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Executives

Kathleen Murphy - Director, Investor Relations and Corporate Reporting

Calin Rovinescu - President and Chief Executive Officer

Mike Rousseau - Chief Financial Officer

Ben Smith - Chief Commercial Officer

Analysts

Kevin Chiang - CIBC

Walter Spracklin - RBC

David Newman - Cormark Securities

Glenn Engel - Bank of America

Chris Murray - AltaCorp Capital

Tim James - TD Securities

Helane Becker - Cowen

David Tyerman - Canaccord Genuity

Air Canada (OTCPK:AIDIF) Q2 2014 Earnings Conference Call August 7, 2014 9:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the Air Canada’s Second Quarter 2014 Conference Call. I would now like to turn the meeting over to Ms. Kathleen Murphy, Director, IR and Corporate Reporting. Please go ahead, Ms. Murphy.

Kathleen Murphy - Director, Investor Relations and Corporate Reporting

Thank you, Valerie, and good morning, ladies and gentlemen. And thank you for joining us on Air Canada’s second quarter conference call. With me this morning are Calin Rovinescu, our President and Chief Executive Officer; Mike Rousseau, our Chief Financial Officer; and Ben Smith, our Chief Commercial Officer.

On today’s call, Calin will review our second quarter 2014 financial and operating performance and provide a status on the progress of our strategic initiatives. Mike will then review our second quarter financial performance in more detail and turn it back to Calin before taking questions from the analyst community. We will start by taking questions from equity analysts followed by questions from fixed income analysts and lenders.

As usual, I would like to point out that certain statements made on this call, such as those relating to our outlook on capacity, cost and strategic plans, are forward-looking within the meaning of applicable securities laws. This call also includes references to non-GAAP measures. Please refer to our second quarter press release and MD&A for important cautionary statements relating to forward-looking information and for reconciliations of non-GAAP measures to GAAP results.

I will now turn it over to Calin Rovinescu, Air Canada’s President and CEO. Calin?

Calin Rovinescu - President and Chief Executive Officer

Thank you, Kathy and good morning, everyone and thanks for joining us on our second quarter earnings call. In our press release this morning, we reported record second quarter adjusted net income of $139 million, $24 million or 21% above last year. I am pleased with this result, which was achieved despite a $131 million or 16% increase in fuel expense. International results highlight the significant and incremental progress being achieved to our various value enhancing strategies. Our investments and those of our industry partners to provide a seamless connection transfer at Canada’s major hubs are starting to show results. The performance of Air Canada rouge continues to exceed expectations from a profitability perspective and allows us to now compete more effectively in leisure markets on a more cost effective basis.

Total revenues were up 8% in the quarter, while passenger revenues increased 7.5%. We saw strong year-over-year revenue growth in all of our five markets, as well as a marked increase in the number of international and U.S. originating customers connecting to our major Canadian hubs. I am also pleased at today’s update on our progress with respect to the very specific performance targets on CASM, return on invested capital and liquidity that we introduced at our Investor Day in June of last year as key to our roadmap to sustain profitability.

Firstly, on CASM, CASM reduction is well on track to achieving the 15% CASM reduction target we committed in June 2013. Despite the weaker Canadian dollar in the second quarter, adjusted CASM declined 4.7% year-over-year. This is quite encouraging particularly given that we are still in the early stages of benefiting from some of the cost savings resulting from new aircraft and reconfigurations, as well as from other initiatives of which I will give three examples. One, we are focused on the implementation of our fleet initiatives and we expect to see increased benefits from these as they are fully implemented. We continue to invest in new aircraft. We took the liberty of the first two of our 37 Boeing Dreamliner 787 aircraft in the quarter and a third was delivered in July.

The renewal of our international fleet with this next generation aircraft is providing us with significant improvements in fuel efficiency, lowering maintenance cost and allowing us to offer customers superior comfort and amenities. We expect 29% lower unit costs when compared to the 767s they will replace and we look forward to realizing the full benefits of our international fleet renewal as new aircraft enters the mainline market.

Secondly, following our receipt of an exemption on the Canadian Aviation Regulations allowing for a ratio of one flight attendant for every 50 passenger seats, we are implementing this change on our narrow-body mainline and rouge aircraft which when fully transitioned is expected to result in annual cost savings of $28 million. Three, on May 1, we outsourced our London operations to a third-party provider which is expected to result in net savings of $10 million on a run-rate basis.

Moving to revenue, from a revenue perspective, the implementation of our new revenue management system is progressing smoothly and we look forward to realizing the benefits of this initiative in 2015, which we have estimated will add an excess of $100 million per year to our top line. As of June 30, our return on invested capital or ROIC was 11% and already within our goal of achieving a sustainable ROIC of 10% to 13% by 2015. Finally, at the end of June, unrestricted liquidity was over $2.95 billion, well above our minimum liquidity level of $1.7 billion and the highest in Air Canada’s history.

A strong brand and award-winning service are other key components of the roadmap to sustain profitability and so I’m especially pleased that once again, international air travelers surveyed by the independent UK-based firm, Skytrax, selected Air Canada as Best Airline in North America for the fifth year in a row. This honor recognizes the continued professionalism of our employees and their commitment to taking care of our customers, as well as their investing and providing in award-winning product.

And with that, I will turn the call over to Mike, for more detailed discussions of our financial performance in the quarter.

Mike Rousseau - Chief Financial Officer

Thank you, Calin and good morning to everyone. And, again, thank you for joining us today. Before we get started on our review of second quarter, I’d like to point out a few important items. First, our focus is on promoting our premium class cabin to optimize revenues, while expanding our international and leisure operations as these markets are key building blocks to making Air Canada more profitable. Other carriers maybe pursuing different strategies such as constraining growth or focusing on regional growth, unit revenue and unit cost comparisons versus other carriers while Air Canada goes through a transformation will not be directly applicable. Margin improvement always has been and will continue to be the focus as we execute on our value enhancing strategies.

Second, as we enter the space in international growth, with additional 777s, 787s and continuing rouge growth, our capacity will be impacted by the size, and the increased seat density of the aircraft, as well as the distance flown by the aircraft. Consequently, we have added the number of seats dispatched to our list of operating stats and have revised the calculation of average stage length to effectively include aircraft seat density in the calculation. And that definition is available in our second quarter MD&A. This new average stage length measure will better explain movements in PRASM and CASM, especially as we execute on our international and major business expansion strategies.

Now, moving on to the quarter, Calin mentioned earlier on an adjusted basis, we reported net income of $139 million in the second quarter, 21% higher than last year’s quarter and the best in Air Canada’s history. On a GAAP basis, net income amounted to $223 million compared to a net loss of $23 million in the same quarter of ‘13, an increase of $246 million. Operating income of $245 million and EBITDAR of $456 million were both $71 million above last year’s levels. We recorded favorable tax related provision adjustments of $41 million in the second quarter, which are included in our EBITDAR and GAAP operating and net income results but are excluded from our adjusted results.

Second quarter passenger revenues increased $208 million or 7.5% on an 8.5% growth in capacity. Traffic increased 9.9% year-over-year, while overall yield decreased 2.1%. The yield decline reflected in large part a 2.5% longer average stage length, which alone had the effect of reducing system yield by 1.5 percentage points in the quarter. Passenger load factor was up 1.1 percentage points to a record 84.2%. Second quarter, PRASM declined 0.8% driven large in part by the 2.5% increase in average stage length. System premium passenger revenues were up $40 million or 2.4% on yield growth of 3.6%. On domestic capacity growth of 3.6%, passenger revenues increased $24 million or 2.2% on traffic growth of 5.3%.

Although this is an improvement from the first quarter, PRASM remained under some pressure in the quarter, down 1.8% from last year. Yield declined 3.3% reflecting increased industry capacity and competitive pricing activities on regional routes in Quebec and Ontario and on routes within Western Canada. In addition, consistent with our international growth priority, we also experienced higher proportional growth of international connecting traffic.

On the U.S. transborder market, revenues increased $61 million or 11.5% in the quarter on capacity growth of 12.2%. PRASM was flat to last year as the passenger load factor improvement of 2.8 percentage points was offset by yield decline of 3.3%. Again, 2.6 percentage points of which can be attributed to a longer average stage length. The long-haul growth was led by lower cost Air Canada rouge flying allowing us to effectively compete on lower yielding price-sensitive leisure routes. In addition, the higher proportion of capacity was more effectively utilized to support our international growth strategy. Offsetting the yield declines were improvements in the premium cabin as a result of pricing changes, a significant increase in higher yielding short-haul traffic as well as a favorable currency impact.

Revenues on Atlantic routes increased $75 million or 12.3% on capacity growth of 16.2%. A passenger decline of 3.3% was due to a 2% decrease in yield and a 1.1 percentage decline in passenger load factor. The lower yield reflected both a higher proportion of longer haul flying and a greater proportion of lower yield in traffic. This was driven by an increase in seasonal flying by Air Canada mainline to longer haul markets, additional Atlantic services being served with lower cost Boeing 77 high-density aircraft, which have a larger economy cabin as well as the new and increased lower cost leisure flying by Air Canada rouge, which offers a premium rouge product, but has no international business class cabin. A favorable currency impact probably offset the yield decline.

In the Pacific on capacity growth of 1.8%, revenues increased $23 million or 5.7%, an improvement in passenger load factor of 1.9 percentage points and yield growth of 1.8% resulted in a 4.1% PRASM improvement. On routes to the Caribbean, Mexico and South America, which we collectively hold the other markets, revenues increased $25 million or 17.7% from the same quarter in 2013. Overall, PRASM improved 7% with growth recorded on all major services.

Looking forward, the demand environment is in line with expectations and we continue to focus on capitalizing on revenue growth as we continue to execute on our strategies. We continue to be extremely pleased with rouge’s performance as well as that of our higher density Boeing 777 aircraft, both of which are meeting or exceeding our expectations from a profitability standpoint. These initiatives are allowing us to access traditionally lower yielding traffic while improving profitability. Again, as a reminder, our key objective is to improve operating margins as our value-enhancing strategies mature.

And now turning over to capacity guidance, for the third quarter of 2014, we expect system capacity to increase to 9% to 10% from the third quarter of last year. Seats dispatched will increase only 6.5% to 7.5%. For the full year 2014, we continue to expect system ASM capacity growth of 7% to 8% when compared to the full year 2013 with the majority of the growth being added at a much lower unit cost than we have seen historically. Like Q3, seats dispatched for the full year will grow at a slower pace, an increase of 5% to 6% versus 2013. And for Canada, we now expect an annual ASM capacity increase of 4% to 5% when compared to the full year of ‘13.

Second quarter cargo revenues increased $7 million or 6.6% on traffic growth of 11.3%. Overcapacity in use remained an issue in the quarter putting downward pressure on yield. We expect the current yield trend to continue throughout the third quarter. Other revenues increased $33 million or 18% year-over-year with more than two-thirds of the growth attributable to the higher ground package revenues at Air Canada vacations.

And now turning over to the operating costs, operating expenses increased $177 million or 6% in the second quarter of 2013. $110 million of which was due to the impact of the weaker Canadian dollar on U.S. denominated operating expenses. Partly offsetting this increase was the impact of a favorable tax related provision adjustments of $41 million. These adjustments are reflected in the other operating expenses. With a solid cost performance in the quarter, even with the unfavorable currency impact which underscores the progress made thus far and executing on our initiatives, all of which are meeting or exceeding our expectations.

Adjusted CASM decreased 4.7% versus the same quarter in ‘13, better than the high-end of the guidance range we provided on May 15. The better than projected CASM performance was largely due to ASM capacity coming in at the top end of the range and an approximate $0.01 improvement in the U.S. Canadian exchange rate. On a unit cost basis, all major expense categories decreased versus prior year’s quarter with the exception of fuel, sales and distribution costs and ground package costs at Air Canada vacations.

Moving to fuel, we reported an increase of $131 million or 16%, of which $64 million was due to the weaker Canadian dollar and $53 million of which was due to higher volume of fuel leaders consumed, reflecting in large part the 8.5% growth in capacity. Our economic fuel price per liter came in $91.6, up 6.9% from the same quarter in ‘13. We continue to hedge to manage fuel price volatility in the short-term. This is done through the use of derivatives, primarily call options. At June 30, we have locked in 40% of our planned fuel requirements for the remainder of ‘14 at an average WTI equivalent cap price of $106 per barrel.

Employee benefit expense decreased $30 million or 21% year-over-year, reflecting actual gains on disability plans driven by lower claims than expected, a reduction in our foreign pension plan liabilities, as well as the favorable impact of higher discount rates on defined benefit pension plans. For the full year 2014, we now expect employee benefit expense to decrease $35 million from the full year 2013, an improvement of $10 million from the prior guidance, which for the most part, reflects the actual gains recorded in the first six months.

Aircraft maintenance expense increased $12 million or 7% year-over-year due to the weaker Canadian dollar, which increased the expense by $12 million and the impact of having fewer lease extensions in the second quarter of 2014 when compared to the second quarter of 2013. Aircraft lease extensions have the effect of reducing the current value of end-of-lease maintenance obligations thus lowering aircraft maintenance expenses. These increases were partly offset by the impact of a lower volume components and airframe maintenance activity.

For the full year 2014, we expect aircraft maintenance expense to increase $65 million from the full year 2013. The improvement of $25 million from our last guidance is driven by aircraft lease extensions in the second half of the year, as well as expected benefits from several cost reduction initiatives. Additional detail on our operating results for the second quarter can be found in our financial statements and MD&A, which were posted on our website and filed on SEDAR this morning.

Turning to our unit cost guidance, based on current forecast, we expect third quarter adjusted CASM to decrease by 3.5% to 4.5%. For the full year, taking into account our strong Q2 CASM performance, we now expect adjusted CASM to decrease by 3.2% to 4.2% when compared to the same periods in ‘13. Our ASM CASM projections reflect Air Canada’s assumptions for the Canadian GEP will grow 2% to 2.5% in ‘14. Air Canada also assumes that the Canadian dollar will trade on average at $1.08 per U.S. dollar for the third quarter and $1.09 per U.S. dollar for the full year 2014 as the price of jet fuel will average $0.90 per liter for the third quarter and $0.91 per liter for the full year 2014.

Moving over to the balance sheet and liquidity, as Calin mentioned earlier, we ended the quarter with unrestricted liquidity of $2.95 billion, well above our minimum target level of $1.7 billion, the highest in our history. Advanced ticket sales of $2.3 billion are the highest in the airline’s history as well, which is consistent with our healthy booking trends that we noted earlier and further indication that the capacity we are adding is being really absorbed by the demand we are experiencing in the markets we serve.

Free cash flow declined $183 million in the second quarter and $296 million in the first six months. This decline in free cash flow was largely due to higher capital expenditures in the quarter reflecting an addition of two Boeing 787 aircraft as well as the addition of the last of the five Boeing high density 777 aircraft and our continued investment in our mainline fleet. Adjusted net debt of $4.3 billion decreased $42 million from December 31. At June 30, our adjusted net debt to 12-month trailing EBITDAR ratio was 2.9 and well within our objective of maintaining the ratio below 3.5.

Moving on to CapEx in our fleet, we are forecasting capital expend of about $648 million for the remainder of 2014 with spending primarily related to the acquisition of our remaining 787 Dreamliners and pre-delivery payments for Boeing 737 MAX aircraft. With respect to our fleet, we have made some minor changes to our plans for mainline and rouge and a revised fleet table can be found in our second quarter MD&A. More specifically, we now plan to have rouge end the year with 28 aircraft, 8 67s and 20 Airbus 319s rather than the 33 we had previously anticipated. The change is driven by Air Canada’s network requirements to ensure that we have sufficient capacity in our mainline fleet through our Embraer 190 transition process, which is planned to start in the fall of 2015.

From a mainline perspective, we have previously planned to have 20 Embraer aircraft exit the fleet in 2015. And we now anticipate 10 of these aircrafts to exit the fleet in 2015 and the remaining 10 to do so in the first half of 2016. Again, this is to ensure that we have sufficient capacity in our extremely busy third quarter.

Looking at the currency, as of June 30, 2014, we had outstanding foreign currency auctions and swap agreements settling in 2014 and ‘15 to purchase at maturity US$3 billion at a weighted average rate of maturity of $1.0727 per U.S. dollar. Based on the notional amount of currency derivatives outstanding at the time, approximately 89% of the net U.S. cash outflow was hedged for the remainder of this year and approximately 47% for 2015.

With respect to pension plans, actuarial valuations have now been finalized and the aggregate solvency surplus in the airlines’ domestic registered pension plans as of January 1, 2014 has been confirmed $89 million.

And with that, I will turn it back to Calin.

Calin Rovinescu - President and Chief Executive Officer

Thank you, Mike. So, I would like to add a few thoughts to Mike’s opening comments. Along with our strong brand and our award winning services, including our premium product offering, we view the expansion of our international leisure businesses as a key strategy in our roadmap to sustain profitability.

In the quarter, we added to our extensive and expanding global network with new service to Milan and to Air Canada rouge, Lisbon, Nice and Manchester. We also increased frequencies or added capacity on other major European routes from Montreal, Toronto, Calgary and Vancouver. Altogether, we are offering 21 destinations across the Atlantic Ocean in Europe and the Middle East. We have two new destinations, Rio de Janeiro and Panama City being added to the network later this year and numerous bilateral air agreements with other countries provide significant future opportunities to add to the network.

We have a strong competitive advantage in pursuing this strategy, Firstly, Air Canada is a widely recognized and respected brand with 77 years of experience and we are the leading carrier in the Canadian market with the largest presence in Toronto, Montreal and Vancouver. And we are strong number two in Calgary. We are the largest foreign carrier into the United States. This is supported with U.S. pre-clearance facilities at nine Canadian airports and a strong airport infrastructure in Toronto, Montreal and Vancouver, which offers seamless options for sterile transit.

In the last quarter, consistent with our objective of increasing global international-to-international connecting traffic so-called sixth freedom, through our major Canadian hubs. We experienced higher proportional growth of international-to-international passenger flows relative to the second quarter of 2013. This sixth freedom traffic was up 32% from the same quarter last year and with a significant portion coming from the United States.

We are particularly pleased with the progress in transforming Pearson into a truly leading North American airport and global hub. Toronto has indeed the potential to become a preferred global routing, because it offers some of the best elapsed travel times between the U.S. and major centers in Europe and Asia. Furthermore, our commercial agreement with the GTAA in effect since the start of this year positions Air Canada to capture a larger share of growing international traffic flows on a more cost-effective basis.

In addition, we continue to exploit the unique potential of our secondary hubs. We can leverage Vancouver’s geography as North America’s closet hub to Asia to grow our Trans-Pacific route offering from that hub, while Montreal is well-positioned to grow in key francophone markets. European leisure markets and high demand destinations currently underserved such as Lebanon and North Africa. We also expect to continue growing capacity at our fourth hub in Calgary, which is a focus city for us with high business traffic demand to Pacific, Asia, Europe and the U.S.

We are able to leverage favorable slot times at busy or slot constrained airports, including London, Frankfurt, Paris, Tokyo, Hong Kong, Shanghai, Beijing, New York and Washington. Our flexible fleet mix, including the high-density Boeing 777 and the new 787 aircraft is another advantage, the potential of which is already evident. The 777 higher density aircraft has significantly improved the contribution of underperforming markets, such as Vancouver-Hong Kong and Montreal-Paris and thanks to the efficiency of the 787 we can fly more passengers at significantly reduced cost. For example, on average, on the Toronto Tel Aviv route, where we have just started deploying the 787, we can now accommodate 31% more passengers, 352% more cargo, all using 3% less fuel.

Air Canada rouge allows us to be a relevant player in leisure markets. And as Mike mentioned, we continue to be very pleased with rouge’s performance from a profitability standpoint. Based on forward bookings, we expect a strong performance on all of rouge’s European seasonal leisure routes, including the three new routes launched this summer. During the quarter, we also expanded rouge’s operations in Western Canada serve a number of markets from Vancouver and Calgary to Los Angeles, San Francisco, Las Vegas and Anchorage as well as to San Diego from Toronto. The conversion to Air Canada rouge flights previously operated by Air Canada mainline allows us to compete more effectively as these markets have both high leisure demand and low-cost competition. As rouge matures and we have now carried nearly 2 million passengers since inception, we are better communicating the rouge-differentiated product to the marketplace and managing the expectations of Air Canada’s premiums customers on these transfer groups.

From a financial point of view, the performance of these routes since the transfer clearly validates our decision. Along with the network, fleets in CASM initiatives I have mentioned, our mainline product is the fourth but critically important component to our international expansion strategy. And we continue to raise our brand profile through Skytrax’s four-star rating and Skytrax’s recognition of Air Canada as the Best Airline in North America for each of the past five years. We are also the best-in-class business class in all mainline aircraft along with Maple Leaf Lounges, concierge program and a world class loyalty program in Air Canada altitude.

Customer response to our new premium economy product being rolled out throughout the mainline wide-body fleet is very favorable. Our market presence is further enhanced by our membership in Star Alliance, which has grown to comprise 27 airlines serving over 1,300 airports in 192 countries, along with code share agreements and the A++ joint venture on the Atlantic.

So, we are now going into our summer peak, which we expect to be strong as evidenced by our load factors. As you may conclude from Mike’s comments, we believe that our performance to-date is a very positive reinforcement of our international growth strategy and our incremental approach to improved results. Together, with an 8.5% growth in capacity, we reported a record 84.2% load factor for this second quarter. This reflects strong demand across our network as well as the solid performance and alignment across our commercial teams and supports the profitable growth plans. These financial results also confirm that we are in a solid position to make the substantial capital investments in our fleet required to increase our competitiveness, significantly lower our costs and take advantage of opportunities to grow the airline and improve margins.

Investment in new fleets in international growth will result in economic development in the communities we serve and new jobs and better jobs for our current employees, particularly in the case of our pilots. This will undoubtedly motivate and increase employee engagement and it also ties in with the progress we are tracking and the commitments we are making for the future in our 2013 Corporate Sustainability Report, which will be publicly available this week.

Consistent with our commitment to corporate sustainability, we share responsibility for the wellbeing of all of our stakeholders and our decision-making must be based on more than just economic consideration. That is one reason why in 2013, Air Canada and the Air Canada Foundation, together contributed a total of $6.5 million in community and charitable investments, above the average of participating Canadian companies in the conference board of Canada’s most recent benchmarking survey.

So, in closing, we are maintaining the momentum we achieved in 2013 that our leadership team is committed to executing on all aspects of our strategic priorities, including the goals established to the financial community in June of last year, which constitute the foundation for sustained profitability for our airline.

With that, I would like to thank you all for joining us on the call today and open it up now for questions.

Question-and-Answer Session

Operator

Thank you, Mr. Rovinescu. (Operator Instructions) Our first question is from Kevin Chiang. Please go ahead with CIBC.

Kevin Chiang - CIBC

Hi, good morning and thanks for taking my question.

Calin Rovinescu

Good morning, Kevin.

Kevin Chiang - CIBC

Just to go back on the yield comment in your prepared remarks, good detail in terms of the impact of stage length on yield in the second quarter, but I am trying to get a sense of what the product mix would have had as well in terms of headwind when you compare rouge and the high-density 777s being in your network this year and not being there last year. I am just trying to get a sense of what maybe same-store fares would like on a year-over-year basis if you take out these various moving parts?

Calin Rovinescu

Well, Kevin, let me make a general comment and then turn it over to Ben. So, first of all, I want to make sure that you and others understand exactly this point, because this is extremely important in taking the time to understand the strategy that we are deploying here. So, we have made an investment in a greater number of seats and a greater number of economy class seats and that is through the high-density product and through the rouge product. So, by definition, that is one factor that will influence yields and the second factor is the way the stage length mix plays out. So, each of these factors, we are purposefully looking at having a lower yield, that is part of the strategy here as we look to have a greater bottom line. Our number one driver for sustained profitability is adjusted net income, as well as EBITDAR. And so these are the drivers that we are building towards. So, I think I have seen some analysts being somewhat confused as to whether or not they were expecting yield decline. The answer is yes, we are expecting yields to decline, but we are expecting bottom line profitability to go up. And this is part of a measured and clearly defined strategy. Now, with that, in terms of a relative same-store sale discussion, maybe I will ask Ben Smith to comment.

Ben Smith

Sure. Yes, as Calin mentioned, the bulk of our international capacity increase was in the economy cabin showed the business class capacity was relatively flat. So, we are quite pleased with our same-store performance in the business cabin. When you look overall because the growth at rouge and with the high density aircraft on most of our international markets was in the economy cabin, that’s where you are seeing the yield reduction, but on an overall same-store basis, we are quite pleased year-over-year. It’s up in almost every area.

Kevin Chiang - CIBC

Okay, that’s great clarity there. And just secondly, looking at July traffic, especially in the Atlantic routes, you added 25% capacity growth in July. Can you just help me understand the differences in what you are seeing versus what some of your other Trans-Atlantic – what some of the other Trans-Atlantic carriers are seeing given that they have had a little bit more cautious tone over the past couple of months? And how are your A++ partners viewing your Trans-Atlantic strategy, just given the amount of capacity you are adding on those routes?

Ben Smith

Yes. Hi, it’s Ben again. We are very, very pleased with our Trans-Atlantic performance over the last quarter and also with advanced bookings into Q3, because of our lack in the past of competitive tool to fly, one of the leisure markets in Trans-Atlantic, we have basically underserved based on the size of our franchise, the Atlantic market. So, we are still going after relatively low-hanging fruit markets, where with the breadth of our network in Canada and the U.S., we are seeing very strong volumes as expected. Most of our competitors and partners across the Atlantic are already outperforming from a capacity perspective, so very difficult for them when currency is on their side, in particular in Europe to have a year-over-year improvement. So, with point-of-sale Europe sale is being strong for us because of the currency impact. I am going into new markets with the right product, with the right cost. We are seeing the results that we were expecting.

Kevin Chiang - CIBC

Perfect. I will leave it there. Thank you.

Calin Rovinescu

Thank you, Kevin.

Operator

Thank you. Our next question is from Walter Spracklin with RBC. Please go ahead.

Walter Spracklin - RBC

Yes, thanks very much. Good morning, everyone.

Calin Rovinescu

Good morning, Walter.

Walter Spracklin - RBC

Just wanted to turn to your ancillary revenue opportunities, I don’t know if Ben, you can you give us a sense on a per passenger basis, where you are, where you are trending, and how that compares to your peers, particularly if it’s very different from the U.S. peers and specifically I guess any update on some of the drivers of that improved ancillary revenue be it your bag fee strategy as well as any of your in-flight product opportunities that you are rolling out – that you have been rolling out?

Ben Smith

Sure. Yes, on the ancillary side, most airlines report it quite differently and in particular us, with the Air Canada Vacations being separate, we are very pleased with ancillary revenue. We are seeing a strong growth with our upgraded products, strong growth with all of our ala carte offerings. On the bag front, we are fully competitive with all of our U.S. competitors on trans-border. And internationally, we are in line with our partners as well as most of our competitors. Domestically, we are completely in line with our main domestic competitor. And at this point, we have made no decision on any change to any of our bag policies in any of the main markets that we serve.

Walter Spracklin - RBC

So, to the extent that you might be different from your peers, are you expecting call it a higher rate of growth in ancillary revenue over the next few years?

Ben Smith

We think we will have obviously a new product which we are expecting the strong results from and that’s premium economy as well as the preferred seat option otherwise known as Economy Plus. So, that is now – the Economy Plus section is now rolled out on all of our North American narrow-body aircraft. So, that gives us an additional ancillary stream. We report that both on the ancillary side as well as in base revenues depending on how the customer purchases that product and then with premium economy rolling out across our rouge fleet as well as our wide-body fleet over the next few years. We see that as another incremental source.

Walter Spracklin - RBC

Can you update us on the premium economy bookings versus what percent as being upgrades and therefore going into ancillary?

Ben Smith

I haven’t got that number in front of me. We could probably follow up with you with that after.

Walter Spracklin - RBC

Okay, sure. And my last question now on the cost side, I guess, this one is for Mike. Mike, your fuel consumption per ASM was very impressive this quarter, I mean, typically we are – we don’t model a significant improvement in that and that speaks, I guess to your – to the lower cost of the aircraft that you are rolling out in your new capacity. When we model this going forward, should we be looking at a meaningful increase in your ASMs per liter along the lines of what you have seen in the second quarter? I mean, because again, that’s having a very significant effect if we were to roll that across our forward estimates, it will certainly have a meaningful contribution if we use that kind of run rate?

Mike Rousseau

Good morning, Walter. It’s Mike. Certainly, you have seen the impact of the high-density 777s now, because they were all in Q2, but what’s coming of course and what we haven’t seen the impact of is the 787s, which are as you know very, very fuel efficient. So, I think that will continue to improve that ratio as we go forward as that strategy matures.

Walter Spracklin - RBC

And that’s not something that goes into your CASM, right, that savings is not in your CASM, but it is in your long-term CASM projection. In other words, your guidance that you give us this year does not include that fact, but your long-term guidance does, is that correct?

Mike Rousseau

Well, in our guidance, when we say $0.90 a liter, it factors in fuel burn and the full cost of the fuel price.

Walter Spracklin - RBC

Okay. But with your CASM ex-fuel guidance I am referring to?

Mike Rousseau

That’s right. It would not be included.

Walter Spracklin - RBC

Right. But your CASM long-term, the 15% does – is not ex-fuel, in other words, you are capturing the benefit of that, the cost impact, the fuel cost savings from the new aircraft in your longer term guidance?

Mike Rousseau

That’s correct.

Walter Spracklin - RBC

Okay, alright. That’s it for me. Thank you very much.

Mike Rousseau

Thanks, Walter.

Operator

Thank you. Our next question is from David Newman with Cormark Securities. Please go ahead.

David Newman - Cormark Securities

Good morning.

Calin Rovinescu

Good morning, David.

David Newman - Cormark Securities

Just looking into Q3 and into the year, obviously the yields that you saw sort of machinations of the rouge and certainly longer stage length in the quarter, I would expect that would continue to Q3, especially given the more leisure focus into Q3. Any sense, I know you don’t provide RASM guidance, but maybe just some color around the various markets on the Atlantic and domestic? And also given your commentary around the CASM ex-fuel and ACV cost, I would assume minus 4.7% this quarter and the sheer force of what you are doing is got to cascade into Q3 that, that would be top end of that range? Any – and just any commentary that you provide on yield, PRASM and CASM into Q3 might be helpful, because obviously the yield was a bit of an impact this quarter?

Calin Rovinescu

Right. So, again, David, Calin here. The yield is affected by both the stage length and the fact that we are investing as I said before more in the economy class here through the additional density. So, you have to factor both of those drivers in. And part of our strategy while we are not providing at this stage yield or RASM guidance, we are looking at – we are expecting there to be a yield RASM decline, but the CASM decline will be significantly greater. And that is the business model of what we are looking. So, in terms of the third quarter, we are expecting as we have given several indicators here that so far, demand has been very, very strong and we expect it to continue. And so you would be correct in assuming that it should be sort of continuation of what we have seen in the second quarter on an incremental basis.

David Newman - Cormark Securities

Okay. And then if you look further out obviously leisure travelers tend to book a little earlier in the curve, but as you are looking into the fall, as the mix kind of changes back into maybe more business-related in the shoulder season. Is there any puts or takes that you have as you look to the booking curve into the fall in strength, weakness, and certainly the commentary from other carriers and just business travel trends into the fall. Is there anything gives you a reason for concern at all?

Ben Smith

Hi, it’s Ben. No, we are very pleased with our advanced booking curves right through the end of the year even into early part of next year. They are all at or ahead of expectation.

David Newman - Cormark Securities

And into the fall, what’s your visibility on that, Ben? Is it like four months or something?

Ben Smith

No. I mean, we look 12 months out, but relevant bookings usually go up four to six months depending on the market.

David Newman - Cormark Securities

Got it. And last one for me, probably for Mike here, obviously great performance on the pension and in the surplus here. And I think you had a plan to sort of immunize the plan, maybe just an update on where you are. I think you are 70% immunized the last time we spoke, where are you now? And do you think you will get to that in a magical near 100% by the end of the year?

Mike Rousseau

Good morning, Dave. It is Mike. We are still at 70%. We haven’t changed, because interest rates are at all-time lows. And so we are just watching the marketplace and we always said we will be opportunistic and we want to find the right entry point. So, we were very satisfied with being 70%. We ultimately like to get the 100% but there is no timeline for us to get there. We will still make a decision over the next year or so as to whether we continue with existing government agreement or whether we opt out.

David Newman - Cormark Securities

Okay very good. And great performance on the cost guys and hopefully this gets reflected in the share price at some point.

Mike Rousseau

Thanks very much, Dave.

Operator

Thank you. Our next question is from Turan Quettawala with Scotiabank. Please go ahead.

Turan Quettawala - Scotiabank

Yes. Good morning. I guess maybe I will ask one on the cabin side, first. Just when you look at your long-term guidance, Mike, of 15% decline off of 2012 levels and I guess there is fuel that includes fuel obviously, but it also is sort of ex-of inflation and then the dollars moved a lot here as well. So, can you give us a sense of as we look at your guidance out into 2014 sort of how much of this is already in your CASM today?

Mike Rousseau

Yes. I would say no more than third of it is in ‘14. As you can appreciate, a lot of our strategies are still yet to mature that drive the 15% and the biggest one by far is 787s. We haven’t seen any benefit from the 787s. And as they mature over the next – they get delivered over the next couple of years, we will see more and more of an impact. And of course with rouge, we had less than half the expected fleet in for the first part of this year. And so again, that has not contributed what it will contribute in the future.

Turan Quettawala - Scotiabank

Okay, that’s really helpful. Thank you. So, basically what you are saying is ‘13 and ‘14 if you combine that improvement sort of by the end of ‘14 you are about a third of the way through?

Mike Rousseau

I think that’s a fair proxy.

Turan Quettawala - Scotiabank

Okay, that’s very helpful. Thank you very much. And I guess my next question on just looking at Encore, I guess and WestJet’s been talking about how successful that’s been for them. I am wondering if you can talk a little bit about that dynamic and how it’s impacting your regional business? I know you did talk a little bit about domestic, particularly Western Canadian yields being heard. So, just if you could give me a bit of sense there? That will be helpful.

Calin Rovinescu

Well, we – there is no question that we were – once Encore has been rolled out, our expectation of modeling what the impact would be on some of our routes was not a surprise to us. And so we have taken measures in some cases by deploying different regional aircraft on some routes ahead of time to be more competitive. And as you know, we have also introduced other regional carriers as well that have somewhat of a lower cost into the mix. And I would say that we are not going to segment the Encore impact on a given regional market, we don’t do that. But suffice it to say that we are well aware that, that requires our regional network to operate at a much more competitive level than they currently are. Our regional partners are well aware of that dynamic and we are fully expecting that with the passage of time. At this stage, it is still relatively de minimis to be very frank. When we look at the aggregate business that we operate, the impact of Encore is relatively de minimis. And with the rollout over the next several years, we certainly expect our regional partners to increase their competitiveness.

Turan Quettawala - Scotiabank

Perfect. I guess any comments there with regard to Chorus then, Calin?

Calin Rovinescu

No. Well, obviously, Chorus is our main and our largest regional partner, great relationship and they know very well that one of the objectives over the coming periods of time is to have a more cost competitive dynamic. Similar to what Air Canada has managed to do with CASM reduction, I know that there are strategies under way on their side to continue to become more competitive.

Turan Quettawala - Scotiabank

Perfect. And I guess last question from me, in the past you have given us the load factors on rouge, is it possible to break that out this quarter?

Calin Rovinescu

I don’t think you should count on that being a number that we wanted to portray on a quarterly basis, I think we will choose where we want to do that and we did it for, I think, last quarter or last traffic result, but again, it’s going to be almost an arbitrary type decision on our part.

Mike Rousseau

And at some stages, part of it is obviously our load factor is very, very strong overall. And in some cases, once we get to some specific markets or once we get to a certain size in rouge, I think we want to just give order of magnitude as to what rouge is doing. That’s why I mentioned the total number of passengers carried it now are already being nearly 2 million passengers. And so, rouge is – relatively speaking, Air Canada carries more than 35 million passengers a year, so it still is a small part of our business, but an increasingly profitable one. And so at this stage we are not segmenting rouge’s results and once it gets to the full fleet size, we will reconsider that decision.

Turan Quettawala - Scotiabank

Okay, perfect. Thank you very much. That’s all I had.

Calin Rovinescu

Thanks, Turan.

Operator

Thank you. Our next question is from Glenn Engel with Bank of America. Please go ahead.

Glenn Engel - Bank of America

Good morning. Thanks. Can you give out departures year-over-year in the third quarter and maybe full year because that might do a better job of bridging the gap between ASMs and perhaps some pressure?

Mike Rousseau

We actually have aircraft frequencies in the MD&A and frequencies in Q2 were 139,000 versus 137,000 last year, it’s up 1.6%.

Glenn Engel - Bank of America

So, it’s not going to – so that’s a much less than capacity and it probably means up in the third quarter, up 2% to 3%?

Mike Rousseau

Yes. Probably, same ballparks, probably, I don’t have the number at the top of my head, Glenn, but certainly yes, lower the seats dispatched and lower the ASMs again reflecting our density – our dense up strategy.

Calin Rovinescu

Well, I think that you are raising a good point here. Just to be clear, I think that this is the kind of thing that analysts are going to take the extra time to understand what we are doing are going to look at. The fact is that the total number of frequencies is not materially greater. The total number of seats dispatched is significantly less than the total number of ASMs in the marketplace. And the point is that we are able to add ASMs because of stage length on a relatively cheap basis. And so, that’s kind of the vision of what we have been doing and obviously given the bottom line impacts here, we are pleased with the results so far.

Glenn Engel - Bank of America

In your MD&A, you said premium traffic was down 1.2%. Why would that – why would you be seeing premium traffic actually fall if you are having more seats and demands better?

Mike Rousseau

The majority of the seats that we are adding, Glenn, are in the economy cabin, so a lot of the routes that we are flying across the Atlantic say for instance, Barcelona used to be flown by mainline, the aircraft has been converted to rouge, the premium cabin is no longer there. That’s an example.

Glenn Engel - Bank of America

If I compared WestJet’s PRASM in the second quarter with just your domestic and trans-border, they significantly outperformed and I wouldn’t think that the – especially even domestically, why would domestic there would be such a gap when that should be affected by rouge or changes?

Mike Rousseau

Glenn, I think a lot of it can be explained by stage length. Their stage length is dropping. Our stage length is to some degree increased even on the North American business, because again we are flying longer-haul leisure routes, primarily through rouge.

Calin Rovinescu

If you look at the – a lot of the WestJet growth is in the regional markets with a very short stage length with their Encore product and correspondingly much higher yields to offset the higher CASM.

Mike Rousseau

And again, Glenn as we have talked about earlier today, a greater proportion of our traffic is connecting traffic as well. And so there is a different yield dynamic on connecting traffic.

Glenn Engel - Bank of America

Your pension benefit was $60 million in the first – expense of $60 million in the first quarter and only $45 million in the second quarter, with the adjustments in the second quarter, and do I expect the pension benefit to go back closer to the first quarter levels?

Calin Rovinescu

I believe somewhere in between.

Glenn Engel - Bank of America

Okay.

Calin Rovinescu

And we do provide guidance I think on pension expense anyways, and it could be a $35 million improvement I think year-over-year for a full-year basis.

Glenn Engel - Bank of America

And finally, can you give sixth freedom growth – the growth in fixed freedom revenues?

Calin Rovinescu

Half year we did up 32%.

Mike Rousseau

32%

Glenn Engel - Bank of America

Okay. Thank you very much.

Mike Rousseau

Thanks Glenn.

Operator

Thank you. Our next question is from Chris Murray with AltaCorp Capital. Please go ahead.

Chris Murray - AltaCorp Capital

Thanks. Good morning, guys.

Mike Rousseau

Hi, Chris.

Chris Murray - AltaCorp Capital

I guess continuing to dig into kind of expectations for Q3, it looks like stage length was, as you said a big player and as well as mix, any – should we be thinking about modeling out as we go into Q3 the stage length, especially you look at that strong growth in Atlantic and more patterned and kind of factoring in a similar impact I guess directionally in the top line and in either RASM or yield?

Mike Rousseau

Again, Chris, we are not – it’s difficult for us to provide that type of clarity on Q3 in this type of conference call. I think what we will do though is take back some of these suggestions especially on stage length and we may look at providing some sort of outlook on stage length as we go forward.

Calin Rovinescu

I think that’s obviously the question has come up now from several analysts, we will definitely look at that. I think if you take assumptions, obviously given the kind of flying that we do in Q3, that stage length will increase in Q3 in relation to Q2 for example, that would be for your modeling purposes Chris, something that you could certainly take into account without us giving you very specific number on the phone right now.

Chris Murray - AltaCorp Capital

Okay, great. And then just turning – Mike, I guess there was – were some press releases talking about the new financing packages you may have entered for I guess the first of the 787s, can you give us any more details on maybe what’s going on there and any impact they may have on either your WACC?

Mike Rousseau

So these – sorry, financing packages for 787s?

Chris Murray - AltaCorp Capital

Yes. I understand that you have been able to use some of the Ex-Im guarantees?

Mike Rousseau

Yes. We had seven of the planes grandfathered under the old ASU at favorable rates. And so we have completed five of those at this point in time. And we expect to do another two before the end of the year. And certainly, those rates are well below our existing average debt rate of roughly 5.8%. The average debt rate for the company is 5.8% right now and so those are going to be well inside that rate.

Chris Murray - AltaCorp Capital

Alright. And the aircraft, as they put the Ex-Im guarantee and I am assuming the aircraft are also a secured as part of the financing?

Mike Rousseau

Yes. Yes.

Chris Murray - AltaCorp Capital

Okay.

Mike Rousseau

Those – that’s worked out very well for us and we continue to look at other financing methods for the other 777s as they are delivered. And Chris, Kathy just pointed out to me we do – we can provide some view on stage length for Q3 as we provide you is part of our guidance ASM growth and we provide you seats dispatched for Q3. And so we now calculate, that’s the way we calculate it. So I think the numbers are available in the press release.

Chris Murray - AltaCorp Capital

Okay. Great, that’s helpful. And if I just can one more, if I can slip it in, the tax charge of $41 million, can you just give us some more color on what that is and why you have included it in EBITDAR as opposed to sort of a tax line?

Mike Rousseau

Well, as you can appreciate large companies have outstanding issues with different tax authorities. And this is not income tax, this is commodity tax, capital tax. And so we were able to negotiate settlements with a couple of the provinces and then that was – we were able to release reserves because of that, because they were less than we initially anticipated. And so, it's – although this type of things are recurring to some degree, they are not ongoing and so as a result, we thought we would take the high road and exclude it from our results from an adjusted basis.

Chris Murray - AltaCorp Capital

Okay. Thanks, guys.

Operator

Thank you. Our next question is from Tim James with TD Securities. Please go ahead.

Tim James - TD Securities

Thank you. Good morning. What is causing the increase and very strong growth in sixth freedom traffic, that’s very, very good to see and I know there are plenty of reasons for its increase and the advantages appears and etcetera, but many of those have existed for some time, if I am not mistaken, I am wondering if there is something in particular, whether it’s a marketing push or some kind of catalyst that’s causing that to really that growth rate to increase.

Ben Smith

Yes. Hi, Tim, it’s Ben. Many reasons for that, first off is the schedule itself. We have repositioned some capacity and timings to better market, big volume, sixth freedom markets that we are going after, so the right capacity at the right time. And then following on that, competitive pricing, we have put in place we may not have filed fares in all the routes that we are targeting today like in the past that may not have been there, so those two combinations are very key. And then of course the improved transit process, this just recently came on in Toronto has definitely helped our position especially the premium customers when they experienced it once they have realized how much easier it is to transit Canada and to enter the United States on a transit pre-clearance basis on the way back in. Of course geography helped us because the allotted time when the flights are timed correctly is extremely competitive. So you put all that together as well as the help from our A++ joint venture partnership, because it is a powerful package to go into the marketplace.

Tim James - TD Securities

Okay. Thank you. And then just turning to Rouge, could you discuss in what ways Rouge is exceeding expectations I know you have mentioned in terms of profitability, I am just wondering if you can provide some color kind of on whether that’s primarily driven by a better cost performance, is it better traffic and load factors or is it the yields that you are seeing overall in the cabin are better than expected, what’s – what are the key components of it?

Mike Rousseau

I would – again, it’s fairly new in the early Rouge strategy, but again they are probable, and they are exceeding our expectations. I would say load factor is up a little more than we expected and the yield is up slightly versus our expectations. The CASM is basically on top of what we always had anticipated it would be.

Tim James - TD Securities

Okay. Thank you. And then, as far as your new calculation of average stage length, how does that compare with previous calculations, I am just wondering if it – if there is a particular relationship there, does it bias average stage length. And I am talking about the measures as opposed to the growth rate, but does it bias average stage length higher or lower, or is there no direct relationship?

Calin Rovinescu

In our situation Tim, it would bias stage length at a higher rate, growth rate. And we think it’s more applicable to our strategy, because now we are measuring how far each seat travels versus how far each plane travels.

Tim James - TD Securities

Okay. Okay. I see.

Calin Rovinescu

Because I think it’s more indicative measure on stage length given our growth and density.

Tim James - TD Securities

Okay. That’s helpful. Thank you. And then just going back to something you mentioned earlier, Mike, about making the calculation for the third quarter given what is provided and forgive me if this is in the report, but is the average, the seats dispatched for Q3 ‘13 available, is that in the report, because we would need that to – it is in there?

Mike Rousseau

Yes.

Tim James - TD Securities

Okay. Thank you. Then just my last question, how do you see the Pacific market shaping up going forward and through 2015, presumably with the 787 deliveries coming, capacity growth in the Pacific for Air Canada is going to ramp up at some point, I am just wondering how the current competitive situation and the demand outlook kind of align with your eventual capacity growth plans there?

Ben Smith

Hi, it’s Ben, we are very pleased with Pacific, in particular our new service to Tokyo-Haneda. We are seeing strength in that market that’s higher than what we are expecting, so very happy with that. Of course, we are the only day time slot from Eastern North America to Haneda. And then on the rest of our Pacific routes, we are seeing healthy demand volume as well as very healthy demand, in particular in the premium cabins.

Tim James - TD Securities

Great. Thank you very much.

Operator

Thank you. Our next question is from Helane Becker with Cowen. Please go ahead.

Helane Becker - Cowen

Thanks operator. Hi, guys. Thanks for taking the time. Just two questions, on connecting the international connecting travel, the sixth freedom, how much does Dublin as a connecting complex out of Europe compete with Toronto or Montreal?

Calin Rovinescu

It’s not a big player as of yet. I mean, I think it has the potential because of it’s geography to be a more important connecting point. We haven’t seen it affect us in a material way to-date, of course the traditional big connecting hubs in Europe, Paris, Frankfurt, Amsterdam and London are much more significant.

Helane Becker - Cowen

Great. But given pre-clearance, Dublin would be the other alternative to Toronto, and you are saying you are not really seeing that as a competitive issue at this point, which is fine. Thank you. And then the other question I had is how should we think about operating margins going forward, given the change in stage length and the yield and so on, maybe it’s easier for us to focus on the margin improvement that you are seeing rather than just focus on the impact stage length is having on yield?

Calin Rovinescu

Precisely, again I am saying earlier is that the focus of this company is to deliver increased bottom line net profit which means that our objective is to have an operating margin that improves from year-to-year and you have seen it this year between this second quarter and last year’s second quarter. And that is precisely the direction that we are expecting to head. And we will see operating margins continue to improve as the strategy is rolled out.

Mike Rousseau

I think one more point to make about Dublin is don’t forget that Air Canada serves over 100 destinations in North America, 60 in the U.S. alone whereas airline like Aer Lingus is single digits into North America, so the breadth of our network is far larger than what they are able to offer.

Helane Becker - Cowen

That’s a good point. Thank you very much. Okay. Thanks. I just kind of wanted to get that margin understanding because that might be easier for people to focus on than understanding necessarily the impact stage length has on yields which obviously longer the stage length, lower the yield not rocket science? Thanks.

Calin Rovinescu

Thanks, Helane.

Helane Becker - Cowen

Thank you.

Mike Rousseau

Thanks very much.

Helane Becker - Cowen

Yes. Thanks.

Operator

Thank you. Our next question is from David Tyerman with Canaccord Genuity. Please go ahead.

David Tyerman - Canaccord Genuity

Yes. So good morning, quick question then on the margin expansion, so you didn’t actually get a lot of margin expansion in Q2 over Q2 last year, is this entirely – it looks to me like it might be entirely due to the Canadian dollar and fuel, do you have any sense of what your margins would have looked like without that?

Mike Rousseau

Dave, it’s Mike, I think your summary is correct. We had to power through some fairly high increases in fuel spends partly because of the Canadian dollar and then also the other expenses were impacted by the weakness in the Canadian dollar as well. Aside from fuel, non-fuel expenses were impacted by roughly $40 million for FX. If that didn’t exist, margins would have been roughly 150 basis points higher.

David Tyerman - Canaccord Genuity

Right. Okay. So Mike, given that this – well, fuel is going to be a lot easier comp going forward, but the Canadian dollar is not, do you have a sense of when you are going to be able to climb over that hurdle?

Mike Rousseau

I mean, I think we have said as our strategies matures, we should – we will see margin expansion. And we are still fairly early in maturity of a number of our key strategies. And honestly, we want to see margin expansion sooner than later. And so we can’t provide guidance as – whether it’s going to happen in Q3 or Q4 or next year, but certainly our objective is to expand as soon as possible.

David Tyerman - Canaccord Genuity

Okay. Fair enough. Just on the stage length question and the increased economy seating, the impact that we saw in Q2, would there be any reason why there would be a different impact in Q3 because it looks like your stage length is going to be fairly similar increase, so I am thinking well, then the impact on yield should be fairly similar too, and the same thing on the economy side with the extra-economy seats, is there any reason why that kind of relationship wouldn’t hold in Q3 relative to Q2?

Mike Rousseau

I mean there are number of factors that impacts the yield as you know, but certainly from a stage length perspective, I think it’s a fairly good proxy.

David Tyerman - Canaccord Genuity

Okay. And the same thing for the increased number of economy seats, like it would be negative – that was a contributor, it sounded like to the negative 0.6% yield...

Mike Rousseau

Right.

David Tyerman - Canaccord Genuity

And value of the stage length?

Mike Rousseau

Yes. I think Q3, certainly from a stage length perspective and the number of economy seats will be similar to Q2.

David Tyerman - Canaccord Genuity

Okay. Fair enough, I understand there are other factors. And then just a question on the revenue management system, so could you just tell us where you are on that and how this $100 million flows in next year, is it all come fairly quickly or is it come in over this course of the year?

Calin Rovinescu

It’s over the course of the year, and it goes to the ability of our people to better manage their inventory and to manage their yield. And so therefore, that is a system that we have had been working on for a long time. We are familiar with what other airlines have experienced and so it’s a forecast that our commercial team is relatively confident about.

David Tyerman - Canaccord Genuity

Okay. But where are you on this right now?

Calin Rovinescu

So right now, we are doing basically a lot of calibration to ensure that the data that drives this model is accurate on a year-over-year basis because of the transition from a leg-based system to origin destination. So once all of that prep work is done, we should be in place early next year to put that into production.

David Tyerman - Canaccord Genuity

Okay. Perfect. Thank you. And the last question I had, there is increasing talk about ULCCs entering the market – domestic market and maybe eventually the transporter, do you have the ability to use Rouge as a tool to fight against that?

Calin Rovinescu

Look, we have positioned Rouge to be capable of serving the leisure markets. And so we are confident that we are going to have a good product if we wanted to deploy it in any market that has the characteristics of leisure market and obviously many of these so called ultra low-cost carrier markets are leisure markets. So to the extent that any of these strategies come to fruition and obviously there is a lot of debate in the marketplace as to whether or not they can, we certainly would expect to be an able competitor for that. There is no restrictions for people coming into the market and in many respects as we have seen in the past, we have had lots of examples in the past people coming into the marketplace and having different strategies on different markets. And so Air Canada has decided that we will compete aggressively in the premium market and we will compete aggressively in the leisure market. And we are quite confident that some of these markets are extremely important for us, our presence will be felt.

David Tyerman - Canaccord Genuity

Okay. So just to be clear, there is nothing preventing you from using Rouge in the domestic market?

Calin Rovinescu

No. There is nothing preventing us from using Rouge in the domestic market. And we will look at on the market by market basis the impact that that might have on the rest of our operation, obviously. Going up against ourselves with the Rouge product and mainland product that we have not done and we will consider that. But obviously this is we have seen the media reports around these, we worked very hard to build to a level of sustained profitability and we certainly expect that we will continue to move in that direction.

David Tyerman - Canaccord Genuity

Alright. Okay, that’s helpful. Actually, one last question, you have mentioned KLM in your comments managing passenger expectations, I think you were referring to mainline, your traditional passenger with respect to Rouge, what exactly are you doing in that area, it seems like a risk?

Calin Rovinescu

Well, no you see, we have made obviously in taking a route that was previously a mainline route and converting it to Rouge requires a good amount of communication. And so when we looked at the first series of routes like all the Caribbean destinations and the leisure destinations in Europe, those were easily understood. When we looked at some destinations from Vancouver to California, for example there were certain number of business class passengers and those who were accustomed to the business class of the mainline product, which obviously is a very superior product. And so the communication has improved, the ability of people who choose to – who really want to have that business class seats, if they want to have their fare – in other words be able to cancel their booking and book with another carrier if that’s the kind of product they want, then we will obviously we give them that choice. But it’s worked out really well. And our load factors are proving that most passengers, once the product is well explained, it is still a very compelling product offering for those customers.

David Tyerman - Canaccord Genuity

Okay. Very good. Thank you.

Calin Rovinescu

Yes. Thanks David.

Operator

Thank you. We have a follow-up question from Walter Spracklin with RBC. Please go ahead.

Walter Spracklin - RBC

Yes. Thanks very much. Just a follow-up here, when I take a little bit step back from the detail a little bit, when I go back to like your indications of a 15% cost savings, it was a pretty impressive number. And then when we looked a little harder, we saw that it was based on a capacity rollout, a very, very low cost capacity. So that helped us understand what the key risk then was and that is that will you be able to fill the seats of all this new capacity coming on and at what price? And I guess the question is for Calin, when I look at what happened, the capacity has come on, but your traffic has actually exceeded that capacity. And my question is why wouldn’t you look to offset a little bit of the negative mix effect and stage length effect from yield by just raising prices to generate a traffic level consistent with or even a little bit below the total traffic increase, why are you stimulating demand to in fact exceed the capacity that you are bringing on?

Calin Rovinescu

Well, we are – this is obviously the magic of airline pricing. And this is as you know, I have discussed in the past different than so many other industries, but the fact that we have added all of this capacity and have actually seen more traffic than what we have added has been a very, very favorable indicator that is heading in the right direction. In terms of pricing, this – the market will bear what the market bears. And I think we might comment a little bit on – from Ben here on the vision that we have to some of this – pricing of this incremental capacity. In some markets, as Mike said earlier, we think we have done better than what our expectations were on yield. And I think that several of the analysts may have gotten overly exuberant as to what the pricing expectations in a market like this. And we – the dynamic is such that you end up in many of these markets matching what the competition is able to do. I don’t know, Ben, do you want to comment further on that?

Walter Spracklin - RBC

Well, maybe if I could just, I guess where I am going is that when demand exceeds supply the opportunity there is to increase price and even regardless of what you are competition is doing. It just seems like it’s an opportunity that with your load factors where they were before you started this capacity increase, they were pretty good. And you indicated that – I believe you indicated in the past that filling even more of the aircraft is not necessarily a primary objective, but that’s as effectively what’s happening when you are rolling out growth increases – traffic growth increase that outstripping the supply, you are effectively allowing demand to exceed supply without seeing price increases?

Ben Smith

Yes. I think, Walter, what you will see – hi, it's Ben, going forward, is a lot of this capacity is brand new. It’s a significant increase for us, an increase in a way that we haven’t seen in a long, long time. We have been optimizing and managing on a very low growth rate over the last few years and we have been squeezing both on the revenue and the cost side as much as we can. As we move forward in this and we get more comfortable with this capacity, you should see improvement both on the revenue and the cost side to drive improved margin.

Walter Spracklin - RBC

Okay. That’s exactly what I am looking for. Say no more, Ben, that’s perfect. I understand. That makes a lot of sense. But I do want to throw out one more question, Calin, I have gotten pinged a few times during this conference call. You have got a question about an equity offering, I think it was a little misunderstood. I want to give you the opportunity to sort of just clarify around the potential miscommunication or misunderstanding of your answer, your view on a potential equity offer?

Calin Rovinescu

Well, look, it was a misunderstood comment from one of the analysts. We have at this stage no intention to do an equity offering, but once the universe unfolds as it does, we would look at the low stock price that we had over the last number of years, but it was unthinkable. In the future, who knows, but we certainly at this moment have no intention to do an equity offering.

Walter Spracklin - RBC

And you have no need for cash right now anyway, right?

Calin Rovinescu

No. We certainly have no need for cash. Look, our cash flow was at the end of the third quarter as again in second quarter was nearly $3 billion, highest cash levels in the history of the company. We certainly have no need for cash through an equity offering or otherwise. We have had fantastic access to other capital markets through debt offerings – unsecured debt offerings, WTC market, the U.S. term loan market, the U.S. high-yield market, lots and lots and lots of access to capital. But somebody would be foolish to say that you would never do something else. So, that was the context of the comment. Right now, sitting on $3 billion of liquidity at the end of the second quarter, clearly, there is no need for liquidity.

Walter Spracklin - RBC

That’s great. Thank you very much.

Operator

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Ms. Murphy.

Kathleen Murphy - Director, Investor Relations and Corporate Reporting

Thank you, Valerie and thank you everyone for joining us on the call today. Thank you very much.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.

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Source: Air Canada's (AIDIF) CEO Calin Rovinescu on Q2 2014 Results - Earnings Call Transcript
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