments with Consolidated Balance Sheet categories: (in millions of dollars) March 31, 2008 ------------------------------- Carrying Carrying Value of Value of Financial Other Assets/ Assets/ Balance Liabil- Liabil- Sheet ities ities Amount ------------------------------- Assets Cash and cash equivalents $ 71.3 $ - $ 71.3 ------------------------------- Accounts receivable and other current assets Accounts receivable 507.7 - Current portion of crude oil swaps 12.9 - Current portion of interest rate swaps 2.6 - Other - 62.0 ------------------------------- 523.2 62.0 585.2 ------------------------------- Investments Equity investments at cost 1.2 - Long-term receivables at amortized cost 17.6 - ABCP 100.8 - Other - 1,599.4 ------------------------------- 119.6 1,599.4 1,719.0 ------------------------------- Other assets and deferred charges Long-term portion of crude oil swaps 7.7 - Long-term portion of interest rate swaps 10.6 - Other - 1,373.7 ------------------------------- 18.3 1,373.7 1,392.0 ------------------------------- Liabilities Short-term borrowings 66.7 - 66.7 ------------------------------- Accounts payable and accrued liabilities Accounts payable and accrued liabilities 770.0 - Current portion of foreign exchange contracts on fuel 1.5 - Current portion of bond forward 40.5 - Current portion of interest rate swaps - - Other - 183.5 ------------------------------- 812.0 183.5 995.5 ------------------------------- Long-term debt maturing within one year 31.1 - 31.1 ------------------------------- Deferred liabilities Long-term portion of foreign exchange contracts on fuel 1.0 - Long-term portion of currency forward 1.8 - Long-term portion of interest rate swaps - - Total return swap 1.1 - Long-term portion of Accounts payable and accrued liabilities 42.6 - Other - 643.9 ------------------------------- 46.5 643.9 690.4 ------------------------------- Long-term debt 4,267.6 - 4,267.6 ------------------------------- (in millions of dollars) December 31, 2007 ------------------------------- Carrying Carrying Value of Value of Financial Other Assets/ Assets/ Balance Liabil- Liabil- Sheet ities ities Amount ------------------------------- Assets Cash and cash equivalents 378.1 - 378.1 ------------------------------- Accounts receivable and other current assets Accounts receivable 483.0 - Current portion of crude oil swaps 12.9 - Current portion of interest rate swaps - - Other - 46.9 ------------------------------- 495.9 46.9 542.8 ------------------------------- Investments Equity investments at cost 1.3 - Long-term receivables at amortized cost 17.5 - ABCP 122.1 - Other - 1,527.7 ------------------------------- 140.9 1,527.7 1,668.6 ------------------------------- Other assets and deferred charges Long-term portion of crude oil swaps 8.5 - Long-term portion of interest rate swaps - - Other - 1,227.1 ------------------------------- 8.5 1,227.1 1,235.6 ------------------------------- Liabilities Short-term borrowings 229.7 - 229.7 ------------------------------- Accounts payable and accrued liabilities Accounts payable and accrued liabilities 750.6 - Current portion of foreign exchange contracts on fuel 2.1 - Current portion of bond forward 30.6 - Current portion of interest rate swaps (1.0) - Other - 198.5 ------------------------------- 782.3 198.5 980.8 ------------------------------- Long-term debt maturing within one year 31.0 - 31.0 ------------------------------- Deferred liabilities Long-term portion of foreign exchange contracts on fuel 1.5 - Long-term portion of currency forward 15.7 - Long-term portion of interest rate swaps (4.5) - Total return swap 3.8 - Long-term portion of Accounts payable and accrued liabilities 41.9 - Other - 656.2 ------------------------------- 58.4 656.2 714.6 ------------------------------- Long-term debt 4,146.2 - 4,146.2 ------------------------------- Carrying value and fair value of financial instruments ------------------------------------------------------ The carrying values of financial instruments equal or approximate their fair values with the exception of long-term debt which has a carrying value of approximately $4,298.7 million (December 31, 2007 - $4,177.2 million) and a fair value of approximately $4,320.9 million at March 31, 2008 (December 31, 2007 - $4,302.6 million). The fair value of publicly traded long-term debt is determined based on market prices at March 31, 2008 and December 31, 2007, respectively. The fair value of other long-term debt is estimated based on rates currently available to the Company for long-term borrowings, with terms and conditions similar to those borrowings in place at the applicable Consolidated Balance Sheet date. Financial risk management ------------------------- In the normal course of operations, the Company is exposed to various market risks such as foreign exchange risk, interest rate risk, other price risk, as well as credit risk and liquidity risk. To manage these risks, the Company utilizes a Financial Risk Management (FRM) framework. The FRM goals and strategy are outlined below: FRM objectives: - Maintaining sound financial condition as an ongoing entity; - Optimizing earnings per share and cash flow; - Financing operations of the group of CP companies at the optimal cost of capital; and - Ensuring liquidity to all Canadian and U.S. operations. In order to satisfy the objectives above, the Company has adopted the following strategies: - Prepare multi-year planning and budget documents at prevailing market rates to ensure clear, corporate alignment to performance management and achievement of targets; - Measure the extent of operating risk within the business; - Identify the magnitude of the impact of market risk factors on the overall risk of the business and take advantage of natural risk reductions that arise from these relationships; and - Utilize financial instruments, including derivatives to manage the remaining residual risk to levels that fall within the risk tolerance of the Company. Under the governance structure established by the Company and approved by the Audit, Finance and Financial Risk Management Committee ("Audit Committee"), the Board of Directors has the authority to approve the Financial Risk Management Policies of the Company. The Board has delegated to the Audit Committee the accountability for ensuring a structure is in place to ensure compliance with the individual Corporate Risk Management Policies across the Company's operations. The policy objective with respect to the utilization of derivative financial instruments is to selectively mitigate the impact of fluctuations in foreign exchange ("FX") rates, interest rates, fuel price, and share price. The use of any derivative instruments is carried out in accordance with approved trading limits and authorized counterparties as specified in the policy and/or mandate. It is not the Company's intent to use financial derivatives or commodity instruments for trading or speculative purposes. Risk factors ------------ The following is a discussion of market, credit and liquidity risks and related mitigation strategies that have been identified through the FRM framework. The is not an exhaustive list of all risks, nor will the mitigation strategies eliminate all risks listed. Risks related to the Company's investment in ABCP are discussed in more detail in Note 9. Foreign exchange risk --------------------- This risk refers to the fluctuation of financial commitments, assets, liabilities, income or cash flows due to changes in FX rates. The Company conducts business transactions and owns assets in both Canada and the United States; as a result, revenues and expenses are incurred in both Canadian dollars and U.S. dollars. The Company's income is exposed to FX risk largely in the following ways: - Translation of U.S. dollar denominated revenues and expenses into Canadian dollars - When the Canadian dollar changes relative to the U.S. dollar, income reported in Canadian dollars will change. The impact of a strengthening Canadian dollar on U.S. dollar revenues and expenses will reduce net income because the Company has more U.S. dollar revenues than expenses. This impact is excluded from the sensitivity in the table below; and - Translation of U.S. dollar denominated debt and other monetary items - A strengthening Canadian dollar will reduce the Company's U.S. dollar denominated debt in Canadian dollar terms and generate a FX gain on long-term debt, which is recorded in income. The Company calculates FX on long-term debt using the difference in FX rates at the beginning and at the end of each reporting period. Other U.S. dollar denominated monetary items will also be impacted by changes in FX rates. Foreign exchange management In terms of net income, excluding FX on long-term debt, mitigation of U.S. dollar FX exposure is provided primarily through offsets created by revenues and expenses incurred in the same currency. Where appropriate the Company negotiates with U.S. customers and suppliers to reduce the net exposure. The Company may from time to time reduce residual exposure by hedging revenues through FX forward contracts. The Company had no revenue forward sales of U.S. dollars outstanding at March 31, 2008. The FX gains and losses on long-term debt are mainly unrealized and can only be realized when U.S. dollar denominated long-term debt matures or is settled. The Company also has long term FX exposure on its investment in U.S. affiliates. A portion of the Company's U.S. dollar denominated long-term debt has been designated as a hedge of the net investment in self-sustaining foreign subsidiaries. This designation has the effect of mitigating volatility on net income by offsetting long-term FX gains and losses on long-term debt. In addition, for long-term debt denominated in U.S. dollars in Canada, the Company may enter into currency forwards to hedge debt that is denominated in U.S. dollars. Occasionally the Company will enter into short-term FX forward contracts as part of its cash management strategy. The table below depicts the quarterly impact to net income and other comprehensive income of long-term debt had the exchange rate increased or decreased by one cent. The impact on other U.S. dollar denominated monetary items is not considered to be material. Three months ended (in millions) March 31, 2008 ----------------------- Impact to Other Impact compre- to Net hensive income income ----------------------- 1 cent strengthening in Canadian dollar $ 3.0 $ (2.0) 1 cent weakening in Canadian dollar (3.0) 2.0 ----------------------- ----------------------- Note: All variables excluding FX are held constant. Impact to net income and other comprehensive income would increase by $10.6 million if the net investment hedge was not included in the above table. Foreign exchange forward contracts In June 2007, the Company entered into a currency forward to fix the exchange rate on US$400 million 6.250% Notes due 2011. This derivative guarantees the amount of Canadian dollars that the Company will repay when its US$400 million 6.25% note matures in October 2011. During the three months ended March 31, 2008, the Company recorded a gain of $13.9 million to "Foreign exchange (gain) loss on long-term debt". At March 31, 2008, the unrealized loss on the forward was $1.8 million (December 31, 2007 - $15.7 million). Interest rate risk ------------------ This refers to the risk that the fair value or income and future cash flows of a financial instrument will vary as a result of changes in market interest rates. In order to manage funding needs or capital structure goals, the Company enters into debt or capital lease agreements that are subject to either fixed market interest rates set at the time of issue or floating rates determined by on-going market conditions. Debt subject to variable interest rates exposes the Company to variability in interest expense, while debt subject to fixed interest rates exposes the Company to variability in the fair value of the debt. The table below depicts the floating and fixed maturities for all financial assets and liabilities: (in millions) March 31, 2008 ----------------------- At At floating fixed interest interest rates rates ----------------------- Financial assets Cash and short-term investments $ 71.3 $ - ABCP 100.8 - Financial liabilities Short-term borrowings 66.7 - Long-term debt 1,446.7 2,852.0 Notional amount Interest rate swaps 205.3 - ----------------------- ----------------------- Interest rate management ------------------------ To manage interest rate exposure, the Company accesses diverse sources of financing and manages borrowings in line with a targeted range of capital structure, debt ratings, liquidity needs, maturity schedule, and currency and interest rate profiles. In anticipation of future debt issuance, the Company may enter into forward rate agreements such as treasury rate locks, bond forwards or forward starting swaps to substantially lock in all or a portion of the effective future interest expense. The Company may also enter into swap agreements to manage the mix of fixed and floating rate debt. The table below depicts the quarterly impact to net income and other comprehensive income had interest rates increased or decreased by 50 basis points. Typically, as rates increase, net income decreases. Three months ended (in millions) March 31, 2008 ----------------------- Impact to Other Impact compre- to Net hensive income income ----------------------- 50 basis point increase in rates $ (1.3) $ 21.6 50 basis point decrease in rates 1.3 (21.6) ----------------------- ----------------------- Note: All variables excluding interest rates are held constant. At March 31, 2008, the Company had outstanding interest rate swap agreements, classified as a fair value hedge, for a notional amount of US$200 million or CDN$205.3 million. The swap agreements convert a portion of the Company's fixed-interest-rate liability into a variable-rate liability for the 6.250% Notes. During the three months ended March 31, 2008, the Company recorded a loss of $0.2 million (March 31, 2007 - $0.4 million) to "Interest expense". At March 31, 2008, the unrealized gain, derived from the fair value of the swap, was $13.2 million (December 31, 2007 - $5.5 million). The following table discloses the terms of the swap agreements at March 31, 2008: Expiration October 15, 2011 Notional amount of principal (in CDN$ millions) $ 205.3 Fixed receiving rate 6.250% Variable paying rate 5.437% ------------------------------------------------------------------ Based on U.S. three-month LIBOR. During 2007, the Company entered into agreements that established the benchmark rate on $350.0 million of long-term debt, which is expected to be issued in 2008. The fair value of this instrument, which is accounted for as a cash flow hedge, was a loss of $40.5 million at March 31, 2008 (December 31, 2007 - $30.6 million). During the three months ended March 31, 2008, losses of $0.9 million were recognised and recorded in net income and unrealized losses of $9.0 million were recorded in other comprehensive income. Stock-based compensation risk ----------------------------- This risk refers to the probability of increased compensation expense due to the increase in the Company's share price. The Company's compensation expense is subject to volatility due to the movement of share price and its impact on the value of certain management and director stock-based compensation programs. These programs, as described in the management proxy circular, include deferred share units ("DSU's"), restricted share units ("RSU's"), performance share units ("PSU's") and share appreciation rights ("SAR's"). As the share price appreciates, these instruments are marked to market increasing compensation expense. Stock-based compensation expense management ------------------------------------------- To minimize the volatility to compensation expense created by changes in share price, the Company entered into a Total Return Swap ("TRS") to reduce the volatility and total cost to the Company over time of the four types of stock-based compensation programs noted above. These are derivatives that provide price appreciation and dividends, in return for a charge by the counterparty. The swaps minimize volatility to compensation expense by providing a gain to substantially offset increased compensation expense as the share price increases and a loss to offset reduced compensation expense when the share price falls. If stock-based compensation share units fall out of the money after entering the program, the loss associated with the swap would no longer be offset by any compensation expense reductions. The table below depicts the quarterly impact to net income as a result of the TRS had the share price increased or decreased $1 from the closing share price on March 31, 2008. Three months ended (in millions) March 31, 2008 -------------------- Impact to Net income -------------------- $1 increase in share price $ 1.7 $1 decrease in share price (1.7) -------------------- -------------------- Note: All variables excluding share price are held constant. During the three months ended March 31, 2008, Compensation and benefits expense decreased by $2.7 million (March 31, 2007 - $6.3 million) due to unrealized gains for these swaps. At March 31, 2008, the unrealized loss on the swap was $1.1 million (December 31, 2007 - $3.8 million). Commodity risk -------------- The Company is exposed to commodity risk related to purchases of diesel fuel and the potential reduction in net income due to increases in the price of diesel. Because fuel expense constitutes a large portion of the Company's operating costs, volatility in diesel fuel prices can have a significant impact on the Company's income. Items affecting volatility in diesel prices include, but are not limited to, fluctuations in world markets for crude oil and distillate fuels, which can be affected by supply disruptions and geopolitical events. Fuel price management The impact of variable fuel expense is mitigated substantially through fuel recovery programs which apportion incremental changes in fuel prices to shippers through price indices, tariffs, and, by contract, within agreed upon guidelines. While these programs provide effective and meaningful coverage, residual exposure remains as the fuel expense risk cannot be completely recovered from shippers due to timing and volatility in the market. The Company continually monitors residual exposure, and where appropriate, may enter into derivative instruments. Derivative instruments used by the Company to manage fuel expense risk may include, but are not limited to, swaps and options for crude oil and diesel. In addition, the Company may combine FX forward contracts with fuel derivatives to effectively hedge the risk associated with FX variability on fuel purchases and commodity hedges. The table below depicts the quarterly impact to net income (excluding recoveries through pricing mechanisms) and other comprehensive income as a result of our crude forward contracts had the price of West Texas Intermediate ("WTI") changed by $1 for the three months ended March 31, 2008: Three months ended (in millions) March 31, 2008 ----------------------- Impact to Other Impact compre- to Net hensive income income ----------------------- $1 increase in price of diesel $ (0.1) $ 0.2 $1 decrease in price of diesel 0.1 (0.2) ----------------------- ----------------------- Note: All variables excluding WTI per barrel are held constant. At March 31, 2008, the Company had crude forwards contracts, which are accounted for as cash flow hedges, to purchase approximately 327,000 barrels over the 2008-2009 period at average quarterly prices ranging from US$30.59 to US$38.19 per barrel. This represents approximately 3% of estimated fuel purchases in 2008 and 2009. At March 31, 2008, the unrealized gain on these forward contracts was CDN$20.6 million (December 31, 2007 - CDN$21.4 million). At March 31, 2008, the Company had FX forward contracts (in conjunction with the crude purchases above), which are accounted for as cash flow hedges, totalling US$11.8 million over the 2008-2009 period at exchange rates ranging from 1.2276 to 1.3008. At March 31, 2008, the unrealized loss on these forward contracts was CDN$2.5 million (December 31, 2007 - CDN$3.5 million). For the three months ended March 31, 2008, Fuel expense was reduced by $3.9 million (three months ended March 31, 2007 - $4.6 million) as a result of $4.6 million in realized gains (three months ended March 31, 2007 - $4.9 million) arising from settled swaps, partially offset by $0.7 million in realized losses (three months ended March 31, 2007 - $0.3 million) arising from the settled FX forward contracts. Credit risk ----------- Credit risk refers to the possibility that a customer or counterparty will fail to fulfil its obligations under a contract and as a result, create a financial loss for the Company. The Company's credit risk regarding its investment in ABCP are discussed in more detail in Note 9. Credit risk management ---------------------- The railway industry services predominantly financially established customers and the Company has experienced limited financial loss with respect to credit risk. The credit worthiness of customers is assessed using credit scores supplied by a third party, and through direct monitoring of their financial well-being on a continual basis. The Company establishes guidelines for customer credit limits and should thresholds in these areas be reached, appropriate precautions are taken to improve collectibility. Pursuant to their respective terms, accounts receivable are aged as follows at March 31, 2008: (in millions) Up to date $ 335.5 Under 30 days past due 100.1 30-60 days past due 27.1 61-90 days past due 11.8 Over 91 days past due 33.2 ---------- 507.7 ---------- ---------- Counterparties to financial instruments expose the Company to credit losses in the event of non-performance. Counterparties for derivative and cash transactions are limited to high credit quality financial institutions, which are monitored on an ongoing basis. Counterparty credit assessments are based on the financial health of the institutions and their credit ratings from external agencies. With exception of ABCP, the Company does not anticipate non-performance that would materially impact the Company's financial statements. With the exception of ABCP, the Company believes there are no significant concentrations of credit risk. The maximum exposure to credit risk can be taken from our financial assets values reported in the table reconciling the carrying value positions of the Company's financial instruments with Consolidated Balance Sheet categories. Liquidity risk -------------- The Company monitors and manages its liquidity risk to ensure access to sufficient funds to meet operational and investing requirements. Liquidity risk management ------------------------- The Company has long-term debt ratings of Baa3, BBB, and BBB from Moody's Investors Service, Inc. ("Moody's"), Standard and Poor's Corporation ("S&P"), and DBRS respectively. The S&P rating has a negative outlook, while the ratings of Moody's and DBRS have a stable outlook. The Company intends to manage its capital structure and liquidity at levels that sustain an investment grade rating. The Company has the following liquidity lines available: - a five year revolving credit facility of $945 million, with an accordion feature to $1.15 billion, of which $539 million was available on March 31, 2008; - an accounts receivable securitization program that provides up to $200 million. On March 31, 2008, $80 million in available capacity remained. The program expires in September 2009; and - an 18 month US$1.8 billion temporary credit facility established to acquire the DM&E. On October 4, 2007, US$1.27 billion was drawn to close the transaction. The facility expires in April 2009. These facilities are arranged with a core group of highly rated international financial institutions. They incorporate pre-agreed pricing. The revolving credit facility and the temporary credit facility are available on next day terms. The accounts receivable securitization program capacity is available on five days notice. The Company plans to access both Canadian and U.S. capital markets to secure long term financing for the temporary credit facility. Market conditions allowing, the Company will access debt capital markets in various maturities periodically prior to the expiry of the temporary credit facility in order to minimize risk and optimize pricing. It is the Company's intention to manage its long term financing structure to maintain its investment grade rating. The Company may decide to enter certain derivative instruments to reduce interest rate and foreign exchange exposure in advance of these issuances. Surplus cash is invested into a range of short dated money market instruments meeting or exceeding the parameters of the Company's investment policy. The table below reflects the contractual maturity of the Company's undiscounted cash flows for its financial liabilities and derivatives: (in millions) March 31, 2008 -------------------------------------- 2009- 2008 2011 2012+ Total -------------------------------------- Financial liabilities Short-term borrowings $ 66.7 $ - $ - $ 66.7 Accounts payable and accrued liabilities 770.0 42.6 - 812.6 Foreign exchange contracts on fuel 1.3 1.2 - 2.5 Bond forward 41.2 - - 41.2 Currency forward - 2.0 - 2.0 Total return swap - 1.1 - 1.1 Long-term debt 23.7 2,226.8 2,238.2 4,488.7 -------------------------------------- -------------------------------------- 13 Additions to investments and other assets Additions to investment and other assets includes the acquisition of $134.7 million in locomotives and freight car assets for the quarter ended March 31, 2008 (quarter ended March 31, 2007 - nil). These assets were purchased in anticipation of a sale and lease back arrangement with a financial institution. 14 Stock-based compensation In the first quarter of 2008, under CP's stock option plans, the Company issued 1,335,500 options to purchase Common Shares at the weighted average price of $71.69 per share, based on the closing price on the grant date. In tandem with these options, 413,200 stock appreciation rights were issued at the weighted average exercise price of $71.69. Pursuant to the employee plan, options may be exercised upon vesting, which is between 24 months and 36 months after the grant date, and will expire after 10 years. Some options vest after 48 months, unless certain performance targets are achieved, in which case vesting is accelerated. These options expire five years after the grant date. Other options only vest if certain performance targets are achieved and expire approximately five years after the grant date. The following is a summary of the Company's fixed stock option plans as of March 31 (including options granted under the Directors' Stock Option Plan, which was suspended in 2003): 2008 2007 -------------------------- -------------------------- Weighted Weighted average average Number of exercise Number of exercise options price options price -------------------------- -------------------------- Outstanding, January 1 6,981,108 43.97 6,815,494 38.50 New options granted 1,335,500 71.69 1,299,800 62.57 Exercised (361,225) 33.66 (356,491) 29.82 Forfeited/ cancelled (26,275) 34.83 (51,175) 35.48 ------------ ------------ Outstanding, March 31 7,929,108 49.14 7,707,628 42.98 -------------------------- -------------------------- -------------------------- -------------------------- Options exercisable at March 31 4,775,458 38.18 4,713,928 33.89 -------------------------- -------------------------- -------------------------- -------------------------- DATASOURCE: Canadian Pacific Railway CONTACT: Media, Leslie Pidcock, Tel.: (403) 880-4349, email: ; Investment Community, Janet Weiss, Assistant Vice-President, Investor Relations, Tel.: (403) 319-3591, email:

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