2018 ANNUAL REPORT - Air Canada

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2018 ANNUAL REPORT

2018 ANNUAL REPORT Management’s Discussion and Analysis of Results of Operations and Financial Condition1. HIGHLIGHTSThe financial and operating highlights for Air Canada for the periods indicated are as follows:Fourth Quarter(Canadian dollars in millions,except where indicated)2017 (1)2018Full Year Change20182017 (1) ChangeFinancial Performance MetricsOperating revenuesOperating incomeIncome (loss) before income taxesNet income (loss)Adjusted pre-tax income (2)Adjusted net income (2)Operating margin %EBITDAR (excluding special items) (2)EBITDAR margin (excluding special items) % (2)Unrestricted liquidity (3)Net cash flows from operating activitiesFree cash flow (2)Adjusted net debt (2)Return on invested capital (“ROIC”) % (2)Leverage ratio (2)Diluted earnings per shareAdjusted earnings per share – diluted 85812.6%2.1 (0.85) 0.20 ) pp6.5%8.4%521222,8512,92813.6%(0.8) 43)1847911,0566,116(258)5,8586,11615.3%(2.7) pp12.6%15.3%2.12.12.10.02 (0.87) 0.60 7.31 0.22 (0.02) 2.45 4.11 Operating Statistics (4)Revenue passenger miles (“RPM”) (millions)Available seat miles (“ASM”) (millions)Passenger load factor %Passenger revenue per RPM (“Yield”) (cents)Passenger revenue per ASM (“PRASM”) (cents)Operating revenue per ASM (cents)Operating expense per ASM (“CASM”) (cents)Adjusted CASM (cents) (2)Average number of full-time equivalent (“FTE”)employees (thousands) (5)Aircraft in operating fleet at period-endAverage fleet utilization (hours per day)Seats dispatched (thousands)Aircraft frequencies (thousands)Average stage length (miles) (6)Fuel cost per litre (cents)Fuel litres (thousands)Revenue passengers carried (thousands) (7)1,813(197)(881)(1,862)(213)(468)(1.9) pp(77)(2.2) pp1,544(43)(265)(258)(2.7) 419,39624,19180.2%17.614.115.815.211.3% Change7.25.81.1 210.685,137103,49282.3%17.114.115.714.410.6% Change8.57.11.0 62.65,597,232 5,331,88850,90448,1261.30.14.91.62.128.45.05.8(1) Air Canada adopted accounting standard IFRS 15 - Revenue from Contractswith Customers effective January 1, 2018 with restatement of 2017 amounts.(2) Adjusted pre-tax income, adjusted net income, adjusted earnings per share –diluted, EBITDAR (earnings before interest, taxes, depreciation, amortization,impairment and aircraft rent), EBITDAR margin, leverage ratio, free cashflow, ROIC and adjusted CASM are each non-GAAP financial measures andadjusted net debt is an additional GAAP measure. Refer to sections 8 and 20 ofAir Canada’s 2018 MD&A for descriptions of Air Canada’s non-GAAP financialmeasures and additional GAAP measures. As referenced in the table above,special items are excluded from Air Canada’s reported EBITDAR calculations.Refer to section 6 of Air Canada’s 2018 MD&A for information on the specialitems.(3) Unrestricted liquidity refers to the sum of cash, cash equivalents and short-terminvestments and the amount of available credit under Air Canada’s revolvingcredit facilities. At December 31, 2018, unrestricted liquidity was comprisedof cash, cash equivalents and short-term investments of 4,707 million andundrawn lines of credit of 1,018 million. At December 31, 2017, unrestrictedliquidity was comprised of cash, cash equivalents and short-term investmentsof 3,804 million and undrawn lines of credit of 377 million.(4) Except for the reference to average number of FTE employees, operatingstatistics in this table include third party carriers (such as Jazz Aviation LP(“Jazz”), Sky Regional Airlines Inc. (“Sky Regional”), Air Georgian Limited(“Air Georgian”) and Exploits Valley Air Services Ltd. (“EVAS”)) operatingunder capacity purchase agreements with Air Canada.(5) Reflects FTE employees at Air Canada. Excludes FTE employees at third partycarriers (such as Jazz, Sky Regional, Air Georgian and EVAS) operating undercapacity purchase agreements with Air Canada.(6) Average stage length is calculated by dividing the total number of availableseat miles by the total number of seats dispatched.(7) Revenue passengers are counted on a flight number basis (rather than byjourney/itinerary or by leg) which is consistent with the IATA definition ofrevenue passengers carried.

2018 ANNUAL REPORTMessage from the President and Chief Executive OfficerAir Canada 2018 Corporate Sustainability Progress ReportCONTENTS2018 Management’s Discussion and Analysis ofResults of Operations and Financial Condition1. Highlights2. Introduction and Key Assumptions3. About Air Canada4. Strategy5. Overview6. Results of Operations – Full Year 2018 versus Full Year 20177. Results of Operations – Fourth Quarter 2018 versus Fourth Quarter 20178. Fleet9. Financial and Capital Management9.1. Liquidity9.2. Financial Position9.3. Adjusted Net Debt9.4. Working Capital9.5 Consolidated Cash Flow Movements9.6. Capital Expenditures and Related Financing Arrangements9.7. Pension Funding Obligations9.8. Contractual Obligations9.9. Share Information10. Quarterly Financial Data11. Selected Annual Information12. Financial Instruments and Risk Management13. Critical Accounting Estimates and Judgements14. Accounting Policies15. Off-Balance Sheet Arrangements16. Related Party Transactions17. Sensitivity of Results18. Risk Factors19. Controls and Procedures20. Non-GAAP Financial Measures21. Glossary2018 Consolidated Financial Statements and NotesStatement of Management’s Responsibility for Financial ReportingIndependent Auditor’s ReportConsolidated Statements of Financial PositionConsolidated Statements of OperationsConsolidated Statements of Comprehensive IncomeConsolidated Statements of Changes In EquityConsolidated Statements of Cash Flow1. General Information2. Basis of Presentation and Summary of Significant Accounting Policies3. Critical Accounting Estimates and Judgements4. Property and Equipment5. Intangible Assets6. Goodwill7. Long-Term Debt and Finance Leases8. Pensions and Other Benefit Liabilities9. Provisions for Other Liabilities10. Income Taxes11. Share Capital12. Share-Based Compensation13. Earnings per Share14. Commitments15. Financial Instruments and Risk Management16. Contingencies, Guarantees and Indemnities17. Capital Disclosures18. Revenue19. Regional Airlines Expense20. Special Items21. Sale-Leaseback22. Related Party Transactions23. Subsequent EventsDirectorsOfficersInvestor and Shareholder 581581581581591601611653

2018 ANNUAL REPORTAir Canada’s strong execution capabilities were on fulldisplay in 2018 given the many challenges faced during theyear, including significantly higher fuel costs and economicand trade uncertainty. The results achieved, including astrengthened balance sheet and an expanded global franchise,demonstrated both resiliency and consistency. Air Canadashares outperformed industry peers as well as the TSXComposite Index, and they have now returned more than4,000% since we first set about to transform ourselves adecade ago.MESSAGE FROMTHE PRESIDENT ANDCHIEF EXECUTIVEOFFICERWe generated record operating revenue of 18.065 billion in2018 and ended the year with record unrestricted liquidity of 5.725 billion. Following on a record year in 2017, we reporteda comparably solid performance on other key metrics, suchas EBITDAR of 2.851 billion (including record fourth quarterEBITDAR of 543 million), operating income of 1.174 billion,net cash from operating activities of 2.695 billion and 791 million free cash flow.Success in any given year depends on many things going right.In this regard, our 2018 record revenue reflected year-overyear increases in passenger revenue in all markets we serve.This underscores both the strength of our network and ahighly efficient fleet deployment across that network.To put this in perspective, we have achieved nine consecutiveyears of revenue growth. Our 2018 passenger revenue was 16.2 billion, an 11.2% increase over 2017.This revenue growth was also accompanied by strict costdiscipline within controllable cost categories. In 2018,Air Canada’s unit costs, or cost per available seat mile (CASM),increased 6.0% compared to 2017, mostly attributable to anincrease in fuel costs of almost 1.2 billion. Adjusted CASM,which excludes fuel expense, the cost of ground packages atAir Canada Vacations and special items, increased only 0.3%,in line with our projections.Calin RovinescuOur free cash flow of 791 million in 2018 was significantlyabove guidance. Adjusted net debt of 5.858 billion was down 258 million from the prior year as an increase in long-termdebt and finance leases was more than offset by an increasein cash, cash equivalents and short-term investments.The company’s leverage ratio of 2.1 was unchanged fromDecember 31, 2017. Our weighted average cost of capitalstood at 7.2% at year-end, 540 basis points lower than ourreturn on invested capital of 12.6%, resulting in continuedvalue creation.Another important record for the year was the numberof customers carried. We flew 50.9 million passengers, anincrease of 5.8% from 2017, with an average load factor of83.3%. To contextualize these numbers, looking back into ourpast, it took us 30 years to fly our first 50 million customers.More importantly, we carried our customers safely and didso with increased levels of customer care as the numerousawards we were privileged to receive in 2018 attest. For thesecond year in a row and the seventh time in nine years,Skytrax named us North America’s Best Airline and weremain the only four-star international network carrier inNorth America. We achieved a five-star rating for our onboard4

2018 ANNUAL REPORTcustomer experience from the Airline Passenger ExperienceAssociation. As well, we continue to lead in the all-important,higher-yielding market segment of frequent business travellers,where Air Canada is the preferred airline for domestic travelfor 92% of this population, according to the Ipsos Reid 2018Canadian Business Traveller Survey.Results such as these speak to the extent of the transformationAir Canada has undergone; one we are committed to pursue evenmore vigorously into the future, as we continue to adhere to thefour corporate priorities that have brought us to this point.Air Canada sharesoutperformed industrypeers as well as theTSX Composite Index,and they have nowreturned more than4,000% since we firstset about to transformourselves a decade ago.The first of these is Revenue Enhancement and Cost Control.Not only have we successfully grown revenue, but the make-upof that revenue has also greatly improved. On a stage-lengthadjusted basis, in 2018, system yield increased 3.7% and PRASMimproved 5% over 2017. We have done this by attracting agreater share of business and premium customers as well asthrough an effective ancillary fee strategy, which resulted ina 13% increase in such revenue over 2017.As mentioned, the counterpart to revenue generation is costcontrol. Our ability to contain unit costs below our forecastis evidence of a cost discipline now engrained throughout ourcompany. Today, on a local currency basis, we operate at thesame adjusted CASM level on average as our much larger U.S.competitors, which should further reduce the valuation discountour company has long been subject to versus our U.S. peers.We anticipate further cost reductions. Already, at year-end, wehad achieved or identified 220 million of 250 million in annualsavings targeted in a two-year Cost Transformation Programwhich began in 2018. Air Canada Rouge, with its 29% loweradjusted CASM compared to Air Canada mainline, continues toexpand in leisure markets and domestically on routes where weface low-cost carrier competition.Our fleet renewal has also been a key driver for CASMreductions. In 2018, we took delivery of five Boeing 787-9 and16 Boeing 737 MAX 8 aircraft into the mainline fleet and addedone Airbus A321, two Airbus A319s and one Boeing 767 aircraftto the Air Canada Rouge fleet. All of these new fleet types havebeen designed to produce significant CASM savings over theaircraft they will replace.We have structured our fleet renewal program to strengthenour balance sheet. At present, 55 aircraft, or 23% of ourcombined mainline/Rouge fleet, are unencumbered, creating apool of assets valued at US 2.6 billion that we can monetize ifneeded. This asset pool will increase as we expect to have closeto 100 or almost 40% of our combined mainline/Rouge fleetunencumbered by the end of 2021.Fleet renewal has also supported our second priority ofInternational Expansion. During 2018, Air Canada andAir Canada Rouge launched 29 new routes, mostly internationaland transborder. With our wide-body fleet renewal largelycompleted, the pace of capacity growth will taper but we willcontinue to add new international routes where margins arehigher and to further diversify and de-risk our network.An equally important consideration is each new route’s potentialto draw incremental international-connecting traffic through ourhubs. In support of this, we undertook several projects in 20185

2018 ANNUAL REPORTto streamline airport connection processes, notably with newmeasures to save connecting and transiting customers significanttime on customs and baggage retrieval. These efforts are bearingfruit, as over the last five years we have grown such connectingtraffic by 142%.We augment our network through close partnerships withother carriers, notably the 28-member Star Alliance. Beyondthis, Air Canada belongs to two important joint ventures, onewith United Airlines and the Lufthansa group of airlines and asecond completed in 2018 with Air China. The latter is the firstjoint venture between a Chinese and North American carrierand it gives us a first mover advantage in the growing Chineseair transport market, which is expected to become the world’slargest by 2022.During the year, wecontinued to work on twomajor initiatives that willfurther spur customerengagement. One of theseis the development ofour new loyalty program,which took a quantumleap in 2018 whenAir Canada reached anagreement to acquireAeroplan and entered intoco-branded credit cardagreements with TD, CIBC,Visa and, after year-end,the Amex Bank of Canada.Our modern fleet and expansive network are essential to ourthird priority of Customer Engagement. Along with investingin aircraft, we have devoted considerable resources totraining, onboard amenities and the airport environment. Amilestone achievement in 2018 was the launch of Air CanadaSignature Service, providing superior curb-to-curb services forPremium customers travelling internationally and on selecttranscontinental itineraries. Other innovations included theexpansion of onboard connectivity to international flights andthe opening of three new Maple Leaf Lounges.During the year, we continued to work on two major initiativesthat will further spur customer engagement. One of these isthe development of our new loyalty program, which took aquantum leap in 2018 when Air Canada reached an agreementto acquire Aeroplan and entered into co-branded credit cardagreements with TD, CIBC, Visa and, after year-end, the AmexBank of Canada. Those transactions will smooth the transitionof more than five million active Aeroplan members to Air Canada’snew program when it launches in 2020. More immediately, itbrings a wealth of talent, technology and data, significantlyde-risking the new program’s launch.A second major customer service initiative is the replacement ofour decades-old reservation system by a new passenger servicesystem. After it goes into service later in 2019, it will modernizeour systems for reservations, inventory and departure control,and allow Air Canada to optimize its flight schedule by providingthe ability to more easily manage inventory between any givenorigin and destination. For customers, one key benefit is that itwill automate rebookings during flight disruptions, such as thosecaused by extreme weather.The new reservation system, by giving employees superiortools to assist customers, will also significantly advance ourfourth priority of Culture Change. While strong finances makeour transformation possible, it is our employees who mostimmediately effect change and carry through Air Canada’stransformation. It is their day-to-day interactions with ourcustomers and their ability to take ever-better care of them thatultimately determines the success of our company.The strength of Air Canada’s culture is widely recognized throughour unprecedented, long-term labour agreements that providestability and common purpose for all employee groups. Forthe sixth year in a row, we have been ranked among Canada’sTop 100 employers and during 2018 we received other awards,6

2018 ANNUAL REPORTincluding One of Canada’s Most Attractive Employers, One of the50 Most Engaged Workplaces, and we were rated fifth in the Top20 Employer Brands in Canada.Another significant recognition from 2018 that we are proud ofand bears on employee engagement is the Eco-Airline of the YearAward from Air Transport World. Studies show that, increasingly,people, particularly millennials, opt for careers with companiesthat act responsibly. This award helps further our recruitment,retention and engagement efforts, not to mention also appealingto customers who quite properly demand responsible behaviourand sustainability commitments from corporations.It has been 10 years nowsince Air Canada firstundertook to repair abadly broken businessmodel with the aim oftransforming itself intoa global champion thatwould be sustainablyprofitable over thelong-term. Our 2018performance, followingon record results of recentyears, can leave no doubtthat we are achieving theseambitious goals.It has been 10 years now since Air Canada first undertookto repair a badly broken business model with the aim oftransforming itself into a global champion that wouldbe sustainably profitable over the long-term. Our 2018performance, following on record results of recent years, canleave no doubt that we are achieving these ambitious goals.However, we are also cognizant that our industry continuouslyevolves and that our competition never rests, so we also view allwe have achieved as a prelude to the next chapter. The resiliencyof Air Canada, as shown by its 2018 results relative to its peers,and its now well-established track record of delivering on itscommitments, gives us every confidence of continued success.Backstopping this confidence is the unwavering support wehave received from our Board of Directors and shareholdersduring every step of our journey. I am deeply appreciative of theguidance provided by our Board of Directors and the long-termcommitment investors have made, as together we progresstoward our ever-closer goal of an investment grade rating.Finally, I also thank the 30,000 employees of Air Canada, whohave so wholly embraced change in a rapidly evolving landscapethat they now occupy a leadership role in the global industry. Aswell, I also thank our customers and assure them that all of us atAir Canada are fully committed to earning their loyalty every dayby continuing to transport them safely with the utmost of careand class.Calin RovinescuPresident and Chief Executive OfficerMarch 1, 20197

CORPORATE SUSTAINABILITY: 2018 PROGRESS REPORTCitizens ofthe WorldAir Canada is committed to conductingits business sustainably and responsibly.To further this objective, theenvironmental, social and economicaspects of sustainability

20. Non-GAAP Financial Measures 88 21. Glossary 94 2018 Consolidated Financial Statements and Notes 96 Statement of Management’s Responsibility for Financial Reporting 97 Independent Auditor’s Report 98 Consolidated Statements of Financial Position 100 Consolidated Statements of Operations 101 Consolidated Statements of Comprehensive Income 102

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