Air Canada's (ACDVF) CEO Calin Rovinescu on Q1 2016 Results - Earnings Call Transcript

| About: Air Canada (ACDVF)

Air Canada, Inc. (OTCQX:ACDVF) Q1 2016 Earnings Conference Call April 29, 2016 9:00 AM ET

Executives

Kathleen Murphy - Investor Relations

Calin Rovinescu - President and Chief Executive Officer

Mike Rousseau - Chief Financial Officer

Ben Smith - President, Passenger Airlines

Analysts

Konark Gupta - Macquarie

Andrew Didora - Bank of America/Merrill Lynch

Walter Spracklin - RBC

Cameron Doerksen - National Bank Financial

Turan Quettawala - Scotiabank

Helane Becker - Cowen & Company

Kevin Chiang - CIBC

Chris Murray - AltaCorp Capital

Tim James - TD Securities

Operator

Good morning, ladies and gentlemen and welcome to the Air Canada’s First Quarter 2016 Results Conference Call. I would now like to turn the meeting over to Ms. Kathleen Murphy. Please go ahead, Ms. Murphy.

Kathleen Murphy

Thank you, Mo and good morning ladies and gentlemen and thank you for joining us on our call today. With me this morning are Calin Rovinescu, our President and Chief Executive Officer; Mike Rousseau, our Chief Financial Officer; and Ben Smith, President, Passenger Airlines.

On today’s call, Calin will begin by highlighting our first quarter 2016 financial performance and progress made on our strategic initiatives. Ben and Mike will then address our first quarter financial performance 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.

As usual, I would like to point out that certain statements made on this call, such as those relating to our forecasted costs, financial targets 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 first quarter press release and MD&A for important assumptions and cautionary statements relating to forward-looking information and for reconciliations of non-GAAP measures to GAAP results.

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

Calin Rovinescu

Thank you, Kathy. Good morning, everyone and thank you for joining us today. We are pleased to report strong financial results for the first quarter of 2016, a quarter which, as you know historically, is one of our most challenging. For the quarter, we reported EBITDAR of $460 million, $18 million or 4% above last year’s record and more than 30% greater than analysts’ consensus estimates. We also continued to meet or exceed the financial targets established at our Investor Day last June.

On a 12-month trailing business, we achieved an EBITDAR margin of 18.3% against a target of 15% to 18%. We achieved a return on invested capital of 17.4% against a target of 13% to 16%. And we maintained our leverage ratio at 2.5x the same level as at December 31, 2015. In a quarter during which we took delivery of four new Boeing 787-9 aircraft and added almost $1.1 billion in total capital spend more than one third of our total capital spend for the year. These metrics are the main financial indicators we use to measure the continuing success of our long-range plan, which is focused on sustained profitable growth.

During the quarter, we also increased our revenue base, increased our unrestricted liquidity and increased net cash flow from operations. The transformation of our business model and the investments we are making towards building a sustainable, profitable business for the long term are delivering as planned despite unsettled economic times in Canadian resource markets, despite a highly competitive pricing environment and despite a continued weak Canadian dollar. All challenges we successfully overcame in the past quarter. We are showing that we can grow and grow profitably in both good times and weaker economic times. I’d like to thank our 28,000 employees for their unwavering focus in taking care of our customers and for their part in achieving these strong financial results.

I will now turn over the call to Ben and then Mike for a more detailed discussion of the quarter.

Ben Smith

Thank you, Calin and thank you all for joining us on the call this morning. We are pleased with the strength and flexibility of our business plan and overall strategy and we continue to take advantage of opportunities and course correct as we manage through the issues that cyclically occur in our industry. Our transformation plan calls for a focus on international growth, including connecting international customers to and from the United States through our Canadian hubs as well as strategically deploying Air Canada rouge in a profitable way to destinations now made viable by rouge’s lower cost structure and we are continuing to realize the benefits.

For the quarter, Air Canada delivered positive passenger revenue growth of $78 million or 2.8% on traffic growth of 7.7%. We are pleased with the overall traffic increases achieved in all markets this quarter. It should be noted that with the shift of the Easter holiday from April last year to March this year, premium traffic in the quarter was impacted in the last week of March, particularly on leisure routes. We have been better able to manage through the hurdles we faced last quarter, thanks in part to our increasingly diversified network and revenue base. And we are seeing continued optimization of our fleet and network to support our strategy. Our plan is working as we expected. The successful implementation of our business strategy of margin expansion anticipates a natural decline in yield, which is in line with expectations given yield is logically impacted by an increase in average stage length and having a higher proportion of seats in long-haul leisure markets and a higher proportional growth of international and sixth freedom connecting traffic. Combined, this enables us to continue to capture a larger share of global flows over Toronto, Montréal and Vancouver.

As discussed on prior calls international growth is being pursued on a significantly lower cost basis primarily through the introduction of Boeing 787 aircraft, increased seating on Boeing 777 aircraft and by increase in Air Canada rouge flying. All this allows us to compete more effectively and to expand margins. Our Boeing 777s are nearing completion of their configuration optimization and refurbishment program. And through a 14% growth in seat density, we will see additional efficiency gains in CASM reduction, not to mention the addition of our industry leading customer product offering on board that will help ensure Air Canada is best positioned competitively.

We are looking forward to fully realizing the benefit from efficiency gains and CASM reductions in the third quarter. Our Boeing 777 and 787 aircraft provide Air Canada with a very competitive, best-in-class mainline wide-body fleet, while the Air Canada rouge fleet, which will be at 44 aircraft by the end of June is allowing us to yield enhanced margins on existing and new leisure routes. Our combined fleet is becoming increasingly optimized, competitive and efficient. We are also very excited about the 61 firm Boeing 737 MAX aircraft we have on order and finalizing our order for 45 Canadian-made Bombardier CS300 aircraft. These aircraft are very well suited to our future network strategy and will result in further CASM reductions given the compelling economics of these aircraft.

Turning to the domestic market, domestic yield was under pressure in the quarter given incremental market capacity and aggressive pricing and trade incentive strategies, particularly in Eastern Canada. When compared to last year, we also saw a decline in higher yielding oil market-related traffic. However, as we said before, Alberta represents only a small portion of total system revenues. Domestic capacity increased 6.3% on a 2.3% decrease in frequencies in the quarter. This growth in capacity, which supports Air Canada’s international expansion strategy, was largely driven by the use of larger aircraft on existing transcontinental and regional routes. This increase in average departure size results in a much lower cost of capacity and improves the airline’s competitiveness in margins. Looking forward to the remainder of 2016, the year-over-year domestic industry capacity growth rate is expected to decline from first quarter levels.

In the U.S. transborder market, southbound leisure traffic was impacted by the Canadian currency. However, other transborder services did perform as planned. The Atlantic delivered strong results in the quarter with revenues increasing $58 million or 12.9% versus the same quarter in 2015. This performance reflected in large part the successful execution of our international growth plans, including the launch of new services to Delhi and Dubai from Toronto. We also experienced an improved premium cabin mix when compared to last year.

We were also extremely pleased with our first quarter performance on the Pacific, on capacity growth of 3.1%, passenger revenues increased $29 million or 7.7%. We recognized the growing importance of the Asian market and have been developing our franchise in China, Japan and Korea. These efforts are paying off with all of these services delivering exceptional results in the first quarter. In the other markets, comprised of Latin and South America, our Caribbean services saw strong passenger growth year-over-year led by lower cost rouge flying. South America, however, continues to be impacted by weaker economic divisions, particularly from point of origin Brazil. However, in line with our international expansion strategy, we are seeing growth in international to international traffic flows.

We are seeing general demand in line with our expectations and demand for premium economy and other new products is exceeding our expectations. As discussed on prior calls, our capacity additions this year are mainly in international markets where we are leveraging our new aircraft, improving cost structure and exporting our extensive and expanding global network. Our joint venture with Lufthansa and United remains a success and we continue to monitor the industry for additional partnership opportunities. We also continued to grow ancillary revenues through a number of channels in the quarter with ancillary revenue for passenger up 5% year-over-year.

I will now turn the call over to Mike for a discussion on our cost performance and balance sheet metrics.

Mike Rousseau

Thank you, Ben and good morning to everyone. For the first quarter, operating expenses increased $140 million or 5% from the first quarter of 2015, mainly on 8.2% increase in capacity and a weaker Canadian dollar, partly offset by a reduction in fuel expense. Adjusted CASM was above last year by 3.3% and significantly better than what we had projected in our news release dated February 17, 2016, which forecasted an increase of 7% to 8%. This improvement was primarily driven by, one the impact of less flying by our regional airline partners where their unit costs are generally higher given the typical – typically shorter stage length flights they operate. Two, the timing of certain aircraft maintenance events. Three, the impact of a stronger Canadian dollar versus what we had previously anticipated. And four, a number of other smaller operating expense reductions. Adjusted CASM would have been flat to last year had the Canadian-U.S. dollar exchange rate remained at the first quarter 2015 level.

Turning to fuel expense, we saw a decrease of $168 million or 25% from last year. A lower base fuel price accounted for a decrease of $238 million to fuel expense in the quarter, while a unfavorable currency impact and a higher volume of fuel liters consumed added $46 million and $14 million, respectively to our fuel costs in the quarter. With respect to hedging, fuel hedging, our strategy remains unchanged. We continue to use call options which protects us against short-term price spikes, but allows us to benefit 100% from a declining fuel price. Our target hedge ratio is approximately 40% of our planned fuel consumption, typically three months to nine months in advance of any given quarter. As of March 31, 2016, approximately 27% of our anticipated purchase of jet fuel for the remainder of 2016 was hedged at an average WTI equivalent cap price of $46 per barrel.

With respect to wages and salaries, these costs increased $34 million or 8% year-over-year on higher average salaries, which reflected primarily the impact of new collective agreements concluded in 2014 and 2015, an increase in crew training costs associated with our new Boeing 787 aircraft as well as a 3.7% increase in employee levels versus the first quarter of 2015. On a unit cost basis, this cost area only increased by 0.4%. And as you know, we have multi-year agreements with our main employee union groups which would provide wage cost certainty over the long-term.

There was an increase in ownership costs in the quarter comprised of depreciation and aircraft rent. This is an outcome of our fleet renewal strategy with eight new Boeing 787 aircraft since this time last year, an increase in expenses related to our aircraft refurbishment programs as well as additional leased aircraft, primarily Airbus 321s and Boeing 767 aircraft to replace the Embraer 190 aircraft, which are exiting the fleet. Other significant cost areas are discussed in our first quarter MD&A and for the most part reflected capacity growth and the impact of the weaker Canadian dollar.

Looking ahead, we are forecasting second quarter adjusted CASM will increase between 2% and 3% when compared to the same quarter in 2015, of which 1 percentage points to 2 percentage points is estimated to result in the weaker Canadian dollar versus the U.S. dollar. In addition the second quarter, we are continuing the conversion of the Boeing 777 aircraft into a more cost effective configuration, adding a premium economy cabin and refurbishing the international business class cabin to the new Boeing 787 state-of-art standard. We expect to complete the conversion by the end of June. Also, as you may recall, we recorded favorable tax related provision adjustments of $23 million in the second quarter of last year 2015, which we do not expect to record in the second quarter of 2016. These favorable tax related provision adjustments were included in last year’s EBITDAR results.

For the full year 2016, Air Canada expects adjusted CASM to decrease between 1.75% and 2.75% from the full year 2015. The value of the Canadian dollar remained at 2015 levels adjusted CASM for the full year ‘16 versus the full year ‘15 would be projected to decrease 2.75% to 3.75%. We have made certain assumptions as part of our forecast which are referred to in the news release we issued this morning.

Moving on to balance sheet and liquidity, we ended the quarter with unrestricted liquidity of $3.2 billion. Net cash flows from operating activities of $968 million in the quarter reflected strong operating results and improved $158 million compared to the same quarter in 2015. This increase in net cash flows from operating activities was mainly due to the impact of higher cash inflows of working capital and the impact of lower pension past service funding payments. During the quarter, we retired nine Embraer 190 aircraft and took delivery of four Boeing 787s for a total of 16 Boeing 787s in our operating fleet at March 31. We have taken delivery of two additional Boeing 787s since then and expect to take delivery of three more before the end of June.

Moving on to debt, as of March 31, our adjusted net debt of $6.3 billion increased $17 million from year end as the impact of higher capitalized operating lease balances, largely driven by additional aircraft leases in the first three months of 2016. And an unfavorable currency impact on aircraft rental expense was mostly offset by higher cash and short-term investment balances. Our adjusted net debt to 12-month trailing EBITDAR ratio was 2.5, unchanged from December 31, 2015. We achieved a return on invested capital of 17.4%, 220 basis points higher than the same quarter in 2015 and 840 basis points above our weighted average cost of capital. This is also above our stated goal of achieving a sustainable ROIC in the 13% to 16% range over the 2016 to 2018 period.

With respect to our previously announced share buyback program, Air Canada completed the purchase of its original allotment of 10 million shares under the normal course issuer bid. And Air Canada’s Board has authorized us to purchase up to an additional 5 million shares for cancellation. This program is in effect until May 28 of this year. Additional detail on our results for the first quarter can be found in our financial statements and MD&A, which are posted on our website and filed on SEDAR this morning.

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

Calin Rovinescu

Thank you, Mike. As I said at the outset, despite some manageable challenges outlined by Ben and Mike, the implementation of our long-term strategic plan with the sustainable and positive impact on our financial results is tracking favorably. This strategy is not dependent on oil prices remaining at current levels. We are delivering on a permanently lower cost structure while positively growing our business with a focus on our international network. We are indeed, in growth mode. The performance of Air Canada rouge continues to exceed our expectations and is allowing us to compete more effectively in leisure markets. New Air Canada rouge being launched this summer include Toronto-Prague, Warsaw, Budapest, Glasgow, Montreal-Casablanca and Vancouver-Dublin. Starting in May, we will launch new nonstop service between our four key Canadian hubs of Toronto, Vancouver, Montreal and Calgary and 12 U.S. cities. The new trans-border routes will introduce new destinations such as Toronto-Washington-Dulles, Toronto-Salt Lake City and Vancouver-San Jose while also creating new city pair routings such as Vancouver-Chicago, Montreal-Houston, Montreal-Denver, Toronto-Portland and Calgary-San Francisco. These new routes will support our international expansion by making it easier for international travelers flying to and from the U.S. to connect to our international network. In June, we will add Toronto-Seoul, Montreal-Lyon and Vancouver-Brisbane daily nonstop service to our growing network.

The next-generation Boeing 787-9 aircraft that entered our fleet in the quarter are providing us with significant productivity improvements, allowing us to offer customers superior comfort and amenities. This summer, we will be operating a total of 21 787s. Toronto-Istanbul will be converted to Boeing Dreamliner service, joining Toronto-Copenhagen, Zurich, Tel Aviv, Tokyo-Narita and select Toronto and Vancouver flights to London-Heathrow as well as Vancouver-Tokyo-Narita, Seoul and Brisbane. Calgary to Tokyo-Narita, London-Heathrow and Frankfurt will also operate with 787 aircraft this summer. Earlier this week, we announced the introduction of the only nonstop flights from Vancouver to Delhi to be operated with a 787-9 beginning this October in time for Diwali festivities. The seasonal three times weekly flights complement our very successful Toronto-Delhi nonstop service launched last fall. The new flight will offer the shortest elapsed flying time from Calgary, Edmonton, Seattle, Portland and Los Angeles to Delhi. The operating economics of the Dreamliner, together with the efforts of the Vancouver Airport Authority who have maintained the airport operating costs at levels amongst the lowest in Canada, have enabled us to grow our Vancouver hub. Together with our extensive western Canadian domestic and Western U.S. trans-border network, combined with the seamless connection experience through Vancouver’s U.S. in-transit pre-clearance facilities. Vancouver is positioned to be the preferred western gateway hub for transpacific travel to and from North America.

As we said, on these last couple of calls, over the last couple of quarters, we are seeing weakened demand in Western Canada due to the downturn in Canadian resource markets. But demand remains at our expected levels in the rest of the Canadian market. We have tremendous flexibility in our fleet to adjust aircraft, modify gauge and shift capacity to other markets to better match demand. We have very recently done just that. We successfully shifted capacity from the Atlantic to the Pacific to respond to specific areas of strength for the summer season.

Advance booking levels are at our expected levels. We now have flexibility in our fleet to manage through a drop in demand for recessionary or other reasons as the combination of unencumbered and leased aircraft in the fleet account for more capacity than we eliminated during the entire financial crisis of 2009. By mid-2016, we will own outright 22 of our older wide-body and narrow-body aircraft comprised of Boeing 767s, Airbus A330s and A319s. We also have leases for 18 narrow-body aircraft which expire over the short-term in 2016 and in 2017. Furthermore, we have deferral rights associated with the Boeing 737 MAX order. As a result of this added stability and other transformational changes we have made to our company, we are confident we could manage through whatever headwinds could buffet the industry, including ongoing softness in Western Canada and an eventual rise in fuel prices.

As you all know, we announced in February an LOI for the purchase of up to 75 Bombardier CS300 aircraft as part of our narrow-body fleet renewal plan. We were the first major North American airline to make this decision. Subject to final documentation and satisfaction of conditions, we look forward to firming up the order soon. The announcement made yesterday of a major order for the C Series by Delta Air Lines is great news for Bombardier and confirms that our confidence in this new next generation technology was well placed and will benefit us well into the future.

We have now set our expectation and are forecasting for the first time full year EBITDAR. In 2016, we are forecasting that this will increase between 4% and 8% over last year. This growth would set yet another record for Air Canada underscoring the effectiveness of our long-range plans, new fleet, density enhancement and overall improved competitive position. We continue to believe we have the right strategy in place to continue towards our goal to make Air Canada a sustainably profitable global industry leader and a company that shareholders will want to own for the long-term.

Thank you for your attention and we will now open it up for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question is from Konark Gupta from Macquarie. Please go ahead.

Konark Gupta

Good morning, gentlemen and congrats on a good quarter.

Calin Rovinescu

Thank you, Konark.

Konark Gupta

Couple of questions on the quarter and outlook. So, on the first quarter, what really surprised you on the CASM side, because the real CASM actually came in much better than what you previously guided. So, was there any kind of sustainable kind of cost reduction that we can see going forward as well as was there any kind of major timing issue on the cost which kind of moved from first quarter to the second quarter?

Calin Rovinescu

So, we always have – I will let Mike give you a bit more of an analysis, but we always have opportunities around our maintenance expenses. And what we have been doing better over the last several years is structuring our maintenance expenses, so that they are over the course of the entire year over several quarters. So, we did have the benefit of lower maintenance expenses in the first quarter. That was a factor. And again, as we start getting new aircraft in, maintenance expenses will continue to go down. If you are looking for sort of sustainable trends as to what is changing in the picture, we have the configuration, which of course is a long-term cost reduction as well as new aircraft which will reduce maintenance costs going forward.

Mike Rousseau

Let me just add a couple of other points. As you know, we have had a very, very strong discipline around cost management and we certainly pushed our entire team in Q1 or just before Q1 looking at opportunities. And so to Calin’s point, we did have some savings in maintenance and we also pushed some maintenance into other quarters, approximately $30 million. But beyond that, there were sustainable savings in maintenance. Second of all, certainly the Canadian dollar has performed better than we expected and many in the industry has expected. And so that helps us as well from an adjusted CASM perspective. And assuming the dollar stays where it is, our new adjusted CASM results – or our guidance reflects that. And third but not least, we saw an opportunity to upgauge some of our frequencies from regional flying to mainline flying. And Ben spoke about that to some degree where our capacity in Canada was up, but our frequencies were down. And that opportunity provided us a lower overall CASM or adjusted CASM given that our regionals typically fly at a higher CASM than mainline. And then beyond all that, there were a series of other opportunities we saw that our teams saw and we took full advantage of that will also have some benefits into the next couple of quarters, but again, a lot of that’s reflected in our updated guidance on adjusted CASM.

Calin Rovinescu

And then also, Konark, another way to think of it is that as we have been adding this capacity typically being very, very efficient capacity inside. There have been more seats on the same airplane without having an extra airplane, without having an extra departure, without having the extra costs involved with all of that. And now we are still in the early innings of dealing with the cost side of these transformations. So, we think that the cost reductions will continue to be there. Our operating folks are adjusting to the new reality of dealing with aircraft that have more passengers on them. And so we are quite confident that, that cost reduction is a sustainable trend.

Mike Rousseau

And I just want to clarify. I mean, our regional partners played an integral part in providing traffic to our major hubs and they actually grew year-over-year, but they grew less than what we initially anticipated in our overall guidance.

Calin Rovinescu

Yes. And Ben with the...

Ben Smith

Yes. Hi, it’s Ben. Just another key thing to note is as rouge expands, I mean, we are going to be at 44 airplanes by June of this year, the lower cost platform that it provides to us is enabling us to run utilization rates in Q1 and in Q4, and to a lesser extent, Q2 at a level that was never available to us in the past. And that is driving CASM down. So that is a shift change, a step change in our CASM, which you should expect to see next year. And then as we continue to optimize, we will see that going forward. Something that we have this year that will diminish next year is we had a disproportionate number of 777 aircraft out for reconfiguration, which does drive lower utilization of these aircraft we are sitting, but they are all going to be finished by – finish the refurbishment by June of this year. We do have some maintenance next that we will be going through but nowhere near at the levels that we have this year. So, that was a one-time hit to utilization that brought down the benefit, say, in – if you are comparing it to rouge for Q1 of this year.

Konark Gupta

Okay. So just to follow up Mike on that $30 million maintenance that you moved to other quarters, is that going to be mostly in second quarter?

Mike Rousseau

Yes. Most of that is going to be second quarter, a little bit into the third.

Konark Gupta

Okay, thanks. And on the stage length, I noticed the length was not up so much as much as I expected, was up only 1 point, some 3% or something. So what happened there? Have you – you have been running about 3% stage length increase for the past couple of years. So, have you pulled back some long-haul flying in the quarter or was there any other event?

Calin Rovinescu

No. No, I think that’s to Ben’s earlier comment that we had a bunch of triples being reconfigured, so they were out of the fleet.

Konark Gupta

Okay, I see. That makes sense. Okay. And on capacity, I know you are obviously not providing capacity guidance. But directionally, as you sort of add lot of capacity to Atlantic market this summer with new routes and frequencies, do we expect capacity growth to directionally accelerate in the summer from first quarter?

Calin Rovinescu

Yes, I think that’s a fair assumption to make.

Konark Gupta

Okay, thanks. And finally, Mike, I noticed on the transborder side, the yield I get it, they were weak obviously because of the stage length and all those things. But the PRASM, which is obviously more and more meaningful, was quite down versus the prior few quarters. So, what really happened there on the load factor side? Are you kind of seeing any weakness in the forward bookings on the U.S. transborder side as well?

Ben Smith

Hi, it’s Ben. I think what you are seeing is as we start to have a larger fleet of 767s at rouge, those airplanes in Q1 are predominantly flying U.S. on rouge into Hawaii as well as the Caribbean. And the large economy cabins on those aircrafts obviously are driving lower PRASMs, but the CASM offset is driving the higher margin. So, you have to look at it from a margin perspective. That’s how we are looking at it.

Konark Gupta

Okay, that makes sense. Thanks a lot guys for the color. Thanks.

Operator

Thank you. A following question is from Andrew Didora from Bank of America-Merrill Lynch. Please go ahead

Andrew Didora

Hey, good morning everyone. Thanks for the questions here. I guess Calin and Ben the theme of weight has been a tough pricing environment coming out of all the U.S. carriers, they have spoken about weak closing yields and I think IAG said some softness in underlying premium demand earlier today. I guess two questions, one are you seeing similar types of pricing behavior, particularly on your international routes. And then second, is your networking cost structure now at a point where you think you can take share in a tougher pricing environment?

Calin Rovinescu

Yes. I mean I will do the second part of that first. The answer is absolutely yes. We feel we can’t take share in a tougher pricing environment because we do have a completely different cost dynamic than we ever had before and with different flexibility and different fleet type than we ever had before. So we are seeing that. The numbers that you have seen in this first quarter are evidence of that. The number that you saw last year are evidence of that. So there is no question that, that dynamic is occurring. That dynamic is occurring over the Atlantic, over the Pacific and in virtually all markets, sun markets as well. So you have the ability to compete with a lower cost product and we are now in – still early innings, I would say, because we don’t have all of our 787s in. We don’t have our entire rouge fleet yet fully deployed. But the answer to that is absolutely yes. In terms of your – the first question as to what we are seeing in terms of yields closer in, Ben, do you want to comment on that. Obviously, we are not providing that level of guidance. So to be very frank, we are going to be measured in our comments here, but we will see what we can do here.

Ben Smith

Definitely, as I mentioned in my remarks earlier, we had – we have seen and witnessed some very aggressive pricing domestic Canada because of a slowdown in Alberta. And we have seen that through pricing, through trade incentives, through, I would say, market promotions that we haven’t seen in a long time. But we had seen them the past. And I think one of the advantages we now have is we have a much more diversified network. And we do have a cost platform, not only on the lower end leisure side, but also a best-in-class premium offering, which enables us to source traffic from throughout North America in a way we never had before. So I would say we are in a much lower risk situation than we have been. We have witnessed and we have been part of many downturns, many very difficult pricing environments. And I would say being in this business a long time, seeing the tools that we have today, you can see the result that we had in Q1. If you had taken us back 5 years, 10 years, we would not have been able to get that kind of performance with the old tools that we used to have. So yes, we are witnessing what you described, but we are able to much better manage.

Andrew Didora

Okay, great. Thanks for that. And then my second question, just in terms of rouge, I think you said you are happy with your bookings right now. But when you look out towards your summer bookings, are they – are volumes up, how do yields look in that type – in that business and what markets do you see as the biggest headwinds and tailwinds? Thanks.

Ben Smith

Yes. Hi, it’s Ben again. Well, Q3 is historically our strongest quarter. And all indications now is it will be another strong quarter for us. Canada is usually an excess demand, both in – throughout domestic Canada, into Canada, out of Canada. We are seeing Europe, a few small headwinds, but nothing for us to be concerned about. We are seeing an overall strong market. The Pacific is very strong. As I mentioned, point-of-sale Brazil is a bit weak, not a big amount of capacity for us there. We are seeing strength in the South Pacific. U.S. is very strong, especially with the dollar. So overall, we are quite bullish on Q3. We have put a lot of effort and a lot of analysis into where best to deploy our capacity to achieve maximum margin expansion. So I would say with the fleet that we have, which is going to be nearing completion of its optimization in June, I would say there are many more tailwinds than headwinds.

Andrew Didora

That’s great. Thanks guys.

Calin Rovinescu

Thanks Andrew.

Operator

Thank you. A following question is from Walter Spracklin from RBC. Please go ahead.

Walter Spracklin

Yes. Thanks very much, very good quarter everyone. I was wondering if I could drill down a little bit on the – not so much going forward at this point for pricing, but the historical. I know you have often mentioned very accurately there, that is a logical. The declines in yield are a logical representation of your strategy, which includes both rouge and international. But you also pointed to some aggressive pricing in domestic Canada, I was wondering Ben, if you could – is there anyway to take that 5% and really break it down between those key factors between, call it core price and then mix?

Ben Smith

Yes. For competitive reasons, we don’t like to get into that kind of granularity.

Walter Spracklin

Okay. Going forward then, on domestic Canada, you are seeing – you mentioned that WestJet is being fairly aggressive, are you – as they conclude their wide-body flying in preparation for international, are you seeing some of that competitiveness start to come off a little bit in the second quarter or into the third quarter on your domestic Canada?

Ben Smith

Well, you can see publicly the capacity gets loaded into the domestics system on the publicly available channels show as a decrease in the rate of year-over-year increase. So we are expecting a reduction in the year-over-year amount of domestic capacity increases. As I said, Q3 we are quite bullish. Q2, there is still some hefty discounting going on that we are seeing similar to Q1 in the East as well as Alberta. But as I said, we have been through some very deep downturns in our history. I think there are some other players in the market that have not seen this in their history, so they are just learning how to do that. And luckily, we are happy to see some rational behavior starting to come back in the market.

Walter Spracklin

Okay. And just last question here maybe for you, Calin. Bigger picture, now as you get the new aircraft on the passenger side in place and your strategies unfolding as expected, do you start to look beyond now of new opportunities for Air Canada and I know you have announced some new partnerships there with Cargojet and just curious if there is anything that you might be looking at longer term that would be incremental to what you are achieving on your core business?

Calin Rovinescu

No. Look, there is no question that as we get stronger and as we roll out the rest of this strategy, we will be looking for the next level of opportunities. Things like Cargojet was at this stage, relatively small, but it’s an interesting opportunity for us to leverage our cargo business in a way that we really can’t ourselves. We are no longer in the freighter business. And we don’t expect to get back into the freighter business. But with that partnership, it enables us to capture a greater share of revenue that we otherwise would have to leave behind. So we are going to look for tactical opportunities like that in the short-term. And then longer term, after we have completed our 787 – all the 787s are in the fleet. And after we complete rouge, for sure we will be assessing whether there are strategic opportunities available to us.

Walter Spracklin

Okay, that’s all my questions. Thanks very much.

Calin Rovinescu

Thanks Walter.

Operator

Thank you. Following question is from Cameron Doerksen from National Bank Financial. Please go ahead.

Cameron Doerksen

Yes. Thanks. Good morning. I guess my question is just on the full year cost guidance, I mean it does sort of imply we are going to see some pretty meaningful year-over-year declines in Q3 and Q4. Obviously, you have mentioned the maintenance expense is going to be lower in the second half of the year, is there anything else in the second half of the year from a cost perspective that’s going to be lower versus what you saw in the – or seeing in the first half of the year?

Mike Rousseau

Cameron, it’s Mike. Not off the top of our heads. I think maintenance was one aspect. And certainly I think the dollar will level out because – year-over-year as well. And of course, as we spoke about earlier in the call, capacity will increase in Q3 and Q4 versus Q1.

Calin Rovinescu

Which will bring the EBITDAR, this will bring the unit costs down fairly dramatically. And as you know, that has historically been the challenge that we put a much less capacity in the first quarter. And so by definition, the CASM numbers in the first quarter are skewed.

Cameron Doerksen

Okay, makes sense. Just second, just modeling question, really, just on aircraft rent, is the Q1 run rate a good rate to use?

Mike Rousseau

Yes, it would be – I think it would be a proper proxy for the rest of the year.

Cameron Doerksen

Okay, that’s all for me. Thanks very much.

Calin Rovinescu

Thanks.

Operator

Thank you. A following question is from Turan Quettawala from Scotiabank. Please go ahead.

Turan Quettawala

Yes. Good morning. I guess my first question, just want to get a sense on the capacity. I know you are not giving guidance anymore, but have they changed meaningfully from what you were thinking about maybe at the beginning of the year?

Mike Rousseau

What guidance are you talking about?

Turan Quettawala

I am sorry. No, I am just wondering about your capacity plans. I know you don’t give guidance anymore obviously, but have your plans changed materially from what you were thinking about at the beginning of the year?

Mike Rousseau

They have been tweaked a bit, but not – no, not materially...

Calin Rovinescu

Not materially.

Turan Quettawala

Okay, great. And I guess my next question was on if I look at your margins then sort of adjust for both fuel and FX, it’s down I guess pretty meaningfully on a year-over-year basis. And I know there is a weak demand environment there that’s obviously impacting you guys as well. If fuel starts to creep up here and maybe the demand doesn’t improve as much, at what point are you going to be thinking about using that flexibility maybe that you always talk about in terms of your capacity?

Mike Rousseau

Well – again, Turan, it’s Mike. We obviously monitor the situation very, very closely. We have the benefit of seeing out 3 to 6 months with our booking curves. So, we have the opportunity to react before the market may see it. We are not seeing any reason to react at this point in time. And – but certainly, we have been very transparent with the market as to how flexible we can be and we certainly our past practice has been to adjust as quickly as we can should market situations change. And so there is no reason that won’t continue.

Calin Rovinescu

We are not seeing that now.

Mike Rousseau

We are not seeing it now.

Turan Quettawala

Yes. But your margins are going down, right?

Mike Rousseau

Well, margins didn’t go down in Q1, Turan.

Turan Quettawala

Well, if you adjust for FX and the fuel...

Mike Rousseau

But again, Turan, we talked about this offline. We don’t think that’s in our proper analysis. There is a lot of other factors that are associated with the fuel and FX environment that have to be taken into consideration when you do a proper review of margin expansion.

Turan Quettawala

Okay, fair enough. I guess maybe last question on the sixth freedom strategy here, maybe Ben can comment on this. Do you think the Canadian dollar change is going to have any impact there? I know the lapse times are pretty good for you guys, but maybe can you talk about how the dollar might make an impact there?

Ben Smith

It’s actually positive for us from a sixth freedom perspective. The point-of-sale U.S. and point-of-sale Europe and point-of-sale Asia revenue, in most cases, that will be more valuable to us. And as you know, other than fuel and aircraft rent, a lot of our expenses are in Canadian dollars. So, it’s margin-enhancing.

Turan Quettawala

I guess I meant if the Canadian dollar keeps appreciating here.

Ben Smith

Well, then that goes the other way.

Turan Quettawala

Okay, fair enough. Thank you.

Operator

Thank you. A following question is from Helane Becker from Cowen & Company. Please go ahead.

Helane Becker

Thanks, operator. Hi, everybody. Thank you very much for the time. Just a question on the cargo business that the joint venture you are just talking about, I don’t know if you want to call it a JV or whatever that opportunity you are thinking about. Who is responsible for the sales for that? Is that your sales force or their sales force? Like, how do you force the cargo?

Calin Rovinescu

It’s our – you see this would be cargo that we would source ourselves through our folks, our people. And they would operate it on their cargo aircraft, which of course we don’t have dedicated cargo aircraft at this time. So, it really is a really interesting opportunity for us as – to partner with somebody who has a cargo aircraft, lower cost, has – is available at times of the week that is not needed for the rest of their operations. So, it’s really a good win-win opportunity for both them and us.

Helane Becker

And is cargo...

Ben Smith

Helane, it’s Ben. One way to look at it simplistically is it’s you can maybe compare it to a regional CPA but for cargo.

Helane Becker

Okay, alright. And it’s just cargo that you couldn’t handle on your own aircraft in the belly, is that it? The opportunity for cargo is just so great?

Calin Rovinescu

Exactly, yes.

Ben Smith

Yes. So, looking at feed from points that we don’t have capacity and we are able to get feed from this partner of ours now on to our main trunk routes. So, it’s just – it’s value added.

Helane Becker

Okay. And that revenue shows up in just the other revenue? Is that where we are going to find it or are you going to have a – is there going to be a separate line item for that? How should we...

Calin Rovinescu

Yes, but it’s not a small to be segmented.

Mike Rousseau

Yes. We do have a separate line for cargo, so it maybe – I think it’s going to be segmented or rolled up in the cargo revenue line.

Helane Becker

Okay, alright. So, that’s fine. So, it won’t show up like where you have regional airlines expense or anything like that? It will just show up as a net number in cargo.

Mike Rousseau

Yes, I am not sure of the accounting yet, but again, it’s fairly small to Calin’s point. At this point in time, we expect to grow it over the next little while, but we will confirm to the market where those – how we do the accounting for it in the next couple of quarters.

Helane Becker

Perfect, okay. Thank you. And then my other question, on your aircraft utilization, it was up about 1%. Is that kind of the max, not – almost 10 hours or can you push that aircraft utilization up if the demand is there?

Ben Smith

Helane, that’s a great question. It’s definitely not at its peak, because we had a significant number of 777 aircraft out for refurbishment and optimization of the interiors over the quarter. That obviously brought the utilization down. As we reassert our position in a profitable way in the regional markets – or sorry, in the leisure markets, we expect the rouge utilization to go up. So, combination of mainline and rouge, we see further opportunity for higher utilization rate, especially in Q4 and Q1. In Q3, I think we are pretty close to tapped out.

Helane Becker

Okay. And then I didn’t see your on-time performance, but certainly, your expenses were very good in the quarter. And I am just wondering did you have a better than normal winter in Canada this winter that helped that, do you think?

Calin Rovinescu

No, I would say marginal. That would not have been a big factor here, Helane. I think that you occasionally will see when you have a terrible winter in terms of the access to sun destinations and all that, but this year, I would say that it was marginal.

Helane Becker

Okay. And then my final question, promise, is on Cuba, you guys have a – pretty much a good business there. And as the U.S. carriers start to think about flying into Cuba, is there a risk? I mean, do you get cross-border travel for Americans going to that market or is that just not doable?

Calin Rovinescu

No, many Americans would not have gone to Cuba on a regular basis, because the restrictions that existed before. So, we think that the business that we have had has largely been Canadians and that business will continue. For sure, there will be some increased traffic. There will be a competition for hotel properties and that sort of thing. We have had international traffic connecting through Canada and some of that international traffic could in theory go over the United States. But we are pretty confident, we have a good franchise into Cuba and we will compete aggressively to continue keeping it.

Helane Becker

Okay, thank you very much.

Operator

Thank you. A following question is from Kevin Chiang from CIBC. Please go ahead.

Kevin Chiang

Hi, thanks for taking my question and congrats on a good Q1 there.

Calin Rovinescu

Thank you, Kevin.

Kevin Chiang

Maybe just following up on some of your prepared remarks it’s that you called out the competitive pricing that you are seeing in both the domestic and transborder markets. So I was just wondering as you kind of work through this year, have you seen that accelerate to the downside or things kind of flattened out there from a competitive pricing perspective? And maybe just with the CAD bouncing off the bottom here, I know there was concerns when the dollar was $1.40 of transborder traffic. Are you seeing some of that reverse in your booking curve or is this too early at this point in time?

Ben Smith

So, first part of your question, as I say, we are definitely seeing the right things taking place in the domestic market. We are seeing our competitors adjust like us. So, the market is adjusting to the situation in Alberta and in the East. So, our expectation right now and our forecast is the domestic market should improve over time. That’s how it’s looking right now. That’s how it’s trending. Q3, we are expecting a strong Q3. And in the U.S., we may make some tweaks. If the Canadian dollar stays relatively high, we may move some of that leisure capacity more to the Caribbean, but there always is and we expect there to be a continued strong demand to the South in the Canadian winter, moving forward to Q4 later this year.

Kevin Chiang

Okay. And this is general transborder traffic, Canadians flying into the U.S. with the dollar moving up here, has that materialized in your booking curve at all or is that still too early?

Ben Smith

A little bit. Not as – actually, we were expecting more. So, when we were modeling out different scenarios with a low Canadian dollar, the expectation of the impact on U.S. transborder, we expect it to be greater and it’s proving to be resilient, especially in areas where Canadians own property in Florida, Arizona parts of California, where the largest expense item is already paid for. The air ticket is bought in Canadian dollars. We didn’t see any kind of reduction that you might see in other areas like, say Orlando or Las Vegas where it’s a different type of traffic mix. But we are seeing very – or we did see in Q1 very strong demand continuing in Mexico, Caribbean, etcetera.

Kevin Chiang

Okay, that’s helpful. And just last one for me. I noticed your Atlantic yields in Q1. I think on a stage-length adjusted basis, they look like they were roughly flat year-over-year, I know you are putting up a lot of capacity there through rouge, I am just wondering are you starting to see a stabilization in Atlantic fares on a year-over-year comparison or is the Q1 results a bit of an anomaly and as you add capacity through the rest of this year we will kind of see the trends we saw last summer from a yield perspective?

Ben Smith

I think that’s a really important question because we now have a much lower cost platform. And we do have a more competitive business class product offering and we have the right transit programs in place at our key airports. The pockets of market demand that we can go after in a profitable way, in a margin expanding way is very unique to Air Canada versus our other North American and international competitors. So we don’t look at – most of our North American competitors and some of our European competitors are really – they are staying status quo and they are trying to maximize margins by optimizing what they already have. We are transforming our business, which is changing the landscape for us. And as you are seeing in Q1, it’s resulting in a much stronger performance. That’s what we are expecting going forward. And we will adjust accordingly because margin expansion is the number one thing we are after, but we do have a very different company to work with now.

Kevin Chiang

That’s great color. And again congrats on a good Q1.

Operator

Thank you. A following question is from Chris Murray from AltaCorp Capital. Please go ahead.

Chris Murray

Thank you. Good morning. Guys, just thinking about the sixth freedom traffic and I guess what I am trying to get my head around and we have had lots of discussion about the Canadian marketplace, but if we think the capacity growth and probably correspondingly traffic growth will be, call it high single-digits this year, how much of that traffic is really going to get driven either through Toronto or Vancouver, I guess as you expand Vancouver internationally, like how should we think about kind of the ratios of how the business evolves over the next couple of years?

Calin Rovinescu

Let me start first and I will ask Ben to comment. Look, I think that when you think of this strategy, execution obviously is key. And I think you go back to where we started, say 5 years ago and you look at what has occurred in each of these sixth freedom markets and what has been the success in attracting that kind of traffic, what kind of decisions are you making as a company in terms of how you distribute the product, how you market the product, how you advertise the product, how you sell the product and assess success. I mean anybody can come up with an idea that you are going to attract traffic from the United States, that doesn’t mean you are going to be successful at it. And so what we have been doing over the last number of years is building our – all of our strategies around that and that’s not something that happens overnight. It depends on how you schedule your flights. So the network has to be consistent and fit in with some of these international opportunities that you have from these hubs. You have to be able to market it. You have to be able to get into the corporates, into these markets, etcetera. So this has been a – this is not an overnight kind of idea. Somebody didn’t just wake up one morning and said, hey that will be a really nice way of doing it. We are quite confident that we are going to be able to execute that. And as we put it, like for example, Delhi is a good example of that in Vancouver. As we launch something like Delhi, there are going to be incremental trans-border flights that are going to be put in there to feed some of that traffic. So I think that the way to think of it is that we are going into these – some of these new international markets with the expectation that we are going to be able to take some traffic from the United States. And that is part – a clear part of our business strategy. And everything that we are doing is consistent with driving that sixth freedom flying. And Ben, do you want to add something to that?

Ben Smith

Sure. I will just add a few more points to that. For 20 years or even more, we had a model that was not optimal to fully take advantage of all the opportunities into and out of Canada. So we disproportionately were affected by some very strong European and Asian competition as well as even out of the U.S. So through this transformation, which we are not – has not been completed yet. But we are well on our way. We are now able to participate in market flows in a profitable way that we never were able to in the past. And with some of the tool that you have heard about on previous calls, the new O&D management system that we now have in place, we can optimize which traffic flows we select to carry, be it point-of-sale in Canada, U.S., international. And the United States market is 10x to 12x larger than the Canadian market. And the amount of capacity that we are putting in on rouge where we have a geographical advantage is proving to be the right strategy for us. And because we had ceded so much market share over the years to foreign carriers into and out of Canada, now with the right tools where we can profitably go back after that share. We are seeing all kinds of opportunities far in excess over the amounts of capacity we are putting in. So it’s a pretty exciting time for us.

Chris Murray

Okay, great. That’s interesting. Just I guess maybe turning to the balance sheet and Mike I guess maybe we can talk about this, but I look at your cash position at the end of Q1 and I think it went back to – even since the IPO, it’s probably the highest cash position you have been sitting at right now. And I think about your level of capital spending this year and some puts and takes, so just I guess a couple of questions on this. At the current cash level you have got, I mean I know the NCIB expires at the end of May, but any further thoughts on maybe what you do past that. But also, just making sure that I understand the numbers, realistically when you think about your capital spending – but I think you have also alluded to the fact that you have got some pension payments that you are not going to have to make like cash pension payments and I think there is also the sale of the 190s, I just want to talk about that and some sale and leasebacks, like what are – reasonably, when do you think you are going to be free cash flow positive again when – as it comes through this?

Mike Rousseau

Good morning, Chris, this is Mike. So let me deal with the easy part first. On the NCIB, you are absolutely right. Our current program ends at the end of May. But we did signal in the last press release we issued where we talked about how many shares we bought that we would talk to the Board about it. And the Board will make that decision in the next couple of weeks as to whether to expand the program or renew the program as is. And so we will provide that visibility to the marketplace when the Board makes that decision. On a more broader question about cash flow, so certainly our cash levels, you are absolutely right are probably the highest we have seen in quite a while and probably higher than what we need. And we talked about that over the last couple of quarters. It’s certainly a nice problem to have and we will utilize that cash, excess cash over the next 8 months to 12 months as we best see fit to deploy. On the free cash flow type question, again we don’t provide guidance that would be giving you an EBITDAR number. We have given you an EBITDAR number for this year, a range certainly. And so you can determine what the cash flow impact would be in 2016. Certainly, our capital needs dropped by several hundred million dollars next year and so it’s difficult for me to say or impossible for me to say whether we will be free cash flow next year. But again, if we decide to provide guidance next year on EBITDAR, you will be able to determine that number next year as well.

Calin Rovinescu

And Chris, this is Calin. Let me just add one or two other thoughts. So when you think of it, you get through this high capital intensive period where we are re-fleeting the airline and so we will end up having spent that $8 billion of capital over the next several years. This year, $3.3 billion, whatever it is.

Mike Rousseau

$3.1 billion.

Calin Rovinescu

$3.1 billion this year. And when you get through that period and you will have an airline with a very, very new fleet, we are still sitting on good cash levels, having had some opportunities to have reduced our level of indebtedness and having had some portion of our liquidity used for a buyback program. So my expectation is that as we get through this re-fleeting program, we are still going to have high cash levels. That’s one of the things that I am very pleased with for this quarter despite having spent – as I said in my introductory remarks, despite having spent $1.1 billion, we are still at the highest cash levels in the company’s history. So that’s a pretty good place to be and that all goes well for us as we get into the rest of this year. We have some opportunities to reduce some of our indebtedness in October and we will consider that carefully then.

Chris Murray

Okay. And just maybe a couple of follow-ups here, just – so the run rate that we saw on Q1 on the pension cash, that’s fair to think that would be run rate for the year?

Mike Rousseau

Well, I think we have slightly revised our pension cash outflow. I think it’s about $90 million, $94 million right now. And so I think Q1 was a little bit heavier. It was like in the mid-30s. So again, for the year it’s going to be $94 million.

Chris Murray

Okay. And then just thinking about – I think you have got some aircraft sales this year and some leasebacks, with Delta taking the C Series and canceling the purchase of the E190s from Boeing, does that impact you at all?

Mike Rousseau

No.

Calin Rovinescu

No. Take or pay in our case.

Chris Murray

Okay. No, that’s good. And then the other thing, just in terms of sales and leaseback, I think you have mentioned that you are going to do a couple of 787s coming in, and that should have cash inflow, I guess two questions, should we expect that will be kind of normal course in a certain ratio of the 87s as they come in through ‘17 and ‘18 as well?

Calin Rovinescu

I think that’s a fair assumption, Chris. And you are absolutely right. We are going to do two sale leasebacks this year of 787s, I think in May roughly. And that will provide a fair amount of cash to the company. And we will probably do something similar next year certainly, and ‘18 is a little farther away. But we have always said that the 37 787s, a small percentage will be sale leaseback and majority will be debt financed. And we still are moving towards that – to that end.

Chris Murray

Okay, great. Thanks guys.

Calin Rovinescu

Thanks Chris.

Operator

Thank you. [Operator Instructions] A following question is from Tim James from TD Securities. Please go ahead.

Tim James

Thanks. Good morning. Congratulations on a great quarter. Just wanted to go back to the comment regarding the Easter and the timing of that this year relative to the previous – well, to last year in particular. I think it was mentioned it had a negative impact on premium economy – or sorry premium cabin revenue. Presumably a bit of an offset there in the economy cabin, I am just wondering if you can indicate whether the net impact of that change in Easter was positive or negative on the quarter or immaterial really?

Mike Rousseau

Slightly negative.

Tim James

Okay. Then just returning to the balance sheet, just looking at longer term here, Mike you have got the net debt to EBITDAR goals, just thinking beyond that, again when free cash flow is certainly in my view, becomes very positive, I mean are your goals for further de-leveraging, I mean potentially an investment grade credit rating down the road or – there was a comment earlier about sort of always having eyes open for other growth opportunities, I mean at that point, do you feel you want to further de-lever the balance sheet once you get to that point towards the end of this decade?

Mike Rousseau

Tim, it’s Mike, I think that’s a fair direction for us to move into. I don’t think we have a burning desire at this point in time to become investment grade. That would take a leverage ratio probably south of one. And when we get to the end of ‘18, we will be at 2.2. But certainly, further de-leveraging between 2.2 and 1, it would be an objective of ours.

Tim James

Okay, great. Thank you.

Operator

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

Kathleen Murphy

Thank you, Mo and thank you, everyone for joining us on our call today. Thank you very much.

Operator

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

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