CANADIAN PACIFIC KANSAS CITY LTD/CN - Quarter Report: 2016 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)


x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016


¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 001-01342

Canadian Pacific Railway Limited

(Exact name of registrant as specified in its charter)



Canada		98-0355078
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

7550 Ogden Dale Road S.E. Calgary, Alberta, Canada		T2C 4X9
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s Telephone Number, Including Area Code: (403) 319-7000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer þ	Accelerated filer o	Non-accelerated filer o	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of the close of business on July 18, 2016, there were 147,771,618 of the registrant’s Common Shares issued and outstanding.

CANADIAN PACIFIC RAILWAY LIMITED

FORM 10-Q

TABLE OF CONTENTS



	PART I - FINANCIAL INFORMATION
		Page
Item 1.	Financial Statements:

	Interim Consolidated Statements of Income	3
	For the Three and Six Months Ended June 30, 2016 and 2015

	Interim Consolidated Statements of Comprehensive Income	4
	For the Three and Six Months Ended June 30, 2016 and 2015

	Interim Consolidated Balance Sheets	5
	As at June 30, 2016 and December 31, 2015

	Interim Consolidated Statements of Cash Flows	6
	For the Three and Six Months Ended June 30, 2016 and 2015

	Interim Consolidated Statements of Changes in Shareholders' Equity	7
	For the Six Months Ended June 30, 2016 and 2015

	Notes to Interim Consolidated Financial Statements	8

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	58
Item 4.	Controls and Procedures	59

	PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	60
Item 1A.	Risk Factors	60
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	60
Item 3.	Defaults Upon Senior Securities	60
Item 4.	Mine Safety Disclosures	60
Item 5.	Other Information	60
Item 6.	Exhibits	61

PART I

ITEM 1. FINANCIAL STATEMENTS

INTERIM CONSOLIDATED STATEMENTS OF INCOME

(unaudited)



	For the three months ended June 30						For the six months ended June 30
(in millions of Canadian dollars, except share and per share data)	2016			2015			2016			2015
Revenues
Freight	$	1,406		$	1,610		$	2,954		$	3,240
Non-freight	44			41			87			76
Total revenues	1,450			1,651			3,041			3,316
Operating expenses
Compensation and benefits	284			308			613			686
Fuel	131			185			256			380
Materials	38			45			94			97
Equipment rents	44			46			89			88
Depreciation and amortization	161			145			323			291
Purchased services and other (Note 4)	241			276			462			516
Total operating expenses	899			1,005			1,837			2,058

Operating income	551			646			1,204			1,258
Less:
Other income and charges (Note 5)	(9		)	(5		)	(190		)	68
Net interest expense	115			84			239			169
Income before income tax expense	445			567			1,155			1,021
Income tax expense (Note 6)	117			177			287			311
Net income	$	328		$	390		$	868		$	710

Earnings per share (Note 7)
Basic earnings per share	$	2.16		$	2.38		$	5.70		$	4.32
Diluted earnings per share	$	2.15		$	2.36		$	5.67		$	4.28

Weighted-average number of shares (millions) (Note 7)
Basic	151.7			163.7			152.3			164.3
Diluted	152.6			165.0			153.2			165.7

Dividends declared per share	$	0.5000		$	0.3500		$	0.8500		$	0.7000

See Notes to Interim Consolidated Financial Statements.

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)



Year ended (in millions of Canadian dollars)	For the three months ended June 30						For the six months ended June 30
(in millions of Canadian dollars)	2016			2015			2016			2015
Net income	$	328		$	390		$	868		$	710
Net gain (loss) in foreign currency translation adjustments, net of hedging activities	3			7			40			(30		)
Change in derivatives designated as cash flow hedges	(29		)	36			(76		)	(33		)
Change in pension and post-retirement defined benefit plans	43			66			90			138
Other comprehensive income before income taxes	17			109			54			75
Income tax (expense) recovery on above items	(7		)	(35		)	(48		)	11
Other comprehensive income (Note 3)	10			74			6			86
Comprehensive income	$	338		$	464		$	874		$	796

See Notes to Interim Consolidated Financial Statements.

INTERIM CONSOLIDATED BALANCE SHEETS AS AT

(unaudited)



	June 30			December 31
(in millions of Canadian dollars)	2016			2015
Assets
Current assets
Cash and cash equivalents	$	92		$	650
Accounts receivable, net	577			645
Materials and supplies	195			188
Other current assets	59			54
	923			1,537
Investments	155			152
Properties	16,160			16,273
Goodwill and intangible assets	195			211
Pension asset	1,565			1,401
Other assets	70			63
Total assets	$	19,068		$	19,637
Liabilities and shareholders’ equity
Current liabilities
Accounts payable and accrued liabilities	$	1,247		$	1,417
Long-term debt maturing within one year (Note 8)	198			30
	1,445			1,447
Pension and other benefit liabilities	751			758
Other long-term liabilities	286			318
Long-term debt	8,383			8,927
Deferred income taxes	3,512			3,391
Total liabilities	14,377			14,841
Shareholders’ equity
Share capital	2,000			2,058
Additional paid-in capital	49			43
Accumulated other comprehensive loss (Note 3)	(1,471		)	(1,477		)
Retained earnings	4,113			4,172
	4,691			4,796
Total liabilities and shareholders’ equity	$	19,068		$	19,637

Contingencies (Note 13)

See Notes to Interim Consolidated Financial Statements.

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)



Year ended (in millions of Canadian dollars)	For the three months ended June 30						For the six months ended June 30
(in millions of Canadian dollars)	2016			2015			2016			2015
Operating activities
Net income	$	328		$	390		$	868		$	710
Reconciliation of net income to cash provided by operating activities:
Depreciation and amortization	161			145			323			291
Deferred income taxes (Note 6)	90			74			183			106
Pension funding in excess of expense (Note 12)	(37		)	(20		)	(79		)	(30		)
Foreign exchange (gain) loss on long-term debt (Note 5)	(18		)	(10		)	(199		)	54
Other operating activities, net	(47		)	(28		)	(113		)	(69		)
Change in non-cash working capital balances related to operations	35			34			(253		)	78
Cash provided by operating activities	512			585			730			1,140
Investing activities
Additions to properties	(330		)	(355		)	(608		)	(618		)
Proceeds from sale of properties and other assets (Note 4)	11			8			71			60
Other	(2		)	(7		)	(2		)	13
Cash used in investing activities	(321		)	(354		)	(539		)	(545		)
Financing activities
Dividends paid	(53		)	(57		)	(107		)	(115		)
Issuance of CP Common Shares	4			11			9			27
Purchase of CP Common Shares (Note 9)	(788		)	(543		)	(788		)	(1,072		)
Issuance of long-term debt, excluding commercial paper	—			—			—			810
Repayment of long-term debt, excluding commercial paper	(7		)	(9		)	(18		)	(67		)
Net issuance (repayment) of commercial paper (Note 8)	176			369			176			(224		)
Other	(1		)	—			(3		)	—
Cash used in financing activities	(669		)	(229		)	(731		)	(641		)

Effect of foreign currency fluctuations on U.S. dollar-denominated cash and cash equivalents	(1		)	(1		)	(18		)	5
Cash position
(Decrease) increase in cash and cash equivalents	(479		)	1			(558		)	(41		)
Cash and cash equivalents at beginning of period	571			184			650			226
Cash and cash equivalents at end of period	$	92		$	185		$	92		$	185

Supplemental disclosures of cash flow information:
Income taxes paid	$	65		$	62		$	257		$	59
Interest paid	$	92		$	94		$	247		$	161

See Notes to Interim Consolidated Financial Statements.

INTERIM CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(unaudited)



(in millions of Canadian dollars, except common share amounts)	Common shares (in millions)		Share capital			Additional paid-in capital			Accumulated other comprehensive loss			Retained earnings			Total shareholders’ equity
Balance at January 1, 2016	153.0		$	2,058		$	43		$	(1,477	)	$	4,172		$	4,796
Net income	—		—			—			—			868			868
Other comprehensive income (Note 3)	—		—			—			6			—			6
Dividends declared	—		—			—			—			(130		)	(130		)
Effect of stock-based compensation expense	—		—			8			—			—			8
CP Common Shares repurchased (Note 9)	(4.7	)	(70		)	—			—			(797		)	(867		)
Shares issued under stock option plan	0.1		12			(2		)	—			—			10
Balance at June 30, 2016	148.4		$	2,000		$	49		$	(1,471	)	$	4,113		$	4,691
Balance at January 1, 2015	166.1		$	2,185		$	36		$	(2,219	)	$	5,608		$	5,610
Net income	—		—			—			—			710			710
Other comprehensive income (Note 3)	—		—			—			86			—			86
Dividends declared	—		—			—			—			(115		)	(115		)
Effect of stock-based compensation expense	—		—			10			—			—			10
CP Common Shares repurchased (Note 9)	(5.2	)	(70		)	—			—			(1,010		)	(1,080		)
Shares issued under stock option plan	0.4		36			(6		)	—			—			30
Balance at June 30, 2015	161.3		$	2,151		$	40		$	(2,133	)	$	5,193		$	5,251

See Notes to Interim Consolidated Financial Statements.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2016

(unaudited)

1 Basis of presentation

These unaudited interim consolidated financial statements of Canadian Pacific Railway Limited (“CP”, or “the Company”), expressed in Canadian dollars, reflect management’s estimates and assumptions that are necessary for their fair presentation in conformity with generally accepted accounting principles in the United States of America (“GAAP”). They do not include all disclosures required under GAAP for annual financial statements and should be read in conjunction with the 2015 annual consolidated financial statements and notes included in CP's 2015 Annual Report on Form 10-K. The accounting policies used are consistent with the accounting policies used in preparing the 2015 annual consolidated financial statements, except for the newly adopted accounting policy discussed in Note 2.

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.

In management’s opinion, the unaudited interim consolidated financial statements include all adjustments (consisting of normal and recurring adjustments) necessary to present fairly such information. Interim results are not necessarily indicative of the results expected for the fiscal year.

2 Accounting changes

Implemented in 2016

Amendments to the Consolidation Analysis

In February 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) 2015-02, Amendments to the Consolidation Analysis under FASB Accounting Standards Codification ("ASC") Topic 810 Consolidation. The amendments required reporting entities to evaluate whether they should consolidate certain legal entities under the revised consolidation model. Specifically, the amendments modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities, eliminated the presumption that a general partner should consolidate a limited partnership and affected the consolidation analysis of reporting entities involved with VIEs, particularly those that have fee arrangements and related party relationships. This ASU was effective for public entities for fiscal years, and interim periods within those years, beginning on or after December 15, 2015. Entities had the option of using either a full retrospective or a modified retrospective approach to adopt this ASU. The Company evaluated all arrangements that might give rise to a VIE and all existing VIEs; no changes to disclosure or financial statement presentation were required as a result of this evaluation.

Future changes

Leases

In February 2016, the FASB issued ASU 2016-02, Leases. The new FASB ASC Topic 842 Leases supersedes the lease recognition and measurement requirements in Topic 840 Leases. This new standard requires recognition of right-of-use assets and lease liabilities by lessees for those leases classified as finance and operating leases with a maximum term exceeding 12 months. This ASU will be effective for public entities for fiscal years, and interim periods within those years, beginning on or after December 15, 2018. Entities are required to use a modified retrospective approach to adopt this ASU. The Company is currently evaluating the impact adoption of this ASU will have on the consolidated financial statements.

Revenue from Contracts with Customers

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations under FASB ASC Topic 606. The amendments clarify the principal versus agent guidance in determining whether to recognize revenue on a gross or net basis. The amendments are effective for public entities for annual reporting periods beginning on or after December 15, 2017, including interim periods within that reporting period. Entities have the option of using either a full retrospective or a modified retrospective approach to adopt this ASU. The Company is currently evaluating the impact adoption of this ASU will have on the consolidated financial statements.

Compensation - Stock Compensation

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation, under ASC Topic 718. The amendments clarify the guidance relating to treatment of excess tax benefits and deficiencies, acceptable forfeiture rate policies, and treatment of cash paid by an employer when directly withholding shares for tax-withholding purposes and the requirement to treat such cash flows as a financing activity. This ASU will be effective for public entities for fiscal years, and interim periods within those years,

beginning on or after December 15, 2016. Early adoption is permitted. The Company is currently evaluating the impact adoption of this ASU will have on the consolidated financial statements.

3 Changes in accumulated other comprehensive loss ("AOCL") by component



	For the three months ended June 30
(in millions of Canadian dollars, net of tax)	Foreign currency net of hedging activities			Derivatives and other			Pension and post-retirement defined benefit plans			Total
Opening balance, 2016	$	125		$	(136	)	$	(1,470	)	$	(1,481	)
Other comprehensive income (loss) before reclassifications	(1		)	(23		)	(2		)	(26		)
Amounts reclassified from accumulated other comprehensive loss	—			2			34			36
Net current-period other comprehensive (loss) income	(1		)	(21		)	32			10
Closing balance, 2016	$	124		$	(157	)	$	(1,438	)	$	(1,471	)
Opening balance, 2015	$	125		$	(103	)	$	(2,229	)	$	(2,207	)
Other comprehensive income (loss) before reclassifications	—			26			—			26
Amounts reclassified from accumulated other comprehensive loss	—			—			48			48
Net current-period other comprehensive income	—			26			48			74
Closing balance, 2015	$	125		$	(77	)	$	(2,181	)	$	(2,133	)



	For the six months ended June 30
(in millions of Canadian dollars, net of tax)	Foreign currency net of hedging activities			Derivatives and other			Pension and post-retirement defined benefit plans			Total
Opening balance, 2016	$	129		$	(102	)	$	(1,504	)	$	(1,477	)
Other comprehensive income (loss) before reclassifications	(5		)	(59		)	(2		)	(66		)
Amounts reclassified from accumulated other comprehensive loss	—			4			68			72
Net current-period other comprehensive (loss) income	(5		)	(55		)	66			6
Closing balance, 2016	$	124		$	(157	)	$	(1,438	)	$	(1,471	)
Opening balance, 2015	$	115		$	(52	)	$	(2,282	)	$	(2,219	)
Other comprehensive income (loss) before reclassifications	10			(26		)	5			(11		)
Amounts reclassified from accumulated other comprehensive loss	—			1			96			97
Net current-period other comprehensive income (loss)	10			(25		)	101			86
Closing balance, 2015	$	125		$	(77	)	$	(2,181	)	$	(2,133	)

Amounts in Pension and post-retirement defined benefit plans reclassified from AOCL



	For the three months ended June 30						For the six months ended June 30
(in millions of Canadian dollars)	2016			2015			2016			2015
Amortization of prior service costs^(a)	$	(1	)	$	(2	)	$	(3	)	$	(3	)
Recognition of net actuarial loss^(a)	48			67			97			134
Total before income tax	47			65			94			131
Income tax recovery	(13		)	(17		)	(26		)	(35		)
Net of income tax	$	34		$	48		$	68		$	96

^(a)Impacts Compensation and benefits on the Interim Consolidated Statements of Income.

4 Gain on sale of properties

Gain on sale of Arbutus Corridor

In March 2016, the Company announced the sale of CP’s Arbutus Corridor (the “Arbutus Corridor”) to the City of Vancouver for gross proceeds of $55 million. The agreement allows the Company to share in future proceeds on the eventual development and/or sale of certain parcels of the Arbutus Corridor. The Company recorded a gain on sale of $50 million before tax ($43 million after tax) from the transaction during the first quarter of 2016.

Gain on settlement of legal proceedings related to the purchase and sale of a building

In 2013, CP provided an interest free loan pursuant to a court order to a corporation owned by a court appointed trustee (“the judicial trustee”) to facilitate the acquisition of a building. The building was held in trust during the legal proceedings with regard to CP’s entitlement to an exercised purchase option of the building. As at December 31, 2014, the loan of $20 million and the purchase option with a carrying value of $8 million, were recorded as “Other assets” in the Company’s Consolidated Balance Sheets.

In the first quarter of 2015, CP reached a settlement with a third party that, following the sale of the building to an arm’s length third party, resulted in resolution of legal proceedings. CP received $59 million for the sale of the building which included repayment of the aforementioned loan to the judicial trustee and recorded a gain of $31 million ($27 million after tax).

5 Other income and charges



	For the three months ended June 30						For the six months ended June 30
(in millions of Canadian dollars)	2016			2015			2016			2015
Foreign exchange (gain) loss on long-term debt	$	(18	)	$	(10	)	$	(199	)	$	54
Other foreign exchange (gains) losses	—			—			(7		)	6
Other	9			5			16			8
Total other income and charges	$	(9	)	$	(5	)	$	(190	)	$	68

6 Income taxes



	For the three months ended June 30				For the six months ended June 30
(in millions of Canadian dollars)	2016		2015		2016		2015
Current income tax expense	$	27	$	103	$	104	$	205
Deferred income tax expense	90		74		183		106
Income tax expense	$	117	$	177	$	287	$	311

The estimated 2016 annual effective tax rate for the three and six months ended June 30, 2016, excluding the discrete item related to the foreign exchange gain on the Company’s U.S. dollar-denominated debt, is 26.93% and 27.25%, respectively, compared to the estimate of 27.50% for the same periods in 2015.

The effective tax rate for the three and six months ended June 30, 2016, including the discrete item, is 26.40% and 24.86%, respectively, compared to 31.30% and 30.51%, respectively, for the same period in 2015.

7 Earnings per share

At June 30, 2016, the number of shares outstanding was 148.4 million (June 30, 2015 - 161.3 million).

Basic earnings per share have been calculated using net income for the period divided by the weighted-average number of shares outstanding during the period.

The number of shares used in earnings per share calculations is reconciled as follows:



	For the three months ended June 30		For the six months ended June 30
(in millions)	2016	2015	2016	2015
Weighted-average basic shares outstanding	151.7	163.7	152.3	164.3
Dilutive effect of stock options	0.9	1.3	0.9	1.4
Weighted-average diluted shares outstanding	152.6	165.0	153.2	165.7

For the three and six months ended June 30, 2016, there were 440,009 options and 443,000 options, respectively, excluded from the computation of diluted earnings per share because their effects were not dilutive (three and six months ended June 30, 2015 - 175,068 and 87,976, respectively).

8 Debt

Revolving credit facility

Effective June 28, 2016, the Company extended the maturity date by one year on its existing revolving U.S. $2.0 billion revolving credit facility, which includes a U.S. $1.0 billion five-year portion and U.S. $1.0 billion one-year plus one-year term-out portion. The maturity date on the U.S. $1.0 billion one-year plus one-year term-out portion has been extended to June 28, 2018; the maturity date on the U.S. $1.0 billion five-year portion was extended to June 28, 2021.

Commercial paper program

The Company has a commercial paper program which enables it to issue commercial paper up to a maximum aggregate principal amount of U.S. $1.0 billion in the form of unsecured promissory notes. The commercial paper is backed by the U.S. $1.0 billion one-year plus one-year term-out portion of the revolving credit facility. As at June 30, 2016, the Company had total commercial paper borrowings of U.S. $135 million ($174 million), presented in “Long-term debt maturing within one year” on the Interim Consolidated Balance Sheets (December 31, 2015 - $nil). The weighted-average interest rate on these borrowings was 0.67%.

The Company presents issuances and repayments of commercial paper in the Interim Consolidated Statements of Cash Flows on a net basis, all of which have a maturity of less than 90 days.

9 Shareholders' equity

On April 20, 2016, the Company announced a new normal course issuer bid ("bid"), commencing May 2, 2016 to May 1, 2017, to purchase up to 6.91 million of its outstanding Common Shares for cancellation.

All purchases are made in accordance with the bid at prevalent market prices plus brokerage fees, or such other prices that may be permitted by the Toronto Stock Exchange, with consideration allocated to share capital up to the average carrying amount of the shares, and any excess allocated to retained earnings. The following table provides activities under the share repurchase program:



	For the three months ended June 30				For the six months ended June 30
	2016		2015		2016		2015
Number of Common Shares repurchased⁽¹⁾	5,127,800		3,058,900		5,127,800		5,233,688
Weighted-average price per share⁽²⁾	$	169.13	$	193.10	$	169.13	$	206.40
Amount of repurchase (in millions)⁽²⁾	$	867	$	590	$	867	$	1,080

⁽¹⁾Includes shares repurchased but not yet canceled at quarter end.

⁽²⁾Includes brokerage fees.

10 Financial instruments

A. Fair values of financial instruments

The Company categorizes its financial assets and liabilities measured at fair value in line with the fair value hierarchy established by GAAP that prioritizes, with respect to reliability, the inputs to valuation techniques used to measure fair value. This hierarchy consists of three broad levels. Level 1 inputs consist of quoted prices (unadjusted) in active markets for identical assets and liabilities and give the highest priority to these inputs. Level 2 and 3 inputs are based on significant other observable inputs and significant unobservable inputs, respectively, and give lower priority to these inputs.

When possible, the estimated fair value is based on quoted market prices and, if not available, estimates from third party brokers. For non-exchange traded derivatives classified in Level 2, the Company uses standard valuation techniques to calculate fair value. Primary inputs to these techniques include observable market prices (interest, foreign exchange (“FX”) and commodity) and volatility, depending on the type of derivative and nature of the underlying risk. The Company uses inputs and data used by willing market participants when valuing derivatives and considers its own credit default swap spread as well as those of its counterparties in its determination of fair value.

The carrying values of financial instruments equal or approximate their fair values with the exception of long-term debt which has a fair value of approximately $10,335 million at June 30, 2016 (December 31, 2015 - $9,750 million) and a carrying value of $8,581 million at June 30, 2016 (December 31, 2015 - $8,957 million). The estimated fair value of current and long-term borrowings has been determined based on market information where available, or by discounting future payments of interest and principal at estimated interest rates expected to be available to the Company at period end. All derivatives and long-term debt are classified as Level 2.

B. Financial risk management

Derivative financial instruments

Derivative financial instruments may be used to selectively reduce volatility associated with fluctuations in interest rates, FX rates, the price of fuel and stock-based compensation expense. Where derivatives are designated as hedging instruments, the relationship between the hedging instruments and their associated hedged items is documented, as well as the risk management objective and strategy for the use of the hedging instruments. This documentation includes linking the derivatives that are designated as fair value or cash flow hedges to specific assets or liabilities on the Interim Consolidated Balance Sheets, commitments or forecasted transactions. At the time a derivative contract is entered into, and at least quarterly thereafter, an assessment is made whether the derivative item is effective in offsetting the changes in fair value or cash flows of the hedged items. The derivative qualifies for hedge accounting treatment if it is effective in substantially mitigating the risk it was designed to address.

It is not the Company’s intent to use financial derivatives or commodity instruments for trading or speculative purposes.

FX management

The Company conducts business transactions and owns assets in both Canada and the United States. As a result, the Company is exposed to fluctuations in value of financial commitments, assets, liabilities, income or cash flows due to changes in FX rates. The Company may enter into FX risk management transactions primarily to manage fluctuations in the exchange rate between Canadian and U.S. currencies. FX exposure is primarily mitigated through natural offsets created by revenues, expenditures and balance sheet positions incurred in the same currency. Where appropriate, the Company may negotiate with customers and suppliers to reduce the net exposure.

Net investment hedge

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. The majority of the Company’s U.S. dollar denominated long-term debt has been designated as a hedge of the net investment in foreign subsidiaries. This designation has the effect of mitigating volatility on net income by offsetting long-term FX gains and losses on U.S. dollar denominated long-term debt and gains and losses on its net investment. The effective portion recognized in “Other comprehensive income” for the three and six months ended June 30, 2016 was an unrealized FX gain of $24 million and $332 million, respectively (three and six months ended June 30, 2015 - unrealized FX gain of $58 million and an unrealized FX loss of $298 million, respectively). There was no ineffectiveness during the three and six months ended June 30, 2016 and June 30, 2015.

Interest rate management

The Company is exposed to interest rate risk, which is the risk that the fair value or 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 debt.

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 issuances, the Company may enter into forward rate agreements, that are designated as cash flow hedges, to substantially lock in all or a portion of the effective future interest expense. The Company may also enter into swap agreements, designated as fair value hedges, to manage the mix of fixed and floating rate debt.

Forward starting swaps

As at December 31, 2015, the Company had forward starting floating-to-fixed interest rate swap agreements (“forward starting swaps”) totaling a notional U.S. $700 million to fix the benchmark rate on cash flows associated with highly probable forecasted issuances of long-term notes. The effective portion of changes in fair value on the forward starting swaps is recorded in “Accumulated other comprehensive loss”, net of tax, as cash flow hedges until the highly probable forecasted notes are issued. Subsequent to the notes issuance, amounts in “Accumulated other comprehensive loss” are reclassified to “Net interest expense”.

During the second quarter of 2016, the Company rolled the notional U.S. $700 million forward starting swaps. The Company de-designated the hedging relationship for U.S. $700 million of forward starting swaps. The Company did not cash settle these swaps. There was no ineffectiveness to record upon de-designation.

Concurrently the Company re-designated the forward starting swaps totaling U.S. $700 million to fix the benchmark rate on cash flows associated with a highly probable forecasted debt issuance of long-term notes.

As at June 30, 2016, the total fair value loss of $144 million (December 31, 2015 - fair value loss of $60 million) derived from the forward starting swaps was included in “Accounts payable and accrued liabilities”. Changes in fair value from the forward starting swaps for the three and six months ended June 30, 2016 was a loss of $32 million and $84 million, respectively (three and six months ended June 30, 2015 - a gain of $34 million and a loss of $39 million, respectively). The effective portion for the three and six months ended June 30, 2016 of a loss of $32 million and $82 million, respectively, (three and six months ended June 30, 2015 - a fair value gain of $34 million and a fair value loss of $37 million, respectively) is recorded in “Other comprehensive income”. For the three and six months ended June 30, 2016, the ineffective portion of $nil and $2 million loss, respectively (three and six months ended June 30, 2015 - $nil and $2 million loss, respectively) is recorded to “Net interest expense” on the Interim Consolidated Statements of Income.

For the three and six months ended June 30, 2016, a loss of $3 million and $5 million, respectively, related to previous forward starting swap hedges have been amortized to “Net interest expense” (three and six months ended June 30, 2015 - a loss of $1 million and $2 million, respectively). The Company expects that during the next 12 months $11 million of losses will be amortized to “Net interest expense”.

11 Stock-based compensation

At June 30, 2016, the Company had several stock-based compensation plans, including stock option plans, various cash settled liability plans and an employee stock savings plan. These plans resulted in an expense for the three and six months ended June 30, 2016 of $1 million and $15 million, respectively (three and six months ended June 30, 2015 - recovery of $5 million and an expense of $24 million, respectively).

Regular options

In the six months ended June 30, 2016, under CP’s stock option plans, the Company issued 402,331 regular options at the weighted average price of $165.55 per share, based on the closing price on the grant date.

Pursuant to the employee plan, these regular options may be exercised upon vesting, which is between 12 months and 48 months after the grant date, and will expire after 10 years.

Under the fair value method, the fair value of the regular options at the grant date was approximately $16 million. The weighted average fair value assumptions were approximately:



	For the six months ended June 30, 2016
Grant price	$165.55
Expected option life (years)⁽¹⁾	5.25
Risk-free interest rate⁽²⁾	1.21%
Expected stock price volatility⁽³⁾	26.58%
Expected annual dividends per share⁽⁴⁾	$1.40
Expected forfeiture rate⁽⁵⁾	2.0%
Weighted-average grant date fair value per regular options granted during the period	$38.98

⁽¹⁾ Represents the period of time that awards are expected to be outstanding. Historical data on exercise behaviour, or when available, specific expectations regarding future exercise behaviour, were used to estimate the expected life of the option.

⁽²⁾ Based on the implied yield available on zero-coupon government issues with an equivalent remaining term at the time of the grant.

⁽³⁾ Based on the historical stock price volatility of the Company’s stock over a period commensurate with the expected term of the option.

⁽⁴⁾ Determined by the current annual dividend at the time of grant. The Company does not employ different dividend yields throughout the contractual term of the option. On April 20, 2016, the Company announced an increase in its quarterly dividend to $0.50 per share, representing $2.00 on an annual basis.

⁽⁵⁾ The Company estimated forfeitures based on past experience. This rate is monitored on a periodic basis.

Performance share unit (“PSU”) plan

In the six months ended June 30, 2016, the Company issued 147,157 PSUs with a grant date fair value of approximately $24 million. These units attract dividend equivalents in the form of additional units based on the dividends paid on the Company’s Common Shares. PSUs vest and are settled in cash, or in CP Common Shares, approximately three years after the grant date, contingent upon CP’s performance ("performance factor"). The fair value of PSUs is measured periodically until settlement, using a latticed-based valuation model.

The performance period for PSUs issued in the six months ended June 30, 2016 is January 1, 2016 to December 31, 2018. The performance factors for these PSUs are Operating Ratio, Return on Invested Capital, Total Shareholder Return ("TSR") compared to the S&P/TSX 60 Index, and TSR compared to Class I railways.

The performance period for the PSUs issued in the fourth quarter of 2012 and in 2013 was January 1, 2013 to December 31, 2015. The performance factors for these PSUs were Operating Ratio, Free cash flow, TSR compared to the S&P/TSX 60 index, TSR compared to Class I railways. All performance factors met the 200% payout thresholds, in effect resulting in a target payout of 200% on 300,095 total outstanding awards as at December 31, 2015. A payout of $79 million on 217,179 outstanding awards occurred on December 31, 2015 and was calculated using the Company's average share price using the last 30 trading days preceding December 31, 2015. In the first quarter of 2016, final payouts occurred on the total outstanding awards, including dividends reinvested, totaling $31 million on 83,563 outstanding awards.

Deferred share unit (“DSU”) plan

In the six months ended June 30, 2016, the Company granted 25,050 DSUs with a grant date fair value of approximately $4 million. DSUs vest over various periods of up to 48 months and are only redeemable for a specified period after employment is terminated. An expense to income for DSUs is recognized over the vesting period for both the initial subscription price and the change in value between reporting periods.

12 Pension and other benefits

In the three and six months ended June 30, 2016, the Company made contributions of $14 million and $34 million, respectively(three and six months ended June 30, 2015 - $20 million and $41 million, respectively), to its defined benefit pension plans. The elements of net periodic benefit cost for defined benefit pension plans and other benefits recognized in the three and six months ended June 30, 2016 included the following components:



	For the three months ended June 30
	Pensions						Other benefits
(in millions of Canadian dollars)	2016			2015			2016		2015
Current service cost (benefits earned by employees in the period)	$	26		$	32		$	3	$	3
Interest cost on benefit obligation	116			116			5		5
Expected return on fund assets	(211		)	(212		)	—		—
Recognized net actuarial loss	47			66			1		1
Amortization of prior service costs	(1		)	(2		)	—		—
Net periodic benefit (recovery) cost	$	(23	)	$	—		$	9	$	9



	For the six months ended June 30
	Pensions						Other benefits
(in millions of Canadian dollars)	2016			2015			2016		2015
Current service cost (benefits earned by employees in the period)	$	53		$	64		$	6	$	6
Interest cost on benefit obligation	233			231			10		10
Expected return on fund assets	(423		)	(413		)	—		—
Recognized net actuarial loss	95			132			2		2
Amortization of prior service costs	(3		)	(3		)	—		—
Net periodic benefit (recovery) cost	$	(45	)	$	11		$	18	$	18

13 Contingencies

In the normal course of its operations, the Company becomes involved in various legal actions, including claims relating to injuries and damage to property. The Company maintains provisions it considers to be adequate for such actions. While the final outcome with respect to actions outstanding or pending at June 30, 2016 cannot be predicted with certainty, it is the opinion of management that their resolution will not have a material adverse effect on the Company’s financial position or results of operations.

Legal proceedings related to Lac-Mégantic rail accident

On July 6, 2013, a train carrying crude oil operated by Montreal Maine and Atlantic Railway (“MMA”) and/or its subsidiary, Montreal Maine and Atlantic Canada Co. (“MMAC”, and collectively with MMA, the “MMA Group”) derailed and exploded in Lac-Mégantic, Quebec on a section of railway line owned by the MMA Group. The previous day CP had interchanged the train to the MMA Group, and after that interchange MMA Group exercised exclusive control over the train.

Following this incident, the Minister of Sustainable Development, Environment, Wildlife and Parks of Quebec issued an order directing certain named parties to recover the contaminants and to clean up and decontaminate the derailment site. CP was added as a named party on August 14, 2013 (the “Amended Cleanup Order”). CP has sought an administrative appeal of the Amended Cleanup Order to the Administrative Tribunal of Quebec. The proceedings before the Administrative tribunal have been stayed until September 2016. Directly related to this matter, the Province of Quebec filed a lawsuit against CP before the Quebec Superior Court on July 6, 2015 in which it claims $409 million for the damages sustained by the province as a result of the expenses incurred following the derailment, including costs incurred for the work carried out pursuant to the Amended Cleanup Order. The province alleges that CP had custody or control of the contaminants that were discharged in Lac-Mégantic on July 6, 2013, and that CP was otherwise negligent and therefore is solidarily (joint and severally) liable with the other third parties responsible for the accident. The province’s lawsuit has been stayed until September 12, 2016. Also directly related to the this matter, the Quebec Minister of Sustainable Development and Environment has served a Notice of Claim on July 5, 2016 claiming nearly $95 million in compensation from CP for having to carry out the cleanup measures set out in the Amended Cleanup Order, alleging that CP had refused or neglected to carry out same. These proceedings are duplicative, in whole or in part.

A class action lawsuit has also been filed in the Superior Court of Quebec on behalf of a class of persons and entities residing in, owning or leasing property in, operating a business in or physically present in Lac-Mégantic (the “Class Action”). The lawsuit seeks

damages caused by the derailment including for wrongful deaths, personal injuries, and property damages. CP was added as a defendant on August 16, 2013. On May 8, 2015, the Superior Court of Quebec authorized the institution of the Class Action as against CP and as against the shipper, Western Petroleum, and the shipper’s parent, World Fuel Services (collectively, the “World Fuel Defendants”). The World Fuel Defendants have since settled. No timetable governing the conduct of this lawsuit has been ordered by the Superior Court of Quebec.

On July 4, 2016, CP was served with subrogated insurance claims brought by 8 insurers for a claimed amount of approximately $16 million. On July 11, 2016, CP was served with subrogated insurance claims brought by an additional 2 insurers for a claimed amount of approximately $3 million. These insurers have not identified in their respective lawsuit the identity of the parties to whose claims they are subrogated and thus it is difficult to determine the extent to which these claims overlap with other claims and the extent to which their claim would be satisfied after their proof of claim has been reviewed and distribution is received from the Plans of arrangements referred to below.

In the wake of the derailment and ensuing litigation, MMAC filed for bankruptcy in Canada (the “Canadian Proceeding”) and MMA filed for bankruptcy in the United States (the “U.S. Proceeding”). Plans of arrangement have been approved both in the Canadian Proceeding and the U.S. Proceeding (the “Plans”). These Plans provide for the distribution of a fund of approximately $440 million amongst those who claimed loss or damage as a result of the derailment and will release those parties which contributed to the fund from any further liability. The Plans also provide for broadly worded third-party releases and injunctions that prevent actions against settling parties. CP has not participated in the settlement and hence will not benefit from any third-party releases or injunctions. In addition, both Plans contain judgment reduction provisions. Pursuant to these provisions, in the event of a judgment against CP in a case arising from the Lac-Mégantic derailment, CP will receive a credit for the greater of (i) the settlement monies received by the plaintiff(s) for the claim, or (ii) the amount which, but for the third-party non-debtor injunctions, CP would have been entitled to obtain from third parties other than MMA and MMAC through contribution or indemnification. CP may also have rights to judgment reduction, as part of the contribution/indemnification credit, for the fault of MMA and/or MMAC. The provisions of the Plans also provide for a potential re-allocation of of the MMA Group’s liability among plaintiffs and CP, the only non-settling party.

An Adversary Proceeding filed by the MMA U.S. bankruptcy trustee against CP, Irving Oil and the World Fuel Defendants accuses CP of failing to ensure that World Fuel Defendants or Irving Oil properly classified the oil lading and of not refusing to ship the oil in DOT-111 tank cars. The trustee has since settled with the World Fuel Defendants and Irving Oil and now maintains that CP misfeasance is based upon the railroad’s failure to abide by a Canadian regulation in North Dakota that supposedly would have caused the originating railroad to refuse to carry the crude oil based upon reason to suspect inaccurate classification. In response to CP’s motion to withdraw the Adversary Proceedings from the bankruptcy reference, the trustee maintained that Canadian law rather than U.S. law controlled, and the Article III court found that if the federal regulations governed, the case was not complex enough to warrant withdrawal. In bankruptcy court CP moved to dismiss for want of personal jurisdiction, but that motion, which was heard on August 18, 2015, has been denied. Motions to dismiss on procedural grounds are pending. The trustee recently withdrew objection to the trial of the Adversary Proceedings to a jury before the Article III district court.

There are also a class action and a mass action instituted Texas and wrongful death and personal injury actions instituted in Illinois and Maine. All the various lawsuits have been removed to federal court and have since been consolidated in Maine. These actions generally charge CP with negligence in the misclassification and mis-packaging (that is the use of inappropriate DOT-111 tank cars). Motions to dismiss have been filed and heard regarding jurisdiction and venue. Decisions on CP’s motions and other parties’ cross-motions are pending.

CP has received two damage to cargo notices of claims from the shipper of the oil on the derailed train, Western Petroleum. Western Petroleum submitted U.S. and Canadian notices of claims for the same damages and, under the Carmack Amendment (49 U.S.C. Section 11706), seeks to recover for all injuries associated with, and indemnification for the derailment. Both jurisdictions permit a shipper to recover the value of damaged lading against any carrier in the delivery chain, subject to limitations in the carrier’s tariffs. CP’s tariffs significantly restrict shipper damage claim rights. Western Petroleum is part of the World Fuel Services group, and those entities settled with the trustee.

On April 12, 2016, Trustee (the “WD Trustee”) of a wrongful death trust (the “WD Trust”), as defined and established under the confirmed Plan, filed an action against CP in federal court in North Dakota seeking to establish Carmack Amendment liability under 49 U.S.C. Section 11706. The WD Trustee asserts the WD Trust was assigned Carmack claim rights by the bankruptcy estate representative. The parties that settled Lac Megantic derailment liability in connection with MMA’s confirmed Plan supposedly gave the bankruptcy estate representative the right to assign Carmack claims. The WD Trustee seeks to recover losses associated with the lost lading (approximately $6 million), as well as settlement amounts the consignor (i.e, the shipper, World Fuel Entities) and the consignee (Irving Oil) paid to the MMA bankruptcy estate to settle all Lac Megantic derailment claims, which are alleged to be $110 million and $60 million respectively. The WD Trustee maintains that Carmack liability extends beyond lading losses to cover all derailment related damages incurred by the World Fuel Services group or Irving Oil. CP disputes this interpretation of damages to lading law and maintains that CP’s tariffs, if applicable, would preclude such a result.

At this early stage of the legal proceedings, any potential liability and the quantum of potential loss cannot be determined. Nevertheless, CP denies liability for the MMA derailment and intends to vigorously defend itself in the proceedings described above and in any proceeding that may be commenced in the future.

Legal proceedings initiated by Canadian National Railway Company

On August 13, 2015, Canadian National Railway Company (“CN”) issued a statement of claim against the Company and an employee. The statement of claim was amended on January 7, 2016 to include an additional employee and an officer of the Company. The principal allegations against the Company are that the Company obtained and benefited from certain confidential CN customer data. CN is seeking damages but has not yet provided evidence to substantiate its damages claim. The Company plans to defend this claim and the amount of loss, if any, to the Company as a result of the claim cannot be reasonably estimated.

Environmental liabilities

Environmental remediation accruals, recorded on an undiscounted basis unless a reliable, determinable estimate as to an amount and timing of costs can be established, cover site-specific remediation programs.

The accruals for environmental remediation represent CP’s best estimate of its probable future obligation and include both asserted and unasserted claims, without reduction for anticipated recoveries from third parties. Although the recorded accruals include CP’s best estimate of all probable costs, CP’s total environmental remediation costs cannot be predicted with certainty. Accruals for environmental remediation may change from time to time as new information about previously untested sites becomes known, and as environmental laws and regulations evolve and advances are made in environmental remediation technology. The accruals may also vary as the courts decide legal proceedings against outside parties responsible for contamination. These potential charges, which cannot be quantified at this time, are not expected to be material to CP’s financial position, but may materially affect income in the particular period in which a charge is recognized. Costs related to existing, but as yet unknown, or future contamination will be accrued in the period in which they become probable and reasonably estimable.

The expense included in “Purchased services and other” for the three and six months ended June 30, 2016 was $1 million and $2 million, respectively (three and six months ended June 30, 2015 - $3 million and $6 million, respectively). Provisions for environmental remediation costs are recorded in “Other long-term liabilities”, except for the current portion which is recorded in “Accounts payable and accrued liabilities”. The total amount provided at June 30, 2016 was $86 million (December 31, 2015 - $93 million). Payments are expected to be made over 10 years through 2026.

14 Condensed consolidating financial information

Canadian Pacific Railway Company, a 100%-owned subsidiary of Canadian Pacific Railway Limited (“CPRL”), is the issuer of certain debt securities, which are fully and unconditionally guaranteed by CPRL. The following tables present condensed consolidating financial information (“CCFI”) in accordance with Rule 3-10(c) of Regulation S-X.

Investments in subsidiaries are accounted for under the equity method when presenting the CCFI.

The tables include all adjustments necessary to reconcile the CCFI on a consolidated basis to CPRL’s consolidated financial statements for the periods presented.

Interim Condensed Consolidating Statements of Income

For the three months ended June 30, 2016



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Revenues
Freight	$	—		$	1,007		$	399		$	—		$	1,406
Non-freight	—			33			98			(87		)	44
Total revenues	—			1,040			497			(87		)	1,450
Operating expenses
Compensation and benefits	—			181			102			1			284
Fuel	—			103			28			—			131
Materials	—			27			8			3			38
Equipment rents	—			53			(9		)	—			44
Depreciation and amortization	—			107			54			—			161
Purchased services and other	—			193			139			(91		)	241
Total operating expenses	—			664			322			(87		)	899
Operating income	—			376			175			—			551
Less:
Other income and charges	(4		)	(12		)	7			—			(9		)
Net interest expense (income)	10			111			(6		)	—			115
(Loss) income before income tax expense and equity in net earnings of subsidiaries	(6		)	277			174			—			445
Less: Income tax (recovery) expense	(6		)	70			53			—			117
Add: Equity in net earnings of subsidiaries	328			121			—			(449		)	—
Net income	$	328		$	328		$	121		$	(449	)	$	328

Interim Condensed Consolidating Statements of Income

For the three months ended June 30, 2015



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Revenues
Freight	$	—		$	1,131		$	479		$	—		$	1,610
Non-freight	—			34			90			(83		)	41
Total revenues	—			1,165			569			(83		)	1,651
Operating expenses
Compensation and benefits	—			198			110			—			308
Fuel	—			134			51			—			185
Materials	—			35			10			—			45
Equipment rents	—			52			(6		)	—			46
Depreciation and amortization	—			102			43			—			145
Purchased services and other	—			192			167			(83		)	276
Total operating expenses	—			713			375			(83		)	1,005
Operating income	—			452			194			—			646
Less:
Other income and charges	(3		)	(8		)	6			—			(5		)
Net interest expense (income)	—			98			(14		)	—			84
Income before income tax expense and equity in net earnings of subsidiaries	3			362			202			—			567
Less: Income tax expense	2			93			82			—			177
Add: Equity in net earnings of subsidiaries	389			120			—			(509		)	—
Net income	$	390		$	389		$	120		$	(509	)	$	390

Interim Condensed Consolidating Statements of Income

For the six months ended June 30, 2016



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Revenues
Freight	$	—		$	2,104		$	850		$	—		$	2,954
Non-freight	—			66			194			(173		)	87
Total revenues	—			2,170			1,044			(173		)	3,041
Operating expenses
Compensation and benefits	—			382			228			3			613
Fuel	—			206			50			—			256
Materials	—			65			18			11			94
Equipment rents	—			107			(18		)	—			89
Depreciation and amortization	—			214			109			—			323
Purchased services and other	—			329			320			(187		)	462
Total operating expenses	—			1,303			707			(173		)	1,837
Operating income	—			867			337			—			1,204
Less:
Other income and charges	(73		)	(150		)	33			—			(190		)
Net interest expense (income)	9			242			(12		)	—			239
Income before income tax expense and equity in net earnings of subsidiaries	64			775			316			—			1,155
Less: Income tax expense	3			181			103			—			287
Add: Equity in net earnings of subsidiaries	807			213			—			(1,020		)	—
Net income	$	868		$	807		$	213		$	(1,020	)	$	868

Interim Condensed Consolidating Statements of Income

For the six months ended June 30, 2015



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)		Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Revenues
Freight	$	—		$	2,250	$	990		$	—		$	3,240
Non-freight	—			63		179			(166		)	76
Total revenues	—			2,313		1,169			(166		)	3,316
Operating expenses
Compensation and benefits	—			460		226			—			686
Fuel	—			295		85			—			380
Materials	—			78		19			—			97
Equipment rents	—			88		—			—			88
Depreciation and amortization	—			204		87			—			291
Purchased services and other	—			334		348			(166		)	516
Total operating expenses	—			1,459		765			(166		)	2,058
Operating income	—			854		404			—			1,258
Less:
Other income and charges	15			78		(25		)	—			68
Net interest expense (income)	—			194		(25		)	—			169
(Loss) income before income tax expense and equity in net earnings of subsidiaries	(15		)	582		454			—			1,021
Less: Income tax (recovery) expense	(2		)	160		153			—			311
Add: Equity in net earnings of subsidiaries	723			301		—			(1,024		)	—
Net income	$	710		$	723	$	301		$	(1,024	)	$	710

Interim Condensed Consolidating Statements of Comprehensive Income

For the three months ended June 30, 2016



(in millions of Canadian dollars)	CPRL (Parent Guarantor)		CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Net income	$	328	$	328		$	121		$	(449	)	$	328
Net gain (loss) in foreign currency translation adjustments, net of hedging activities	—		20			(17		)	—			3
Change in derivatives designated as cash flow hedges	—		(29		)	—			—			(29		)
Change in pension and post-retirement defined benefit plans	—		41			2			—			43
Other comprehensive income (loss) before income taxes	—		32			(15		)	—			17
Income tax expense on above items	—		(5		)	(2		)	—			(7		)
Equity accounted investments	10		(17		)	—			7			—
Other comprehensive income (loss)	10		10			(17		)	7			10
Comprehensive income	$	338	$	338		$	104		$	(442	)	$	338

Interim Condensed Consolidating Statements of Comprehensive Income

For the three months ended June 30, 2015



(in millions of Canadian dollars)	CPRL (Parent Guarantor)		CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Net income	$	390	$	389		$	120		$	(509	)	$	390
Net gain (loss) in foreign currency translation adjustments, net of hedging activities	—		59			(52		)	—			7
Change in derivatives designated as cash flow hedges	—		36			—			—			36
Change in pension and post-retirement defined benefit plans	—		64			2			—			66
Other comprehensive income (loss) before income taxes	—		159			(50		)	—			109
Income tax (expense) recovery on above items	—		(55		)	20			—			(35		)
Equity accounted investments	74		(30		)	—			(44		)	—
Other comprehensive income (loss)	74		74			(30		)	(44		)	74
Comprehensive income	$	464	$	463		$	90		$	(553	)	$	464

Interim Condensed Consolidating Statements of Comprehensive Income

For the six months ended June 30, 2016



(in millions of Canadian dollars)	CPRL (Parent Guarantor)		CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Net income	$	868	$	807		$	213		$	(1,020	)	$	868
Net gain (loss) in foreign currency translation adjustments, net of hedging activities	—		330			(290		)	—			40
Change in derivatives designated as cash flow hedges	—		(76		)	—			—			(76		)
Change in pension and post-retirement defined benefit plans	—		86			4			—			90
Other comprehensive income (loss) before income taxes	—		340			(286		)	—			54
Income tax expense on above items	—		(46		)	(2		)	—			(48		)
Equity accounted investments	6		(288		)	—			282			—
Other comprehensive income (loss)	6		6			(288		)	282			6
Comprehensive income (loss)	$	874	$	813		$	(75	)	$	(738	)	$	874

Interim Condensed Consolidating Statements of Comprehensive Income

For the six months ended June 30, 2015



(in millions of Canadian dollars)	CPRL (Parent Guarantor)		CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Net income	$	710	$	723		$	301		$	(1,024	)	$	710
Net (loss) gain in foreign currency translation adjustments, net of hedging activities	—		(298		)	268			—			(30		)
Change in derivatives designated as cash flow hedges	—		(33		)	—			—			(33		)
Change in pension and post-retirement defined benefit plans	—		134			4			—			138
Other comprehensive (loss) income before income taxes	—		(197		)	272			—			75
Income tax recovery (expense) on above items	—		13			(2		)	—			11
Equity accounted investments	86		270			—			(356		)	—
Other comprehensive income	86		86			270			(356		)	86
Comprehensive income	$	796	$	809		$	571		$	(1,380	)	$	796

Interim Condensed Consolidating Balance Sheets

As at June 30, 2016



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries		Consolidating Adjustments and Eliminations			CPRL Consolidated
Assets
Current assets
Cash and cash equivalents	$	—		$	47		$	45	$	—		$	92
Accounts receivable, net	—			406			171		—			577
Accounts receivable, inter-company	78			80			159		(317		)	—
Short-term advances to affiliates	—			470			3,758		(4,228		)	—
Materials and supplies	—			164			31		—			195
Other current assets	—			49			10		—			59
	78			1,216			4,174		(4,545		)	923
Long-term advances to affiliates	501			—			88		(589		)	—
Investments	—			26			129		—			155
Investments in subsidiaries	8,217			9,753			—		(17,970		)	—
Properties	—			8,560			7,600		—			16,160
Goodwill and intangible assets	—			—			195		—			195
Pension asset	—			1,565			—		—			1,565
Other assets	—			50			20		—			70
Deferred income taxes	14			—			—		(14		)	—
Total assets	$	8,810		$	21,170		$	12,206	$	(23,118	)	$	19,068
Liabilities and shareholders’ equity
Current liabilities
Accounts payable and accrued liabilities	$	156		$	804		$	287	$	—		$	1,247
Accounts payable, inter-company	3			235			79		(317		)	—
Short-term advances from affiliates	3,960			247			21		(4,228		)	—
Long-term debt maturing within one year	—			198			—		—			198
	4,119			1,484			387		(4,545		)	1,445
Pension and other benefit liabilities	—			675			76		—			751
Long-term advances from affiliates	—			589			—		(589		)	—
Other long-term liabilities	—			159			127		—			286
Long-term debt	—			8,323			60		—			8,383
Deferred income taxes	—			1,723			1,803		(14		)	3,512
Total liabilities	4,119			12,953			2,453		(5,148		)	14,377
Shareholders’ equity
Share capital	2,000			1,037			5,808		(6,845		)	2,000
Additional paid-in capital	49			1,630			418		(2,048		)	49
Accumulated other comprehensive (loss) income	(1,471		)	(1,471		)	548		923			(1,471		)
Retained earnings	4,113			7,021			2,979		(10,000		)	4,113
	4,691			8,217			9,753		(17,970		)	4,691
Total liabilities and shareholders’ equity	$	8,810		$	21,170		$	12,206	$	(23,118	)	$	19,068

Condensed Consolidating Balance Sheets

As at December 31, 2015



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries		Consolidating Adjustments and Eliminations			CPRL Consolidated
Assets
Current assets
Cash and cash equivalents	$	—		$	502		$	148	$	—		$	650
Accounts receivable, net	—			452			193		—			645
Accounts receivable, inter-company	59			105			265		(429		)	—
Short-term advances to affiliates	—			75			3,483		(3,558		)	—
Materials and supplies	—			154			34		—			188
Other current assets	—			37			17		—			54
	59			1,325			4,140		(3,987		)	1,537
Long-term advances to affiliates	501			207			376		(1,084		)	—
Investments	—			22			130		—			152
Investments in subsidiaries	7,518			9,832			—		(17,350		)	—
Properties	—			8,481			7,792		—			16,273
Goodwill and intangible assets	—			3			208		—			211
Pension asset	—			1,401			—		—			1,401
Other assets	—			55			8		—			63
Deferred income taxes	25			—			—		(25		)	—
Total assets	$	8,103		$	21,326		$	12,654	$	(22,446	)	$	19,637
Liabilities and shareholders’ equity
Current liabilities
Accounts payable and accrued liabilities	$	54		$	1,122		$	241	$	—		$	1,417
Accounts payable, inter-company	—			325			104		(429		)	—
Short-term advances from affiliates	3,253			230			75		(3,558		)	—
Long-term debt maturing within one year	—			24			6		—			30
	3,307			1,701			426		(3,987		)	1,447
Pension and other benefit liabilities	—			676			82		—			758
Long-term advances from affiliates	—			877			207		(1,084		)	—
Other long-term liabilities	—			186			132		—			318
Long-term debt	—			8,863			64		—			8,927
Deferred income taxes	—			1,505			1,911		(25		)	3,391
Total liabilities	3,307			13,808			2,822		(5,096		)	14,841
Shareholders’ equity
Share capital	2,058			1,037			5,465		(6,502		)	2,058
Additional paid-in capital	43			1,568			613		(2,181		)	43
Accumulated other comprehensive (loss) income	(1,477		)	(1,477		)	840		637			(1,477		)
Retained earnings	4,172			6,390			2,914		(9,304		)	4,172
	4,796			7,518			9,832		(17,350		)	4,796
Total liabilities and shareholders’ equity	$	8,103		$	21,326		$	12,654	$	(22,446	)	$	19,637

Interim Condensed Consolidating Statements of Cash Flows

For the three months ended June 30, 2016



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Cash provided by operating activities	$	75		$	374		$	219		$	(156	)	$	512
Investing activities
Additions to properties	—			(206		)	(124		)	—			(330		)
Proceeds from sale of properties and other assets	—			11			—			—			11
Advances to affiliates	—			(482		)	(285		)	767			—
Repayment of advances to affiliates	—			208			—			(208		)	—
Capital contributions to affiliates	—			(348		)	—			348			—
Other	—			—			(2		)	—			(2		)
Cash used in investing activities	—			(817		)	(411		)	907			(321		)
Financing activities
Dividends paid	(53		)	(53		)	(103		)	156			(53		)
Issuance of share capital	—			—			348			(348		)	—
Issuance of CP Common Shares	4			—			—			—			4
Purchase of CP Common Shares	(788		)	—			—			—			(788		)
Repayment of long-term debt, excluding commercial paper	—			(7		)	—			—			(7		)
Net issuance of commercial paper	—			176			—			—			176
Advances from affiliates	762			—			5			(767		)	—
Repayment of advances from affiliates	—			—			(208		)	208			—
Other financing activities	—			(1		)	—			—			(1		)
Cash (used in) provided by financing activities	(75		)	115			42			(751		)	(669		)
Effect of foreign currency fluctuations on U.S. dollar-denominated cash and cash equivalents	—			(1		)	—			—			(1		)
Cash position
Decrease in cash and cash equivalents	—			(329		)	(150		)	—			(479		)
Cash and cash equivalents at beginning of period	—			376			195			—			571
Cash and cash equivalents at end of period	$	—		$	47		$	45		$	—		$	92

Interim Condensed Consolidating Statements of Cash Flows

For the three months ended June 30, 2015



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Cash provided by operating activities	$	59		$	525		$	143		$	(142	)	$	585
Investing activities
Additions to properties	—			(210		)	(145		)	—			(355		)
Proceeds from sale of properties and other assets	—			8			—			—			8
Advances to affiliates	(500		)	(633		)	(500		)	1,633			—
Capital contributions to affiliates	—			(500		)	—			500			—
Other	—			(6		)	(1		)	—			(7		)
Cash used in investing activities	(500		)	(1,341		)	(646		)	2,133			(354		)
Financing activities
Dividends paid	(57		)	(57		)	(85		)	142			(57		)
Issuance of share capital	—			—			500			(500		)	—
Issuance of CP Common Shares	11			—			—			—			11
Purchase of CP Common Shares	(543		)	—			—			—			(543		)
Repayment of long-term debt, excluding commercial paper	—			(9		)	—			—			(9		)
Net issuance of commercial paper	—			369			—			—			369
Advances from affiliates	1,030			500			103			(1,633		)	—
Cash provided by (used in) financing activities	441			803			518			(1,991		)	(229		)
Effect of foreign currency fluctuations on U.S. dollar-denominated cash and cash equivalents	—			(1		)	—			—			(1		)
Cash position
(Decrease) increase in cash and cash equivalents	—			(14		)	15			—			1
Cash and cash equivalents at beginning of period	—			153			31			—			184
Cash and cash equivalents at end of period	$	—		$	139		$	46		$	—		$	185

Interim Condensed Consolidating Statements of Cash Flows

For the six months ended June 30, 2016



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Cash provided by operating activities	$	98		$	425		$	417		$	(210	)	$	730
Investing activities
Additions to properties	—			(338		)	(270		)	—			(608		)
Proceeds from sale of properties and other assets	—			68			3			—			71
Advances to affiliates	—			(517		)	(285		)	802			—
Repayment of advances to affiliates	—			208			—			(208		)	—
Capital contributions to affiliates	—			(357		)	—			357			—
Repurchase of share capital from affiliates	—			6			—			(6		)	—
Other	—			—			(2		)	—			(2		)
Cash used in investing activities	—			(930		)	(554		)	945			(539		)
Financing activities
Dividends paid	(107		)	(107		)	(103		)	210			(107		)
Return of share capital to affiliates	—			—			(6		)	6			—
Issuance of share capital	—			—			357			(357		)	—
Issuance of CP Common Shares	9			—			—			—			9
Purchase of CP Common Shares	(788		)	—			—			—			(788		)
Repayment of long-term debt, excluding commercial paper	—			(11		)	(7		)	—			(18		)
Net issuance of commercial paper	—			176			—			—			176
Advances from affiliates	788			—			14			(802		)	—
Repayment of advances from affiliates	—			—			(208		)	208			—
Other financing activities	—			(3		)	—			—			(3		)
Cash (used in) provided by financing activities	(98		)	55			47			(735		)	(731		)
Effect of foreign currency fluctuations on U.S. dollar-denominated cash and cash equivalents	—			(5		)	(13		)	—			(18		)
Cash position
Decrease in cash and cash equivalents	—			(455		)	(103		)	—			(558		)
Cash and cash equivalents at beginning of period	—			502			148			—			650
Cash and cash equivalents at end of period	$	—		$	47		$	45		$	—		$	92

Interim Condensed Consolidating Statements of Cash Flows

For the six months ended June 30, 2015



(in millions of Canadian dollars)	CPRL (Parent Guarantor)			CPRC (Subsidiary Issuer)			Non-Guarantor Subsidiaries			Consolidating Adjustments and Eliminations			CPRL Consolidated
Cash provided by operating activities	$	115		$	824		$	416		$	(215	)	$	1,140
Investing activities
Additions to properties	—			(303		)	(315		)	—			(618		)
Proceeds from sale of properties and other assets	—			59			1			—			60
Advances to affiliates	(500		)	(936		)	(729		)	2,165			—
Capital contributions to affiliates	—			(617		)	—			617			—
Other	—			14			(1		)	—			13
Cash used in investing activities	(500		)	(1,783		)	(1,044		)	2,782			(545		)
Financing activities
Dividends paid	(115		)	(115		)	(100		)	215			(115		)
Issuance of share capital	—			—			617			(617		)	—
Issuance of CP Common Shares	27			—			—			—			27
Purchase of CP Common Shares	(1,072		)	—			—			—			(1,072		)
Issuance of long-term debt, excluding commercial paper	—			810			—			—			810
Repayment of long-term debt, excluding commercial paper	—			(24		)	(43		)	—			(67		)
Net repayment of commercial paper	—			(224		)	—			—			(224		)
Advances from affiliates	1,545			500			120			(2,165		)	—
Cash provided by (used in) financing activities	385			947			594			(2,567		)	(641		)
Effect of foreign currency fluctuations on U.S. dollar-denominated cash and cash equivalents	—			(1		)	6			—			5
Cash position
Decrease in cash and cash equivalents	—			(13		)	(28		)	—			(41		)
Cash and cash equivalents at beginning of period	—			152			74			—			226
Cash and cash equivalents at end of period	$	—		$	139		$	46		$	—		$	185

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the Interim Consolidated Financial Statements and related notes for the three and six months ended June 30, 2016 in Item 1. Financial Statements, and other information in this report. Except where otherwise indicated, all financial information reflected herein is expressed in Canadian dollars.

For purposes of this report, all references herein to “CP,” “the Company,” “we,” “our” and “us” refer to CPRL, CPRL and its subsidiaries, CPRL and one or more of its subsidiaries, or one or more of CPRL's subsidiaries, as the context may require.

Available Information

CP makes available on or through its website www.cpr.ca free of charge, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such reports are filed with or furnished to the Securities and Exchange Commission (“SEC”). Also, filings made pursuant to Section 16 of the Securities Exchange Act of 1934 (“Exchange Act”) with the SEC by our executive officers, directors and other reporting persons with respect to the Company's Common Shares are made available free of charge, through our website. Our website also contains charters for each of the committees of our Board of Directors, our corporate governance guidelines and our Code of Business Ethics. SEC filings made by CP are also accessible through the SEC’s website at www.sec.gov. The information on our website is not part of this quarterly report on Form 10-Q.

The Company has included the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) certifications regarding the Company's public disclosure required by Section 302 of the Sarbanes-Oxley Act of 2002 as an Exhibit to this report.

Executive Summary

Second Quarter of 2016 Results

Financial Performance - In the second quarter of 2016, CP reported Diluted earnings per share ("EPS") of $2.15 and Adjusted diluted EPS of $2.05, down 9% and 16% respectively, due in large part to a 12% drop in revenues. Revenue challenges in the quarter included lower-than-anticipated bulk volumes, devastating wildfires in northern Alberta and a strengthening Canadian dollar. The Company took action to adapt its cost structure as quickly as possible, but it was not able to fully mitigate the precipitous volume decline; as a result, second quarter operating ratio was up 110 basis points to 62.0%. Adjusted diluted EPS is defined and reconciled in Non-GAAP Measures and discussed further in Results of Operations of this Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Operating performance - CP’s continued focus on asset utilization and network investments resulted in improvements to a number of CP’s key operating metrics. The following metrics are discussed further in Performance Indicators of this Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.


•	Average train speed increased by 11% to 24.1 miles per hour;


•	Average train weight increased by 3% to 8,540 tons;


•	Average train length increased by 4% to 7,275 feet; and


•	Average terminal dwell time improved by 3% to 6.5 hours.

Recent Developments


•	On April 20, 2016, CP announced a new normal course issuer bid ("NCIB") to repurchase, for cancellation, up to 6.91 million of its Common Shares, which received Toronto Stock Exchange ("TSX") approval on April 28, 2016. As at June 30, 2016, CP had repurchased 5.13 million shares under the NCIB.


•	Also on April 20, 2016, CP announced an increase to the Company's quarterly dividend to $0.50 per share from $0.35 per share.


•	On April 20, 2016, the Company announced that Mr. Robert Johnson was appointed Executive Vice-President, Operations.


•	On July 19, 2016, Dr. Anthony R. Melman resigned as a member of the Company’s Board of Directors.

Performance Indicators

The following table lists the key measures of the Company’s operating performance:



	For the three months ended June 30				For the six months ended June 30
	2016	2015⁽¹⁾	% Change		2016	2015⁽¹⁾	% Change
Operations Performance
Gross ton-miles (“GTMs”) (millions)	57,460	66,598	(14	)	119,432	132,682	(10	)
Train miles (thousands)	7,291	8,705	(16	)	15,155	17,340	(13	)
Average train weight – excluding local traffic (tons)	8,540	8,253	3		8,518	8,218	4
Average train length – excluding local traffic (feet)	7,275	6,989	4		7,188	6,881	4
Average terminal dwell (hours)	6.5	6.7	(3	)	6.7	8.6	(22	)
Average train speed (mph)	24.1	21.7	11		23.7	20.5	16
Fuel efficiency (U.S. gallons of locomotive fuel consumed / 1,000 GTMs)	0.979	0.993	(1	)	0.989	1.020	(3	)
Total employees (average)	12,341	14,195	(13	)	12,387	14,280	(13	)
Total employees (end of period)	11,988	14,071	(15	)	11,988	14,071	(15	)
Workforce (end of period)	12,033	14,128	(15	)	12,033	14,128	(15	)
Safety Indicators
FRA personal injuries per 200,000 employee-hours	1.30	1.44	(10	)	1.37	1.74	(21	)
FRA train accidents per million train miles	0.50	1.35	(63	)	0.72	1.41	(49	)

⁽¹⁾ Certain figures have been revised to conform with current presentation or have been updated to reflect new information.

Operations Performance

Three months ended June 30, 2016 compared to the three months ended June 30, 2015

•

GTMs are defined as the movement of total train weight over a distance of one mile. Total train weight comprises the weight of the freight cars, their contents, and any inactive locomotives. An increase in GTMs indicates additional workload. GTMs for the second quarter of 2016 were 57,460 million, a decrease of 14% compared with 66,598 million in the same period of 2015. This decrease was primarily due to a drop in volumes in the Crude, Potash and Canadian Grain lines of business.


•	Train miles decreased by 16% for the second quarter of 2016 compared to the same period of 2015. This reflects the impact of lower volumes and continuous improvements in operating efficiency from longer, heavier trains.

•

The average train weight is defined as the average gross weight of CP trains, both loaded and empty. This excludes trains in short-haul service, work trains used to move CP’s track equipment and materials, and the haulage of other railways’ trains on CP’s network. Average train weight increased by 3% for the second quarter of 2016 compared to the same period of 2015. This increase was due to improvements made in operating plan efficiency.


•	The average train length is defined as the sum of each car length multiplied by the distance travelled, divided by train miles. Local trains are excluded from this measure. Average train length increased by 4% for the second quarter of 2016 compared to the same period of 2015. Similar to benefits to the average train weight, this was also due to improvements made in operating plan efficiency.

•

The average terminal dwell is defined as the average time a freight car resides within terminal boundaries expressed in hours. The timing starts with a train arriving in the terminal, a customer releasing the car to the Company, or a car arriving at interchange from another railway. The timing ends when the train leaves, a customer receives the car from CP, or the freight car is transferred to another railway. Freight cars are excluded if they are being stored at the terminal or used in track repairs. Average terminal dwell decreased by 3% in the second quarter of 2016 compared to the same period of 2015. This favourable decrease was primarily due to continued improvements in yard operating performance.

•

The average train speed is defined as a measure of the line-haul movement from origin to destination including terminal dwell hours. It is calculated by dividing the total train miles travelled by the total train hours operated. This calculation does not include delay time related to customer or foreign railways and excludes the time and distance travelled by: i) trains used in or around CP’s yards; ii) passenger trains; and iii) trains used for repairing track. Average train speed increased by 11% in the second quarter of 2016 compared to the same period of 2015. This favourable increase was primarily due to improved train design and operating plan execution.


•	Fuel efficiency improved by 1% in the second quarter of 2016 compared to the same period of 2015. Improvements in fuel efficiency were a result of increased locomotive productivity, operational fluidity and execution of the Company's fuel conservation strategies.

Six months ended June 30, 2016 compared to the six months ended June 30, 2015


•	GTMs for the first six months of 2016 were 119,432 million, a decrease of 10% compared with 132,682 million in the same period of 2015. This decrease was primarily due to a drop in volumes in the Crude, Export Potash and Coal lines of business.


•	Train miles decreased by 13% for the first six months of 2016 compared to the same period of 2015. This reflects the impact of lower volumes and continuous improvements in operating efficiency from longer, heavier trains.


•	Average train weight increased by 4% for the first six months of 2016 compared to the same period of 2015. This increase was due to improvements made in operating plan efficiency.


•	Average train length increased by 4% for the first six months of 2016 from the same period of 2015. This favourable increase was also due to improvements made in operating plan efficiency.


•	Average terminal dwell decreased by 22% in the first six months of 2016 compared to the same period of 2015. This favourable decrease was primarily due to continued improvements in yard operating performance.


•	Average train speed increased by 16% in the first six months of 2016 compared to the same period of 2015. This favourable increase was primarily due to improved train design and operating plan execution.


•	Fuel efficiency improved by 3% in the first six months of 2016 compared to the same period of 2015. Improvements in fuel efficiency were a result of increased locomotive productivity, operational fluidity and execution of the Company's fuel conservation strategies.

Total Employees and Workforce

An employee is defined by the Company as an individual currently engaged in full-time or part-time employment with CP. Employees could be engaged in a full-time, part-time or seasonal capacity. The average number of total employees decreased by 13% in the second quarter and first six months of 2016, compared to the same periods of 2015. This reduction was primarily due to lower volumes, improved operational efficiency and natural attrition.

The Company's workforce is defined as total employees, plus contractors and consultants. The Company's reduction of total workforce during 2016 has been consistent with the reduction in the number of total employees. As at June 30, 2016, the total workforce was 12,033, a decrease of 866 or 7%, when compared to 12,899 as at December 31, 2015. As at June 30, 2016, the total workforce decreased by 2,095 compared to June 30, 2015.

Safety Indicators

Safety is a key priority and core strategy for CP’s management, employees and Board of Directors. The Company’s two main safety indicators – personal injuries and train accidents – follow strict U.S. Federal Railroad Administration (“FRA”) reporting guidelines.

The FRA personal injury rate per 200,000 employee-hours is the number of personal injuries multiplied by 200,000 and divided by total employee hours. Personal injuries are defined as injuries that require employees to lose time away from work, modify their normal duties or obtain medical treatment beyond minor first aid. FRA employee-hours are the total hours worked, excluding vacation and sick time, by all employees, excluding contractors. The FRA personal injury rate per 200,000 employee-hours for CP was 1.30 in the second quarter of 2016, down from 1.44 in the same period of 2015. For the first six months of 2016, the FRA personal injury rate per 200,000 employee-hours for CP was 1.37, down from 1.74 in the same period of 2015. The FRA train accidents per million train miles was 0.50 in the second quarter of 2016, a decrease from 1.35 in the same period of 2015. For the first six months of 2016, FRA train accidents per million train miles was 0.72, a decrease from 1.41 in the same period of 2015.

Financial Highlights



	For the three months ended June 30						For the six months ended June 30
(in millions, except per share data, percentages and ratios)	2016			2015			2016			2015
Financial Performance
Revenues	$	1,450		$	1,651		$	3,041		$	3,316
Operating income	551			646			1,204			1,258
Net income	328			390			868			710
Adjusted income⁽¹⁾	312			404			696			779
Basic earnings per share	2.16			2.38			5.70			4.32
Diluted earnings per share	2.15			2.36			5.67			4.28
Adjusted diluted earnings per share⁽¹⁾	2.05			2.45			4.55			4.70
Dividends declared per share	0.50			0.35			0.85			0.70
Cash provided by operating activities	512			585			730			1,140
Free cash⁽¹⁾	137			173			66			485
Operating ratio⁽²⁾	62.0		%	60.9		%	60.4		%	62.1		%
	As at June 30, 2016						As at December 31, 2015
Financial Position
Total assets	$	19,068					$	19,637
Total long-term obligations⁽³⁾	8,460						9,012
Shareholders’ equity	4,691						4,796
	For the twelve months ended June 30
	2016						2015
Financial Ratios
Return on invested capital ("ROIC")⁽¹⁾	14.7					%	15.0					%
Adjusted ROIC⁽¹⁾	14.9					%	15.7					%


⁽¹⁾	These measures have no standardized meanings prescribed by accounting principles generally accepted in the United States of America ("GAAP") and, therefore, may not be comparable to similar measures presented by other companies. These measures are defined and reconciled in Non-GAAP Measures of this Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.


⁽²⁾	Operating ratio is defined as operating expenses divided by revenues, further discussed in Results of Operations of this Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

⁽³⁾Excludes deferred income taxes: $3,512 million and $3,391 million; and other non-financial deferred liabilities of $960 and $991 million at June 30, 2016 and December 31, 2015, respectively.

Results of Operations

Three months ended June 30, 2016 compared to the three months ended June 30, 2015

Income

Operating income was $551 million in the second quarter of 2016, a decrease of $95 million, or 15%, from $646 million in the same period of 2015. This decrease was primarily due to lower volumes. The northern Alberta wildfires contributed to an estimated $29M decline in Operating income with a significant decrease in volumes, in addition to negatively impacting fuel input costs without triggering a commensurate offsetting impact to benchmark fuel recovery prices. Operating income for the second quarter of 2016 was also negatively impacted by the timing effect of the customary lag in adjustments to fuel surcharge program in periods of significant fuel price changes.

This decrease in operating income was partially offset by:


•	efficiencies generated from improved operating performance and asset utilization;


•	higher defined benefit pension plan income of $22 million; and


•	the favourable impact of the change in foreign exchange (“FX”) of $17 million.

Net income was $328 million in the second quarter of 2016, a decrease of $62 million, or 16%, from $390 million in the same period of 2015. This decrease was primarily due to lower Operating income and higher interest expense on new debt issued in 2015. This was partially offset by a decrease in Income tax expense due to lower taxable earnings along with a lower effective tax rate compared to 2015 and the favourable impact of FX translation on U.S. dollar-denominated debt.

Adjusted income, defined and reconciled in Non-GAAP Measures of this Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, was $312 million in the second quarter of 2016, a decrease of $92 million, or 23%, from $404 million in the same period of 2015. This decrease was due to the same factors discussed above for the decrease in Net income, except that Adjusted income excluded the favourable impact of FX translation on U.S. dollar-denominated debt.

Diluted Earnings per Share

Diluted earnings per share was $2.15 in the second quarter of 2016, a decrease of $0.21, or 9% from $2.36 in the same period of 2015. Adjusted diluted EPS, defined and reconciled in Non-GAAP Measures of this Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, was $2.05 in the second quarter of 2016, a decrease of $0.40, or 16%, from $2.45 in the same period of 2015. These decreases were primarily due to lower Net income and Adjusted income, respectively, partially offset by lower average outstanding shares due to the Company’s share repurchase program.

Operating Ratio

The Operating ratio provides the percentage of revenues used to operate the railway. A lower percentage normally indicates higher efficiency in the operation of the railway. The Company’s Operating ratio was 62.0% in the second quarter of 2016, 110 basis point higher from 60.9% in the same period of 2015. This increase was primarily due to lower volumes, partially offset by efficiencies generated from improved operating performance and asset utilization, and higher defined benefit pension plan income.

Return on Invested Capital (ROIC)

ROIC is a measure of how productively the Company uses its long-term capital investments, representing critical indicators of good operating and investment decisions made by management, and is an important performance criteria in determining certain elements of the Company's long-term incentive plan. ROIC was 14.7% for the twelve months ended June 30, 2016, a 30 basis point decrease compared to 15.0% for the twelve months ended June 30, 2015. Adjusted ROIC was 14.9% for the twelve months ended June 30, 2016, an 80 basis point decrease compared to 15.7% for the twelve months ended June 30, 2015. These decreases were largely due to lower volumes experienced during 2016. ROIC and Adjusted ROIC are defined and reconciled in Non-GAAP Measures of this Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Six months ended June 30, 2016 compared to the six months ended June 30, 2015

Income

Operating income was $1,204 million in the first six months of 2016, a decrease of $54 million, or 4%, from $1,258 million in the same period of 2015. This decrease was primarily due to lower volumes and higher wage and benefit inflation of 3%. The northern Alberta wildfires contributed to the significant decrease in volumes, in addition to negatively impacting fuel input costs without a commensurate impact to benchmark fuel recovery prices. This decrease was partially offset by:


•	efficiencies generated from improved operating performance and asset utilization;


•	the favourable impact of the change in FX of $71 million;


•	higher defined benefit pension plan income of $55 million; and


•	lower casualty expense of $12 million (excluding an unfavourable FX impact of $2 million).

Net income was $868 million in the first six months of 2016, an increase of $158 million, or 22%, from $710 million in the same period of 2015. This increase was primarily due to the favourable impact of FX translation on U.S. dollar-denominated debt and a decrease in Income tax expense due to lower taxable earnings along with lower effective tax rate compared to 2015. This increase was partially offset by lower operating income and higher interest expense on new debt issued in 2015.

Adjusted income, defined and reconciled in Non-GAAP Measures of this Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, was $696 million in the first six months of 2016, a decrease of $83 million, or 11%, from $779 million in the same period of 2015. This decrease was due to the factors discussed above for Operating income and Net income, excluding the favourable impact of FX translation on U.S. dollar-denominated debt.

Diluted Earnings per Share

Diluted earnings per share was $5.67 in the first six months of 2016, an increase of $1.39, or 32% from $4.28 in the same period of 2015. This increase was primarily due to higher Net income and lower average outstanding shares due to the Company’s share repurchase program.

Adjusted diluted EPS was $4.55 in the first six months of 2016, a decrease of $0.15, or 3%, from $4.70 in the same period of 2015. This decrease was primarily due to lower Adjusted income, which excludes the gain on FX translation on U.S. dollar-denominated debt, partially offset by lower average outstanding shares due to the Company’s share repurchase program.

Operating Ratio

The Company’s Operating ratio was 60.4% in the first six months of 2016, a 170 basis point improvement from 62.1% in the same period of 2015. This improvement was primarily due to efficiencies generated from improved operating performance and asset utilization, and higher defined benefit pension plan income. This improvement was partially offset by lower volumes.

Impact of FX on Earnings

Fluctuations in FX affect the Company’s results because U.S. dollar-denominated revenues and expenses are translated into Canadian dollars. U.S. dollar-denominated revenues and expenses increase (decrease) when the Canadian dollar weakens (strengthens) in relation to the U.S. dollar. The following tables indicate the average and periodic exchange rates when converting U.S. dollars to Canadian dollars for the three and six months ended June 30, 2016 and the comparative periods in 2015.



Canadian to U.S. dollar
Average exchange rates	2016		2015
For the three months ended – June 30	$	1.29	$	1.23
For the six months ended – June 30	$	1.34	$	1.23



Canadian to U.S. dollar
Exchange rates	2016		2015
Beginning of year – January 1	$	1.38	$	1.16
Beginning of quarter – April 1	$	1.30	$	1.27
End of quarter – June 30	$	1.29	$	1.25

In the second quarter of 2016, the impact of a stronger U.S. dollar resulted in an increase in total revenues of $40 million, an increase in total operating expenses of $23 million and an increase in interest expense of $3 million from the same period in 2015.

Similarly, in the first six months of 2016, the impact of a stronger U.S. dollar resulted in an increase in total revenues of $148 million, an increase in total operating expenses of $77 million and an increase in interest expense of $10 million from the same period in 2015.

The impact of FX on total revenues and operating expenses is discussed further in Item 3. Quantitative and Qualitative Disclosures About Market Risk, Foreign Exchange Risk.

Impact of Fuel Price on Earnings

Fluctuations in fuel prices affect the Company’s results because fuel expense constitutes a significant portion of CP's operating costs. As fuel prices fluctuate, there will be a timing impact on earnings. The following table indicates the average fuel price for the three and six months ended June 30, 2016 and the comparative periods in 2015.



Average Fuel Price
(U.S. dollars per U.S. gallon)	2016		2015
For the three months ended – June 30	$	1.82	$	2.30
For the six months ended – June 30	$	1.64	$	2.31

In the second quarter of 2016, the impact of lower fuel prices resulted in a decrease in total revenues of $53 million and a decrease in total operating expenses of $33 million from the same period in 2015. The results of the second quarter of 2016 were negatively impacted by the timing effect of the customary lag in adjustments to fuel recovery prices in periods of significant fuel price changes. A portion of the adverse impact, however, is not attributable to timing, as the wildfires in northern Alberta negatively impacted fuel input costs by an estimated $9 million without triggering a commensurate offsetting impact to benchmark fuel recovery prices.

Similarly, in the first six months of 2016, the impact of lower fuel prices resulted in a decrease in total revenues of $135 million and a decrease in total operating expenses of $100 million from the same period in 2015.

Impact of Share Price on Earnings

Fluctuations in the Common Share price affect the Company's operating expenses because share-based liabilities are fair valued. The following tables indicate the opening and closing CP Common Share Price on the TSX and the New York Stock Exchange for the three and six months ended June 30, 2016 and the comparative periods in 2015.



CP Common Share Price
Toronto Stock Exchange (in Canadian dollars)	2016			2015
Opening Common Share Price, as at January 1	$	176.73		$	223.75
Ending Common Share Price, as at March 31	$	172.55		$	231.90
Ending Common Share Price, as at June 30	$	166.33		$	200.02
Change in Common Share Price for the three months ended June 30	$	(6.22	)	$	(31.88	)
Change in Common Share Price for the six months ended June 30	$	(10.40	)	$	(23.73	)



CP Common Share Price
New York Stock Exchange (in U.S. dollars)	2016			2015
Opening Common Share Price, as at January 1	$	127.60		$	192.69
Ending Common Share Price, as at March 31	$	132.69		$	182.70
Ending Common Share Price, as at June 30	$	128.79		$	160.23
Change in Common Share Price for the three months ended June 30	$	(3.90	)	$	(22.47	)
Change in Common Share Price for the six months ended June 30	$	1.19		$	(32.46	)

In the second quarter of 2016, the impact of the change in Common Share price resulted in a decrease in stock-based compensation expense of $3 million compared to a decrease of $25 million in the same period in 2015.

In the first six months of 2016, the impact of the change in Common Share price resulted in a decrease in stock-based compensation expense of $5 million compared to a decrease of $18 million in the same period in 2015.

The impact of share price on stock-based compensation is discussed further in Item 3. Quantitative and Qualitative Disclosures About Market Risk, Share Price Impact on Stock-Based Compensation.

Operating Revenues

The Company’s revenues are primarily derived from transporting freight. Non-freight revenue is generated from leasing of certain assets, contracts with passenger service operators, switching fees, transload activities and logistical management services. Changes in freight volumes generally contribute to corresponding changes in freight revenues and certain variable expenses, such as fuel, equipment rents and crew costs.



					2016 vs. 2015
For the three months ended June 30	2016		2015		% Change		Total Change			FX Impact⁽²⁾
Freight revenues (in millions)⁽¹⁾	$	1,406	$	1,610	(13	)	$	(204	)	$	40
Non-freight revenues (in millions)	44		41		7		3			—
Total revenues (in millions)	$	1,450	$	1,651	(12	)	$	(201	)	$	40
Carloads (in thousands)	614		668		(8	)	(54		)	N/A
Revenue ton-miles (in millions)	32,091		36,281		(12	)	(4,190		)	N/A
Freight revenue per carload (dollars)	$	2,291	$	2,409	(5	)	$	(118	)
Freight revenue per revenue ton-miles (cents)	4.38		4.44		(1	)	(0.06		)

⁽¹⁾Freight revenues include fuel surcharge revenues of $20 million in 2016, and $73 million in 2015.

⁽²⁾FX impact is a component of the Total Change.

•

Freight revenues were $1,406 million in the second quarter of 2016, a decrease of $204 million, or 13% from $1,610 million in the same period of 2015. This decrease was primarily due to an overall decline in volumes. In particular, there was an estimated $20 million decline in revenues as a direct result of the northern Alberta wildfires. Additionally, revenues from other freight activities declined by $30 million primarily due to reductions in haulage and ancillary revenues. Lower fuel prices also reduced fuel surcharge revenue by $53 million. The favourable impact of the change in FX of $40 million partially offset these decreases.

•

RTMs are defined as the movement of one revenue-producing ton of freight over a distance of one mile. RTMs measure the relative weight and distance of rail freight moved by the Company. RTMs for the second quarter of 2016 were 32,091 million, a decrease of 12% compared with 36,281 million in the same period of 2015. This decrease was primarily due to a drop in volumes in the Crude, Potash and Canadian Grain lines of business. Increased shipments in the Forest Products line of business partially offset the decrease in RTMs.


•	Non-freight revenues were $44 million in the second quarter of 2016, an increase of $3 million, or 7% from $41 million in the same period of 2015. This increase was primarily due to higher revenues from logistics services and transload revenues following the acquisition of Steelcare Inc. in the third quarter of 2015.



					2016 vs. 2015
For the six months ended June 30	2016		2015		% Change		Total Change			FX Impact⁽²⁾
Freight revenues (in millions)⁽¹⁾	$	2,954	$	3,240	(9	)	$	(286	)	$	147
Non-freight revenues (in millions)	87		76		14		11			1
Total revenues (in millions)	$	3,041	$	3,316	(8	)	$	(275	)	$	148
Carloads (in thousands)	1,228		1,310		(6	)	(82		)	N/A
Revenue ton-miles (in millions)	66,426		72,344		(8	)	(5,918		)	N/A
Freight revenue per carload (dollars)	$	2,405	$	2,473	(3	)	$	(68	)
Freight revenue per revenue ton-miles (cents)	4.45		4.48		(1	)	(0.03		)

⁽¹⁾Freight revenues include fuel surcharge revenues of $42 million in 2016, and $177 million in 2015.

⁽²⁾FX impact is a component of the Total Change.


•	Freight revenues were $2,954 million in the first six months of 2016, a decrease of $286 million, or 9% from $3,240 million in the same period of 2015. This decrease was primarily due to an overall decline in volumes and the impact of lower fuel prices on fuel surcharge revenue of $135 million. The favourable impact of the change in FX of $147 million partially offset this decrease.


•	RTMs for the first six months of 2016 were 66,426 million, a decrease of 8% compared with 72,344 million in the same period of 2015. This decrease was primarily due to a drop in volumes in the Crude, Potash, Coal and Metals, Minerals & Consumer Products lines of business.


•	Non-freight revenues were $87 million in the first six months of 2016, an increase of $11 million, or 14% from $76 million in the same period of 2015. This increase was primarily due to higher transload revenues following the acquisition of Steelcare Inc. in the third quarter of 2015, and from logistics services and leasing revenues.

Lines of Business

Canadian Grain



					2016 vs. 2015
For the three months ended June 30	2016		2015		% Change		Total Change			FX Impact⁽¹⁾
Freight revenues (in millions)	$	201	$	255	(21	)	$	(54	)	$	3
Carloads (in thousands)	64		72		(11	)	(8		)	N/A
Revenue ton-miles (in millions)	5,727		6,622		(14	)	(895		)	N/A
Freight revenue per carload (dollars)	$	3,153	$	3,546	(11	)	$	(393	)
Freight revenue per revenue ton-mile (cents)	3.51		3.86		(9	)	(0.35		)