Transat A.T. Inc.

Hello, everyone, and welcome to the Transat conference call for the presentation of the financial results of the third quarter ended July 31, 2019. I’m here with Jean-Marc Eustache, President and CEO; Annick Guérard, COO; and Denis Pétrin, our CFO.

Denis will review the financial results and we will then answer questions from financial analysts. Questions from journalists will be handled offline.

The conference call will be in English, but questions may be asked in French or English. As usual, our Investors’ presentation has been updated and is posted on our Web site in the Investors section.

Denis may refer to it as he comments. Today’s call contains forward-looking statements.

There are risks that actual results will differ materially from those contemplated by those forward-looking statements. For additional information on such risks, please consult our filings with the Canadian Securities Commissions.

The call also contains certain forward-looking statements concerning a potential transaction involving the acquisition of all the shares of the corporation. These statements are based on certain assumptions deemed reasonable by the corporation, but are subject to certain risks and uncertainties, several of which are outside the control of the corporation, which may cause actual results to vary materially.

In particular, the completion of the transaction will be subject to certain closing conditions, including regulatory approval described in Transat’s management information circular dated July 19, 2019, as well as other customary closing conditions. In addition, a public interest assessment regarding the arrangement is being undertaken by Transport Canada with input from the Commissioner of Competition.

If the required regulatory approvals are obtained and conditions are met, it is now expected that the transaction will be completed by the second quarter of the calendar year 2020. In addition, statements regarding the results of the potential transaction will depend on the purchases planned following the completion of the potential transaction.

Forward-looking statements represent Transat’s expectations as at September 12, 2019, and accordingly are subjected to change after such date. However, we disclaim any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise other than as required by law.

Finally, we may refer to IFRS and non-IFRS financial measures. In addition to IFRS financial measures, we are using non-IFRS measures to assess the corporation’s operational performance.

It is likely that the non-IFRS financial measures used by the corporation will not be comparable to similar measures reported by other issuers or those used by financial analysts as their measure may have different definitions. The measures used by the corporation are intended to provide additional information and should not be considered in isolation or as a substitute for IFRS financial performance measures.

Additional information on non-IFRS financial measures, such as their definition and their reconciliation with the more comparable IFRS measures, are available in our annual report. With that, let me turn the call over to Denis.

Thank you, Christophe. Good morning, everyone.

We are reporting today our numbers for the third quarter for which the results are primarily driven by the Transat and Air Transat market. As usual, I will review the financial results and then share our outlook for the summer season.

At the end, I will also make some comments on the plan of arrangement signed with Air Canada. But first, as I did last June, allow me to say a few words on the adoption of two accounting standards and the impact on comparative numbers.

Corporation adopted IFRS 9, Financial Instruments, and IFRS 15, Revenue from Contracts with Customers on November 1, 2018 and restated the 2018 figures. The main changes are described in the Note 3 of our financial statements.

Here are the most important ones. On our statement of income, revenue and related costs from the land portion of holiday packages are now recognized over the course of the stay.

Prior to the adoption of IFRS 15, revenue was recognized when passengers departed. All airport taxes are now reported on a net basis.

Prior to the adoption of IFRS 15, revenue from certain airport taxes was reported gross and the corresponding expense was recorded. The impact for the quarter ended July 31, 2018 consisted in a $32 million decrease in revenue and an $11 million decrease in EBITDA.

On our statement of financial position, from November 1, 2018 onwards, the adoption of IFRS 15 led to a modification of all the balance of cash interest or otherwise reserve is calculated. As of July 31, 2019, the impact is a $21 million increase of cash interest and an equivalent decrease in our free cash position.

For information IFRS 16 with regards to leases will come into force in the first quarter of next year. So for all markets combined, Q3 results were as follows.

Revenue of $699 million, up $34 million or 5.2% and adjusted operating income of $22 million compared with $2 million last year. The adjusted net income was $6 million compared with an adjusted net loss of $5 million in 2018.

On our transatlantic route, our main market during the summer, our capacity was 1.7% higher, selling prices were up 1.3%, our load factor was up 2.2%. Therefore, after taking into account higher maintenance costs and slightly unfavorable impact of pure FX on our costs, profitability was higher than in 2018.

On our sun destination program, which was a low season for leisure travelers, capacity was 2.6% lower, selling prices of our packages were 4.8% higher, load factor was up 1.5%. The variants of fuel and FX did not have a significant impact on our operating costs.

Consequently, margins were higher than last year. For financial statements, the net loss was $11 million compared with $5 million last year.

The third quarter includes expenses of $13.7 million related to the potential acquisition of the corporation by Air Canada comprising an amount of $6 million of professional fees and adjustment to certain provisions related to stock-based compensation plans following the significant rise in the share price during the quarter as well as the forward [ph] investing period for these compensation plans. These provisions have been calculated using the share price at the end of July which was $11.48.

Until closing, adjustments to provisions will be booked. For illustration, if share price is at let’s say $15 at the end of October, then the adjustment book in the fourth quarter will represent approximately $5 million.

With regard to the fourth quarter outlook when compared to 2018 on the transatlantic market, global capacity is 5% higher; our capacity is similar to last year. Currently, 83% of our capacity has been sold, load factor are down 0.9%, fares are up 2.1%.

The combined effect of fuel cost and currency fluctuations does not currently result in an increase in operating expenses. On sun market, 83% of the capacity have been sold, load factor are up 5.6% and unit margin are currently higher compared with those recorded on the same date last year.

For all markets combined, if these trends hold; results should be slightly improved compared to 2018. Looking further ahead, there are a few preliminary comments regarding next winter season.

As of now on the sun destinations when compared to last year, global capacity is up 5%; our capacity is up 9% at the opening of the season. As usual, this figure may be reduced as the season unfolds.

It includes also an increase in seats sold through a third party vendor [indiscernible] 27% of our capacity is sold and load factor are ahead by 1.8% versus last year. As we speak, variance of fuel and FX should not have a significant impact on our operating costs.

Despite these indicators, it is too soon to draw any conclusions on the winter results at this point. Now for our balance sheet.

The corporation's free cash totaled $724 million as of July 31, 2019, a decrease of 143 million versus a year ago, which is mainly due to the adoption of the new recognition standard IFRS 15 which led to a modification of all the balance of cash interest or otherwise reserve is calculated for $21 million. The land in Mexico for a total of $78 million acquired before the signatures of the definitive agreement with Air Canada, the purchase of a spare engine for the introduction of the Airbus A321neo fleet $17 million, commissioning costs on aircraft added to our fleet which are included in the CapEx during the last 12 months for which a portion will be recovered from lessors in the coming months and some other timing issues for $14 million.

And finally, professional fees related to the transaction plus settlement of a litigation for a total of $13 million. Obviously, our credit facilities remain unused.

Deposit for future travels stood at $611 million compared with $587 million at the same date last year. Off balance sheet agreements stood at $2.4 billion, a $153 million decrease when compared to year end due to repayments made during the nine-month period, partially offset by the weakening of the dollar against the U.S.

dollar. As said earlier, IFRS 16 leases will be applied as of Q1 2020.

The net present value of the future lease payments will then be accounted on the balance sheet as an asset and as a liability. Furthermore, cost of major maintenance; engine, fuselage, landing gear will be capitalized and amortized over their useful life.

This will eliminate the need for a provision for overall of leased aircraft as presently shown on our balance sheet. As already announced on June 26, the corporation restated its annual consolidated financial statements for 2018 as well as for the first end of second quarter this year.

The restatement is related to the carrying amount of non-controlling interest in the traffic to Air Canada subsidiary. The total impact of the restatement is a reevaluation of the liability for this non-controlling interest of 20.5 million as at April 30.

It has no direct impact on the consolidated statement of income. As part of this restatement, the corporation reviewed subsequent events up to September 11, 2019, an amount of $6.7 million related to the settlement of a litigation which procure on June 5 of this year and was previously recorded during the quarter ended April 30, 2019 is now recorded as a subsequent event under special items in the restated consolidated statement of income for the quarter ended October 31, 2018.

A few remarks on the potential transaction with Air Canada. On August 23, 2019, a significant majority of the corporation shareholders voted in favor of a special resolution approving the previously announced plan of arrangement following which Air Canada will acquire all of the issue and outstanding voting shares of Transat for a cash consideration of $18 per share.

On August 20, 2019, the corporation announced that the Superior Court of Quebec issued a final order approving the plan of arrangement with Air Canada. The arrangement remains subject to certain closing conditions including regulatory approvals described in Transat’s management information circular dated July 19, 2019, as well as other customary closing conditions.

If the required regulatory approvals are obtained and conditions are met, it is now expected that the transaction will be completed by the second quarter of the calendar year 2020. The corporation has agreed to limit its undertakings and expenses related to the execution of its hotel strategy in the period leading up to the closing of the potential transaction.

In conclusion, we are pleased with the massive support from our shareholders for our plan of arrangement. We will give updates on major developments regarding the potential transaction, if any.

However, we remain fully focused on our operations and coming back to our results, they show improvement for the third quarter compared to last year and the increased selling prices and load factors are encouraging in the context of a very competitive market environment. For the fourth quarter of 2019, the outlook is also slightly favorable compared to last year.

We will now proceed with your questions.

Thank you. Good morning.

I’m just wondering if I look at the outlook that was provided in the Q2 results, it looks to me that the revenue in the third quarter was actually probably stronger than anticipated. I’m just wondering what markets or regions drove that result if I’m actually correct in my interpretation?

You’re implying the increasing revenue.

Well, specifically the stronger revenue than it appears to me was indicated in the Q2 outlook for the summer season.

As Denis explained, our results come from a combination of increase in the load factors as well as in the revenues with passengers. Most of our increase would come from both Europe and South.

Major increases in the load factors for the month of May and June which were very difficult last year in 2018 in terms of load, so very good improvement on that side. And as for the South season, we have the good improvement both on the load side as well as the revenues per passengers.

Feeder program helped as well. We were able to increase the loads as well on those program as well as the revenues per passenger.

So overall, we were able to increase revenues per seat mile in a significant way for Q3.

Let me try asking it slightly differently. Was revenue in the third quarter similar to what you anticipated when you published the second quarter – the outlook for the third quarter with the second quarter results or was it weaker or stronger the same as --?

It was pretty within line.

Okay, thank you. My second question is I think there was an indication that sort of packaged volume was lower in the third quarter year-over-year, which I assume means more air only revenue.

Just wondering if you could talk about the reason behind that mix shift?

We see a slight increase year-over-year on the South destination in flight only, so a slight increase in demand for flight only. People tend to buy the flight and buy their accommodation sometimes elsewhere or do their own.

However, the packages are still very strong. We saw on both the packages and the flight an increase in dollar per passenger in terms of revenues.

But overall I think we disclosed that during winter time, the flight only business on the South destination represent about 30% of our capacity whereas in the summer time it’s much lower than that.

And Tim if I could add, I think this explanation was more for the winter season to your question because for Q3 we did not really notice a shift in packages versus seat only. But for the winter we made that comment and in our MD&A we were referencing I think the winter season when we made that.

If you notice somewhere that we have said that for Q3, please let us know.

Okay, I will.

And it was not be very significant. It will not be very, very significant.

Okay, yes. It is indicated on the cost for providing tourism services, but we can chat about that after.

And then I guess just my last question, there are a number of references in terms of the costs on a year-over-year and I guess slightly higher capacity year-over-year and this is overall capacity, yet the rent expense or lease expense was down I think 5% or 6% year-over-year. Can you just talk about why rent expense was down a little bit year-over-year compared to the third quarter of fiscal '18?

Last year we were having – you know that we bring seasonal plane for the winter period and last year planes were returned to their original airline later than this year. Then that increased our cost of last year because we didn’t have the situation this year than it had a positive impact on this specific line.

Okay, that’s helpful. That’s great.

Thank you very much.

Hi. Thanks for taking my question here.

Maybe just to follow up on Tim’s question maybe just so that I understand it. When I look at your outlook that you provided with your second quarter in terms of your outlook for summer 2019 in the transatlantic market, at that point in time you had noted that the selling price was similar to last year.

I think that’s what was stated a quarter ago and then what I look at I’ll call it Slide 10 on your investor deck with the third quarter, it looks like yield management drove a positive 24 million impact on EBITDA. So I guess I’m wondering did pricing maybe improve over the last, let’s say, three months relative to what you thought exiting the winter season and are you still seeing maybe stronger pricing as you look out the next let’s say six months and into the winter season and is that being driven maybe partly because of some of the max grounding constraining capacity overall into some of these markets that you service?

When we posted our results for Q2 and made the outlook for the summer, looking at the numbers at the time we were slightly ahead and we said that we were expecting result to be slightly better. We’re ending up the third quarter with an improvement again on an adjusted basis, but if we look at the EBITDA improvement of 19 million, 19 million is spread [ph] to be significant, then we’re happy with this.

Then it’s a combination of let’s say ending up the quarter with sales at prices that we’re happy with. And like Annick was saying also with load factors again and ancillary revenue and lots of factors contributed to this 20 million.

Then say that we’re completely surprised with these numbers, I would say no. But let’s say that they were on the higher side of what we were expecting.

This is how we ended up the quarter.

Maybe just a comment on that from the last time that we had this meeting, what we realized and were a little bit surprised about coming into the summer season was how much late bookings – last minute bookings we were getting especially on Europe. It started around the month of April slightly and then May was really important in terms of last minute bookings and June and that trend followed up until now.

So I don’t know if it’s going to continue like this on Europe for the months to come, but for September this is what we’re still seeing. October might be the same.

And now we’ll see for next winter. So I think that was one of an important difference that we saw which allow us of course to increase load factors, but as well to increase pricing at the end towards the departure date.

Annick, maybe you should talk about the revenue management and the changes that we made almost two years ago. That’s part of the question also.

Of course. So we started implementing or doing large transformation within the revenue management structure and processes about 18 to 24 months ago.

This is a long process. It takes a long time to turn around.

We’re seeing it paid off for the last winter. The problem was last winter of course the costs were higher, but in terms of revenues per available seat mile we saw an important increase of about 5%.

And this trend in terms of increasing revenues per seat miles is continuing towards the summer and so far we think it’s going to be positive as well in terms of revenues for next winter.

Okay. And maybe when I think about the winter and I appreciate that it’s early and so I can understand why you’re remiss to provide any financial guidance.

But when I look at the max grounding, two of your main competitors in that market are being impacted by that, specifically I’m talking about Sunwing and WestJet there and just looking at your expectations for sun destination capacity, growth from those two competitors, this upcoming summer is a fraction of what you saw them do just last winter. So I’m wondering even with the early part of the booking curfew, are you seeing stronger pricing reflecting maybe some more constrained capacity into that market which has been very challenging for you for the past decade?

When we look at next winter, the overall increase in capacity in the market is around 5%, so we are not seeing any decreases from competitors at this point in terms of what’s being offered at the different South destination. We are pleased because our bookings we’ve increased the capacity on large side as well.

We are seeing bookings that are in advance compared to last year, so we’re pleased by that. In terms of pricing, pricing is still aggressive for most of the competitors for us as well at this point.

We expect that it could get a little bit higher over the next months to come. But at this point it’s still a battle I would say in the field and there’s a lot of pressure on pricing for next winter.

Okay. That’s very helpful color.

Thank you very much.

Hi. This is Almena [ph], Konark’s associate.

I do have a question on nonrecurring. It’s around 13 million this quarter.

I’m wondering what do you expect next quarter.

I would separate that in twofold. The first one is everything that is linked to compensation, which is again a provision and not really payment.

But as I was saying earlier is we have used at the end of July the price of the share which was $11.48, we end up at the end of the fourth quarter and having the share price the same value than it is today, then around $15. We should expect something like $5 million more to be added in Q4.

Obviously, if we get to the transaction by Q2 somewhere, then there will be a couple of dollars to add to this to go from 15 to 18, then an additional 5 million per quarter than we anticipated. In terms of professional fees, we have booked up until now $6 million.

In circular posted earlier this summer, we were saying that we were estimating those costs to be like $12 million in total. This $12 million was calculated using the price at the time which was 13, moving that to 18 it had 1.5 million than total that we estimate.

Today it’s like $13.5 million for which 6 have been put to the P&L up until now. Then some will come at the end obviously, some are on the success fees but some will be spent also progressively up until the closing of the transaction.

Okay. You mentioned the outlook was going to be better going forward.

Do you see any benefits from the airline shutdown or the 737 MAX?

No, not really. For Q4 we haven’t seen.

But most of our program is on the Atlantic markets. We haven’t seen on that market significant benefits for us in terms of lower capacity from our competitors.

They have been able to look for alternate solution to replace that capacity in most of the markets where we compete.

Okay. And do you see any global impacts such as Brexit or any other impacts in Europe that will impact demand from Europe?

In terms of Brexit?

Yes.

In terms of Brexit, we’ve seen lower demand out of the UK towards Canada. That started last year as well and it’s continuing this year.

Fortunately, the Canadian market is able to compensate for that decrease in terms of demand. So we are seeing higher loads out of Canada and lower loads out of the UK on our Canadian-UK flights.

Okay. And just a question on the fleet.

How many aircrafts do you expect in the future quarters?

Are you talking about the A321neo long range or overall?

Overall.

Okay. So as you know for this summer we receive the first two A321neo long range, so for this summer our fleet was composed of 20 330s, six 310s, two 321neo long range and we had about 10 narrow bodies.

If we look at next winter, so we will still fly our 20 330s, we will decrease of course the number of 310. It’s going to be the last season where we operate the 310s, so we will leave them off the ground at the end of the winter.

And progressively during winter, we will go up to three and four A321neo long range. We will have for next winter as well 24 narrow bodies.

Next summer, we will operate with not the same fleet as this summer, except that we will go up to six A321neo long range.

Okay. Thank you.

I don’t have any more questions.

So thanks, everyone. And let me remind you that our fourth quarter results will be released on the 12th of December.

Thank you and have a good day.