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2018 ANNUAL REPORT 2018 ANNUAL REPORT | Management’S Discussion and Analysis of Results of Operations and Financial Condition

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2018 ANNUAL REPORT 2018 ANNUAL REPORT | Management’S Discussion and Analysis of Results of Operations and Financial Condition 2018 ANNUAL REPORT 2018 ANNUAL REPORT | Management’s Discussion and Analysis of Results of Operations and Financial Condition 1. HIGHLIGHTS The financial and operating highlights for Air Canada for the periods indicated are as follows: Fourth Quarter Full Year (Canadian dollars in millions, except where indicated) 2018 2017 (1) $ Change 2018 2017 (1) $ Change Financial Performance Metrics Operating revenues 4,246 3,820 426 18,065 16,252 1,813 Operating income 122 133 (11) 1,174 1,371 (197) Income (loss) before income taxes (216) 20 (236) 405 1,286 (881) Net income (loss) (231) 8 (239) 167 2,029 (1,862) Adjusted pre-tax income (2) 68 77 (9) 952 1,165 (213) Adjusted net income (2) 54 60 (6) 677 1,145 (468) Operating margin % 2.9% 3.5% (0.6) pp 6.5% 8.4% (1.9) pp EBITDAR (excluding special items) (2) 543 521 22 2,851 2,928 (77) EBITDAR margin (excluding special items) % (2) 12.8% 13.6% (0.8) pp 15.8% 18.0% (2.2) pp Unrestricted liquidity (3) 5,725 4,181 1,544 5,725 4,181 1,544 Net cash flows from operating activities 360 389 (29) 2,695 2,738 (43) Free cash flow (2) 141 (43) 184 791 1,056 (265) Adjusted net debt (2) 5,858 6,116 (258) 5,858 6,116 (258) Return on invested capital (“ROIC”) % (2) 12.6% 15.3% (2.7) pp 12.6% 15.3% (2.7) pp Leverage ratio (2) 2.1 2.1 - 2.1 2.1 - Diluted earnings per share $ (0.85) $ 0.02 $ (0.87) $ 0.60 $ 7.31 $ (6.71) Adjusted earnings per share – diluted (2) $ 0.20 $ 0.22 $ (0.02) $ 2.45 $ 4.11 $ (1.66) Operating Statistics (4) % Change % Change Revenue passenger miles (“RPM”) (millions) 20,801 19,396 7.2 92,360 85,137 8.5 Available seat miles (“ASM”) (millions) 25,598 24,191 5.8 110,866 103,492 7.1 Passenger load factor % 81.3% 80.2% 1.1 pp 83.3% 82.3% 1.0 pp Passenger revenue per RPM (“Yield”) (cents) 18.2 17.6 3.8 17.6 17.1 2.5 Passenger revenue per ASM (“PRASM”) (cents) 14.8 14.1 5.2 14.6 14.1 3.8 Operating revenue per ASM (cents) 16.6 15.8 5.1 16.3 15.7 3.8 Operating expense per ASM (“CASM”) (cents) 16.1 15.2 5.7 15.2 14.4 6.0 Adjusted CASM (cents) (2) 11.4 11.3 0.5 10.6 10.6 0.3 Average number of full-time equivalent (“FTE”) 30.5 28.3 7.6 29.9 27.8 7.4 employees (thousands) (5) Aircraft in operating fleet at period-end 400 395 1.3 400 395 1.3 Average fleet utilization (hours per day) 9.7 9.7 (0.1) 10.4 10.4 0.1 Seats dispatched (thousands) 15,185 14,522 4.6 63,800 60,820 4.9 Aircraft frequencies (thousands) 137.7 138.4 (0.5) 578.9 569.6 1.6 Average stage length (miles) (6) 1,686 1,666 1.2 1,738 1,702 2.1 Fuel cost per litre (cents) 84.3 67.5 24.8 80.4 62.6 28.4 Fuel litres (thousands) 1,293,063 1,254,111 3.1 5,597,232 5,331,888 5.0 Revenue passengers carried (thousands) (7) 11,909 11,314 5.3 50,904 48,126 5.8 (1) Air Canada adopted accounting standard IFRS 15 - Revenue from Contracts (4) Except for the reference to average number of FTE employees, operating with Customers effective January 1, 2018 with restatement of 2017 amounts. statistics in this table include third party carriers (such as Jazz Aviation LP (2) Adjusted pre-tax income, adjusted net income, adjusted earnings per share – (“Jazz”), Sky Regional Airlines Inc. (“Sky Regional”), Air Georgian Limited diluted, EBITDAR (earnings before interest, taxes, depreciation, amortization, (“Air Georgian”) and Exploits Valley Air Services Ltd. (“EVAS”)) operating impairment and aircraft rent), EBITDAR margin, leverage ratio, free cash under capacity purchase agreements with Air Canada. flow, ROIC and adjusted CASM are each non-GAAP financial measures and (5) Reflects FTE employees at Air Canada. Excludes FTE employees at third party adjusted net debt is an additional GAAP measure. Refer to sections 8 and 20 of carriers (such as Jazz, Sky Regional, Air Georgian and EVAS) operating under Air Canada’s 2018 MD&A for descriptions of Air Canada’s non-GAAP financial capacity purchase agreements with Air Canada. measures and additional GAAP measures. As referenced in the table above, (6) Average stage length is calculated by dividing the total number of available special items are excluded from Air Canada’s reported EBITDAR calculations. seat miles by the total number of seats dispatched. Refer to section 6 of Air Canada’s 2018 MD&A for information on the special (7) Revenue passengers are counted on a flight number basis (rather than by items. journey/itinerary or by leg) which is consistent with the IATA definition of (3) Unrestricted liquidity refers to the sum of cash, cash equivalents and short-term revenue passengers carried. investments and the amount of available credit under Air Canada’s revolving credit facilities. At December 31, 2018, unrestricted liquidity was comprised of cash, cash equivalents and short-term investments of $4,707 million and undrawn lines of credit of $1,018 million. At December 31, 2017, unrestricted liquidity was comprised of cash, cash equivalents and short-term investments of $3,804 million and undrawn lines of credit of $377 million. 2018 ANNUAL REPORT Message from the President and Chief Executive Officer 4 Air Canada 2018 Corporate Sustainability Progress Report 8 2018 Management’s Discussion and Analysis of Results of Operations and Financial Condition 14 1. Highlights 2 2. Introduction and Key Assumptions 15 3. About Air Canada 17 4. Strategy 18 5. Overview 27 6. Results of Operations – Full Year 2018 versus Full Year 2017 29 7. Results of Operations – Fourth Quarter 2018 versus Fourth Quarter 2017 37 8. Fleet 48 9. Financial and Capital Management 51 9.1. Liquidity 51 9.2. Financial Position 51 9.3. Adjusted Net Debt 52 9.4. Working Capital 53 CONTENTS 9.5 Consolidated Cash Flow Movements 54 9.6. Capital Expenditures and Related Financing Arrangements 55 9.7. Pension Funding Obligations 57 9.8. Contractual Obligations 58 9.9. Share Information 59 10. Quarterly Financial Data 60 11. Selected Annual Information 63 12. Financial Instruments and Risk Management 64 13. Critical Accounting Estimates and Judgements 67 14. Accounting Policies 71 15. Off-Balance Sheet Arrangements 74 16. Related Party Transactions 74 17. Sensitivity of Results 75 18. Risk Factors 76 19. Controls and Procedures 87 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 Consolidated Statements of Changes In Equity 102 Consolidated Statements of Cash Flow 103 1. General Information 104 2.f Basis o Presentation and Summary of Significant Accounting Policies 105 3. Critical Accounting Estimates and Judgements 117 4. Property and Equipment 119 5. Intangible Assets 120 6. Goodwill 121 7. Long-Term Debt and Finance Leases 122 8. Pensions and Other Benefit Liabilities 126 9. Provisions for Other Liabilities 135 10. Income Taxes 136 11. Share Capital 139 12. Share-Based Compensation 141 13. Earnings per Share 144 14. Commitments 145 15. Financial Instruments and Risk Management 146 16. Contingencies, Guarantees and Indemnities 153 17. Capital Disclosures 155 18. Revenue 156 19. Regional Airlines Expense 158 20. Special Items 158 21. Sale-Leaseback 158 22. Related Party Transactions 158 23. Subsequent Events 159 Directors 160 Officers 161 Investord an Shareholder Information 165 3 2018 ANNUAL REPORT Air Canada’s strong execution capabilities were on full display in 2018 given the many challenges faced during the year, including significantly higher fuel costs and economic and trade uncertainty. The results achieved, including a strengthened balance sheet and an expanded global franchise, demonstrated both resiliency and consistency. Air Canada shares outperformed industry peers as well as the TSX Composite Index, and they have now returned more than 4,000% since we first set about to transform ourselves a decade ago. We generated record operating revenue of $18.065 billion in 2018 and ended the year with record unrestricted liquidity of $5.725 billion. Following on a record year in 2017, we reported a comparably solid performance on other key metrics, such as EBITDAR of $2.851 billion (including record fourth quarter MESSAGE FROM EBITDAR of $543 million), operating income of $1.174 billion, THE PRESIDENT AND net cash from operating activities of $2.695 billion and CHIEF EXECUTIVE $791 million free cash flow. Success in any given year depends on many things going right. OFFICER In this regard, our 2018 record revenue reflected year-over- year increases in passenger revenue in all markets we serve. This underscores both the strength of our network and a highly efficient fleet deployment across that network. To put this in perspective, we have achieved nine consecutive years 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 cost discipline 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 an increase in fuel costs of almost $1.2 billion.
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