Air Canada

TSX:AC

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen. Welcome to Air Canada's First Quarter 2019 Conference Call. Please note that immediately following the first quarter call, Chris Isford and Kathy Murphy will host a discussion on accounting policies related to Air Canada's acquisition of Aeroplan. [Operator Instructions] I will now turn -- like to turn the meeting over to Kathy Murphy. Please go ahead, Ms. Murphy.

[Kathleen Murphy]

Thank you, Valerie, and good morning, everyone, and thank you for joining us on our first quarter call. With me this morning are Calin Rovinescu, our President and Chief Executive Officer; Mike Rousseau, our Deputy Chief Executive Officer and Chief Financial Officer; Lucie Guillemette, our Executive Vice President and Chief Commercial Officer; and Craig Landry, our Executive Vice President of Operations. On today's call, Calin will begin by highlighting our financial performance for the quarter. Lucie and Mike will then address our first quarter financial performance in more detail and turn it back to Calin, before taking questions from the analyst community. Immediately following the earnings call, our Vice President and Controller, Chris Isford, and I will remain on the line to host an information session on the accounting policies related to Aeroplan. A presentation on this topic was posted on aircanada.com earlier this morning. Before we get started, I would like to point out that certain statements made on this call, such as those relating to our forecast 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'm now going to turn it over to Calin Rovinescu, Air Canada's President and CEO.

[Calin Rovinescu, CEO, President & Non Independent Director]

Thank you, Kathy. Good morning, everyone, and thank you for joining us on our call today. I'm very pleased to report an excellent quarter, exceeding both last year's results and market expectations, attributable to a very strong revenue performance and better-than-expected Aeroplan results. We achieved these results in a quarter where we faced extremely severe weather events early in the quarter literally from coast to coast and the first 18 days of the Boeing 737 MAX grounding at the end of the quarter. To add some perspective, in the quarter, we canceled 8,000 flights, over 1,600 of which were on mainline, a 40% increase over mainline cancellations last Q1. Our strong financial and operating performance is a testament to the great work of our employees in every department across the airline. We reported first quarter EBITDA of $583 million and operating income of $127 million, both well above last year's first quarter results and market expectations. We generated record first quarter operating revenues of close to $4.5 billion. Passenger revenues grew $327 million or 9.4% on a yield improvement of 5% and traffic growth of 4.2%. Looking ahead, we're encouraged by the strong booking trends we're seeing for the second quarter. On the cost side, we achieved savings in several areas of the organization including in our regional operations as a result of our newly amended capacity purchase agreement with Jazz. In terms of cost containment, we're pleased to report we made significant progress in the quarter and have now realized or identified savings of $242 million of our $250 million CTP target by the end of 2019. We ended the quarter with record unrestricted liquidity of nearly $6.9 billion and lowered our leverage ratio to 1.2, ahead of our target timetable to do so. These results are further evidence that Air Canada is achieving sustainable long-term profitability. Our greater financial resiliency was acknowledged during the quarter by a debt rating upgrade from Standard & Poor's which advances us to 1 level below our goal of investment-grade status. Fitch also recently upgraded our debt rating. The agility of our business model, our fleet and our entire team were firmly on display in the quarter when we were forced to adjust to the grounding of our 24 Boeing 737 MAX aircraft literally overnight. These aircraft represent about 20% of our narrow-body fleet and carry about 9,000 to 12,000 passengers per day. Employees working in every part of the company rallied immediately. Our network planners and operations teams reorganized our schedule virtually overnight. Flight crews agreed to change shifts and work extra time. Airport staff and call centers took care of impacted customers. Maintenance and other employees redoubled their efforts to keep the remaining fleet available and fleet planning to secure additional aircraft. Our customer service group protected passengers on other flights including competitors where we needed to. In the end, approximately 98% of affected flying was covered in March. It was a textbook display of the type of nimble response I have over the last decade insisted Air Canada must become capable of if it is to thrive. More importantly, everything we did was driven by a focus on safety and providing superior customer care. Our response to this exceptional event showed very clearly there are no silos at Air Canada and we are winning as one team. Before turning the call to Lucie for a discussion on the revenue performance in the quarter, I'd like to thank our employees for their adaptability and commitment to taking care of our customers this past quarter especially during the challenges created by the grounding of the MAX. They stepped up to put customers first. And I'd also of course like to thank our customers for their continued loyalty in choosing to fly with us. And with that, I'd like to turn the call over to Lucie.

[Lucie Guillemette, Executive VP & Chief Commercial Officer]

Thank you, Calin, and good morning, everyone. I would also like to thank our employees for the passion and dedication they demonstrated in the quarter, particularly for their unwavering resolve in minimizing disruption for our customers. Teamwork and cooperation were on display across all our business units, and for that, we are very proud. In the quarter, passenger revenues increased $327 million or 9.4% on a capacity growth of 4.6%. We saw traffic increase of 4.2% and yield growth of 5%. The impact of the 737 MAX grounding on our capacity for March was mitigated somewhat by our system operations control and network planning groups who developed a contingency strategy, enabling us to cover approximately 98% of the planned flying in March despite removing 24 aircraft from our schedule. The yield improvement versus last year included additional revenue recorded from Aeroplan flight redemption, amortization revenue related to proceeds received from our credit card partners of $1.2 billion, breakage revenues related to the Aeroplan program and ancillary fees related to Aeroplan flight redemptions. The additional Aeroplan yield favorably impacted each of our 5 key geographic markets. Given the typical estimated time lag of 3 months between redemption and air travel, and given that the higher consideration from the sale of Aeroplan Miles is only applicable for Aeroplan bookings made after January 10, the yield is expected to even further improve in Q2 when we expect the recognition lags to be fully substantially eliminated. Our business class cabin performed very well in the quarter with a passenger revenue increase of 90 million or 12.4% versus last year's first quarter on traffic and yield increases of 8% and 4.1%, respectively. This strong performance in the quarter further demonstrates the continued strength of the Air Canada brand in the premium market as well as a clear return on investment on our premium products over the last few years, including the introduction of our Air Canada Signature Service, which provides an elevated premium experience throughout the entirety of our customer's journey. It also reaffirms why Air Canada is the preferred carrier for 92% of business travelers according to last year's Ipsos Reid survey. Looking ahead to our key markets. On a slight reduction of capacity, domestic passenger revenues increased $63 million or 6% from the first quarter of 2018 on yield growth of 5.3% and a traffic increase of 0.6%. We achieved a year-over-year increase in PRASM partially attributed to the easing of market capacity growth, and we were particularly pleased with the PRASM performance on our long-haul transcon services. Our domestic yield and PRASM improvement reflected strong gains in the Business cabin, specifically on our transcontinental services, with select frequencies offering our new Air Canada Signature Service as of the second quarter in 2018. In the economy cabin, yield improvements reflected the favorable impact of new fare categories and our continued effort to optimize the buy-up levels between our suite of fare categories and the optimization of our ancillary offers. We achieved improvements in our domestic regional services in large part due to more favorable economics as a result of the renegotiated CPA with Chorus Aviation. As we look forward to Q2, we anticipate our year-over-year domestic revenue performance to be close to our original expectations. Our network planning team developed a schedule that covers a substantial amount of flying that was impacted by the grounding of the 737 MAX. Within Canada, we have consolidated several transcontinental frequencies with larger aircraft, and beginning in May, we will be strategically leveraging Rouge on select routes and frequencies. We were pleased with our U.S. transborder performance in the quarter, with revenues up $100 million or 11.7% on capacity growth of 8%. Traffic increased 6.4% on continued strong passenger demand between Canada and the U.S. as well as growth in connecting passengers flows from the U.S. Yield improved 5%, reflecting growth on all major U.S. transborder services for the first quarter. The U.S. leisure markets performed very well while the Eastern Seaboard U.S. business markets continued to experience competitive pressures. The launch of our new fare categories, specifically our comfort fare, contributed to the positive yield performance, as did the favorable foreign exchange impact of our U.S. dollar sales. Our transborder results also reflect continued strong traffic and revenue performance related to customers transiting our hubs to and from the United States, which can be attributed to the success of our international transit strategy and the investments we have made to improve the connection process in all 3 of our hubs. In addition to our performance into U.S. leisure markets, we were particularly pleased with the performance of our services between Eastern Canada and California as well as into Texas, and these markets have been key drivers of our success in the United States. Looking ahead to the second quarter. We are expecting positive year-over-year revenue and traffic results. Capacity on Eastern Seaboard U.S. business services will be impacted by the MAX grounding. Our services between Vancouver and Honolulu and Vancouver and Maui, which have been operated by the 737 MAX, will be operated by a larger aircraft with reduced frequencies in April and May. In June and July, these routes will be flown through a wet lease operation with Omni Air International. Recovering our Hawaii operation is another example of our commercial team's ability and our fleet flexibility in mitigating the impact to our schedule during the 737 MAX grounding. On capacity growth of 7.4%, revenues on the Atlantic increased $81 million or 11.8% versus last year's first quarter on traffic growth of 8.1% and a yield improvement of 3.5%. Traffic and yield increases were reported on all major Atlantic services and we were particularly pleased with our performance to the U.K. which saw strong gains in the business class cabin. Our strong performance in the first quarter demonstrates the very tangible results of our long-term strategy to expand our international network, leveraging both mainline and Rouge, with a focus on hub-to-hub flying. Looking ahead, our second quarter outlook is showing year-over-year revenue growth in line with expectations prior to the 737 grounding, again demonstrating the resilience of our fleet and diverse network despite exceptional circumstances. Due to the grounding of the MAX aircraft, we have made several necessary adjustments to our schedules, including temporarily suspending service from the Maritimes to the U.K. through July, delaying the start date of our new service from Montréal to Bordeaux and reducing frequencies on several continental European seasonal services starting in June. We will also be operating our Montréal to Barcelona service and one of our Montréal to Paris frequencies to wet lease from mid-June to mid-August. Additionally, due to the closure of Pakistan airspace following regional conflicts, we had to make adjustments to our Toronto-Delhi schedule, and from mid-June to the end of July, we will be suspending the service given the uncertainty around when the airspace will be reopened. We will then have the flexibility to reallocate the aircraft elsewhere in our network. Our transatlantic strategy, built on hub-to-hub flying with a focus on premium traffic and the optimal mix of mainline and Rouge, is proving to be resilient and sustainable, supporting our expectation of a continued strong performance. In line with this strategy, last week, we initiated our new year-round service between Vienna and Toronto with cooperation from our joint venture partner, Austrian Airlines, and we expect this route to perform very well for us. Turning to the Pacific. On a capacity reduction of 1.5%, revenues increased $24 million or 4.7% on strong yield growth of 6.7%. All major Pacific services recorded yield increases, with the exception of services to Australia. The yield growth reflected increases in base fares and carrier surcharges as well as a general improvement in the overall fare mix. We were particularly pleased with the strong performance of Japan, which continues to benefit from our strategy in Tokyo, where we consolidated our service from Toronto to Haneda and started our Narita service from Montréal. Previously, we had operated into both Haneda and Narita from Toronto. The geopolitical situation between Canada and China negatively impacted travel demand between Canada and China and Canada and Hong Kong in the first quarter of 2019. However, reallocating capacity from China to other markets has helped mitigate the impact and further illustrates our ability to adapt quickly to market changes. Services to Australia continued to be under a slight pressure from a PRASM and yield perspective due to increased industry capacity from North America. Australia remains an important part of our strategy and efforts to reduce seasonality throughout our network. Looking forward to the second quarter, our booking posture is in line with our expectations. Travel demand between Canada and China and Hong Kong continues to be impacted by their geopolitical situation. However, the impact will continue to be somewhat mitigated by strategically down-gauging and reallocating capacity to the transatlantic market. In our effort to counter seasonality, we recently announced our non-stop seasonal service between Vancouver and Auckland, which will be launched in December of this year. To fully optimize the service, we have also signed an MOU with our Star partner and codeshare partner, Air New Zealand, as we pursue a joint venture relationship in order to form a deeper, more integrated partnership that will provide greater customer choice, more frequency, comprehensive benefit and an expanded transpacific network. Revenues from our other services increased $59 million or 14.8% on traffic growth of 9.4% and a yield improvement of 5%. All major services reported yield growth apart from South America, which saw significant increase in stage length. Services to the Caribbean and Mexico reflected particularly strong improvements. I've discussed on prior calls, in May 2018, we removed the short-haul tag between Santiago and Buenos Aires and began serving both markets on a nonstop basis. In early April, we reverted back to one-stop service to Buenos Aires with a connection in Santiago, and we expect to realize yield and RASM benefits from this transition throughout the year. On a stage length adjusted basis, overall yield for the other markets increased 7.3% from the first quarter of 2018. For the second quarter, in addition to the yield and PRASM benefits we will realize from reverting Buenos Aires back to one-stop, we expect strong revenue and traffic results in line with our expectations prior to the 737 grounding. On our last call, we mentioned that we were exploring seasonal growth opportunities in South America and we recently announced our seasonal nonstop Air Canada Rouge service between Toronto to Quito and our seasonal non-stop Air Canada mainline service from Montréal to São Paulo, both beginning this December. Moving on to cargo. Cargo revenue increased $9 million or 5% reflecting traffic and yield growth of 3.4% and 2.1%, respectively. Cargo revenues were impacted by route adjustments and flight cancellations that were necessary due the closure of Pakistan airspace as well as the 737 MAX grounding. In the second quarter, our cargo revenues will continue to be impacted by the Toronto to Delhi schedule adjustments including a route suspension in mid-June. The impact of the 737 MAX groundings will be largely mitigated by fleet adjustments throughout the network in April and June. In May, Lufthansa, our joint venture partner, has assumed our service between Montréal and Frankfurt, which has the benefit of protecting our customer and provides us with additional fleet flexibility. However, it does have a negative impact on our cargo revenues. Finally, we saw a significant increase in our other revenues in the quarter, which were up $46 million or 11% when compared to the same quarter in 2018. This increase was mainly due to the net margin recorded on the redemption and delivery of non-air goods and services related to the Aeroplan program. We also experienced an increase in ground package revenues at Air Canada Vacations. I will now turn the call over to Mike for a discussion on our cost performance and balance sheet metrics.

[Michael Stewart Rousseau, Deputy CEO & CFO]

Thank you, Lucie, and good morning to everyone. I'd like to add my thanks to all of our employees for an excellent first quarter and for their continued focus on taking care of our customers. Despite some unplanned events, from a financial perspective, we had a very solid start to the year, including a strong financial performance from Aeroplan. We continue to effectively manage our cost and now have substantially achieved our CTP target. As Calin mentioned earlier, by the end of March, we had realized or identified $242 million of our $250 million target and we look forward to successfully attaining the rest before year-end. We are intensely focused on cost reduction and containment, and this will continue into the future. Adjusted CASM, which excludes fuel expense, ground package costs at Air Canada Vacations and the operating expense of Aeroplan, increased 3.2% versus the same quarter in 2018, with flight cancellations and a lower capacity from the MAX grounding impacting us by approximately 0.5 percentage point. The impact on our unit cost is expected to increase the longer the grounding persists, particularly heading towards our -- the busy summer season. This impact on unit costs include the continued accounting of depreciation of our fleet of Boeing 737 MAX aircraft, the impact of lower ASM capacity and the relatively higher unit costs of the replacement capacity. This includes wet lease costs and the lower efficiency of the aircraft leases being extended through the summer, such as the Airbus 320s. Aeroplan's operating expenses amounted to $45 million in the quarter consisting primarily of wages, salary and benefit expense, depreciation and amortization expense and IT-related costs. These costs are consolidated within Air Canada's financial statements as of January 10. Turning to wages, salary and benefits, we saw an increase of $99 million or 14% in these costs in the quarter mainly driven by growth in full-time equivalent employees of 11%; and to a lesser degree, an increase in stock-based compensation given the significant increase in our share price during Q1. The increase in employees was due to a capacity growth and the inclusion of Aeroplan. Moving on to fuel. Fuel expense increased $58 million or 6% in the quarter with the unfavorable currency impact accounting for $41 million and a higher volume of liters consumed adding another $28 million. Lower jet fuel prices, which accounted for a decrease of $10 million, was an offsetting factor. The average price of fuel was CAD 0.755 per liter in the quarter, up 3% versus the same quarter in 2018. We have not entered into any fuel hedging contracts to date for 2019. Looking ahead, our assumption is that fuel -- price of jet fuel will average CAD 0.85 per liter in the second quarter of 2019 and CAD 0.84 per liter for the full year 2019, and that Canadian dollar will trade on average at CAD 1.34 per U.S. dollar in the second quarter and for the full year 2019. Air Canada's financial guidance for 2019 was suspended given the grounding of the Boeing 737 MAX aircraft and Boeing's decision to suspend MAX deliveries to airline customers. We will reinstate guidance for 2019 once we have greater clarity on the situation. The financial guidance provided for the years 2020 and '21 for annual EBITDA margins and annual ROIC and the cumulative free cash flow over the 2019 to 2021 period remains in place. Now turning to our balance sheet and liquidity. Unrestricted liquidity amounted to a record $6.9 billion at the end of the quarter. The net cash impact of the Aeroplan acquisition and related agreements amounted to the increase in cash of $1.115 billion, representing the commercial agreement consideration of $1.212 billion and the $400 million prepayment of Aeroplan Miles, less the purchase price of $497 million which remains subject to certain adjustments. Excluding the onetime proceeds related to the acquisition of Aeroplan, free cash flow amounted to $579 million in the quarter, $261 million above last year's first quarter. The increase in free cash flow was due to higher cash from operating activities and, to a lesser extent, a lower level of capital expenditures year-over-year. Air Canada acquired one Boeing 737 and 6 Boeing 737 MAX aircraft in the quarter using cash. We had expected to take delivery of an additional 3 Boeing 737 MAX aircraft in the quarter, which did not occur. So the level of free cash flow was higher than it otherwise would have been. The capital commitments table in the Q1 MD&A assumes no changes to the Boeing 737 aircraft deliveries scheduled for 2019 and beyond. However, Boeing's decision to suspend deliveries may change the timing of these commitments. Net debt of $3.8 billion decreased $1.4 billion from December 31, 2018, reflecting an increase in cash and short-term investment balances of almost $1.2 billion and, to a lesser extent, a decrease in long-term debt and lease liabilities. Our leverage ratio was 1.2 at the end of March. The steady improvement in our financial results, our lower risk profile and our future outlook was acknowledged during the quarter by a debt rating upgrade from Standard & Poor's which advances us to 1 level below our goal of investment-grade status. Fitch also upgraded our debt rating in Q1. At quarter end, our return on invested capital was 14.5%, while our weighted average cost of capital was 7.5%. With respect to our normal course issuer bid, Air Canada repurchased for cancellation approximately 1.5 million shares in the quarter at an aggregate cost of $51 million. We will continue to utilize our normal course issuer bid to buy back shares when opportunities present themselves, although these opportunities will be assessed in light of the MAX grounding and return to service. Additional information can be found in our financial statements and MD&A, which was posted on our website and filed on SEDAR this morning. With that, I'll turn it back to Calin.

[Calin Rovinescu, CEO, President & Non Independent Director]

Thanks, Mike. The first quarter is always the most demanding for Canadian airlines. This year was no exception and it was made more so with the unexpected grounding of the 737 MAX. By delivering a solidly profitable quarter above last year and as I said earlier above consensus estimates, despite the MAX grounding and the challenges of extreme weather this winter, our team demonstrated the strength of our business model and the extent of our transformation. 737 MAX Black Swan event has stress-tested us and we passed. But more importantly, for the long term, during the quarter, we also maintained our focus to make significant progress on the 4 priorities that drove our transformation, notably revenue generation and cost control. We completed 2 highly strategic initiatives that are already contributing positively to our results, the acquisition of Aeroplan and conclusion of an improved CPA for Jazz line. As we've said previously, we believe that having control of our own loyalty program and a more competitive cost of regional lift should narrow our valuation discount as compared to major U.S. carriers, and we are already seeing their contribution to our earnings. As we've expressed during our successful Investor Day in February, we're confident enough in the future that we've raised the targets for our key metrics of EBITDA margin and ROIC for 2020 and 2021, and cumulative free cash flow over the 2019 to 2021 period. And although our 2019 guidance have been put in the balance for the immediate term pending resolution of the MAX issue, be assured that our commitment to continue to achieve sustainable profitability remains firm. And our Q1 results and the 737 MAX mitigations are a great proxy for that commitment. Respecting our second priority of international expansion, while we have -- we've said the pace of growth will now temper with the maturing of wide-body fleet plans. Nonetheless, this past week, we launched yet another promising new international route between Vienna and Toronto. During the quarter, we also announced new services next winter from Vancouver to Auckland, Toronto to Quito and Montréal to São Paulo. We'll continue to look for ways to optimize our network to increase connectivity. Moreover, as mentioned, the outlook for the summer travel period with its heavy international component remains very robust. During the quarter, we were also recognized as one of Montréal's Top Employers for the sixth consecutive year and one of Canada's Best Diversity Employers for the fourth year. This speaks to our third priority of culture change, and culture change was most evident in the quarter with our nimble yet prudent response to the 737 MAX grounding. And of most carriers, we announced a revised schedule and quickly found additional aircraft and other replacement flying for our customers rather than simply canceling bookings. Our response was driven by the twin concerns of safety and customer service. It also underscored how we have made teamwork a core value to Air Canada, with every employee group pitching in to find solutions for our customers. Boeing has historically manufactured very capable aircraft, and we're confident that working together with the independent expert review board and other regulators, we will collectively find the right solution to get the MAX flying safely again. Our final decision on returning the MAX to service will be based on our own safety assessment following the lifting of government safety notices and approval of the software modification and training protocol by the FAA, Transport Canada and other relevant regulatory authorities. Our focus on customer engagement, our fourth priority, has been broadly recognized since the start of the year. We've received accolades and awards for our services and products including prices for our loyalty program, IFE, food service and amenity kits. There was also an award from an influential travel site, TripAdvisor, where we were named best North American business class in its annual Travellers' Choice Awards. The excellence of our results in the first quarter, including record operating revenue, a leverage ratio which we believe is at an investment grade level and record levels of liquidity, position us well for the remainder of the year and beyond. In conclusion, I'd like to, again, thank our more than 33,000 employees for their hard work and dedication to our customers. I'm very proud of the results in this first quarter. Additionally, I'd also thank our customers for their continued loyalty and for choosing to fly with Air Canada. And with that, we're pleased to take your questions.

[Operator]

[Operator Instructions] Our first question is from Rajeev Lalwani with Morgan Stanley.

[Rajeev Lalwani, Executive Director]

First, a question on the RASM environment. Can you provide a little bit of color as far as what 1Q will look like once you back out some of the Aeroplan benefits? And then as you look forward, given the grounding on the MAX side and the reduction in capacity that we're seeing in the market broadly here, are you seeing an offset on the yield side? It seems like that's the case given the comment about hitting your revenue targets prior to the events.

[Calin Rovinescu, CEO, President & Non Independent Director]

Right. So Calin here, Rajeev. I'll start and I'll turn it over to Lucie. So what we are seeing in the yield environment is an excellent demand environment in the first quarter. And while Aeroplan -- the Aeroplan results contributed to it, it certainly was not representative of the lion's share of that. And so I think that sort of augurs well, I mean, before you get into the MAX analysis. But I'll just ask Lucie to give a little bit better visibility on the composition of the RASM.

[Lucie Guillemette, Executive VP & Chief Commercial Officer]

Yes. Hi, it's Lucie. For sure, we did see very good performance in our premium cabins, which was very, very helpful in terms of our RASM results, and we also saw very good performance in our premium economy product on our transatlantic network. In addition to that, we were also able to grow our point of sale U.S. performance which of course, given the currency also, provides a nice upside on the yield front. And I think one other initiative that we've been focused on for quite some time and we spend a lot of effort on that is optimizing our branded fares, our branded fare products, as well as our ancillary menu. So all those items all contributed to the yield performance in the first quarter.

[Calin Rovinescu, CEO, President & Non Independent Director]

And on your question on the MAX, to just sort of give you a way to think of it is that we -- overnight, we removed these aircraft from the fleet. So we had 18 days where we were scrambling to actually take care of our customers and therefore in some cases, filling seats that we otherwise would have sold -- continue to sell close end. So you actually -- in those last 18 days, we did actually lose some incremental upside, if you like, from the close-end bookings that we didn't get a chance to benefit from given that we were using the available seats to take care of the passengers who were displaced by the grounding.

[Rajeev Lalwani, Executive Director]

And how is that looking into 2Q? I imagine you don't see those headwinds and then maybe there may be a tailwind as simply capacity is coming in a bunch for the market.

[Calin Rovinescu, CEO, President & Non Independent Director]

There's no question in that aspect that that's accurate. And also now that Q2 we had the ability to plan a bit better as to how we were handling that, of course, the remaining bookings that were in Q2 that had been made well before Q2 that also have to be accommodated, and that's why you're seeing some of the mitigation steps that we put in place. But you're right, by definition, taking out some capacity will have a positive impact on yield.

[Operator]

Our next question is from Walter Spracklin with RBC Capital Markets.

[Walter Noel Spracklin, Analyst]

So I'd like to -- you called out 50 basis points in costs associated with MAX, but you indicated that that's going to ramp, Mike, as you go into the busier season. Can you give us a sense of what the magnitude of that ramp is and maybe an annualized number when you think the quarters where it's not as impacted like this quarter? Including the quarters where it is, what an annualized number, just to give us a broader context of how much of this MAX is affecting your full year cost -- the cost guidance you had provided for a full year basis before.

[Michael Stewart Rousseau, Deputy CEO & CFO]

Right, which we suspended. But on the cost side, there's no doubt just the CASM is going to be influenced primarily by the reduction in ASMs in seat miles. We've very little in Q1, honestly, and that's why it only affected us by 0.5 point. From our press releases, we've said that for the most part, we're covering -- we won't be covering 3% to 4% of the capacity that we otherwise would have, and so that will also negatively influence the adjusted CASM results. So that is the principal reason for the increase in adjusted CASM as we go forward. Once we get that capacity back, we'll also be back to where we otherwise would have been. A secondary reason but much smaller is the incremental costs associated with wet leases and extensions of planes that are otherwise not as efficient as 737s. But I will say that's a distant second from the ASM impact.

[Walter Noel Spracklin, Analyst]

Okay. Got it. And on that ASM impact, kind of we had ball-parked higher than the 3% last year but I think below the 7% which was indicated. But is there a broad range? Are we now back more toward flat or flat to 3% rather than 3% to 7%? Is there any kind of just goalpost we can wrap around the capacity for this year assuming that the MAX stays out for the better part of the year?

[Michael Stewart Rousseau, Deputy CEO & CFO]

On the capacity? Okay.

[Walter Noel Spracklin, Analyst]

Yes.

[Michael Stewart Rousseau, Deputy CEO & CFO]

Well, again, it depends on your assumption of when the MAX comes back in and what is our ability to bring them back in quickly.

[Walter Noel Spracklin, Analyst]

Yes. I kind of prefaced it by saying it doesn't come in at all for this year, does it?

[Michael Stewart Rousseau, Deputy CEO & CFO]

Yes. For Q2, we're -- I think our press releases so far have indicated capacity in around 96%, 97%. So we're losing 3% to 4% of what we otherwise would've had in Q2. And for the year, our capacity growth was pretty well spread equally among all the 4 quarters.

[Walter Noel Spracklin, Analyst]

Right. Okay. That's helpful. From a -- I was looking at your Business cabin as a good read into the economy and saw that -- I think you were up 4.1% -- I'm sorry, up 8% on yield of 4.1%. Lucie, is that a -- are you seeing -- you mentioned that the booking curve is looking in line with expectations, but were you forecasting any weakness here? Or is the strength in the Business cabin expected to continue based on the booking or the forward booking curve that you're looking at right now?

[Lucie Guillemette, Executive VP & Chief Commercial Officer]

Based on what we're seeing for these premium cabins, we don't expect any major changes as we move forward. Things are looking pretty solid in the premium for us.

[Walter Noel Spracklin, Analyst]

Okay. And just last question. I don't know, Mike, if you have this. You backed out Aeroplan from your CASM to give us kind of an apples to apples, but you left it in your yield. If you were to kind of back out Aeroplan out of yield, is there a good sense of what the like apples to apples would have been on yield? Do you have that?

[Michael Stewart Rousseau, Deputy CEO & CFO]

We have that, we just can't share that at this point in time because I'd be segmenting the profitability for the market.

[Operator]

Our next question is from Andrew Didora with Bank of America.

[Andrew George Didora, Director]

Walter just asked one of my questions on the yield impact of Aeroplan. But Lucie, I wanted to clarify something in your prepared remarks. You had mentioned that, I think, you expect yield to further improve in 2Q. Does that mean that 2Q, you just expect yield to be positive in 2Q? Or should they be north of 5% growth that you came in at in 1Q?

[Lucie Guillemette, Executive VP & Chief Commercial Officer]

I think the comment that I was referring to was with respect to the Aeroplan adjustment. So we're expecting that it will be further improvement in the second quarter.

[Andrew George Didora, Director]

From -- just from the Aeroplan contribution.

[Lucie Guillemette, Executive VP & Chief Commercial Officer]

Exactly. Exactly.

[Andrew George Didora, Director]

Okay. Great. And then...

[Michael Stewart Rousseau, Deputy CEO & CFO]

Andrew, sorry, it's Mike. Just some more color. Again, we talked about this and Chris will talk more about it following this. But revenue recognition is that -- we'll probably get them -- the run rate of Aeroplan will be probably fully in place in Q2. It was not in Q1 because customers that redeem post Jan 10 didn't -- somewhat didn't fly before March 31. And in Q2, that will get a full impact for the quarter, and so we'll be at a full run rate from an Aeroplan's perspective in Q2.

[Andrew George Didora, Director]

Got it. Okay. That makes sense. And then I'm sorry if I missed this in your prepared remarks, but obviously you guys have kind of hit your leverage goal here. Did the MAX grounding change the way you're thinking about the buyback at all? And can you maybe just remind us of when you can be back in the market buying stock because I know you were restricted from buying that for a little bit?

[Michael Stewart Rousseau, Deputy CEO & CFO]

Andrew, it's Mike. So we can start buying back stock 2 days after the release of these results, so Wednesday morning we'll be able to -- we'll be out of the blackout period. And does the MAX grounding affect our decision process? Slightly it's a filter that we need to walk through. But again, our leverage ratio is where we had always talked about getting to and so we're going to be comfortable going back into the market. But certainly the MAX grounding is another decision point for us to consider as we continue the NCIB.

[Operator]

Our next question is from Fadi Chamoun with BMO.

[Fadi Chamoun, MD & Analyst]

Just one clarification first. Lucie, I think in the prepared remarks, you talked about meeting original expectations. Is that a comment referring to RASM or meeting original expectations in terms of revenues?

[Lucie Guillemette, Executive VP & Chief Commercial Officer]

Actually, I was referring to revenues.

[Fadi Chamoun, MD & Analyst]

Okay. Great. The second question quickly, maybe on the M&A side. I mean Air Canada has been associated in the media with a number of kind of M&A activity. I was wondering, Calin, if you can kind of comment on those. And maybe directly or from a higher level, how should we think about kind of M&A in your capital allocation priorities?

[Calin Rovinescu, CEO, President & Non Independent Director]

Right. So Fadi, you appreciate we don't comment on any of the speculation that's in the media. We've seen speculation both in terms of domestic situations, international situations. So we're not commenting on any of the media speculation around M&A. And suffice it to say that we're going to continue down the exploitation of our business plan that has brought us this far. And we're not making further comment on anything that appeared in the media.

[Operator]

Our next question is from Cameron Doerksen with National Bank Financial.

[Cameron Doerksen, Analyst]

Just a couple of 737 MAX questions. Obviously, we don't know when the plane is going to be back in service here. But even if the grounding was lifted tomorrow, I mean, how long do you think it would take for Air Canada to get those aircraft operational once you've assessed that you're comfortable with the safety? I mean presumably, it'll take several weeks at least before you could actually get the aircraft back in service even if the grounding was lifted right away.

[Calin Rovinescu, CEO, President & Non Independent Director]

Right. That's correct, Cameron. And this is operationally complicated, both in terms of mitigating the consequence of the grounding as we've done over the last couple of months and complicated to put them back in service when the time comes. So we have -- we started to work on various plans, and indeed one of the things we've done is put all of our MAX pilots, who today are not able to fly because of the grounding and are not flying other equipment, all those pilots are actually doing their time in the simulator to be as prepared as they can be, including having modeled some of these scenarios that occurred in the 2 accidents. So that has given us a leg up in terms of the readiness for the pilot group to go back into flying these aircraft. But there are, of course, maintenance readiness steps that need to be taken. And again, those we're able -- some of those we're able to do in preparation for it. And then there'll be the basic rollout, but that will take several weeks. And that's why I think, as Mike has said, while we're not changing any of our expectations for the time being as to the total number of MAX that will be in the fleet by the end of the year, they certainly will not be as fully operational as they would have been had the grounding not occurred. And so all the mitigation steps that we've taken, we've taken that into account. And the extension of leases, and some of these wet leases have gone beyond the -- sort of the most optimistic view of when the MAX would be back flying. So putting them back in will take several weeks, although they will come in gradually. So you'd see if the lifting -- if the grounding was lifted tomorrow, you might see a couple come in at the beginning and then over the next 2 weeks, a few more and then a few more and then a few more until the fleet is fully functioning.

[Cameron Doerksen, Analyst]

Okay. No, that's great. Just secondly sort of related -- I'm just wondering if you can talk about lessons learned from this. I mean obviously, you've done a very good job of managing through this issue. But I wonder if there's any sort of lessons as far as the ability for Air Canada to fly a tighter schedule or perhaps operate with a fewer spare aircraft. Just anything that you've learned from this whole process that could benefit the business on a long-term basis.

[Calin Rovinescu, CEO, President & Non Independent Director]

Well, some of the -- the answer is, of course, in any of these difficult events, especially as we call them Black Swan events, you're always going to learn something from it. We certainly learned a great deal from this. In terms of operating a tighter schedule, Air Canada flies its airplanes as hard as any carrier certainly in North America does, and that's the wide-body and the narrow-body. And so in terms of flying a tighter schedule, something like that, I mean there's nothing we're saying there. In terms of consolidation of flight, there's always a balance between consolidating several flights into a larger-gauge aircraft. And then of course -- but you do give up frequency. You give up connections. Over the last number of years, we've been building up our strategy around the connecting traffic in our hubs, and that means having more frequencies that can bring in people to connect. So I think that as we've looked at this, it has sort of sharpened the assessment of which markets are the ones that drive the most profitability, which markets are the ones that we are looking to protect, how do we look at the transcontinental markets. So all of these drivers have given us a sharper focus, but not -- frankly, not from the perspective of sweating the assets any harder than we already were because that was already the case. So I'd say that, that -- in terms of how the company has responded, as I said in my remarks, I've been very, very proud of how the company has responded in literally every nook and cranny of the organization, and that will augur well in terms of as we introduce other new equipment in. And also, the respect that Air Canada has internationally with respect to the partners that have wanted to work with us. We've had access to some excellent carriers who, while they're competitors in many respects, stepped up when we needed them.

[Operator]

Our next question is from Chris Murray with AltaCorp Capital.

[Christopher Allan Murray]

Just thinking about your narrow-body fleet strategy, just -- it looks like you've added some additional 321s into the fleet and they're all going into Rouge. And just wondering a couple of things, especially with the 737 MAX still grounded, any thoughts around other options if you did need additional lift to bring back that 3% to 4%? I'm thinking about availability of aircraft for you. And as well, is there any chance that you could accelerate the A220 intake just to try to take some of the pressure off your schedule?

[Calin Rovinescu, CEO, President & Non Independent Director]

So the -- we like the 321 a lot, for sure, and we expect to like the 220 a lot as well. But the reality of accelerating, it's just not practical beyond what we've already done just based on the pilot training requirements, being able to have the maintenance regime in place, certification and paperwork to bring aircraft in. So I think that when you look at anything in terms of talking about a couple of months, it -- there's nothing more that would be done in terms of bringing incremental aircraft into the fleet like on a more permanent basis. The acceleration of the WOW airplanes, because these were the -- these discussions with WOW -- not with WOW, but with the lessors of WOW were in place well before the MAX grounding, and so all we did is we accelerated the capability to bring them into the fleet, and in some cases, with compromises on the onboard product until we're able to reconfigure it to be able to accommodate our passengers. But it's not something that we can bring in overnight at this stage, so that's why we're using wet leases to buffer and to fill in the remaining gaps.

[Christopher Allan Murray]

Okay. Fair enough. And then, Mike, if you can, there's kind of a onetime tax expense recovery. Just kind of curious about just tax and NOLs with the Aeroplan transaction. Does this change your thoughts around the timing of payment of cash taxes or anything like that? Just if you can give us some color on that what trend -- what that actual item was and any thoughts around cash taxes.

[Michael Stewart Rousseau, Deputy CEO & CFO]

Sure. The recovery in the quarter was a result of some tax planning on the Aeroplan transaction, where normally we would have to pay tax on the entire amount of proceeds from the banks and we were able to structure a transaction that we did not pay all of that, and so that recovery represents the savings from what we otherwise would have paid in taxes. And that's a onetime -- as you said, a onetime issue. Second part of your question, certainly the inclusion of Aeroplan and with the higher financial results will accelerate the cash taxes that we otherwise would have paid on the timetable that we would have paid them. So it's probably -- we'll start getting some cash taxes later this year, early next year, but it will not be a full amount depending on how much money we make, of course, but certainly, it probably moved up the timetable by 1 year.

[Christopher Allan Murray]

Okay. And should we think of the effective tax rate kind of in the 25%, 26% range?

[Michael Stewart Rousseau, Deputy CEO & CFO]

Yes. I think 27% is the effective rate.

[Christopher Allan Murray]

Okay. And then if I can, just one more. Just can we get any update, we haven't really talked about at it, on how the planning for the cutover for the PSS systems is going and how should we expect that in the back end of the year?

[Lucie Guillemette, Executive VP & Chief Commercial Officer]

It's Lucie. Well, in fact, I would say to you that the planning of the project is going quite well and we are still on track in terms of our implementation and we are working on the project at sort of 3 angles. We have the reservation system, a new reservation system. We also have the departure control system that we're working on and also the availability side. So we're very confident that we're going to be able to meet that or very close to that target date. And I think earlier someone asked a question of Calin regarding lessons learned. I'll tell you, we were extremely driven during the 737 MAX event to do right by our customers, to reaccommodate. But I -- and I can tell you when we do have the Amadeus product in place, it will make these types of events a lot easier for us to be able to manage. So we're excited about the new system coming online.

[Operator]

Our next question is from Kevin Chiang with CIBC.

[Kevin Chiang]

Maybe just following on Cam's question around some of the logistics of when the MAX get back up in the air. Would you plan to -- would you put them back into fleet once Transport Canada signs off? Or would you prefer for other larger jurisdictions to sign off, like Europe, before you put this plane up in the air? Just trying to get a sense of some of the goalpost to think about as we get through the next year.

[Calin Rovinescu, CEO, President & Non Independent Director]

No. Look, it's an excellent question and it's one that we're spending a lot of time discussing internally. So first of all, we're working very closely with Transport Canada, so Transport Canada knows our thinking. And as I said in our remarks, we will make our own assessment once we see what the other regulators have said.I think that the objective here, as I think this has been largely in the public domain, the objective on the Boeing side is to work with as many regulators as possible. The FAA's objective is to include this expert board or panel that will advise on the -- both the fix and the training required for the fix. We may have training requirements that exceed what it is that Boeing and the FAA have instituted as requirements. So we may end up exceeding that. But certainly, obviously, that is the minimum entry point. And we will assess once we see the review board recommendations, the Boeing and the FAA recommendations and the Transport Canada recommendation. So we do have the capability of doing more than what they -- what anybody recommends out there because of the fact that we have the simulator. We -- we're the only ones in the United States and Canada to have the MAX simulator and so that gives us additional flexibility in terms of what training protocols we want to put in, and so we'll assess that in the fullness of time. And it may be that when the -- when it's lifted, Transport Canada certainly will be one of the main drivers of our assessment.

[Kevin Chiang]

That's super helpful. And just maybe secondly from me. When you look at the first quarter here, despite all these -- the challenges you had noted, you put up a positive EPS. When we think of the first quarter now, is this now a structurally positive earnings quarter for you? Like is it safe to assume that now? Or -- is it something that we can maybe think about over time? But when I think of the headwinds you faced, to put up the numbers you put up seem pretty impressive.

[Calin Rovinescu, CEO, President & Non Independent Director]

Right. Well, thank you very much, Kevin. Look, I think that, that certainly is our view that we worked hard to try to make this business less seasonal and less dependent only on Q3. And so this has been -- even before the MAX grounding -- and MAX grounding is 18 days at the end of the quarter. But even before the MAX grounding, we had very, very severe weather events. That's why we called out the number of cancellations and so on. And I think that our model, the flexibility of the fleet, the fact that we've got all of these different aircraft that we can substitute, we can make money in different markets at different times, our attempts at this counter-seasonality by operating to Australia and eventually to New Zealand in the winter months, all of these things are drivers of the stability of it. And the -- and so from our perspective, it does augur quite well in terms of having a first quarter that can be profitable.

[Michael Stewart Rousseau, Deputy CEO & CFO]

Right. And then just to add to that, also the inclusion of Aeroplan, some portion of Aeroplan and that Jazz renegotiation also helped our results as well. And those are permanent changes to our business model as we go forward. And so I agree with Calin that Q1 is -- in the future will be -- will continue to be stronger quarter than it was historically.

[Operator]

And our next question is from Jamie Baker with JPMorgan.

[Jamie Nathaniel Baker, U.S. Airline and Aircraft Leasing Equity Analyst]

Most of my questions have been answered, but I also have a MAX related one. Given the absence of non-MAX 73s in the fleet, can you quantify what the cost drag is associated with grounded pilots? And at what stage, if any, would it make sense to start retraining a portion of them on other types? And what sort of -- what level of expense and time might be involved with that exercise?

[Calin Rovinescu, CEO, President & Non Independent Director]

Right. Yes. So Jamie, we're going through that right now. We've made a decision to look at a subset of the total 400-ish, 425 I think or so, MAX pilots that we have. And as I said earlier, these pilots are not just sitting around sort of doing nothing, we're actually able to have some simulator training for them as this is going on. But we have made the decision given the ramp-up, back up to an earlier question that was asked, but it's not going to be ramping up overnight, we have made a decision to take a subset of those pilots. And if they have operated equipment within the last year, other equipment within the last year, they -- it makes sense. If they haven't operated other equipment within the last year, it doesn't make sense to have them retrained on other equipment from a timing perspective. So that is -- that's kind of directionally where we're heading. That means that they could be operating the Airbus narrow-body -- typically, it would be either the Airbus narrow-body or the Embraer 190 which is still in the fleet. And that's kind of -- if they operated that equipment within the last year, they can return to it. So it's a number -- we haven't publicly announced what that number of pilots is at this stage, but it's a subset of the 450, a small-ish subset of the 450, I would say. And in terms of the amounts, Jamie, what we're doing is we're categorizing and keeping all of the costs that relate to the grounding. And obviously, our discussions with Boeing will be confidential. So we're not putting out any number in terms of any cost mitigation at this stage.

[Operator]

[Operator Instructions] Our next question is from Turan Quettawala with Scotiabank.

[Turan Quettawala]

I guess firstly, Mike, I was wondering if you can talk a little bit about how quickly you would get delivery of the MAX that are current -- that are sitting with Boeing right now if the grounding was to get obviously removed.

[Michael Stewart Rousseau, Deputy CEO & CFO]

Okay. Good question, Turan. So we have 12 planes to come in. We had 24 in our fleet when it was grounded, we were supposed to take another 12 deliveries last part of March to the last part of June. We understand roughly half of those -- 6 of those are completed and are parked at this point in time. The other 6 are on the production line, some level of the production line. So certainly, 6 of them could come in fairly quickly once we did our inspections and our -- but the other 6 would take a little bit longer. Obviously, it's dependent upon where they are in the production line.

[Turan Quettawala]

Perfect. That's helpful. And I guess Boeing is not really changing the order of deliveries, right, to different airlines presumably.

[Michael Stewart Rousseau, Deputy CEO & CFO]

We don't know what their plans are. We're really, obviously, focused on our plans. What they have done is, as you probably know, they reduced their production rate by 15%, 20%.

[Calin Rovinescu, CEO, President & Non Independent Director]

Yes. Down to 42%.

[Michael Stewart Rousseau, Deputy CEO & CFO]

Down to 42%. So that may influence the timing of our -- or the 6 that are currently on the production line.

[Turan Quettawala]

Perfect. And then I guess the other one I was wondering was, again, sort of related to the MAX. But presumably, a lot of the effect on capacity would be domestic and transborder, right? Does that have a follow-through impact with regard to Sixth Freedom traffic? Or is that just too small and you've been able to protect most of it?

[Lucie Guillemette, Executive VP & Chief Commercial Officer]

It's Lucie. There's -- so there are a couple of things there. You're correct that the transcontinental routes, domestic and also some of the long-haul U.S. routes were heavily operated by the MAX. And of course, those are key routes not only just for Sixth Freedom traffic but also for local demand. So we were able to protect both of those either through up-gauge or using strategically Rouge, for example, in July on some of the transcontinental routes. So they were in fact high 737 markets, but those were the ones that we aim to protect as best as we could. There is a little bit of reflow, so changes in terms of some of the connecting traffic as a result of the schedule change, but no significant impact to our Sixth Freedom strategy. Those are all the kind of things that we would aim to protect as we redesign the schedule.

[Operator]

There are no further questions registered at this time. This ends the first quarter call. For those who wish to join the discussion on the accounting policies related to Air Canada's acquisition of Aeroplan, please remain on the line. We will be with you shortly.