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2009 Air Canada Annual Report (Canadian dollars in millions) December 31, 2009 December 31, 2008 Consolidated Statement of Financial Position Current assets Collateral deposits for fuel derivatives $ 43 $ 328 Current liabilities (1) Fair market value of fuel derivatives designated under hedge accounting Fair market value of fuel derivatives – economic hedges n/a $ (31) $ (405) $ (15) Shareholders’ equity (AOCL) Net loss from fuel derivatives designated under hedge accounting (net of tax in 2009 - $1 million and 2008 - $5 million) $ (184) $ (606) (1) The balance is reflected within current liabilities on Air Canada’s Consolidated Statement of Financial Position due to the counterparty’s ability to terminate the derivatives at fair value at any time prior to maturity. Summary of gain on financial instruments recorded at fair value The following is a summary of gain on financial instruments recorded at fair value included in non-operating income (expense) on Air Canada’s consolidated statement of operations for the periods indicated: Fourth Quarter Full Year (Canadian dollars in millions) 2009 2008 2009 2008 Ineffective portion of fuel hedges $ - $ 59 $ - $ 83 Fuel derivatives not under hedge accounting 24 (40) 102 (9) Cross-currency interest rate swaps - (2) - 4 Other (2) 15 (7) 14 Gain on financial instruments recorded at fair value $ 22 $ 32 $ 95 $ 92 Liquidity risk Liquidity risk is the risk that the Corporation will encounter difficulty in meeting obligations associated with its financial liabilities and other contractual obligations. The Corporation monitors and manages liquidity risk by preparing rolling cash flow forecasts, monitoring the condition and value of assets available to be used as security in financing arrangements, seeking flexibility in financing arrangements, and establishing programs to monitor and maintain compliance with terms of financing agreements. The Corporation’s principal objective in managing liquidity risk is to maintain a minimum unrestricted cash balance in excess of a target liquidity level of 15% of annual operating revenues. As at December 31, 2009, Air Canada had cash, cash equivalents and short-term investments of $1,407 million which represented 14% of 2009 operating revenues. Management believes that the significant events as described in section 6 of this MD&A improve the Corporation’s current liquidity position. However, certain risks remain such as those related to the current economic environment, including risks related to market volatility in the price of fuel, foreign exchange and interest rates and increased competitive pressures as well as risks relating to restrictive terms under the Corporation’s financing, credit card processing and other arrangements and other risks as identified below. The H1N1 influenza virus may also continue to impact demand for air travel. The Corporation is continuing to monitor the H1N1 influenza virus risk. While the Corporation has developed contingency plans related to the H1N1 influenza virus risk, it is unable to predict the likelihood of this risk materializing or the impact on the Corporation to the extent this risk does materialize. The Corporation is also monitoring the impact on the demand for air travel of the new security measures imposed in December 2009 by Canadian and U.S. government authorities on flights from Canada to the U.S. Pension funding obligations Refer to section 10.6 of this MD&A for a discussion on Air Canada’s pension funding obligations. 50
2009 Management’s Discussion and Analysis Covenants in credit card agreements The Corporation has various agreements that process customer credit card transactions. Approximately 85% of the Corporation’s sales are processed using credit cards, with remaining sales processed through cash-based transactions. The Corporation receives payment for a credit card sale generally in advance of when the passenger transportation is provided. As at December 31, 2008, under the terms of certain credit card processing agreements with one of its principal credit card processors, the processor was entitled to withhold payment of funds to Air Canada upon the occurrence of certain events (“triggering events”), which included unrestricted cash (as defined per the agreements and generally based on the aggregate sums of cash and cash equivalents and short-term investments) being less than $900 million as at the end of any month and operating losses in excess of certain amounts. During 2009, the Corporation entered into amendments with this processor to amend certain credit card processing agreements under which the triggering events related to operating losses were removed, the levels of unrestricted cash required to be maintained by Air Canada were reduced to $800 million and Air Canada provides the processor with deposits, to be accumulated over time, and security. The agreements provide that should Air Canada maintain unrestricted cash of more than $1,200 million for two consecutive months, the unrestricted cash requirement increases to $1,100 million at which time the processor will return to Air Canada all deposits and security previously provided by Air Canada. This occurred during the third quarter of 2009, and as a result, no deposit was provided under these processing agreements as at December 31, 2009. As long as unrestricted cash remains at or above $1,100 million at each month-end, Air Canada has no obligation to provide deposits or security to the processor. In addition, should the Corporation’s unrestricted cash be less than $1,100 million at any month-end, its obligation to provide deposits to the processor would be capped at an amount not to exceed $75 million, provided unrestricted cash is not less than $800 million. The current agreements with this credit card processor expire in May 2010. Cargo investigations and proceedings The Corporation is exposed to potential liabilities related to the proceedings and investigations of alleged anti-competitive cargo pricing activities, as described in section 19 of this MD&A. The preliminary estimate recorded by the Corporation during 2008 is based upon the current status of the investigations and proceedings and the Corporation’s assessment as to the potential outcome for certain of them. This provision does not address the proceedings in all jurisdictions, but only where there is sufficient information to do so. Management has determined it is not possible at this time to predict with any degree of certainty the outcome of all proceedings. Additional material provisions may be required. Amounts could become payable within the year and may be materially different than management’s preliminary estimate. Credit risk Credit risk is the risk of loss due to a counterparty’s inability to meet its obligations. As at December 31, 2009, the Corporation’s credit risk exposure consists mainly of the carrying amounts of cash and cash equivalents, short-term investments and accounts receivable as well as collateral deposits for fuel derivatives extended to counterparties. Cash, cash equivalents and short-term investments are in place with major financial institutions, the Canadian government, and major corporations. Accounts receivable are generally the result of sales of tickets to individuals, often through the use of major credit cards, through geographically dispersed travel agents, corporate outlets, or other airlines. Credit rating guidelines are used in determining counterparties for fuel hedging. In order to manage its exposure to credit risk and assess credit quality, the Corporation reviews counterparty credit ratings on a regular basis and sets credit limits when deemed necessary. At January 31, 2010, the Corporation has $55 million in collateral deposits extended to fuel hedge counterparties. Credit risk related to these deposits is offset against the related liability to the counterparty under the fuel derivative. Refer to the “Asset Backed Commercial Paper” section below for information on credit risks. Market risks Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises three types of risk: foreign exchange risk; interest rate risk; and other price risk, which includes commodity price risk. The Corporation uses derivative instruments to reduce market exposures from changes in foreign currency rates, interest rates, and fuel prices. The Corporation uses derivative instruments only for risk management purposes and not for generating trading profit. As such, any change in cash flows associated with derivative instruments is designed to be offset by changes in cash flows related to the risk being hedged. 51
Page 1 and 2: ANNUAL REPORT 2009
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Investor and Shareholder Informatio
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