Azul SA (AZUL) 2018 Q3 法說會逐字稿

Hello, everyone, and welcome to Azul's Third Quarter 2018 Results Conference Call.

My name is Larissa, and I will be your operator for today.

This event is being recorded.

(Operator Instructions) I would like to turn the presentation over to Andrea Bottcher, Investor Relations Manager.

Please proceed.

Thank you, Larissa, and welcome all to Azul's third quarter earnings call.

The results that we announced this morning, the audio of this call and the slides that we will reference are available on our IR website.

Presenting today will be David Neeleman, Azul's Founder and Chairman; and John Rodgerson, CEO.

Alex Malfitani, our CFO; and Abhi Shah, our Chief Revenue Officer, are also here for the Q&A session.

Before I turn the call over to David, I would like to caution you regarding our forward-looking statements.

Any matters discussed today that are not historical facts, particularly comments regarding the company's future plans, objectives and expected performance, constitute forward-looking statements.

These statements are based on a range of assumptions that the company believes are reasonable but are subject to uncertainties and risks that are discussed in detail in our CVM and SEC filings.

Also during the course of the call, we will discuss non-IFRS performance measures, which should not be considered in isolation.

With that, I'll turn the call over to David.

David?

Thanks, Andrea.

Okay.

Welcome, everyone, to join us for our third quarter 2018 earnings call.

As always, I want to start by thanking our crew members at Azul for creating this great result for us.

They are truly amazing and they do an amazing job every day.

We're relieved that the Brazilian elections are finally over and that the macroeconomic environment in Brazil is more stable.

And we're very optimistic with the new administration, they seem to be taking all the right steps to promote economic development in the country.

I've always been a great believer in Brazil.

It's a huge country with a lot of potential.

We've had a couple of tough years, but the future looks bright.

Now going back to the third quarter results.

Once again, we demonstrated our resilience in an extremely adverse fuel and currency environment, while successfully executing on our long-term margin expansion plan.

On the operational front, we continue to rank as the most on-time airline in Brazil and are also among the top 5 in all the world.

Incredible, an incredible accomplishment.

I am proud to report that last month, we were voted the best not -- we were voted the best airline in Latin America by Kayak customers, a leading travel research engine, sweeping all categories, boarding, comfort, on-board service, entertainment, and most importantly, crew members, who really make it happen.

We were also recognized by ReclameAQUI, which is -- it's complain here, which is Brazil's consumer economic advocacy website, for having the highest standard of customer satisfaction and the fewest customer complaints year-to-date of all the other airlines.

I couldn't be more excited about the quality of our service and our future growth opportunities.

Through our fleet transformation plan, which we've talked a lot about, as we told you many times, we're replacing the E1s with A320s and we have -- that have similar trip costs with 56 more seats.

And also, the E2s that have 18 more seats with a much lower trip cost than the E1s.

And this is why we are actively marketing the E1s to accelerate that process, and it's going well.

We've built an unbelievable network.

And now, every new generation aircraft we add strengthens our airline even more by reducing our unit costs.

On a fuel and neutral basis, our CASK,, and John will talk more about this in detail, would have been down 6.8%.

It's incredible.

I mean to be down 6.8% year-over-year, I don't think -- I've never seen that from another airline.

And that's obviously because these neos have such a lower cost.

The performance of the 320neos in our network have surpassed all of our expectations.

Adding the neos, for the sixth quarter in a row, we have increased capacity and RASK.

These aircraft are flying an average of 14 hours a day and are bringing up our fleet jet utilization rate to 12.6 hours a day, while improving connectivity across the airline.

At the end of the quarter, we had 17 320neos flying in only 27 out of 218 markets, representing 27% of our total capacity.

And these planes have a 29% lower unit cost.

Every single one of these is desperately needed and we'll continue do so for many years to come.

When one arrives, we stick it where it's needed, and we have so many needs for these aircraft.

It's a real party here every time one is delivered.

No other airline in the world is transforming its fleet as significantly as we are, replacing 118-seat aircraft with next-generation 174-seat airplanes.

And then starting next year, our fleet transformation accelerates when we start adding the E2s mid-'19, so that those will have come at a really rapid pace once they start coming.

With both these generation aircraft, we are creating a competitive sustainable advantage, which will continue to drive margins higher and allow us to offset any future macro headwinds we may encounter.

In summary, we are confident on our margin expansion plan that we told you from the very beginning.

When we were on the roadshow, that was our message and it hasn't changed.

And we will continue to communicate that message.

And as we build -- on our way to building a more profitable airline, we have the best crew members, the strongest network and the most reliable operation.

I couldn't be more excited.

With that, I'll pass it over to John, who will give you more details on the quarter results.

Thank you, David, and hello, everyone.

I also want to thank our crew members for all their hard work during the past quarter.

As you can see on Slide 5, the core airline drove strong results in a tough macroeconomic environment.

The 47% spike in fuel and the 25% depreciation of the real impacted our results by BRL 323 million or 16 margin points.

Thanks to our ability to raise fares and reduce costs through our fleet transformation, we were able to recover 11 margin points, reaching an EBIT margin of 7.1% for the quarter and a 28% EBITDAR margin, while recording net income of BRL 117 million.

We grew capacity by 19% in the third quarter while also expanding our top line by 23% and our RASK by 2.7%.

On a stage-length adjusted basis, our RASK increased 8% year-over-year.

CASK ex-fuel decreased 1.8%.

Controlling for currency and fuel, as David mentioned earlier, CASK would have been down 6.8% year-over-year.

We received our 17th A320 in the quarter, and the A320neos represented 27% of our third quarter capacity.

The E2s coming next year will help us further accelerate the fleet transformation.

Moving on to Slide 6, you can see that fuel and currency had a negative impact on our results in the third quarter, which represented 16 margin points.

Thanks to our margin expansion strategy and obvious ability to recapture revenue, we recorded an operating margin of 7.1%, recovering 11 of the 16 margin points during a very challenging macroeconomic environment.

Moving onto the revenue performance on Slide 7, we continue to benefit from a healthy demand environment and drove up ancillary revenue.

Considering that our average stage length increased 11% in the third quarter, our RASK adjusted for this increase rose 8%.

Our network advantage allowed us to grow capacity by 19% while increasing average fares by 11%, and at the same time, increasing load factor.

Once again, we increased capacity, yield and load.

This shows the network really needed the A320s.

Moving on to Slide 8. Our loyalty program, TudoAzul, maintained a strong growth pace during the second quarter, reaching 10.5 million members.

Gross billings ex-Azul went up 36% year-over-year, with a majority of this increase coming from our TudoAzul Club and our banking partners, further increasing our share of the Brazilian loyalty market.

As you heard us say all along our decision not to spin-off TudoAzul proved to be the right one.

Our competitors have all backed away from having a separate loyalty company.

We now have 17% gross billings share, up from 14% just 1 year ago and still well below our fair share of this market.

On the right-hand side of the slide, you can see that our cargo business is also performing well.

Revenue increased 63% year-over-year.

In October, we deployed our first dedicated cargo airplane into our network and it's already flying with a 90% load factor.

Clearly, our cargo team earned the right to get these planes into our network.

Moving onto the balance sheet on Slide 9, I'm proud to report that we ended the quarter with an even stronger liquidity position, representing 46% of our last 12 months revenue while also reducing our total debt position by BRL 100 million.

Taking advantage of our comfortable liquidity position and high credit rating, we eliminated all restricted cash in the third quarter.

Even with the strong depreciation of the real, we ended the quarter with leverage at 4.2 compared to 4 in the third quarter of 2017.

This result reflects our decision to hedge 100% of the principal and interest payment for the $400 million denominated bond issued in 2017, protecting ourselves against currency risk.

Our low currency exposure is reflected on Slide 10.

Only 33% of our balance sheet debt is denominated in U.S. dollars and virtually all of our working capital debt is denominated in local currency.

Additionally, as you can see on the right side of the slide, we continue to be long dollar.

Our assets denominated in foreign currency, namely our cash, deposits and maintenance reserves abroad and our investment in TAP, surpass our dollar-denominated liabilities.

And that excludes aircraft engines and spare parts, which are not restated to be exchanged every quarter but are also priced in dollars.

For this reason, in times of weakening currency, we have strong assets denominated in foreign currency that naturally protect Azul.

We are not nearly as impacted as our competitors.

This reaffirms our position as the airline with the strongest balance sheet in Brazil.

Moving on to Slide 11, we've been proactive in adjusting our capacity to the changing fuel and currency environment and have kept our growth at the lower end of our guidance.

As a result, we expect our operating margin for the year to be around 9% and our CASK ex-fuel to decrease around 1% year-over-year.

We expect to release our 2019 guidance together with our 4Q results in March, which will also include an estimate of the impact of IFRS 16.

We've done a preliminary analysis and expect to see a large increase in EBIT compared to the current accounting standards as well as a significant reduction in debt and leverage.

We will continue to execute on the pillars of our margin expansion plan, shown on Slide 12.

Our goal of reaching an operating margin of 15% by 2020 has not changed.

Our fleet transformation strategy is working.

And now that we have a more stable macro environment in Brazil, we are even more confident on our ability to expand margin over the coming years.

We have built the strongest network in Brazil.

We have a solid balance sheet and have great customer service.

I couldn't be more proud of our 11,000 crew members.

With that, I'll turn the call over to the operator for Q&A.

(Operator Instructions) Our first question comes from Savi Syth with Raymond James.

I know you don't, like, provide kind of RASK broken out by domestic and international, but if you wouldn't mind providing some color on maybe kind of yield demands in the 2 different areas.

Generally how it trended in 3Q and what do you think as you go into 4Q?

It's Abhi Shah here.

So yes, I would say that the strong overall RASK increase of 8% adjusted per stage, I would say was mostly driven by strength in the domestic market.

So I'll talk about that first and then talk about international.

It's hard to believe the World Cup was in this quarter, it seems like a lifetime ago.

But we saw a strong bounce in bookings post World Cup, a very good August and very good September domestically.

September was one of our highest domestic RASKs ever in the history of Azul, which is surprising to me, frankly, given the fact that we have 17 A320s flying, which mathematically should bring the RASK down.

So very strong on the domestic side.

If you look at our corporate revenue, for the first 9 months of the year, in ABRACORP, which is the corporate travel agency revenue, we grew the most in revenue and we also grew our average fare the most, even though we already have the highest fares.

So I would say strong domestic environment.

It continues today.

October was good as well, other than a small interruption due to the elections.

November has picked up nicely, so -- and that continues to be our focus.

It's the A320s are all flying domestically in other than one route.

The E2s are all focused domestically, so that's really our focus the next 2, 3, 4, 5 years is I really see a lot of opportunity on the domestic side.

And so that has driven most of the RASK increase overall.

On the international side, dollar did impact demand.

You heard that from other airlines as well that talked about the LatAm region, so it's not too surprising.

And we've adjusted capacity accordingly.

So we've made strong capacity adjustments.

If you look at the dates, September, October, November, we're down pretty significantly in international capacity.

And we've extended those cuts out through May of next year, just to give it some time to rebound because it's a longer booking curve.

And then June and beyond next year, we will look to see if it makes sense.

So I'm very comfortable with the international capacity.

We've made the right adjustment.

It's a good base level of capacity.

And if you look at our traffic results, our international has held up better than the other players in the region.

We had an 87% load factor in the third quarter, even with the dollar very high.

So I would say international is stable, and we've made the right adjustment to account for the impact of the currency.

But I'm really excited about domestic demand.

It did well in the third quarter.

It continues to do well and that's going to be our focus going forward.

That's super helpful.

And if I may just follow-up on the cargo.

Can you provide an update on the JV and I think you have 1 already but maybe 2 dedicated freighter coming.

Would you put that into service even before the JV commences?

Or just what's the plan on the cargo side?

Yes, Savi.

We already have the one cargo plane in operation, it's going really well.

As I mentioned, it has a 90% load factor.

And so what we've been able to do is we stopped -- we were flying our 330s domestically because of a couple big cargo contracts that we had.

And so we're very excited to have those.

The government has changed.

The president of the Correios, in the last month, has changed 3 times.

But I was most recently with the new president that was just appointed last week, he's very much in favor of the deal.

And so we need to let the process play out with the antitrust.

And -- but we provide a great service to the Correios and will give them a significant cost reduction from what they are paying today.

And so I think everybody is in favor.

And I think the new government is very much in favor of privatization.

And so I think the election certainly helped the joint venture going forward.

So we're excited, but we had the plans to get these cargo airplanes independent of that because we've got some great contracts with some partners of ours that are going extremely well.

As you've seen, we grew cargo in the quarter by 63%, and so that's -- it's pretty exciting, what -- the type of cargo business that we built.

There is really one airplane flying now and then the second one...

Start flying in December.

In December.

Our next question comes from Renata Faber with Itau BBA.

My question is regarding the IFRS 16 and the impact that, that is going to have on your balance sheet.

Yes, Renata.

So we've done the work and we have the preliminary results.

What we're planning to do is we want to dot the Is and cross the Ts and also get the blessing from our auditors that we're going in the right direction.

But you can -- I mean, it's pretty straightforward.

You can see that we have more rent than anybody else, and the rent is going to get capitalized, right?

Because with IFRS 16, everything that is an operating lease gets treated as a finance lease, right?

So the benefit to EBIT and the benefit to debt and to leverage to Azul should be higher than to airlines that have less rent expense.

Also, we still expense a lot of our maintenance, right, and that also gets capitalized.

So there should be a big impact to EBIT and debt and leverage, as I mentioned, and we'll provide that once we know the numbers with certainty.

Renata, I just want to add to Alex's comment.

These off market leases that we have on the E1s, they go away over the next 2, 3 years.

So when we capitalize these and put them on the balance sheet next year, some of these are going on for 1 year, 2 years, 3 years, and so the impact on our leverage is very minimal.

And so we're actually going to get a good guy in EBIT and a significant good guy on leverage.

And so that's something that we're excited about.

Now when we talk about getting to a 15% operating margin in 2020, that's independent of the IFRS changes, so that IFRS is only going to make those numbers look better.

But so we're pretty excited about the change.

It's going to kind of level the playing field for everybody.

And so, everybody will be accounting for maintenance the same way, accounting for aircraft rent and debt the same way.

And so it'll be exciting to kind of show our numbers next year in comparison to all airlines in the world.

Okay.

And a question for Abhi.

Abhi, you said that most of the RASK improvement came from the domestic market.

Now that the BRL is appreciating, probably the economy will start to do better.

Do you also see room to increase yield in the international?

Yes, I definitely see room to increase yields.

And I think that's going to happen slowly over the next couple of months.

As the currency stabilizes at this level, I think our customers will get more confidence in the currency being stable, and that's going to drive more demand back toward international.

So yes, I definitely see room for yield expansion.

It is a longer booking curve, so it does take longer to realize those benefits in the flown data, which is why we've cut our capacity all the way out through May of next year to give ourselves and the market some time to recover.

And then, I think, past June, July of next year, if this trend of improvement continues, then perhaps, we'll look at adding some more capacity internationally.

But for now, we will let the market recover, let the market develop.

And I think yield is going to be the way that, that happens.

And, Renata, I think it's important, we cut capacity from our expectation because of Airbus delays.

And so I think as you look at it, it's not like we're burdening ourselves with additional aircraft rent that we're not flying.

And in fact, Airbus has been delayed significantly on the 330neo program and that's actually -- could be a benefit to us in a weaker international environment.

So that -- those got moved to the right a little bit, so I don't want you to think that we're burdening ourselves with aircraft that we're not fully utilizing.

Our next question comes from Bruno Amorim with Goldman Sachs.

I have 2 questions on tax benefit.

The first one is what you expect for 2019 in terms of payroll taxes?

Any change vis-à-vis what you had to pay or not in 2018?

And second, on the tax benefits on some of the states where you operate in Brazil, any expected change in those benefits under the new administration in Brazil from January on?

And also any color you could give us in terms of the amount of those benefits currently will be helpful as well.

Bruno, it's Alex here.

So on the payroll tax burden, as you know, it was expected to come back in, but right now, we're not paying it, right?

We're in the incentive mode still.

With the change in government, I think there is something that we thought it was almost a certainty and was actually included in our guidance originally, now we don't know, right?

So I think it's a new government.

We have to see how they're going to go about taxes in general.

And so when we put out the guidance for 2019, hopefully, we'll have a clearer view and then we'll communicate accordingly whether the burden is in or not.

And, Bruno, on your second question on the individual tax agreements we have in each state, I think it's important to highlight to everybody that we fly to 101 destinations domestically in Brazil.

Nobody comes even close to what we do.

And so when we sit down with a Governor and have a lot of air service in their state, it's essential for economic activity.

And that's something that we're proud of that we've done, it's a great partnership that we have with the states, and so we don't see that changing, we see it actually enhancing.

We're the only ones in Brazil with a diversified fleet that flies the ATRs, that flies the E-Jets and flies the A320s domestically, and so we're bringing essential air service to a lot of different places.

And so every time we go into a state, it's net positive for them from a tax base perspective.

Our next question comes from Dan McKenzie with Buckingham Research.

My question, with respect to the IFRS 16 impact, we continue to model the FX volatility in that particular line item, that doesn't change that.

Is that -- just as a house cleaning question.

Not sure we understand.

I mean, it's going to go on the balance sheet once, but it -- there should not be volatility from a P&L perspective.

But the debt on the balance sheet will adjust up and down, Dan.

But whereas now, my aircraft rent goes up and down based on FX, you'll see a lot more stability as it relates to our EBIT margin, if you will.

Yes, I think the way to think about it, Dan, is it's just like a finance lease, right?

So today, we do have some adjustment on the finance leases on the liability side because the debt gets repriced every quarter and the asset doesn't.

And that's why, as you know, the whole industry doesn't pay a lot of attention to net income.

Obviously, it's an important metric, but it carries a lot of noise, right, a lot of noncash impact every quarter.

And that's going to get somewhat, a similar kind of effect on the op leases, which will now be treated as financing.

So our expectation, like John mentioned, we're looking forward to the change because I think it will provide a lot more standardization and more of a level playing field to look at airlines that have finance leases and op leases in a similar way and make sure that everybody is accounting for it similarly.

But I think the same way that the whole industry focuses a lot on EBITDAR, maybe they'll focus a lot on EBITDA or EBIT, right, but there were still be noise on the net income line.

I think EBIT and EBITDA will still be sort of the more stable numbers that will provide a better view at how well the airline is effectively operating.

That's great clarification, appreciate that.

And then I was a little bit late joining the call.

I'm not sure if you talked about or updated the fleet transition, just the percent of -- if we factor in the E2s, the percent of the fleet that would be up-gauged at the end of 2018 versus 2019 and 2020?

So, Dan, we're working actively on that.

We don't have news at this point, but it's -- we're going to be ahead of plan from what we had previously kind of committed to the market as we exit out our E1s and pull forward E2s.

And so we'll give you more detail the next time we catch up on that because I want to make sure we close out some of these agreements.

But we're ahead of schedule from where we wanted to be, and that's what makes us so excited about the future.

The airline today is performing really, really well.

Imagine what it's going to look like when our entire fleet is A320neos and E2s that have 29% lower seat cost, the same trip cost and the E2s have 26% lower seat cost.

It's going to be a phenomenal transformation, and it's going to happen over the next couple of years.

Dan (inaudible).

Remember, this is a brand new airplane that's just being certified.

It's just engines, so obviously, we're not worried about the performance of it.

But getting the IFE, the in-flight entertainment, and everything settled, we don't know exactly which month we're going to receive the first one.

It's moving 1 month this way or that way, and then how many we can receive in a year.

But we're committed to taking in absolutely as many as Embraer can deliver that's in our spec and the way we want it for our customers.

So we don't want to take deliveries and redo the airplane as it comes in, so it may move 1 month the other way.

So Embraer is motivated to deliver as many planes as they possibly can.

So they're working really hard to make the plane exactly the way we want it and then give us as many as we possibly can get.

And we have natural leases that were coming off next year, 6 to 8 that were coming off lease anyway next year.

And now that we're actively remarketing, we're going to accelerate that further.

Very good, appreciate that.

If I could just squeeze in maybe 1 or 2 last ones here.

Abhi, there's been a lot of stock market -- a lot of macro volatility in Brazil.

And I'm just wondering if you can provide a little bit more granularity with respect to demand volatility.

Even as good as the PRASK was in the third quarter, I have to believe that there was a lot of travel that didn't take place.

And I'm wondering if there's any pent-up demand that could potentially manifest in the fourth quarter here or in early 2019 as FX stabilizes.

I guess, that's really one.

And then just kind of following up on a couple of other prior questions, just legislative priorities under Bolsonaro, I know you guys talked a little bit about tax, talked about other things, but are there other legislative priorities under Bolsonaro that you guys are watching that could potentially impact the business directly or indirectly next year?

Dan, so I'll take the first one about the demand.

So I mean, looking back to the third quarter, it was pretty smooth post World Cup.

So if you go back even further, you remember the truckers strike and then the World Cup, which sort of ended toward the middle of July, so that's -- from then on, it was pretty smooth.

And there definitely was repressed demand prior to that, that came strong end of July.

August was very good, and September, as I said, was one of our highest ever domestic RASKs in our history.

And being more current, October was also good, but we had the elections, the first round and second round, which, in those weeks, in particular, you saw a little bit of drop off in demand, mostly due to distraction effect or sort of people not wanting to travel during election week.

That I do expect will bounce back as I think it will now in November and towards December.

So I would say in the third quarter, there was repressed demand from the truckers strike and the World Cup, which came in strong.

I think what we're seeing now is some repressed demand from October in terms of the election, but that's coming in nicely as well.

And the forward curves are building strong for November, December.

One thing that's jumped out at me is our load factors.

I've never been a load factor guy, we've never had load factor targets, but our load factors are probably higher than they've ever been.

And one reason is that the 320 is driving great connectivity throughout our network and that's helping the smaller routes the E-Jet routes, the ATR routes.

And as I look ahead, that load factor momentum is continuing into early next year, which is giving us a lot of confidence to be aggressive on the yield side.

So I expect that momentum to continue in terms of demand domestically.

Internationally, I think is going to recover as well, mostly on the yield, our load factors are already 85, 86, 87, and I think that those yields will recover as the currency stabilizes over the next couple of weeks and months.

I think, Dan, I'll pass it off to Alex to answer your question on the reforms.

But keep in mind, fuel is down significantly over the last 60 days and the currency has also strengthened a lot over the last 30 days since the election.

So those are also 2 big benefits that we'll be seeing as we move forward, and that's kind of what brings a lot of the optimism.

And the country seems to be back to work, people are pretty excited about the future.

And it just needed to have the election get behind us, to everybody now focused on moving forward.

I think the country really has come together and the current government is talking about reform and the new government that's formed is also talking about reform.

Yes, Dan.

So and I think there's so much optimism here because obviously if the reforms happen and we have a lot of confidence that they will happen, it will be very beneficial to Brazil.

And the best thing for Brazil in general and specifically for our sector is for Brazil to grow again.

Right?

Brazil went through a deep recession for a couple of years.

We still haven't kind of snapped back to even what we were prior to the recession.

So there's still some room to grow until we get back to that level.

And it's what David identified kind of 10 years ago, when Brazil started -- when Azul started, right?

There is -- the potential in the country is huge.

And over the last 10 years, the industry has doubled in size but average GDP growth has only been 1.5%, right?

So you can just imagine how this industry could do if GDP starts growing 2%, 3%, 4% as Brazil should be growing as an emerging market and with all the potential that we see here.

So I mean, if you ask us, the list of things that could be reformed and that would beneficial to the country is huge, and I think that's what the new government is seeing as well.

There's a lot of opportunity, there's a lot of potential and I think it will be just a question of them to start coordinating, start aligning and negotiating well with Congress and start pursuing all of these opportunities.

Our next question comes from Matt Fallon with Deutsche Bank.

Matt on for Mike here.

I know you addressed this briefly, but could you give us a little more color on what impact the A330-900neo delivery delays have on your capacity allocation and network plan?

Matt, so initially, we were looking at getting A330neos in service towards the end of this year.

We were obviously informed, along with other operators, that the airplanes would be delayed towards the end of January, if you will, which would be past our high season, our summer season.

And so in that case, we said, well, let's just -- we'll delay them a little bit further because we don't want to take those airplanes in the middle of the low season.

So in that case, we pushed them to the right, closer to the next high season, which is in the June, July time frame.

So that has delayed the start of a couple of new markets, which, in this currency environment, we're perfectly comfortable with.

And we will now time them to take advantage of the next high season, that's sort of the southern winter, the northern summer, if you will, around the late May or June time frame.

So it's still not clear whether we'll get 1 or 2 A330s and kind of it's still a little bit in flux.

But I expect that the first A330neo routes will only start service late May -- in that early June time frame.

Just I have 2 quick follow-ups.

One, could you give us an early read on 2019 capacity?

And the second is this 70% recapture rate, should we assume this type of performance can continue in Q4 and beyond?

Yes.

In terms of capacity for 2019, I think it'll be similar.

I think you will see domestic a little bit more representative.

So I think this year, domestic was 8% to 10%.

So next year, we'll -- this year, I think it's closer to 8%, I think next year, it'll be closer to 10%.

And international will be in the 40-ish percent range for an overall capacity growth of around 18%, something like that.

This year, our initial guidance was 18% to 20%, and then we brought it down to 16% to 18%.

So I would say very similar capacity growth overall.

A little bit more biased towards the domestic side.

That's where our focus is, that's where I think the opportunity is anyway, and I think -- because we're going to have the A320s as well as the E2s starting to come in.

And remember, Matt, that's all coming from up-gauging, right?

It's one aircraft out, one aircraft in and better utilizing the assets that we have.

And I'll have Abhi talk to the recapture rate, but keep in mind that, in the third quarter, we paid the highest fuel price we've ever paid at Azul.

And then, the exchange rate was the highest we've ever seen sustained in a quarter.

I think it hit 4.15 in the quarter, but it averaged just under 4. And so we're obviously in much better place right now.

But Abhi can talk to the demand environment and his ability to recapture.

Yes.

So in terms of recapture.

There are 2 parts of this.

One is revenue recapture, which is average fares, ancillary fees, all those kinds of things and basically RASK.

And the other part is what we're getting in terms of what I call margin recapture, which is the efficiency that we're getting with the A320s and the E2s next year.

So for us it goes very much hand in hand because RASK, of course, is affected by the capacity that we're putting in, that's very, very efficient and low unit cost capacity.

Overall, I do expect similar or better percentages in terms of recapture.

Yes, the mix between sort of RASK and CASK could vary as capacity growth changes, as we get more A320s, as we get more E2s and we really are able to lower our unit costs with those super-efficient airplanes.

But overall, yes, I do expect similar or I think we want to be even better in terms of overall margin recapture.

Our next question comes from Helane Becker with Cowen.

Just a quick question.

I think this morning, you announced a codeshare agreement with Copa.

And I'm just kind of wondering 2 things.

One, you have fairly high load factors.

And so what do you think the exchange in passengers will be?

Do you have any expectations for revenue benefit from the codeshare, a, from the codeshare and, b, from the frequent flyer exchange?

So maybe you could talk about that a little bit.

So this morning, we did announce our codeshare with Copa and a bilateral frequent flyer agreement.

We're very -- I'm very excited about this agreement, we've been talking to them for a while.

Copa is a great airline.

They operate more than 70 weekly flights into Brazil to 9 different cities.

And so there's a lot of places that we can connect that are just not sort of the 2 main international airports in Brazil, São Paulo and Rio.

Belo Horizonte, one of our biggest hubs.

They fly Recife, one of our biggest hubs, and all the other places.

So in terms of volumes, I think it's going to be on par with the other codeshares that we have.

We don't break it down by individual codeshare, but it's incremental demand.

And it's incremental demand in sort of our spoke cities.

Call it, Belo Horizonte, Recife, Salvador, Fortaleza, all of these kind of cities that Copa flies where they can really use the connectivity that we have.

That's the benefit.

So for us, it's incremental demand in these cities.

And for Copa, it's additional connecting options for their customers as they fly into Brazil.

So I really think it's a win-win.

In terms of loyalty, customers love using their points and we really want to allow them to use their points in our partners.

So today, our TudoAzul customers, in addition to Azul, can use their points on TAP, can use their points on United.

And Copa is going to be a great option for them, whether it's Latin America, whether it's the Caribbean or even some parts of the U.S. So I think it just -- it adds to the portfolio of our loyalty redemption, and I think it makes the program that much stronger.

Our next question comes from Alberto Valerio with UBS.

I have 3 [of them] on my side.

The first one would be if you could give some color on the reverse provision that it was in the results today?

The other operating expenses, the reversal on some of the provisions.

So, Alberto, as you know, other operating expenses is kind of a mixed bag, it's kind of catch all.

There are a lot of different line items in the account, some of them going up, some of them going down.

A lot of them are sort of administrative and onetime, they're not completely tied to the operation.

But out of the ones that I think are most relevant this quarter, we revised some provisions for liability claims, some taxes and some cost of redelivering aircraft that we sold.

So I think there's about a BRL 20 million number that you can -- that's sort of the most relevant line.

Like I said, a lot of things going up or down, but I think the most relevant would be a BRL 20 million expense that we decreased.

But it all it sums up to the BRL 20 million, but there's a bunch of little stuff in there.

Correct..

Okay.

Perfect.

And I also saw some civil lawsuits that were reported.

It could be a recurrence here [for cuts or costs] or it would be just one time?

There are some that happens occasionally.

I mean, customers love us as you see from all the awards and recognition that we get.

But every now and then we mishandle a bag and then that becomes a claim.

So that's part -- it's not a -- there's an expense line item that's recurrent on our operating P&L.

And we periodically look at this to see if they are going up or down.

And like I said, they don't necessarily -- customers have until 5 years to enter a claim, and so there's not necessarily a big tie to capacity or passenger numbers.

So there's a little bit of volatility there.

Sometimes it goes up, sometimes it goes down.

This quarter is one -- it was a line that went up more significantly than the rest.

Perfect.

My last one, sorry for that, a follow-on on the oil price.

I saw that in this quarter, we had a high increase in the jet fuel than the Brent oil.

And in the previous quarter, the first quarter and second quarter, was the opposite.

What we can expect for the next quarter and the next year?

So the main thing is there's about a 45-day [lag] impact that you see on international jet fuel prices as well as foreign exchange, right?

Well, the 45 is an average number because what happens is -- Petrobras is sort of the sole supplier of fuel to all the distributors here in Brazil.

They have a fixed price for the full month and that price is somewhat tied to the behavior of jet fuel prices internationally as well as FX for the previous month, right?

So on average, you have about a 45-day lag.

So I think even in October, we were still paying a fairly high fuel price.

Now November will be a little bit better but it will still be higher than what you see on your screen today.

And probably in December, we'll get the full benefit of the improvement that you've seen both on FX and on fuel.

And I'm assuming that the international prices stay flat, that's where our local jet fuel prices would stabilize as well.

But like I said, if it goes up or down, there's always going to be this 45-day delay until we see the impact on average.

That delay helps if it's going up, but you don't get the full benefit as it goes down, but we'd rather -- it works out fine for us for both ways.

Our next question comes from Savi Syth with Raymond James.

Just a quick follow up on TAP.

I just wondered if you could give an update there.

And just with fuel prices going higher is there any risk of some of those subleased aircraft being returned?

No.

So the subleased aircraft are -- we have a full commitment to the end of the lease term, and so there's no risk on that.

In 2023 or...

Yes.

Until they go off lease with us.

Yes.

And I will say that TAP is performing very well.

Look at what the team over there has done.

And we're very excited about all the work that they've done.

And that airline is going through a similar transformation.

They're improving significantly the product, getting new aircraft and have opened up a lot of new destinations.

For those of you in the U.S. that want to visit Europe, go through the gateway in Lisbon.

It's an unbelievable city.

And one thing that we're finding, Savi, is that Lisbon is kind of the new Miami for Brazilians.

And so it's a hotspot for Brazilians and it's actually been -- it's a very, very cool city to visit.

And so the guys at TAP that are running it are doing a fantastic job.

I mean, TAP is doing great to Brazil and Azul is doing great to Portugal.

We've got some of our -- probably our most profitable international flight goes to Lisbon.

So it's -- and Portugal is just hot right now.

It's hot for people going to the U.S. I used to walk around the streets and say, hey, has anyone ever been to Portugal?

And people would say, no, but it seems like a great place.

And now, it seems like everyone is going to Portugal, so -- and TAP has really benefited from kind of the euphoria over Portugal right now.

It's a great place and anyone [who's not yet] been there, you're missing out.

And if you have a significant position in Azul, we'll get you a good fare as well.

That's right.

Next question from Dan McKenzie, Buckingham Research.

Hey, just one quick question.

Regarding 2019, at this point, how are you thinking about foreign exchange for purposes of internal planning?

Are you thinking that the real might appreciate from here?

Or how -- maybe you'd provide some perspective about how you're -- there's a lot of moving pieces here, just wondering how you're thinking about things at this point.

Dan, we're in the middle of our -- we're finalizing our budget right now.

Normally, we use the Focus survey as well as the forward curve as kind of guidelines to determine what kind of FX we're going to expect for next year.

Between now and when we actually publish our guidance, obviously, we'll again see where foreign exchange rates level out as well as how confidence with the new government also materializes.

So between now and then, I think we'll have a better gauge on where FX is going to level off.

But it's normally very close to where both the Focus survey, which is a collection of market players here in Brazil, opinion on FX as well as the forward curve.

And that's normally what you can assume is the rate that we've used for our planning purpose as well as our guidance.

Yes, Dan, when we do the budget, we typically use a higher FX to challenge our people internally to lower costs, to be honest with you.

But I think kind of the...

Don't tell them.

I think the consensus on the Street is that it'll trade between 3.50 and 3.70 next year.

And so that's -- I think that's where most people are kind of planning.

I mean, the big issue here in Brazil, if it can get done, is obviously pension reform.

And there's a lot of talk about maybe not -- I'm not putting an odds on it, I mean, it could be very [different], but even getting it done with the current Congress and the current president kind of giving a fresh start to the new president when he starts January 1, maybe even getting something passed.

And obviously, that will affect the exchange rate.

If they're able to get a significant pension reform done, then we would fully expect [everyone] to strengthen the real from where it is today.

Yes, right, exactly.

Well, my condolences to all the employees there.

But one final follow-up question here, (inaudible)...

It doesn't affect us.

With the Brazilian post office, is there a sense of timing for when you might have some more perspective about when the economic benefit might begin to manifest itself with the JV with the post office?

Dan, I think, as we go through the budget process now, you'll probably start to see something in our 2019 forecast for it.

We're certainly not -- we will not see any benefit this year.

And it's most likely a Q2 2019 story, as we move forward, as we sit down with the new administration and make sure that they're on board with the negotiated deal that we did with the previous administration at the Correios.

But all things indicate that they are and we're jointly working with the antitrust authority, CADE, in Brazil currently, so it's really a 2019 story.

(Operator Instructions) Ladies and gentlemen, this concludes today's question-and-answer session.

I would like to invite John to proceed with his closing statement.

Please go ahead, sir.

Thank you for joining the call today.

And as always, feel free to follow-up with Andrea, myself, Alex, Abhi, any members of our team.

And we look forward to seeing you at the conferences over the next couple of weeks and giving you more details about Azul.

Thanks, everybody, for your support.

See you next quarter.

That does conclude the Azul audio conference for today.

Thank you very much for your participation, and have a good day.