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Edited Transcript of WJA.TO earnings conference call or presentation 7-May-19 2:00pm GMT

Q1 2019 WestJet Airlines Ltd Earnings Call

CALGARY Jun 3, 2019 (Thomson StreetEvents) -- Edited Transcript of WestJet Airlines Ltd earnings conference call or presentation Tuesday, May 7, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Edward Sims

WestJet Airlines Ltd. - President, CEO & Non-Independent Director

* Henry P. Taylor

WestJet Airlines Ltd. - CFO & Executive VP of Finance

* Jeff Hagen

WestJet Airlines Ltd. - Manager of IR

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Conference Call Participants

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* Cameron Doerksen

National Bank Financial, Inc., Research Division - Analyst

* Christopher Allan Murray

AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research & Senior Analyst of Diversified Industries

* Conor T. Cunningham

Cowen and Company, LLC, Research Division - Associate

* Jamie Nathaniel Baker

JP Morgan Chase & Co, Research Division - U.S. Airline and Aircraft Leasing Equity Analyst

* Michael James Maugeri

Wolfe Research, LLC - Analyst

* Tim James

TD Securities Equity Research - Research Analyst

* Turan Quettawala

Scotiabank Global Banking and Markets, Research Division - Director, Transportation and Aerospace, Equity Research

* Walter Noel Spracklin

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Thank you for standing by. Welcome to WestJet's 2019 First Quarter Conference Call and Webcast. (Operator Instructions.] I would now like to hand the conference to your speakers, Mr. Ed Sims, Chief Executive Officer; and Mr. Harry Taylor, Executive Vice President, Finance and Chief Financial Officer.

I'd like to turn the conference over to Mr. Jeff Hagen, Manager of Investor Relations. Please go ahead, sir.

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Jeff Hagen, WestJet Airlines Ltd. - Manager of IR [2]

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Thank you, Ariel, and good morning, everyone. Welcome to WestJet's 2019 First Quarter Results Conference Call. I have with me this morning Ed Sims, our President and Chief Executive Officer; Harry Taylor, our Executive Vice President of Finance and Chief Financial Officer; Charles Duncan, our Executive Vice President and Chief Strategy Officer; and John Weatherill, our Vice President of Revenue Management and Pricing. Ed and Harry will provide a brief overview of financial performance, and we will then follow with questions from analysts. When we are in the question-and-answer portion of the call, I would request that questioners limit themselves to 2 questions. That should allow us to get to as many questioners as possible in the hour we have allotted for this call.

Before turning the call over to Ed, I would like to read the customary cautionary language. We caution you that today's conference call will contain forward-looking statements about WestJet's future financial and operational performance. This information is based on certain assumptions and reflects WestJet's expectations as of May 7, 2019, and accordingly are subject to change after such date. Forward-looking information is subject to a number of risks and uncertainties that could cause actual results or events to differ materially from our expectations. These risks and uncertainties are discussed in documents WestJet files from time to time with securities regulatory authorities. Except as may be required by Canadian securities law, we do not undertake any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Furthermore, certain non-GAAP measures and additional GAAP measures may be discussed or referred to on today's conference call. Please refer to the section entitled Reconciliation of Non-GAAP and Additional GAAP Measures in WestJet's Management Discussion and Analysis for the 3 months ended March 31, 2019, for further information.

Now I'll pass the call over to Ed.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [3]

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Thank you, Jeff, and good morning, everyone, and thank you all for joining us. Today we reported a 33.4% year-over-year increase in our first quarter net earnings, delivering a profit of CAD 45.6 million or earnings per diluted share of CAD 0.40. In the first quarter we flew a record 6.3 million guests. And for the third consecutive year, we are proud to be recognized as the Best Airline in Canada in TripAdvisor's 2019 Traveler's Choice Awards for Airlines. We're also being recognized as a winner amongst midsized airlines in North America. To win the prestigious Best Airline in Canada award 3 years in a row as voted by the traveling public is testament to how effectively 14,000 WestJetters create a remarkable experience for our guests every day.

Before I move on to some of the highlights from the quarter and beyond, I want to address the closing of Canadian air space to the Boeing MAX 8 aircraft. As of today WestJet has 13 Boeing MAX aircraft in our fleet, representing less than 10% of our jet fleet, approximately 7% of our total fleet, and approximately 10% of our total 2019 system capacity. From March the 13th, led by our network and schedule planning, maintenance and our operational control center teams, we rose to the challenge of the grounding as one team of WestJetters, and we were able to mitigate much of our controllable costs as a result of the MAX groundings. Our teams have been calm, methodical and resourceful all the way through this latest challenge.

Nonetheless, for the last 18 days of March, our absolute revenue was adversely impacted, as we spent considerable effort reaccommodating thousands of disrupted guests, in the process losing some of our ability to capture close-in, high-yield premium traffic. Adjusting for lower capacity, the RASM impact in the first quarter was broadly neutral. Our flight schedules currently reflect the removal of our Boeing MAX aircraft through the entire second quarter.

Since the grounding and through proactive planning and a well-designed contingency plan, we have covered 96% of our system capacity. We are actively monitoring this situation on a daily basis, and we'll continue to put safety and the interests of our guests first.

Over the next 2 weeks, we'll be implementing our contingency plan for the peak months of July, which will utilize our entire fleet to create more available aircraft time and mitigate much of the impact of lost MAX capacity. While the MAX aircraft have been grounded, they have been reconfigured with our new 2-by-2 seat configuration in the premium cabin, ahead of their originally scheduled configuration dates.

As a result of the lost MAX capacity, we chose to extend one 737-700 lease until the end of July to bridge our capacity into the busy summer season. However, we have no plans to extend or bring on any other market-inflated capacity through any type of arrangement to offset lost flying. We currently have only one market, Halifax to Paris, that cannot be flown economically on any of our other narrow-bodied fleet types, and we have used alternative routings, like our 787 Calgary-Paris service, to reaccommodate guests while also utilizing partners like Air France to further minimize guest disruption.

We remain steadfast in our commitment to prudent growth and believe that the detrimental impact of bringing excess capacity back into the market outweighs the short-term capacity loss, especially given that we firmly believe that this issue now has a critical path towards resolution. I continue to have 100% confidence that the 20-year-plus experience of WestJet pilots operating Boeing's NG 737s puts WestJet in a strong position for a safe reintroduction to service.

In the first quarter, the demand environment remained strong, and we are pleased with the underlying health of our core WestJet mainline business, inclusive of WestJet Encore, which showed significant year-over-year rapid growth despite Easter shifting into the second quarter. Specifically, we continue to see premium demand strength, with revenue from premium cabin fares up 76% year-over-year, driven primarily by our enhanced ability to manage inventory at both the cabin level and through our branded fares.

Spending within our top loyalty tiers was up 19% year-over-year in the first quarter, driven by recent enhancements made to our loyalty tiers, including the introduction of our new Platinum tier and our unlimited lounge access for both Platinum and Gold tiers.

Ancillary revenue remained strong in the quarter, up 15.2% in total and up 10.2% per guest at a consolidated group level. This is despite the strength seen throughout our premium cabins, as we are seeing a greater proportion of guests electing to pay a full premium fare, which has resulted in fewer seats available for ancillary upgrades, a tradeoff which we welcome and expect to continue.

Regionally, in the domestic market, our prudent capacity growth, combined with more stable levels of industry capacity, drove significant year-over-year domestic revenue growth in our core WestJet business. We generated essentially the same absolute revenue year-over-year in the first quarter on 10% less WestJet capacity in the domestic market. And since our last call, over 66,000 guests have been able to experience the world-class product offered on our 787 Dreamliner as we cycled our first 2 deliveries domestically between our hubs in Calgary and Toronto Pearson.

We are very happy with how our 787s have performed operationally, with revenue and paid load factor strength seen in all cabins. Canadians are clearly ready to have a viable and competitive alternative in the premium space, and WestJet and guests continue to rave about the new WestJet onboard experience.

Turning to our transborder and international regions, our transborder region was our only region with a decline in year-over-year unit revenue growth. This softness was driven by considerable increases in competitor capacity to leisure destinations, which combined to constrain hotel inventory and inflate prices to a point where we saw guests start to adjust their behavior and shift travel to alternate sun destinations like Mexico.

In our international regions, we saw continued strength in our sun markets, as we saw year-over-year unit revenue growth despite significant year-over-year capacity growth. And finally, the first quarter marked our seventh consecutive quarter of positive unit revenue growth in the transatlantic market.

As we now look forward, guest enthusiasm for our 787 has translated into sustained strength across all markets and all cabins on our transatlantic services into Europe. We are very pleased with both current bookings and forward trends and expect to not only improve yields, but also fully absorb significant transatlantic capacity growth in the second quarter. Calgary-London is performing exceptionally well as it transition from our 767 service offered last year to the 787.

Notwithstanding significant year-over-year capacity growth, we are seeing improved load factors and yields in our economy and premium cabins while commanding a substantial yield benefit in our business cabins. Additionally, our non-787 transatlantic flying is also performing well and generating double-digit increases in year-over-year revenue despite a reduction in WestJet capacity.

Our strategic initiatives continue to contribute to positive results. With capacity reductions from MAX groundings and the overlap of the threat of labor action that occurred in the second quarter of 2018, our focus for the second quarter of 2019 is on maximizing yields, and we expect the current strengths seen in our core WestJet business to continue.

Turning to Swoop. In line with Swoop's business model and as a result of its disproportionately higher growth rate, we are experiencing and expect to see peak RASM dilution in the first 2 quarters of 2019. This dilutive impact will start to improve through the second half of this year but will not fully dissipate until we annualize a full fleet of 10 aircraft.

We are pleased with Swoop's performance, as it continues to do exactly what it was designed to do -- operating with the lowest costs in the Canadian aviation industry and quickly approaching our target of CAD 40 in ancillary revenue per traveler. However, as Swoop is still very early in its maturation curve, not even celebrating its first anniversary until June of this year, we are learning from our first winter of operations. Through the softer shoulder months, we experienced greater variability at Swoop than in our core WestJet business, with significant fluctuations seen in load factors between peak travel periods.

As a result, we are actively working to mitigate these fluctuations and have already expanded Swoop's distribution model while we continue to assess and optimize Swoop's network. We have extended the Swoop brands onto low-cost metasearch engines such as Google Flights and Skyscanner. Since launching on these platforms, we have seen an immediate uptick in both awareness and conversion. We're now exploring and negotiating agreements with other large online travel agencies like Expedia, which we expect will continue to drive incremental bookings, build awareness, and further establish Swoop's place as the top choice for travelers in the Canadian ultra-low-cost space.

In closing, we continue to work towards long-term stability and more harmonious relationships with all of our labor groups. Subsequent to the end of the quarter, a 5-year compensation agreement with our WestJet and WestJet Encore aircraft maintenance engineers was ratified. Further to this announcement, we then reached a ratified agreement with the Air Line Pilots Association, ALPA, representing WestJet Encore pilots. And finally, I am very pleased to announce this morning that we have now also reached a tentative agreement with the Canadian Air Line Dispatchers Association, CALDA, representing our WestJet and WestJet Encore dispatchers. All of these agreements, agreed in the course of the last 2 months, are a testament to WestJet's rapidly developing labor relations maturity in interest-based bargaining. I would like to pay tribute to the hard work and dedications of the negotiating teams on both sides.

Additionally, we are actively working to finalize the implementation of the terms of the collective agreement as decided by the arbitrator with respect to our WestJet and Swoop pilot groups. Negotiations with the Canadian Union of Public Employees, CUPE, who represent our flight attendants, began on the 25th of March, and WestJet remains committed to achieving a sustainable resolution in the best interests of all parties involved.

As always, I want to thank every individual WestJetter for your continued dedication and for rising to the challenge of delivering our award-winning brand of caring service in trying circumstances. I also want to thank the guests who traveled with us in the first quarter for your continued support and for once again reaffirming our status as Canada's best airline.

With that, I'll turn it over to Harry.

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [4]

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Thank you, Ed. Good morning, everyone, and thanks again for joining us today. Before I begin, I wanted to highlight that our first quarter financial statements and our financial metrics are presented using the new lease accounting standard, IFRS 16.

Turning to the quarter, our total CASM was 0.6% higher year-over-year, while our CASM excluding fuel and employee profit share increased just 0.9% in the quarter. This was achieved despite some incremental costs associated with the MAX grounding as we continue to effectively manage our internal spending. We remain committed to prudent cost management and to keeping our controllable expense growth in line with capacity growth but, similar to other carriers, expect our CASM and our CASM excluding fuel and employee profit share to be under pressure in the second quarter due to the short-term impacts of the MAX grounding.

As seen in our first quarter results, we are widening our cost advantage and continue to ensure that internal spending is allocated to critical initiatives. Through our Owners Mindset program, we expect to deliver on our CAD 120 million target for 2019 on the way to realizing CAD 200 million of margin improvements in 2020.

Specifically, one of the initiatives that has been accelerated through this program is the use of required navigation performance approaches, which use satellite-based navigation to optimize flight paths and allow us to execute continuous and fuel-efficient descents. In the first quarter, WestJet executed over 22,000 of these RNP approaches at 12 Canadian airports, saving over 700,000 liters of fuel. The benefit from all of our fuel savings initiatives can be seen in our first quarter results, as fuel consumption increased by only 1.1% on capacity increase of 5.3%.

During the first quarter of 2019, we finalized the sale and leaseback of our first 3 Boeing 787s, and we're very pleased with the terms of these transactions, providing WestJet with over CAD 570 million in funding. In accordance with IFRS 16, a gain of CAD 13.8 million on the sale and leaseback transactions was recorded in our first quarter statement of earnings, and the remainder of the total gain was applied to the right-of-use assets, reducing amortization over the term of the leases.

Our balance sheet remains strong. We ended the first quarter with a cash, cash equivalents and marketable securities balance of CAD 1.6 billion, which was 34% of our trailing 12 months revenue. When combined with our undrawn revolving credit facility of CAD 400 million, we have just over CAD 2 billion in unrestricted liquidity, which is more than 40% of our trailing 12 months revenue. This positions us well as we evaluate the sources of financing available to us based on our requirements, including upcoming maturities of existing debt.

As at March 31, 2019, our adjusted debt/equity ratio was 1.28, up from 1.13 at the end of 2018, and our net debt was CAD 1.29 billion, up from CAD 1.25 billion at December 31, 2018. Our trailing 12-month earnings before interest, taxes, depreciation and amortization was CAD 0.8 billion, resulting in a net debt/EBITDA ratio of 1.62, up slightly from 1.59 at December 31, 2018.

In closing, I want to reiterate that we will not be providing any formal 2019 financial guidance due to the uncertainty of the cessation of the MAX grounding. We remain confident in the strength of our business model, our ability to withstand and adapt to a tougher external and competitive environment and our ability to execute on our strategic initiatives. We firmly believe that our strategy will yield expanding margins and attractive shareholder returns over time.

I would also like to thank all WestJetters for the dedication, hard work and terrific service they provide our guests every day. With that, I will turn the call over to Ed.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [5]

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Thank you, Harry. I think we are now ready, operator, to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Walter Spracklin of RBC Capital Markets.

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Walter Noel Spracklin, RBC Capital Markets, LLC, Research Division - Analyst [2]

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So I'd like to touch on yield. In your prepared remarks, I think you mentioned that Swoop played a role, because if I recall back from the last quarter call, you had anticipated some yield improvement. I noted you did over 2% in the fourth quarter and at least before, you were guiding at a higher RASM. So just curious what happened in the first quarter with regards to Swoop that came as unexpected. Was it a competitive response or some other aspects? And did I read you right that the yield now will be a similar flat kind of into second quarter, and then I think you said it might stay constrained until you lap the full year fleet. So is that saying that it is going to stay constrained now for a year? Or maybe just give us a little bit more color on that.

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [3]

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Sure, Walter, it's Harry. The yield, we were delighted with our performance at WestJet Airlines through the first quarter. We had one of the strongest first quarters in terms of growth rates that we've had in a long time. Swoop was diluted, as it's designed to be. Because it's not in our base -- our base meaning last year -- for the first half of the year, we're at peak or maximum dilution. And so we will see that start to dissipate once we anniversary, if you will, the introduction of Swoop on June 20. It will take us a full year and a half to get to complete annualization as we get to 10, but we think the maximum dilution is Q1 and Q2 of this year.

Having said that, Swoop was weaker than we expected and would have liked. These shoulder seasons have proven to be more variable, when in the peak seasons, it's great. And one of the things that we have done, as you heard Ed say, is expand distribution. Because awareness is so low -- it hasn't even had its first birthday yet -- that we needed to go beyond flyswoop.com. And once we got listed on Skyscanner and Google Flights, we're seeing immediate increase in both awareness but also bookings.

So we do expect, although we're not giving any guidance for Q2 or the rest of the year because the MAX is making things a little more difficult to predict, we do expect to see the continued dilution on the unit revenues for the first half, and then that mitigating substantially in the second half of the year.

There are -- I don't want you to take away that we're negative on Swoop. It's doing what it was designed to do. We always knew it was going to be a lower unit revenue model, but also a lower unit cost model, and it works through our P&L in both ways. So we are not giving up or worried about it. It's doing what it was designed to do, and we are bullish on what it can do, particularly as awareness builds, as our share builds and as we adjust the network and flex, because it -- the other thing we learned through is what routes do work well for us and what work less well. And so we'll be flexing our routes over time as we publish our schedules.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [4]

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I think, Walter -- it's Ed here -- just thought I'd just expand on that. One of the key roles that Swoop plays is to stimulate new traffic and to repatriate the Canadian traffic that was fleeing south of the border to places like Buffalo and Bellingham on U.S. carriers. It's still 9 months into its development. That repatriation is underway. But we've launched in the region at 11 new routes on Swoop over the last 6 months, so in that effort to stimulate traffic, inevitably you stimulate first at the pricing level to drive load factor. And it's that load factor that is also driving up the ancillary revenue per guest, because clearly, without the load, you don't get that ancillary contribution as well.

So it is pretty much performing exactly in line with modeling, but we don't think we will get the full benefit of that modeling until we transition to 7 aircraft next month and then 10 aircraft during the fall.

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Walter Noel Spracklin, RBC Capital Markets, LLC, Research Division - Analyst [5]

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And that's really what I was trying to get at. I understand the objective of Swoop is very clear. I was just trying to understand if there was something unexpected. In other words, you had a 2% to 4% RASM guidance for the full year. Would we, if we were to isolate Swoop, has something happened in the first quarter that would cause you to come in below that, had you still had that guidance in place, is kind of where I was going with that.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [6]

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We are still working towards that guidance, Walter. I think it's the startup of Swoop that needs to be stimulating. And as we mentioned earlier, with those 18 days within Q1 of the MAX grounding, there was some impact from the loss of last-minute walkup fares that traditionally we would sell at a premium.

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Walter Noel Spracklin, RBC Capital Markets, LLC, Research Division - Analyst [7]

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Got it, got it. Okay. My second question...

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [8]

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Just to pile on, Walter, the other thing -- because I want give Swoop its due, which is on the ancillary side, one of the things that we've been doing is getting as aggressive as we can. They're booking north of CAD 40 a traveler on the ancillaries, which also contributes to the RASM. So this is -- it was a little worse than we expected in Q1, but for the full year, not worried at all.

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Walter Noel Spracklin, RBC Capital Markets, LLC, Research Division - Analyst [9]

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Got it, got it, okay. And then for my second question, I know you don't have the guidance there anymore at 6.5% to 8.5%, but is there any way to goalpost if, for example, we were to assume that the MAX were out of the -- or grounded -- until the end of the year, what that 6.5% to 8.5% would be now that you've had some time to kind of, like you said, recapture some of that, some of those bookings and get a better visibility into how your schedule will look like for the rest of the year if we do go down the scenario where the MAX is out for the full year?

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [10]

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It's not what we anticipate, Walter. We -- as I mentioned in my opening remarks, we now believe we have a clear line of sight between the rollout of the software modifications from Boeing, the procedural amendments that we will be making with, in conjunction with all of our pilots retraining and the training program itself. We do not anticipate that moving in the time horizon that you're suggesting. So we haven't really remodeled system capacity beyond the 6.5% to 8.5% because we believe we will still get back to that with the reintroduction to service of the MAX.

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Operator [11]

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Our next question comes from Helane Becker of Cowen.

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [12]

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It's actually Conor Cunningham in for Helane. Just on the MAX, I was curious if you guys had any change of thought on how far in advance you might be ordering aircraft in the future, just given all the issues that have arised since this plane has kind of come in. Like are you looking to potentially place aircraft orders like more near-term than you were in the past? And also, just on the MAX as well, can you provide the CASM MAX headwind from grounding of the plane during the first quarter?

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [13]

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Hey, Conor, it's Harry. Let me answer the second question first; that's easy. The MAX impact on our CASM, the MAX grounding impact on our CASM, was immaterial, not even significant. And we -- our teams did some great jobs in terms of reaccommodation, et cetera, so there's really nothing there.

In terms of the delivery schedule, there's no question that Boeing is challenged given that there's so much inventory sitting on the ground right now. They slowed their production down. We're not clear what the ramp-up will be. At this point we're not anticipating changing our orders or delivery schedule. Trying to accelerate it, just given the backlog and the jam that they've got right now, is virtually impossible. And so we're going to work very closely with them. They've been great partners to us, and we expect them to continue to be great partners. We'll work with them to get the deliveries as close to the scheduled dates as possible.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [14]

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And Conor, it's Ed here. We may see slippage because of the reduction in the production schedule from 45 months down to a rate closer to 32, which has been well publicized. We may see slippage in the delivery schedule of a month or 2, either side. But we remain committed to the forward order for their aircraft. Our first focus is getting the 13 back up in the air during Q3 safely and prudently, and then we will go back and look at what, if any, impact on delivery has on anticipated schedules that we were building. But right now, we are still focused on the delivery plan as originally scheduled for the next 3 years.

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [15]

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And to be clear, we're not that dependent. We don't have a large order book over the next 2 years. It's 2 remaining this year, 2 next year is what's on order. So we'll work with Boeing as best we can to get them as close to schedule. We're anticipating some delays, and a lot of it depends on how the grounding is lifted. If it's global, then it's a bit of a sprint. But if it's rolling, then that gives them some, a little bit of flexibility.

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [16]

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Okay. Fair enough. And then on the 787, what's the introduction of that aircraft in the continued push into a full-service airline? How has there been -- has there been any changes to how customers are utilizing your loyalty program or credit card? I think you mentioned that you saw a 19% increase on top-tier spending. Is that all related to, like, your build-out of premium services, or is there something else there?

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [17]

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It's not all related. I think we've reported on previous calls that we've seen very significant CAGR growth in the utilization, in particular of the RBC World Elite Mastercard. So a lot of that is driving that continued momentum behind the growth in both credit card traffic and in the growth of the premium tiers. But without a shadow of doubt, carrying almost 70,000 guests, obviously, a high proportion of those in the premium cabins on the 787, is reaffirming our drive towards capturing a greater share of the premium business of Canadian and international travelers.

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Operator [18]

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Our next question comes from Cameron Doerksen of National Bank Financial.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [19]

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Just a question on capacity. You've taken the MAX out of the schedule for Q2. Is there anything you can talk about for Q2, your expectations for capacity growth? Because you must have some idea of what that looks like.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [20]

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We haven't guided to date, Cam. We're probably seeing, as I mentioned in the earlier answer, we're evaluating the impact of this at a year-end basis, and it's probably fair to say, given the size of the MAX impact on the fleet, that’s probably taking probably up to 2% to 3% of our Q2 capacity down, and we'll be working through what the full evaluation of that is at a year-end basis. But we are obviously mitigating the impact of that pure MAX reduction through the utilization of the rest of our Boeing 737 NG fleet.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [21]

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Okay. No, that's helpful. And just on the recurring costs, you mentioned in Q1 the CASM impact was relatively immaterial. What if I just think about Q2? What are sort of the major costs on the MAX of just having it sitting around, beyond the fact that, obviously, you're going to have lower capacity growth, but just the actual cost to have them sitting? But I'm assuming maybe you've got some excess pilots, you've got some leasing expense and depreciation. Is there anything else we should be thinking about?

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [22]

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Well, certainly, Cam -- it's Harry -- certainly we have the ownership costs. They're not going away. But because our crews are flying the NGs, we don't have some of the issues that other airlines have in terms of inefficiency. So for us, the challenge is it's a low CASM, high fuel efficient aircraft. So losing that capacity hurts us. But other than that, there is not any real pressure, if you will, other than what we've got in the business.

One of the things as we've adjusted our schedules is to give both our revenue management team enough time to optimize and maximize the revenue we can get from reduced capacity and minimize our reaccommodation and IROP costs, because it's the reaccoms that can both take up valuable inventory but also have some costs for us. So we're trying to mitigate in every way the impact of losing some of our most efficient capacity and mitigate it.

We've also pulled some planes out of maintenance, and so at some point they've got to go back into maintenance, so there's some moving parts overall. And it does put pressure on our CASM line; there's no question.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [23]

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Yes, so Cam, just to add a couple of other elements to it, we have not seen the need to take advantage of short-term, highly inflated market lease capacity. Firstly, it causes all kinds of problems with standardization with the rest of your fleet to take some of that short-term capacity. And secondly, it comes with a very substantial market premium, which we don't believe we require.

And secondly, there will be some costs in Q2 that were effectively -- we are now, as I mentioned, reconfiguring all of the MAX fleet, the 13 fleet, while that's on the ground. There will be some deferral of the standardization of the configuration of the rest of the fleet. We're more likely to see that cost probably accelerate during Q3.

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Operator [24]

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Our next question comes from Hunter Keay of Wolfe Research.

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Michael James Maugeri, Wolfe Research, LLC - Analyst [25]

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This is actually Mike Maugeri on for Hunter. So I'm just wondering on your fleet, will joint ventures and partnerships factor into future fleet decisions in terms of manufacturer and type and also in terms of gauge and onboard product in general?

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [26]

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Thanks, Mike. This is Ed here. Yes and no. We are obviously looking to introduce standardization of service with our joint venture partners. And as you know, we have filed and are awaiting regulatory approval for the transborder joint venture with Delta and are at relatively early stage of commercial negotiations of a similar transatlantic joint venture with Air France and KLM. The majority of those fly mixed fleets but have a higher proportion of Airbus aircraft. I think the actual manufacturer that each of us is flying is less material than trying to coordinate and to streamline issues like booking systems, our frequent flyer systems, seamless transfers, seamless connectivity, coterminals. Those are actually more material than the nature of the aircraft in which the guest is flying.

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Michael James Maugeri, Wolfe Research, LLC - Analyst [27]

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Okay. That's really helpful. And then along the same lines, Canada's recent change to its JV review process, does that have any effect on the efforts on getting these JVs approved and any effect on your approach or feelings towards JVs in general? Any thoughts, I'd appreciate it.

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [28]

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The changes have been really driven by the foreign voting restrictions, or commonly known as foreign ownership restrictions. But we don't anticipate that it's going to negatively impact the review of our joint venture. And so we've made all the filings and we're just going through the process, but the change will not, we don't believe will impact the outcome or even the timing.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [29]

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As we understand it, Mike, the primary driver of the foreign ownership review is around issues of public interest. And as we have filed for the transborder joint venture with Delta, we remain 100% confident that the public interest is not going to be affected by a joint venture which sees our combined entities still have a lower market share on the transborder traffic than our largest competitor. So we believe there's no impact on either public interest or on foreign ownership requirements around the JVs.

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Operator [30]

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Our next question comes from Turan Quettawala of Scotiabank.

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Turan Quettawala, Scotiabank Global Banking and Markets, Research Division - Director, Transportation and Aerospace, Equity Research [31]

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I guess just to be clear on the RASM here, when I look at the performance for the quarter and what I guess you were guiding to before when you reported Q4, are we saying that the slight miss there off the low end is mainly due to the issues with MAX and then a little bit of an underperformance at Swoop? Is that right?

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [32]

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I think the other way around, Turan. We're mostly attributing the 0.2% increase relative to the full year guidance of 2% to 4% is due to Swoop, and the impact of lower fares stimulating domestic traffic through the winter season at the ULCC end is a reasonably significant challenge. That's the primary driver. And then as we mentioned, we lost around 18 days of premium walkup traffic on the MAX right at the end of the first quarter.

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [33]

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And Turan, for clarity -- it's John Weatherill here -- that the impact of MAX in Q1 was in absolute revenue but not really in RASM. We were effectively neutral in RASM.

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Turan Quettawala, Scotiabank Global Banking and Markets, Research Division - Director, Transportation and Aerospace, Equity Research [34]

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Got it. Okay. And then I guess just one more from me here in terms of were there any sort of startup expenses and so on and so forth that maybe you had in the quarter just with the 787 coming in? If you could just highlight those, that would be great.

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [35]

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Hey, Turan, it's Harry. I wouldn't classify it as startup expenses. The 787s are -- only one of them is now effectively is flying the mission it's designed for, which is the long haul, Calgary to London Gatwick. The others we're operating transcon gave us lift, but not really what it's designed for. So we won't see all the benefits and the economies of scale from the 87 until they're all flying to their destinations. So I think we have some inefficiency, for lack of a better term, from a CASM point of view, but not pure startup costs that are there. And that will be with us right through Q2.

We start service from Calgary to Paris on May 17 and then Calgary to Dublin on June 1. So it's only the month of June that the entire 787 fleet is operating as it's designed to do. But we needed the lift, it was a great decision, we got a lot of practice for our crews and we got a lot of exposure. 66,000 guests flew on those 87s, and I'll say 65,900 of them loved every minute of it. There may have been 100 that didn't like something, but the reviews were very strong.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [36]

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But it is fair to say, Turan, Calgary-Toronto is not the purpose of the 78. So there's some incremental operating costs relative, for example, to have operated as we had planned, primarily through MAX 737 services. So there's some CASM impact in the quarter, but relatively marginal.

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Operator [37]

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Our next question comes from Tim James of TD Securities.

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Tim James, TD Securities Equity Research - Research Analyst [38]

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Harry, you've indicated in the past that, I believe, that the initial 787 operations would be dilutive temporarily, I believe, to return on invested capital. Just wondering if that indication still holds, given where consolidated return on invested capital is at around 5% here, or just below 5%. And if so, how long do you think it would be dilutive before it actually starts to kind of be in line with your targets or accretive?

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [39]

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Well, they're 2 different things. Our targets are dilutive in the first couple of years before they become accretive, so they're actually performing probably above target right now, given the incremental utilization. But it will take us a couple of years to get to accretive to ROIC. Sadly, our overall ROIC is below where we want it to be, so it's easier, for lack of a better term, to get them to be accretive. But it will still take us a good 18 months to 2 years to get them up and generating the returns that we are targeting for the whole business.

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Tim James, TD Securities Equity Research - Research Analyst [40]

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Okay, so it's safe to say, then, between now and then, the ROIC coming from the 787 operations is somewhere between the consolidated business and your target at this point?

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [41]

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Yes.

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Tim James, TD Securities Equity Research - Research Analyst [42]

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Okay. And then my second question is really more of a clarification. Ed, when you talk about core WestJet, am I correct that you're excluding Encore and Swoop, or just Swoop?

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [43]

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No, we're just excluding Swoop. We include Encore within our definition of core, Tim.

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [44]

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Hey, Tim, just to be clear, that includes Encore. It includes the linked Saab operation and it includes our charter operations as well.

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Operator [45]

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Our next question comes from Jamie Baker of JPMorgan.

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Jamie Nathaniel Baker, JP Morgan Chase & Co, Research Division - U.S. Airline and Aircraft Leasing Equity Analyst [46]

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I was impressed by how adamant you were that no incremental lift would be sought in the event of the MAX grounding dragging on. I'd like to just confirm that this isn't necessarily a WestJet-specific view, it's not about the complexity. It sounds like it's solely a function of an overheated aircraft market in terms of where lease rates on MAX substitutes have headed after the grounding. Is that accurate?

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [47]

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Jamie, it's Ed here. We had already flagged, firstly to the last quarter of the previous year, but also working through this full year, that we were going to be pulling back on capacity and pulling back on ASMs. To some extent, we have essentially looked at elements like utilization and densification of the existing NG fleet to supplement the gap and the shortfall that was created. And to some extent, I think it's almost right-sizing the overall market, certainly in the shoulder seasons. So it gets more challenging, obviously, as we move into the peak months like July and August. But certainly I have not seen an economic rationale that would justify the costs of short-term leases relative to the position on capacity in the marketplace at the moment.

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Jamie Nathaniel Baker, JP Morgan Chase & Co, Research Division - U.S. Airline and Aircraft Leasing Equity Analyst [48]

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Okay. That's helpful. And then the second question, the topic of loyalty overall is a fairly material component in the investment thesis in the U.S. It's obviously part of the Air Canada strategy right now. I don't believe you mentioned the Ampli program in your prepared remarks. I'm curious if this was deliberate. Should we not be thinking about the contribution of loyalty economics as a profit driver for WestJet? Does it imply relative margin depth that is larger as airlines do go down this path? I'm just trying to square where WestJet may ultimately sit on the topic of loyalty.

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Edward Sims, WestJet Airlines Ltd. - President, CEO & Non-Independent Director [49]

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Yes, it's a great question, Jamie. We are in very detailed commercial negotiations with our largest financial partner, RBC, at the moment, and in conjunction with Mastercard. And I think while those negotiations are underway, we are effectively examining our model and will be probably in a much better position to share that modeling on our second quarter call than we are now. So we, like you, share your absolute belief that this is fundamental to how we differentiate ourselves in the marketplace, particularly with a scheme that is as transparent as ours, that doesn't overbook, that doesn't create blackouts in terms of redemptions and remains spend-based. And we remain convinced that guests prefer the transparency of a transfer for a point for a dollar in their scheme, particularly at a time of huge uncertainty as to the value of that point and the changing value of break fees, depending on who your financial partner is and their level of investment in your scheme. So while we continue to conclude those negotiations, we will probably -- we are deliberately silent on this call relative to where we would be able to provide further clarity in Q2.

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Operator [50]

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(Operator Instructions) Our next question comes from Chris Murray of AltaCorp Capital.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research & Senior Analyst of Diversified Industries [51]

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Just, Harry, maybe just thinking about the balance sheet a little bit, with the sale and leaseback now, and even the IFRS 16 change, your leverage ratios have dropped substantially. So I guess a couple of questions on that. With the change in -- or I guess the delay in some of the 37s, stuff like that -- are you still fairly comfortable with your older CapEx guidance that you'd probably be somewhere between CAD 1 billion and CAD 1.1 billion, with half of that covered by the sale and leaseback we just saw? And I'm also thinking about you've got some debt coming due. So I guess in total, how do you think about your credit rating on a go-forward basis now that everything's there? How do you refinance that CAD 400 million? Any thoughts around additional capital spending and use of cash on the balance sheet as we go through the year?

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [52]

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Chris, I'll say first the -- our CapEx plans have not changed. Depending on the timing of the delivery of the MAXs, the 2 remaining MAXs, that may at the margin make some minor changes, but nothing substantial.

In terms of funding, the proceeds from the sale and leaseback were sufficient that we can -- we'll redeem our bonds without any issues whatsoever. We are thinking about what we do with our term loan, which comes due in January of next year, and we're looking at different options. My goal from a credit rating point of view is to make sure that we earn our way back into having 2 investment-grade credit ratings again. The balance sheet as adjusted clearly looks a little better in terms of debt and credit metrics. But that's not the only metric used by the agencies, and so the continued margin expansion and profit growth will help fuel a return to having 2 investment-grade credit ratings.

So we are currently looking at the options for the term loan. We're not concerned about the redemption of the Canadian dollar bond at all and have not adjusted our CapEx plans at this point.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research & Senior Analyst of Diversified Industries [53]

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Okay, fair enough. And then just if you can, just to normalize, what was the tax impact of the sale leaseback? Is that just at your normal rates or is there a capital gains rate or something like that?

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Henry P. Taylor, WestJet Airlines Ltd. - CFO & Executive VP of Finance [54]

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It was at normal rates. There was nothing, no interesting tax angle that came with that.

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Operator [55]

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(Operator Instructions) There are no further questions at this time. I would now like to hand the call back over to Mr. Hagen for closing remarks.

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Jeff Hagen, WestJet Airlines Ltd. - Manager of IR [56]

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Thank you, Ariel. This call has been webcast and is available for replay. Details were provided in our earnings release that was issued this morning. We will also be holding our Annual and Special Meeting of Shareholders this morning at 10 a.m. Mountain Time. This meeting will also be available through an Internet webcast in the Investor Relations section of our website. Thank you again for joining us this morning, and thank you for your interest in WestJet.

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Operator [57]

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This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.