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Edited Transcript of AC.TO earnings conference call or presentation 29-Oct-19 12:30pm GMT

Q3 2019 Air Canada Earnings Call

DORVAL Nov 3, 2019 (Thomson StreetEvents) -- Edited Transcript of AIR Canada earnings conference call or presentation Tuesday, October 29, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Calin Rovinescu

Air Canada - CEO, President & Non Independent Director

* Kathleen Murphy

Air Canada - Director of IR & Corporate Reporting

* Lucie Guillemette

Air Canada - Executive VP & Chief Commercial Officer

* Michael Stewart Rousseau

Air Canada - Deputy CEO & CFO

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Conference Call Participants

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* Andrew George Didora

BofA Merrill Lynch, Research Division - Director

* Christopher Allan Murray

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

* Douglas Taylor

Canaccord Genuity Corp., Research Division - Director

* Fadi Chamoun

BMO Capital Markets Equity Research - MD & Analyst

* Helane R. Becker

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Hunter Kent Keay

Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense

* Jamie Nathaniel Baker

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

* Kevin Chiang

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst

* Konark Gupta

Scotiabank Global Banking and Markets, Research Division - Analyst

* Rajeev Lalwani

Morgan Stanley, Research Division - Executive Director

* Tim James

TD Securities Equity Research - Research Analyst

* Walter Noel Spracklin

RBC Capital Markets, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to Air Canada's Third Quarter 2019 Conference Call. I would now like to turn the meeting over to Kathleen Murphy. Please go ahead, Ms. Murphy.

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Kathleen Murphy, Air Canada - Director of IR & Corporate Reporting [2]

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Thank you, Alayna, and good morning, everyone, and thank you for joining us on our third 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 third quarter financial performance in more detail and turn it back to Calin before taking questions from the analyst community.

We'll start by taking questions from equity analysts, followed by questions from fixed income analysts.

Before we get started, I will point out that certain statements made on this call, such as those relating to our forecasted 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 third 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 will now turn the call over to Calin Rovinescu, our Air Canada's President and CEO.

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [3]

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Thank you, Kathy. Good morning, everyone, and thank you for joining us on our call today. I'm extremely pleased to report an excellent third quarter with EBITDA of $1.472 billion, 9% above last year's third quarter and better than the increase of approximately 5% projected in our news release of July 30 and better than analysts' consensus estimates for EBITDA again in this quarter. We reported operating income of $956 million in the quarter, up $33 million year-over-year. Record third quarter operating revenue of almost $5.6 billion, grew 3% versus the same quarter in 2018.

Unrestricted liquidity of nearly $7.4 billion was another record, and our leverage ratio improved to 0.8 at the end of September, half of what it was at year-end. The progress made in improving our balance sheet was recognized once again with Moody's upgrading our debt rating by 1 notch and advancing us to one level below our goal of investment grade status.

Also, we all know that increasingly, investors look at ESG measures when making investment decisions. Therefore, I was extremely pleased by Air Canada's top ranking of 1 in all 3 pillars of the ISS Environmental, Social and Governance quality score, which we received within the last several days. We ranked in the top 1% of all companies in the ISS survey and as the top transportation company worldwide. This indicates lower risk and better disclosure versus the industry group index or region.

Back to our financial performance, I consider our Q3 results to be extremely impressive in light of the serious disruption to our overall operations and to our cost structure and profitability, created by the Boeing 737 MAX grounding. We covered approximately 95% of planned flying in Q3 and were able to successfully manage through this extremely challenging and complex situation. We've now removed the aircraft from our schedule until February 14, so as to give customers certainty in their travel plans. We've also wet leased to 2 Airbus A330s in addition to the 2 Boeing 767s already wet leased to ensure we have enough capacity this winter and into next year. The removal of 36 737 MAX aircraft or about 24% of our narrow-body fleet from our schedule during our peak summer season exacted a toll from a financial, route, product, and I would say, human resource perspective. And there's no doubt that the grounding is preventing us from realizing our flow potential. However, I'm confident that if regulators unground the aircraft near term, our ongoing transformation will quickly regain its former trajectory. For this reason, at this point in time, we have chosen not to adjust our longer-term Investor Day targets for 2020 and 2021.

With respect to Transat, we're very pleased to see that in Q3, Transat shareholders approved the definitive acquisition agreement with Air Canada by a vote of approximately 95%. This overwhelmingly favorable result underscores the numerous benefits for all stakeholders from the proposed merger. The vote was followed by the approval of the plan of arrangement by the Superior Court of Québec and the acquisition remains subject to regulatory approvals, which we hope to receive by mid-next year.

Before turning it over to Lucie, I'd like to thank the entire Air Canada team for their resourcefulness, skill and dedication. They've done an incredible job. And I also applaud and thank them for their continued hard work and taking care of our customers, especially from the time the Boeing 737 MAX grounding order was issued.

I also thank, of course, our customers for their continued loyalty.

And with that, I'll turn the call over to Lucie.

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Lucie Guillemette, Air Canada - Executive VP & Chief Commercial Officer [4]

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Thank you, Calin, and good morning, everyone. I would also like to thank our team of 36,000 for their continued passion, dedication and consistently demonstrating strong teamwork while taking care of our customers during the busy summer peak.

Turning to our revenue performance for the quarter. Passenger revenues increased $146 million or 2.9% on a yield improvement of 4.8%, partly offset by decline in traffic of 1.8%. This traffic decline was driven by a capacity reduction of 2.1%. PRASM increased 5.1% year-over-year on the higher yield. Consistent with the second quarter, the system yield improvement versus last year reflected increases in fares and carrier surcharges and an overall improvement in fare mix. Additional yield earned on Aeroplan redemption revenue, which impacted all 5 key markets and growth in higher-yielding local traffic also contributed. The impact of the Max grounding on our capacity in our operation was amplified during the summer peak as 36 of these aircraft were removed from our schedule for the third quarter, which would have represented 9% of our planned third quarter capacity.

Despite the complexity that this event created, our teams continued to mitigate the impact by executing our contingency strategy, including the deferral of nonessential maintenance, extending aircraft leases, strategically leveraging Air Canada's Rouge, making necessary schedule adjustments and wet leasing aircraft, which enabled us to cover approximately 95% of the planned flying schedule in the third quarter, as Calin mentioned.

Although we experienced a year-over-year quarterly capacity decline for the first time in several years in the third quarter, we anticipate that we will achieve capacity growth of approximately 3% in the fourth quarter as the summer peak ends, and we continue to execute our mitigation efforts.

In the business cabin, on the system basis, passenger revenue increased $33 million or 3.9% versus last year's third quarter on a growth in yield. Looking at our key markets, despite capacity reductions in each, we achieved year-over-year revenue, yield and PRASM growth in all markets, except for the Pacific.

Turning to the domestic market. On a slight reduction in capacity, domestic passenger revenues increased $123 million or 8.6% from the third quarter of 2018. Yields increased 9.3% with the impact of the capacity constraints and the launch of new fare categories contributing to the yield growth year-over-year. Profit improvements were recorded on all major domestic services.

Looking to the fourth quarter, we will continue our efforts to mitigate the impact of the MAX grounding, including strategically leveraging Rouge and consolidating frequencies with larger aircraft. This will allow us to maintain our domestic capacity stable despite flying fewer frequencies.

On the U.S. transborder market, on a capacity reduction of 4%, revenues increased $54 million or 5.6%. Growth in higher-yielding local traffic and gains in the business cabin lifted yields in the quarter. We realized significant rise in yield improvement with gains recorded on all major U.S. transborder services. The eastern seaboard business markets continued to perform extremely well for us with strong year-over-year revenue growth in addition to yield and PRASM gains in the third quarter.

The U.S. leisure markets achieved year-over-year revenue growth with significant PRASM improvement despite the MAX grounding having a significant impact on our capacity to these markets, especially to Hawaii, where we were required to reduce our frequencies from Vancouver to Honolulu and Maui, which were previously flown by the MAX. As of mid-June, these routes are operated through a wet lease Boeing 767 aircraft.

Our international transit strategy of connecting U.S. customers to international destinations through our hubs, was also negatively impacted by the MAX grounding, as we consolidated frequencies to several U.S. markets. This strategy has yielded very strong results over the last years and has been a key component of our profitable international growth. The negative impact on our transit traffic is felt throughout our international network.

Looking forward, we will continue to see the impact of the MAX grounding on the U.S. transborder market capacity. We do anticipate year-over-year revenue growth, supported by yields and PRASM improvements. We've extended the wet lease Boeing 767, which will continue to operate our Honolulu and Maui services from Vancouver, and we've executed a wet lease agreement for a second Boeing 767 beginning in mid-December, which will assume the Vancouver to Maui service and will also operate Vancouver to Phoenix.

We're looking forward to the delivery of our first Airbus 220 in December, and we recently announced our nonstop Montreal to Seattle service as well as our nonstop Toronto to San Jose, California, both of which will be operated by the A220, beginning in May of next year. Benefiting from a modern and efficient aircraft, these routes will bolster our extensive U.S. network and will support our strategy to attract U.S. customers to transit over our hubs when traveling internationally.

On a capacity reduction of 1.3% in the quarter, revenues in the Atlantic increased $7 million or yields growth of 1%. As projected during our second quarter call, we saw pressure on our Atlantic revenue due to the capacity constraints in our schedule and negative currency impacts created by weaker European currency and a stronger inbound sales mix. Additionally, we continue to observe very competitive pricing over the Atlantic on all services. We also saw a slowdown in carrier surcharges vis-à-vis what we had observed in the first 6 months of the year. PRASM grew 1.8% when compared to same quarter last year. Due to the grounding of the MAX, the impact of several necessary adjustments to our schedule continues to be felt. This includes temporarily suspending our profitable and productive service from Halifax and St. John's to the U.K.

In June, we began operating our Montreal to Barcelona service and one of our Montreal to Paris frequencies through a wet lease operation. For the fourth quarter, these services will be returned to Air Canada Rouge and Air Canada mainline operation, respectively, and will no longer be operated by wet leased aircraft.

Additionally, due to the closure of Pakistan air space, we suspended our well-performing Toronto to Delhi service as of mid-June. Although this provided the flexibility to reallocate the wide-body aircraft elsewhere in our network and gave certainty to our customers when booking their summer travel, this represents a key piece of our international strategy.

We're pleased to have resumed our daily nonstop service to Delhi from Toronto as of October 1. And on October 27, we increased capacity by utilizing the Boeing 777 on this route.

As part of our mitigation strategy in the quarter, we also reallocated capacity from the Pacific market to the Atlantic market. And although that change had a negative impact on PRASM, the overall impact to the quarter's profitability was favorable.

Looking ahead to the fourth quarter, we anticipate year-over-year traffic and revenue growth despite the MAX grounding, demonstrating the resilience of our fleet and diverse network when facing exceptional circumstances. As part of our mitigation strategy, we will continue to redeploy capacity from the Pacific over the Atlantic. In addition to the resumption of our Delhi to Toronto service, our full India schedule is now operational with our nonstop daily flights to Delhi from Vancouver, operating since August and the return of our nonstop seasonal service to Mumbai from Toronto. We currently offer up to 18 weekly flights to India.

Recently, we announced our new year-round nonstop service from Toronto to Brussels beginning next May. This service complements our service to Belgium's capital from Montreal and offers excellent connectivity for beyond Brussels traffic. Additionally, we announced our year-round nonstop service from Montreal to Toulouse beginning next June. We'll be the only airline offering year-round service between these cities linking 2 of the world's leading aerospace industry hubs.

Moving on to the Pacific. On a capacity reduction of 4.1%, revenues decreased $46 million or 5.8% on a traffic decline of 4.7%, and a yield decrease of 1.1%. The geopolitical situation between Canada and China continues to negatively impact travel demand between Canada and China and Canada and Hong Kong, and we were able to mitigate the impact by reallocating capacity from these markets to elsewhere throughout our network, including to markets where capacity was constrained due to the MAX grounding.

Australia continued to be negatively impacted by increased industry capacity from North America in the quarter. Looking forward to the fourth quarter, we expect to continue our strategy to redeploy capacity from the Pacific throughout our network to mitigate the impact of the softening travel demand between China and Canada. We anticipate a slight improvement in year-over-year yield and PRASM in line with our expectations.

In December, we will begin our nonstop seasonal service between Vancouver and Auckland in our continued effort to counter seasonality. Revenues from other services increased $8 million or 3.5% on yields and traffic growth of 2.3% and 1.2%, respectively. We saw double-digit PRASM growth on services to South America with Air Canada having reverted to one-stop service to Buenos Aires with the connection in Santiago, favorably impacting yields. Yield on services to traditional sun destinations also improved with capacity declining to Mexico due to the redeployment of aircraft through our network to mitigate the impact of the MAX. We project a strong fourth quarter for the other services with anticipated year-over-year traffic and revenue improvement.

In December, we will begin our seasonal nonstop Air Canada Rouge service between Toronto to Quito and our seasonal nonstop Air Canada mainline service from Montreal to São Paulo as part of our strategy to counter seasonality.

From a product perspective, in August, we launched our partnership with award-winning Canadian Chef Antonio Park, who will curate route-specific meals, which started on our Montréal to Narita flight in the third quarter and will be rolled out on our flights to Japan in all cabins in the fourth quarter, followed by our Signature Class cabin from Montreal to São Paulo later this year. This partnership complements our existing partnership with Chef, David Hawksworth and sommelier Véronique Rivest, further elevating our meal options for our customers traveling internationally.

Moving on to cargo. The third quarter of 2019 saw a year-over-year reduction in cargo revenues of 18.6%, with the Atlantic and Pacific being impacted by an industry-wide decrease in air cargo demand. Overall, cargo yield was down 11.5%, while traffic declined 8% versus last year's third quarter. We are not projecting any improvement in the current yields or global trade trends in the fourth quarter, but we will be focusing our cargo efforts on domestic share shift, increased tonnage and strategic initiatives focused on capacity utilization, using artificial intelligence and other tools.

Turning to other revenues. We saw an increase of $33 million or 18% in the quarter with the net margin recorded on the redemption and delivery of non-air goods and services related to Aeroplan program being the largest contributor. We also saw an increase in ground package revenues at Air Canada Vacations.

To close, in the quarter, we removed 36 aircraft from our schedule, operating multiple wet leased aircraft and experienced softening travel demand between Canada and China. I would like to, once again, thank our team for a strong performance in our most important quarter despite these significant obstacles and for always continuing to put our customers first.

I will now turn the call over to Mike for a discussion on our cost performance and balance sheet metrics.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [5]

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Thank you, Lucie, and good morning to everyone. I'd like to add my recognition and thanks to all our employees for an exceptional third quarter and for their commitment and taking care of our customers. With respect to our strong EBITDA results, our better-than-guided performance for the third quarter was mainly the result of lower jet fuel prices, partially offset by higher-than-expected professional fees, mainly related to the Transat arrangement agreement and related filings as well as higher stock-based compensation expense, driven by the appreciation of our share price in the quarter.

Moving to the full year of 2019, in our news release issued this morning, we disclosed that we expect an EBITDA margin of approximately 19%, which is within the range we established at our February Investor Day. This is quite an achievement when you consider the many challenges triggered by the MAX grounding. This speaks to the strength of our business model and the work ethic and creativity of the Air Canada team.

I'd like to now touch on Aeroplan. We continued to be extremely pleased with Aeroplan's financial results, which, once again, exceeded our expectations and continue to contribute meaningfully to our free cash flow. We continue to see strength from our credit card issuing partners with acquisition and retention results above expectations. Redemptions are stable, healthy and tracked within 1% of our expectations during the third quarter.

Looking ahead, discussions are underway with a number of new potential partners for the redesign program. Additionally, we are looking to increase and diversify our Aeroplan membership base and are exploring international opportunities for growth. Our digital efforts supporting the new loyalty program, including launching our new customer data platform and creating a single customer profile across Aeroplan and Air Canada are well underway. We are also extremely excited that our new -- all new Air Canada mobile App is in public beta now, and will be launching in November, which will enhance how our customers interact with us. Of course, we also remain on track to relaunch our loyalty program in late summer 2020.

Now turning to our costs in the quarter. Adjusted CASM, which excludes fuel expense, ground package cost, Air Canada Vacations and the operating expense of Aeroplan, increased 9.3% versus the same quarter in 2018. These increases reflected, in large part, the impact of the MAX grounding, which resulted in an ASM decline of 2.1% in the quarter versus a planned ASM increase of approximately 3%. With relatively higher costs associated with replacement aircraft and the ongoing match-related operating expenses, including depreciation and pilot wages, which continue to be incurred despite the grounding.

Turning to fuel. Fuel expenses decreased $151 million or 11% in the quarter on lower jet fuel prices when compared to last year. The average price of fuel was CAD 0.747 per liter in the quarter, down 10% versus the same quarter in 2018. Looking ahead, the expected price of jet fuels average CAD 0.77 per liter for Q4 and the full year. Air Canada has not entered into any fuel hedging contracts for Q4 or 2020.

Turning to wages and salaries. We experienced an increase of $46 million or 8% in the quarter, driven by the growth in full-time equivalent employees of 9.8%, in part due to the addition of Aeroplan. We also recorded increases in expenses related to employee profit-sharing programs and to stock-based compensation. An increase in aircraft maintenance expense of $16 million or 7% in the quarter reflected, in large part, timing of maintenance activity versus last year's third quarter. In addition, in order to mitigate the impact of the MAX grounding, we extended leases for Airbus 320s and Embraer 190 aircraft, which resulted in a higher volume of maintenance activity than planned.

Now turning to our balance sheet and liquidity. As Calin mentioned earlier, we ended the quarter with unrestricted liquidity of almost $7.4 billion, another record. Free cash flow amounted to $553 million in the quarter, $64 million below the prior year. You may recall that in the third quarter of last year 2018, Air Canada received proceeds of $293 million from the sale and leaseback of 25 Embraer aircraft. And of course, no such proceeds were received in the third quarter of this year.

In the quarter, an increase in cash flows from operating activities of $284 million was partly offset by an increase in capital expenditures of $55 million. The higher level of capital expenditures mainly reflected our ongoing investments in new technology, including our new reservation and loyalty systems.

Looking at the full year 2019, we project free cash flow of between $1.3 billion and $1.5 billion. Free cash flow in 2019 is positively impacted by a number of factors, including the deferral of MAX aircraft deliveries from 2019 to 2020, timing of certain capital expenditures, stronger working capital performance, the impact of aircraft lease extensions, which defers the end-of-lease maintenance obligations and the favorable impact of higher cash and investment balances on net interest expense.

Excess cash, which Air Canada defines its total cash and investments in excess of the minimum cash required to support operations, amounted to almost $2.7 billion at the end of September. This is expected to be deployed over the next several years to purchase aircraft, make strategic investments and reduce existing gross debt levels. Shareholder buyback programs will be funded by annual free cash flows.

Net debt of $3 billion decreased $2.2 billion from December 31. This reflected an increase in cash, cash equivalents and short- and long-term investment balances of almost $1.7 billion and a decrease in long-term debt and lease liabilities of $561 million. Our leverage ratio was 0.8 at the end of September versus a ratio of 1.6 at the end of December. We foresee our leverage ratio not exceeding 1 by the end of the year.

At quarter end, our return on invested capital was 15.5%, while our weighted average cost of capital was 7.2%. For the full year 2019, we project ROIC of between 15.5% and 16%. With respect to the normal course issuer bid, we repurchased for cancellation approximately 2.1 million shares at an aggregate cost of $91 million in the quarter. On a year-to-date basis to September 30, we repurchased over 6.4 million shares for a sum of $250 million.

Additional information can be found in our financial statements and MD&A, which were posted on our website and filed on SEDAR this morning.

And with that, I'll turn it back to Calin.

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [6]

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Thanks, Mike. Air Canada today has reported another excellent quarter, this one covering our peak summer period. As you've heard, we generated record operating revenue, a 9% increase in EBITDA year-over-year, operating income of almost $1 billion and ended the quarter with record liquidity in excess of $7 billion. We also made significant progress on our balance sheet, reducing our net debt by more than $2 billion since the start of the year. Even with the MAX grounding depriving us of 36 aircraft or, as I said, about 24% of our narrow-body fleet, we still operate at 95% of previously planned capacity this summer. We've not allowed the MAX situation to knock us off our game plan or deter us from pursuing our long-term transformational goals.

I'd like to reiterate my appreciation and once more commend our employees for how they've responded to this challenge. All parts of the company have come together to develop innovative solutions to take care of our customers and run our airline profitably for our shareholders. In the face of this rapidly unfolding situation, we've been able to pivot multiple times, we've anticipated events, prepared for contingencies and acted decisively, often ahead of others similarly affected. For these reasons, the shadow cast by the MAX 737 grounding should not be allowed to obstruct anyone's view of our company or distract anyone's attention from the progress we are making.

In addition to operating safely and consistently delivering strong financial results, we've maintained focus on a host of key activities to continue transforming and improving Air Canada. These programs and strategic initiatives, any one of which might overwhelm a less nimble company, are moving us along our path towards our goals, including investment-grade status and sustainable long-term profitability.

Immediately, we're preparing to roll out our new passenger service system by Amadeus to replace our legacy RES III reservation system. The first phase next month, we'll see the migration of our reservation inventory and ticketing functions to the Amadeus Altéa Suite. Then starting early in the new year, PSS will be progressively introduced at airports for departure control functions.

The importance and benefits of this 2-year project cannot be overstated, neither can its complexity to implement. It will, however, equip us with the tools to serve our customers better and more efficiently, enable us to interact more easily with our key airline partners and lay the groundwork for some improvements in the future. We also expect it to generate more than $100 million in annual incremental benefits once fully implemented.

With the implementation of PSS, we will also have in place the IT architecture for another transformational initiative, launch of our new loyalty program in December 2020. With the integration of EMEA, Canada now essentially complete a significant accomplishment in itself. We've been introducing improvements to the Aeroplan program and our mobile app. Efforts are now intensifying to refine the program's value offering, including finalizing attractive new partnerships. These changes will better secure Aeroplan's place as Canada's best traveler rewards program.

Another major program is the introduction of the Airbus A220. The arrival of a new aircraft type in the fleet takes years of preparation. Yet, we've been very, very ready and eager to take delivery of our first A220 this December. The A220 promises a step change with operating characteristics that open entirely new markets for us. In the quarter, we already announced 2 such routes, Montreal to Seattle and Toronto to San Jose, California.

Our network planners love this aircraft for its economics. We know our customers will love it too for its comfort and spaciousness. And from a carbon footprint and overall economic perspective, we love the aircraft as well as it averages 20% less fuel consumption per seat, emits less greenhouse gases and is significantly quieter than other aircraft in its category.

Another key strategic initiative, on which we made excellent progress in the quarter, is our acquisition of Transat. We are very pleased to see shareholders of Transat, including its 3 largest shareholders, voting overwhelmingly in August to accept our offer and to see the Québec Superior Court subsequently sanction it. We're now into the regulatory approval process and hope to receive the necessary approvals by mid-next year.

We know the combination will create numerous benefits for all stakeholders, particularly those in Québec, where travelers will have more options, employees' more job security; in Montreal, the advantages of seeing the further development of a Québec-based transportation and leisure company.

In addition to these major initiatives, we've also pursued a host of ongoing initiatives this past quarter. Many of these were designed to improve the customer experience, including the opening of the new Toronto café, our agreement with Chef Antonio Park, as Lucie mentioned, and the launch -- or announcement of new routes, including the new nonstop service between Montreal and Toulouse and Toronto and Brussels next year.

We also maintained focus on our core priorities, such as culture change. Our success here already amply displayed in our handling of the 737 MAX issue was recognized in July when we were named one of the 50 most engaged workplaces for the fourth consecutive year by Achievers. Subsequent to the quarter, our change culture was again affirmed in a 10-year labor agreement with our U.S.-based employees represented by Teamsters.

Taken together, the continuing strong financial results we achieved while successfully managing such a range of other major issues and projects should leave no doubt that ours as a company transformed. We've remade Air Canada into an airline that is flexible, durable, customer-focused and positioned for long-term sustainable profitability.

So in conclusion, I thank our customers for their loyalty to Air Canada and for choosing to fly with us.

And now we'll be pleased to take some questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Konark Gupta with Scotiabank.

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Konark Gupta, Scotiabank Global Banking and Markets, Research Division - Analyst [2]

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Calin, congratulations on a good quarter considering the MAX impact, obviously, in Q3. So I just wanted to get started on capacity here. Thanks for providing some color on Q4. So it looks like for 2019, despite the MAX grounding, you guys are tracking I think toward 2% capacity growth for the full year with 3% in Q4. Now if the MAX comes back next year as you are anticipating in February, maybe, and I think you've previously kind of clarified that there will be some lag effect in terms of getting those aircraft ungrounded. And then there's another 26 deliveries coming in next year. So do you think next year, we should see the capacity growth kind of what we anticipated for 2019? Like it's kind of a reversal in capacity growth next year?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [3]

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Konark, it's Mike. I think that's a fairly good proxy to use and good rationale for 2020. Again, it is a moving target. It depends on how the 737s are coming -- when they will be on -- grounded obviously. And we have provided some visibility that it will take us up to a year to put all 50 back in operation. So using the original plan for 2019 is a good proxy.

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [4]

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And Konark, Calin here. Just add one more thing is that, as Mike said, it could take a year to get them all in. And it's the first 24, of course, we have pilots that are already allocated to those aircraft. But for the next, we actually have to hire pilots. This is a process that will be indeed gradual. This is not an overnight process. And that's why we say it could take up to 1.5 years to have all 50 aircraft in operation. So you would not see the incremental capacity from 50 aircraft flooding the markets in the first few months of 2020.

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Konark Gupta, Scotiabank Global Banking and Markets, Research Division - Analyst [5]

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Okay. And that's great color. And then with respect to pilot hiring, would you wait for the Transport Canada certification before starting the hiring process? Or would you be doing something slightly before that because you have to train pilots as well?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [6]

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Yes, no, exactly. So we will be doing prudent steps on hiring. Once we know that the FAA, where we've been very close in touch with our Transport Canada regulators here, of course. And so we're quite informed on the dynamics as between the regulators. And so we would hope that the ungrounding occurs soon and once it occurs, at least in the United States, we would start taking steps towards reinstating our hiring, and we're looking at potentially hiring up to 350 incremental pilots next year.

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Konark Gupta, Scotiabank Global Banking and Markets, Research Division - Analyst [7]

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Okay. And my second question is on CapEx here. It looks like there's a slight bump in CapEx for 2020. And I saw that there's, I think, 3 incremental A220 or C Series aircraft that you're taking next year, and there's probably some leases on A320 and E190 that you extended. Any color on what also contributed to CapEx increase next year, Mike?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [8]

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Yes, it's Mike. So you're absolutely right. There is a small increase in overall CapEx, 3 different reasons. One, you are right, we're taking a couple of extra 220s at the end of the year that we'd originally planned, just moving from 2021 to 2020. So just really a timing issue from a capital perspective into 2020.

Second, as you know, we were fortunate enough to pick up 8 very, very productive wild 321s, and so we will basically modify the interiors of those planes next year. So that's some extra capital. Not expensive, but certainly, that will produce a better return for us for those planes. And third, some extra technology projects that we'd want to put on the sleeve for next year as well.

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Konark Gupta, Scotiabank Global Banking and Markets, Research Division - Analyst [9]

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Okay, that's great color, Mike. And then lastly on the cost. So second -- third quarter costs came in I think slightly better, I'm talking about nonfuel as well, compared to what we -- probably the market would have anticipated given the capacity decline. It seems like you probably mentioned the stock-based compensation and some other kind of headwinds. But despite that cost seem to be under control here, any color on your cost transformation program, any incremental costs you recognized during the quarter as well as it looks like Aeroplan also had some lower costs in Q3?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [10]

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Yes, I think there's no doubt, our $250 million cost transformation program continues to be the strong focus for us and continue to look at areas of improvement. As you can appreciate, those are getting a little more difficult, but we are still realizing some areas of improvement across many different cost buckets, that -- some of which were reflected in Q3, and some of which will be reflected in Q4 and on a go-forward basis.

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Operator [11]

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The next question is from Fadi Chamoun with BMO.

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Fadi Chamoun, BMO Capital Markets Equity Research - MD & Analyst [12]

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Congratulations on a very good execution here. Mike, if you can frame to us like if you're adding those MAX in 2019, assuming the aircraft is ungrounded, you have 50 aircraft coming in, how many aircraft can leave the fleet like between what you've wet leased between the Airbus that you were planning to retire? Just to help us kind of understand what you have at your disposal to manage the supply-demand next year.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [13]

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Fadi, great question. And it's a complex project to bring in and exit planes. As you know, we extended leases for the 190s and 320s to cover a portion of the lost capacity. So a rough estimate is about 15 planes that we will be able to exit over the next 12 to 18 months, given the lease expiry dates of those planes,

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [14]

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Plus the wet leases.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [15]

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Plus the wet leases. And so the 190s are pressing forward. 320s, we tried to negotiate short-term lease extensions. And so in total, about 15 that we'll be able to exit in -- within the next 12 to 15 months.

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Fadi Chamoun, BMO Capital Markets Equity Research - MD & Analyst [16]

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Okay. That's great. So I guess between the gradual reentry of the MAX and the plan that you can exit, you have some flexibility, obviously here to kind of match the supply and demand and protect the yields?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [17]

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Yes. As you know, Fadi, we've always tried to build in that flexibility. And I think we've done a fairly good job of given the uncertainties and -- but given our plans to manage capacity appropriately, but still have some flexibility to ensure that we cover any potential scenario.

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Fadi Chamoun, BMO Capital Markets Equity Research - MD & Analyst [18]

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Okay. And one question maybe to Lucie. The business cabin growth this quarter of 3.9%, I think the lowest we've seen in at least 2 years. Can you offer up any kind of insight into the trends that you're seeing by market? Is this a region-specific or is it kind of broad-based slowdown that you're seeing in business cabin?

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Lucie Guillemette, Air Canada - Executive VP & Chief Commercial Officer [19]

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Well, there's a couple of things. The first is we did see a material decline in the business cabins and business travel on China routes -- so China and Hong Kong. So in those areas, we did see the close -- or higher-yielding traffic significantly declined.

The other issue is with us making adjustments to the schedule as a result of the MAX, we do have rules also flying on some domestic and U.S. routes, which normally would have been operated by the MAX, which has also caused a little bit of a decline. But when you look at it, the key routes where we have really good solid J class demand, for example, transcon, the U.K., those type of -- California, the premium cabins continue to perform very, very well.

In particular, this summer, the domestic market, U.K., was also very, very strong. So there's nothing there that's a big surprise to us, most of the performance we anticipated.

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Operator [20]

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

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Walter Noel Spracklin, RBC Capital Markets, Research Division - Analyst [21]

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So on the MAX reentry, and as you -- Calin, as you mentioned, you're going to be flexible, you keep some redundancy, if we see all the airlines doing that next year, aren't we into a little bit of a risk here that we have excess capacity with a big flood of 737s coming back in, some extra planes that everyone will now be keeping to keep that flexibility? How do you see that playing out from a competitive dynamic, where we might see a 2020 that has far too much capacity for -- capacity out there in the airline industry?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [22]

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I don't see that, Walter. Our stance is that this somewhat inefficient aircraft will come out of the marketplace. I think that the -- in our case, we've extended, for example, the 190s, even though we announced a long time ago that we wanted to be out of the 190s. 190 is not the right airplane for many of the routes. And so we would look to stop flying those if we had the MAX coming in a meaningful way, and we had pilots and so on and so forth.

I think part of the dynamic is that we don't have a firm date on the reentry. I think as all carriers had a firm date on the reentry into service of the MAX, obviously, these plans could be made somewhat differently. But given that it's been a moving target, we've had to have that type of flexibility.

But nobody -- certainly, we don't want to fly inefficient airplanes that consume more fuel than we need to, that have a higher cost per seat than we need to. We don't -- we're not in that game. And I think that, certainly, in our case, our idea would be to do the thing that is most efficient for the routes that we need to serve using the right aircraft on those routes. And so there's not really a desire to have inefficient airplanes flying around operating inefficient routes.

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Walter Noel Spracklin, RBC Capital Markets, Research Division - Analyst [23]

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Okay.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [24]

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And Walter, it's Mike. Just to add into the earlier question, our 2020 capacity increase, ASM increases somewhat in the same ballpark as what we had initially thought for 2019, I think the market can certainly absorb that fairly quickly.

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [25]

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And actually, another reflection point, Walter, on the question because it's a good question, when you look at -- hear some of Lucie's comments earlier on the impact that the MAX grounding has had our Sixth Freedom traffic, we need the MAX to operate those Sixth Freedom routes. There's not much advantage for us to be giving up that Sixth Freedom flying and so connecting traffic that we've been developing over the last number of years. So I think that you would -- we would not have any particular desire to continue operating inefficient airplanes on those routes.

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Walter Noel Spracklin, RBC Capital Markets, Research Division - Analyst [26]

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So even if you were to perfectly -- and everyone reduce those inefficient, just the MAX alone, everybody taking deliveries of MAX, all the same date, all the same -- all at once, you don't expect that, to Mike your point, that can be absorbed?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [27]

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No. A, it could be absorbed and b, it cannot come in overnight. I mean again, as we explained in our case, it's impossible for it to come in overnight because in our case, it's going to take us a full year to get up to 50 million. Others may have their own staffing constraints and other dynamics in their union contracts or otherwise. So it's not as if all of these airplanes can come back into market overnight.

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Walter Noel Spracklin, RBC Capital Markets, Research Division - Analyst [28]

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Right. Okay. That makes sense. Mike, I heard in your prepared remarks something interesting there. You said your -- you have excess cash on the balance sheet that would be there to fund CapEx and debt reduction and that free cash flow would be for buyback, if I look at your guidance for 2019 to 2021, cumulative free cash flow of $4 billion to $4.5 billion and then your guidance for 2019 at $1 billion to $1.5 billion, let's say, ballpark $3 billion left for 2020 and 2021, does that mean $3 billion goes into buyback?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [29]

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It means the $3 billion is a potential for buyback. All I want -- and this is what I've been talking to the market about for quite some time. The excess cash currently benefits our leverage ratio, and so that is parked to help CapEx and reduce debt levels. As we go forward and we generate free cash flow, that gives us the greater ability to be more aggressive in buying back shares. And we've done that in 2019. We've bought back $250 million of shares after 9 months. That's much, much greater than it was last year. And that $250 million obviously reflects the free cash flow this year adjusted for the deferral of the MAX capital into next year.

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Walter Noel Spracklin, RBC Capital Markets, Research Division - Analyst [30]

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Okay, perfect. And last question here is just on your -- I guess your guidance strategy as we hopefully zero in on a MAX reentry date. You've effectively, I guess, guided here for capacity for next year. You've typically obviously given some guidance for CASM and margin, et cetera. When do you think you'll kind of dovetail the 2020 guidance into that 2020 to 2021 longer-term guidance that you have out there already?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [31]

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Our plan right now, Walter, is to do that as part of our year-end release in early February.

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Operator [32]

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The next question is from Hunter Keay with Wolf Research.

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Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [33]

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Calin, the RES system, you said in the prepared remarks that it's going to permit improvements in the future after it's implemented. What kind of initiatives are you teasing there?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [34]

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Well, we see the ability of this system to help us with a lot of our inter-airline transactions is going to be significant. We have a large number of our Star Alliance partners that are on the Altea system. That will be one large driver. But then there are a series of, I would call, blocking and tackling enhancements. At least you can describe some of the things that we're contemplating, things that are just in the system that we've been wanting to do for a long time, have not been able to do, which will facilitate upgrade revenue, for example. Upgrade has been a big deal, the flexibility of upgrading, where we do upgrades, where we sell upgrades, I'm talking about. These sorts of things, there'll be a series of, I would say, 2 big categories, the improvements to our own dynamic with our own product and then the airlines. Lucie, why don't you just give two or three examples?

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Lucie Guillemette, Air Canada - Executive VP & Chief Commercial Officer [35]

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Sure. There's quite a few benefits, but the ones that we're most excited about, one is around our ability to do more frequent scheduling changes. So the way we operate today is we generally have a schedule change, which is quite massive, but we don't have the ability to adjust frequently as much as we would like to. So that is obviously a huge benefit. And Calin touched on it a little bit when he talks about other airlines, but the ability for us to have our availability better in sync with our partners and also with other airlines and to also have real-time availability in all channels. So in the environment we are in today, it's not optimal. So tomorrow, that will be a very big benefit for us and also on the ancillary side of the business.

So today, we have the ability to sell ancillaries. But tomorrow, we'll have the ability to, a, introduce more of them, but also to optimize the revenue that we generate from the sale of ancillaries. And that's just really from a revenue perspective. But when you look at it from a customer service point of view, the benefits, our ability to better serve the customer in the airport environment and in contact centers will also be meaningful.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [36]

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Which will, obviously, of course, Hunter, result in revenue. And so I'd say, to be frank, I think that the $100 million estimate is conservative.

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Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [37]

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Okay. Great. And then interesting to see that domestic yield up so much with domestic loads down, that's not how every airline that operates the MAX is seeing that go down, it's more -- sometimes more of a load factor benefit. So I'm wondering, for you guys, is this a function of mix where you're just basically cutting service in lower-yielding markets? Or are you actually able to take some of the supply reduction and push incremental price sort of across the system?

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Lucie Guillemette, Air Canada - Executive VP & Chief Commercial Officer [38]

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Yes. Hi, it's Lucie. There's actually 3 things that are most important on the domestic network. The first is, we can't neglect the comparable to last year. If you recall in the third quarter of '18, our competitor was facing a strike threat. So basically, there were a lot of very, very significant pricing activities last summer that we didn't observe this year. So that's one thing for sure that gives us good yield comparisons.

In addition to that, we also pursued a lot of opportunities on branded fares side of the business and also basically fare increases, so where we have the opportunity, strong demand, we did actually push up the fares. So those 3 things are really the biggest drivers for the domestic performance.

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Operator [39]

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

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Andrew George Didora, BofA Merrill Lynch, Research Division - Director [40]

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My first question, I think, is for Lucie. Can you talk about your ability to manage fares in 4Q, considering that it is at the lower load factor period relative to Q3? Is there something we should think about 4Q as having maybe a few more tailwinds, given the longer lead time on bookings and a little bit more flexibility on loads?

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Lucie Guillemette, Air Canada - Executive VP & Chief Commercial Officer [41]

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There's one thing, for sure, particularly on the international networks and that's our ability to collect incremental fuel surcharge revenues. So the fuel surcharge is really peaked in the third quarter of '18 for obvious reasons. So when we look at our ability to push international fares up, it's a little bit more difficult because we don't have the ability to push the surcharges up so much. The environment is very competitive, as we know, particularly on the international front. But on the U.S. transborder market and even on the domestic market, to a large extent, I think that the pricing environment is going to be far more stable in the fourth quarter.

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Andrew George Didora, BofA Merrill Lynch, Research Division - Director [42]

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That's helpful. And then my second question for Mike. On your 2019 free cash flow guide of the $1.3 billion to $1.5 billion you outlined in your release today, it looks like you already have over $1.6 billion year-to-date. And if I do my math correctly, it seems like 4Q implied EBITDA should cover the remainder of CapEx for the year. So what's the disconnect here? Is there some change in kind of working capital seasonality or something? Just want to see what I'm missing on the free cash flow guidance.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [43]

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Yes. I don't have the exact answer to that question, but I think it has got to be working capital seasonality that drops off in Q4.

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Andrew George Didora, BofA Merrill Lynch, Research Division - Director [44]

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Okay. Maybe we can follow up afterwards.

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Operator [45]

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The next question is from Doug Taylor with Canaccord Genuity.

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Douglas Taylor, Canaccord Genuity Corp., Research Division - Director [46]

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A lot of questions on what happens when the MAX comes back online as we inch closer to that. I just wanted to flip it around, in the off chance that the delays extend further than you anticipate, can you talk about whether any of the remedies you've used to replace that capacity or would reach end-of-life anytime soon? Are there any measures? Or is it possible that you might extend the 737s coming back online if you were given the option.

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [47]

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So first of all, yes. I mean we obviously are continuously looking at alternative scenarios, Doug. And we do have a series of airplanes that we've done the maintenance work to ensure that they continue operating for us well into next year, even though we were otherwise planning to exit them. And so we have done that work. Several of the airplanes that we extended their useful life on the engines until the end of those will, we know, at the time -- the exact timing of that. And so those will not have flexibility if it extends indefinitely. But we have a large number of our contingency aircraft available with maintenance work being done, with MRO facilities having been secured and steps being taken as well. We've also, as you know, we've worked very, very well with really 4 different operators of wet lease arrangements at this point, and we have arrangements that are available and flexible to go on into a longer period of time, should that be necessary.

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Douglas Taylor, Canaccord Genuity Corp., Research Division - Director [48]

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And does the cost of that replacement lift as you exit peak summer travel season change at all? Is it lower? Is it less competitive for people fighting to -- for that scarce resource right now?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [49]

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No. There's no question that the wet -- for example, wet lease market, which is a short-term tool, the wet lease market increases based on demand, much as any other supply and demand dynamic would. But we were able to -- like, for example, the very useful Qatar airplanes that helped us through the summer, that wet lease arrangement is over. So we are not paying for that in the fourth quarter, for example.

And so we mentioned that into next year, we've secured 2 other 330s that will help us at a lower cost, at a substantially lower cost, than the Qatar one, for example. And so as we go forward, and based on seasonality, the wet lease cost do in fact differ. On the other hand, we do want to maintain the flexibility until we have full visibility on the return to service.

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Douglas Taylor, Canaccord Genuity Corp., Research Division - Director [50]

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That's helpful. Last question for me. I think most people agree that there's a pretty significant pilot shortage globally. I mean I understand you're not wanting to hire too soon for the 737 MAX, but can you talk to your ability or what risks there are in your ability to hire the pilots you need as quickly as you need them, given that you uniquely don't have the NG aircraft to pull pilots up from and things like that?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [51]

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Right. So first of all, we have, as we've said a few times, we have the 400-or-so pilots operating the 24. So that issue is covered already. The pilots have continued to do simulator training. And as you know, we're the only ones in North America who have the simulator. And so they've done the simulator training over this period of time. They are going to be ready to go fairly -- and be deployed fairly quickly upon reentry into service. That's the initial 400.

Beyond that, we have a very detailed program with each of our 2 largest regional partners, Jazz, and Sky Regional. And we have pilot flow agreements that provide for pilots to apply to Air Canada. We already have a detailed approval process, and we know which pilots have been approved. They, in turn, have got arrangements with flight training schools and other capabilities that create a system. So think of it as a farm system, and the farm system is working. We've been developing it for a number of years now. We've invested in it. It's actually helped us reduce our cost and given them greater stability and greater -- and given their pilots greater visibility on the -- on career opportunities to Air Canada. So we actually know where -- a lot of the -- that doesn't mean that 100% of our pilots will come from these 2 operators, but that provides a good base for future pilot flow.

We've also had -- given that Air Canada's recent success, we've also had success in attracting, and we'll continue to attract pilots from our competitor, other competitor carriers in Canada. And so we're feeling confident that we will be able to fill the pilot requirements for next year and going forward beyond next year.

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Operator [52]

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The next question is from Chris Murray with AltaCorp Capital.

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

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Lucie, maybe just is more of a question for you. Looking at the cargo performance over the last few quarters, it's certainly been breaking down. And I know, we've talked a little bit about international trade. But one of the things about cargo is there's also been a fairly decent leading indicator of your business program and business travel. I know in an earlier question you talked a little bit about it. But is there anything that we should be thinking about different this time about how you -- how we should be thinking about business travel into 2020, given where the metrics are on cargo? Or is there a bit of a disconnect that we may be missing on this one?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [54]

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Yes. Actually, I'll -- maybe I'll take that, Chris. It's Calin here. When we look at -- and you're absolutely right, cargo has tended to be a good barometer of economic activity globally and sort of macroeconomic trends are often influenced by what we see in cargo. However, in our particular case, we have seen extremely attractive and bullish passenger market other than in the areas that Lucie pointed out, which include pockets of instability, like in China, in Hong Kong, and those were, of course, influenced by other factors. So we have seen this year a disconnect between demand on the cargo side and demand on the passenger side, other than in those pockets. So we're not reading into -- if your question is, should we be reading the indicators coming out of the cargo business as being indicators of a coming recession, we're not reading that into our demand curve for 2020.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research for Diversified Industries & Senior Analyst [55]

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Even -- and particularly in the business cabin?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [56]

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And that includes the business cabin, yes. And that -- it's true as far the business cabin is concerned as well. Correct.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research for Diversified Industries & Senior Analyst [57]

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All right. Fair enough. And then, Mike, just a quick question. One of the -- some of the early headline numbers this morning, just talked about your EPS number maybe missing some consensus numbers, I think tax rates in the quarter were a little higher than maybe we would have expected. I think at the Investor Day, you talked about Q4, we'd start seeing some tax impacts. Just now and I appreciate with the integration of Aeroplan, there's probably been some changes in your tax thinking. Just a couple of questions. Just as we think about setting up the estimates for Q4 in 2020, how do we think about tax rates? And I think the last time we talked about it, you thought that you would be cash tax paying some time in the 2021 time frame, but just any update you can give us would be great.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [58]

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Sure. Good morning, Chris. So I still think we should -- the market should use the 27% corporate tax rate on a go-forward basis. I think that's the best proxy to use. On the cash taxes, we did actually say, there'll probably be some leakage this year in 2019 and more in 2020 and then potentially fully taxable in 2021, as our loss carryforwards run out. We've been able to structure some things that will allow us to defer that a bit. So the cash impact will be a little bit less on a go-forward basis.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research for Diversified Industries & Senior Analyst [59]

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All right. So your thinking is 27%, should be kind of a baseline number we should assume at this point?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [60]

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Absolutely.

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Operator [61]

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The next question is from Rajeev Lalwani with Morgan Stanley.

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Rajeev Lalwani, Morgan Stanley, Research Division - Executive Director [62]

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Mike, you had talked about your ability to support yields, RASM, et cetera, so a healthy top line, if you will, going into next year, but what about the unit cost side? Is there going to be any material lingering effects from the MAX, just general color on puts and takes and maybe your ability to get down unit cost next year, just given all the inflation next year and so on?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [63]

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It's a great question. And we're still working through those issues, given the uncertainty of the MAX situation and the overlap of fleets from a mitigation perspective. So there would be probably some leakage next year from a cost perspective to -- and that -- I would consider that risk insurance for the most part.

Aside from that, there are a couple of structural issues next year, but we think we can absorb those issues. And again, as I said to an earlier question, we'll have clear guidance in early February as to where CASM X will end up in 2020.

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Rajeev Lalwani, Morgan Stanley, Research Division - Executive Director [64]

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Okay. As a follow up, you talked about leverage a bit in buybacks, is there a way that we can approach maybe what a lower bound is on what the leverage metric would be, meaning, are you willing to go to 0.5x leverage or something like that, so we can start to put some numbers around the ability to buy back stock and so on?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [65]

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No. That's a very fair question. I think we believe where we are today, 0.7 to 1.2 range is investment-grade level. There are other metrics obviously involved in Moody's or S&P's analysis of giving this investment grade. But as a proxy for the leverage ratio, I don't see us going much lower than we were in Q3 at 0.8. Frankly, I don't think that's efficient from a capital allocation point of view. But that, that range will be plus or minus 20, 30 points from where we are at, let's say, year-end.

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [66]

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It's Calin here. As you probably know, the consistency that you maintain those levels is also a factor that they look at. And so I think that it's not just doing it for 1 or 2 quarters, making sure that it's sort of -- the message is at a sustained leverage ratio.

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Operator [67]

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The next question is from Helane Becker with Cowen.

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Helane R. Becker, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [68]

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Calin, I think you made a comment, I don't want to read too much into it, but you talked about the MAX and when the grounding in the U.S. is lifted, did you mean to imply that the U.S. would lift the grounding before the Canadian market? Or am I reading too much into that statement?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [69]

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I would say probably -- you're probably reading more into it because I have no visibility myself on that topic. But I think that we know that the FAA needs to be the regulator of first resort here, if you like. And so whether or not Transport Canada or other regulators go at the same time, we really are looking to the regulator of first resort, the FAA and its initial step as being an indicator as to the return to service. And so we're hopeful that other regulators will act in tandem. We have no visibility that they won't, but we would certainly view that as a step to start taking constructive actions ourselves in terms of pilot hiring.

We have, of course -- we know the dynamic with EASA That was somewhat disconnected in the past, and we hope that EASA would act at the same time. So we don't know where all the regulators are going to be. But we would start taking some steps towards reestablishing the return to service because this is, as I said several times, this is not an overnight feat.

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Helane R. Becker, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [70]

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Right. Got you. Okay. And then my other question is with respect to the deferred maintenance that you guys were doing to keep as many aircraft in the air as possible, as we think about that for, say, 2020, and let's think about it from like the second quarter on and assume that sometime in the first quarter the aircraft gets back into service, how much deferred maintenance should we think about you guys having to do in the last 9 months of next year for catch-up purposes?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [71]

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Let's separate maintenance into regular maintenance, which is being done on an ongoing basis per schedule. For example, we have -- we've deferred on Wi-Fi on many planes. And so that's more of a capital item than it is an operating expense item. It's, obviously, a customer service item. But that -- we pull planes out of WiFi conversion. And as you know, we're changing the paint as well on many of our planes. So we've taken those 2 programs and basically deferred those into next year, or until we have certainty around the MAX situation.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [72]

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Yes, at the same time, we've been putting dual HUDs on our 737 MAX this year while the airplanes have been sitting, putting WiFi on while they've been sitting. So you do have a little bit of that trade-off where we've been doing some of the work this year that would, otherwise, not have been done this year, given that the airplanes we're sitting. So it's a little bit of a trade-off that you're seeing there, Helane.

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Helane R. Becker, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [73]

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Okay. Great. And then my last question is just on -- so a while back, maybe 2 years, you guys renegotiated the agreements with your regional partners, and I'm just kind of wondering if those renegotiated agreements are working as you anticipated and if you can somehow quantify the revenue benefits of those for, I guess, the second half of this year maybe into 2020.

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [74]

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Sure. Well, I'll try and answer that question. So the biggest contract we have, the biggest partner we have, of course, is Jazz, and we renegotiated and extended that contract earlier this year in February. Certainly, the biggest short-term impact is a reduction of approximately $50 million in fees that we would pay Jazz to operate those planes on our behalf. That is obviously being realized, as we speak.

There were other network benefits associated with more flexibility around their fleet, which we're getting some benefit now. But of course, the MAX situation has also caused that to be deferred a bit. So we expect a much better impact next year on the network side regarding the Jazz fleet.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [75]

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And to give you an example, Helane, is that one of the things you may remember we talked about the fact that we were able to, as a result of the changes to the contract, we're able to introduce Rouge aircraft on some of the regional routes, which obviously has a much lower CASM dynamic, [hospitality] dynamic than the Jazz airplanes would. That -- in some cases, that had to be suspended because of the fact that we needed to use the Rouge airplane to fly other missions that were otherwise flown by main line. And therefore, the regional carrier was continuing to operate the regional route. So that's I think -- what I referred to, that's an additional benefit that we'll get next year and the following year, once the MAX returned to service.

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Operator [76]

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And the next question is from Kevin Chiang with CIBC.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [77]

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Just a couple of quick ones for me. Just one on pension funding. I see your 85% national liabilities to go up about 2.5 points quarter-over-quarter. Just wondering if there's a time frame to get this to 100% or if that's even a target of yours over the near term here?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [78]

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The hedging?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [79]

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The hedges?

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [80]

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The pension funding. Sorry, your pension funding?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [81]

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Okay. Yes. We're currently -- sorry, Kevin. We're currently at 85%. We'll look to step it up over time, but we think we're fairly risk-adjusted at this point in time, 85%. We look at risk measure, which is less than half of where it was when we started this journey. And we're comfortable with that risk profile at this point. So again, we may step it up over time, but currently 85%, we're very comfortable on the immunization process.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [82]

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That's helpful. And then you had commented on the Sixth Freedom strategy in some of your earlier comments, I'm just wondering, how does the end market outlook for the Atlantic or the Pacific impact that strategy? So if the Pacific's weaker and maybe a little bit more competition on the Atlantic, do you throttle back your long-term outlook for that Sixth Freedom growth strategy? Or do you look at them independently?

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [83]

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What we've done on the -- when we look at Sixth Freedom as a -- we view the Sixth Freedom opportunity as a long-term opportunity as we have been building out our 3 hubs. So we expect the good portion of our business model, kind of, in perpetuity to be in and around this connecting traffic. So it's not something that we're going to go in and out of. But what we will do is, as Lucie mentioned, is that we will allocate capacity where we see weaknesses. But we're not -- we don't exit the Sixth Freedom market to the Pacific just because the Pacific is a bit tougher or China is a little bit tougher. So you will see movement in it as between Atlantic and Pacific. But we certainly have big aspirations and we'll continue a big aspirations for Sixth Freedom traffic in each of our 3 hubs. And certainly, we're not getting out of the Sixth Freedom business in Vancouver, for example.

So this is a big, big part of our strategy. It's going extremely well, and we have a bit of a slowdown because of the 737 MAX grounding. We're still not anywhere near our fair share of what we consider the Sixth Freedom business to be, and we'll continue to be moderating. So I think if you've seen the third quarter, we sort of took a bit of a pause with it. And certainly, it's not based on demand, but it's based on the lack of the right aircraft to take passengers over the hub.

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Lucie Guillemette, Air Canada - Executive VP & Chief Commercial Officer [84]

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And just to add a comment on that. If you look at our transatlantic performance, basically in 2 quarters, we operated at 88% or 89%. So in essence, our job is to try and capture the highest yielding traffic, which in many cases would have been the local passengers. So as a result of the MAX grounding, there comes a point where we have to optimize the revenue. So we didn't lose any load factor on the transatlantic, it's just that a connecting passenger would have given us net revenue potential. So that's why you see a little bit of decline.

If we had the transborder decline, we could have redeployed some of the U.S. connections to maybe some of the softer transatlantic markets or a little bit more on the Asia Pacific. But it's really a question of optimizing all the flows that we have at our disposal.

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Operator [85]

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And the next question is from Jamie Baker with JPMorgan.

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Jamie Nathaniel Baker, JP Morgan Chase & Co, Research Division - U.S. Airline and Aircraft Leasing Equity Analyst [86]

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Most of my questions have been answered, but I also have a follow-up on wet leasing. And pardon my ignorance here, but I don't have much experience on this topic since scope clauses here in the States generally don't allow for it. So it does seem like you're going to be in a situation where MAXs and wet leased aircraft simultaneously overlap one another. It sounds like the plan is to operate both. My question, is there any contractual ability to switch from a wet lease to a dry lease, in which case it might make sense to just sit the leased aircraft? It seems that, that would address what is clearly growing concern over supply next year. And I apologize if that's a dumb question, but if there's a situation where you'd only be on the hook for the cost of the shell, it seems that, that might prove economically preferable.

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [87]

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Right. So Jamie, Calin here. First of all, thanks for the question, and thanks for being on the call. I say two things. One is that these wet leases are very, very short-term leases. So we can -- I think we put the expiry dates in our comments, I think that the new wet leases will expire at the end of the first quarter. And so we're not -- this is not something that's going to go on into all of next year, unless there's a further extension to the grounding. So, a, they're very, very short-term leases.

Secondly, the operators of these wet leases are in the wet lease business, so to speak, that they're not conventional lessors of aircraft, they actually do this as a business. So I thought the sort of thing that you separate the crew from the aircraft. But it's not -- it really is not a major part of our overall cost dynamic here from the MAX. This is a -- we have many other costs that have come up as a result of the MAX. This is part of it. But this is not the major factor. Now -- and we only have 4 wet leases in any event going on -- into next year, the 2 new 330s, which is very, very short term. And then the two 767s that we operate at Hawaii, which also -- which we've extended because of the extension of the grounding, but which will also -- and at the end of the first quarter.

So it's not a full year problem. I mean we might choose to extend them further if the grounding extends, but this is not a big cost dynamic for us.

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Operator [88]

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(Operator Instructions) The next question is from Tim James with TD Securities.

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Tim James, TD Securities Equity Research - Research Analyst [89]

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Question for Mike. I wonder if you can help me reconcile the fleet change table, which shows 38 removals I think in 2020 between 767s, 320s and the 190s combined with your comment about the 15 kind of flex aircraft that you have, is that ability to remove 15? I believe it was that you mentioned earlier in the call. Is that in addition to the plans that we see in the table?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [90]

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It's a great question, Tim. It is -- in addition, we -- well, some of them are -- we do have specific plans to exit some of these planes because of maintenance issues, full summer of 2020. So the ones that are actually planned because of maintenance issues or they run end of life are in the fleet table. And then again, there's a couple of those 15 that allow a little more flexibility, depending on what happens with the MAX situation.

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Tim James, TD Securities Equity Research - Research Analyst [91]

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Okay. So the 15 -- some of the 15 are aircraft... right, are built in.

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [92]

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Built in. Ones that we know will exit the fleet for valid reasons.

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Tim James, TD Securities Equity Research - Research Analyst [93]

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Okay. The next question, Mike, the stronger working capital performance that you mentioned in reference to 2019, I'm just wondering if those are kind of sustainable changes in the model in terms of cash coming from working capital or should those influences reverse or kind of moderate in 2020?

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Michael Stewart Rousseau, Air Canada - Deputy CEO & CFO [94]

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No. I think, Tim, a majority of that is sustainable. Again, I think we're still learning on the economics of Aeroplan. I think we were probably conservative when we issued our initial guidance that we suspended on free cash flow for the year. We tend to take a more conservative view of working capital. But as we continue to grow, as you know, advanced ticket sales continue to grow, which is a good leading indicator to the booking curves, and you've seen growth in Q3 as well. And so I think the majority of that is sustainable as we continue to grow.

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Tim James, TD Securities Equity Research - Research Analyst [95]

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Okay. And then just my final question, I guess, for Lucie here, I'm just wondering if you -- with the new daytime slots that are being provided to U.S. Airlines at Haneda, I think services starting in March of 2020, I'm just wondering if you're seeing any -- or your thoughts on the potential impact on pricing into that kind of key market for Air Canada?

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Lucie Guillemette, Air Canada - Executive VP & Chief Commercial Officer [96]

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Well, certainly, we haven't seen any of that impact yet. But I think, given the type of market that Haneda is, my feeling is that we would probably see very marginal impact on price.

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Operator [97]

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There are no further questions registered at this time, so I would like to turn the meeting back over to Ms. Murphy.

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Kathleen Murphy, Air Canada - Director of IR & Corporate Reporting [98]

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Thank you, Elena, and thank you, everyone, for joining us on the call today.

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Calin Rovinescu, Air Canada - CEO, President & Non Independent Director [99]

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Thanks, everyone.

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Operator [100]

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Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.