Allegiant Travel Company
Q3 2015 Earnings Call Transcript

Published: 22 Oct 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Allegiant Travel Company's Third Quarter 2015 Financial Results Conference Call. We have on the call today Maury Gallagher, the company's Chairman and Chief Executive Officer; Scott Sheldon, the company's Chief Financial Officer; and Jude Bricker, the company's Senior Vice President of Planning. We ask that you begin to queue up for questions now as we will have a very brief commentary and we'll shortly begin our question-and-answer session. First, we wish to remind listeners that the company's comments today will contain forward-looking statements, and they are only predictions and involve risks and uncertainties. Forward-looking statements made today may include, among others, references to future performance and any other comments about our strategic plans. There are many risk factors that could prevent us from achieving our goals and causing the underlining assumptions of these forward-looking statements and our actual results to differ materially from those expressed or implied by our forward-looking statements. These risk factors and others are more fully disclosed in our filings with the Securities and Exchange Commission. Any forward-looking statements are based on information available to us today, and we are undertaking no obligation to update publicly any forward-looking statements, whether as a result of future events, new information, or otherwise. The company cautions users of this presentation not to place undue reliance on forward-looking statements, which may be based on assumptions and events that do not materialize. These earnings release as well as the rebroadcast of the call are available on the company's Investor Relations site at ir.allegiantair.com. At this time, I'd like to turn the call over to Maury Gallagher. Please proceed.

[Maurice J. Gallagher:]

Thank you, operator, and good afternoon, everyone. I'd like to let Jude make a few comments on revenue just to anticipate some of your questions. Jude?

[Jude I. Bricker:]

Thanks, Maury. Today we're announcing 3Q decline in TRASM of down 8.2% and 4Q TRASM guide of down 10.5% to 8.5%. And we just wanted to kind a go over some color on those numbers and what we're seeing. And as we've expressed in past quarters, we believe the majority of those declines are things that we do to ourselves and our earnings-accretive initiatives. So specifically, we're going really rapidly. In the third quarter, we grew ASMs 24.2%, and we're guiding similar growth in the fourth quarter. Growth always put pressure on unit revenues, but particularly, because of our model of low utilization, we're able to grow off-peak opportunities more rapidly. So some characteristics of that growth, which are particularly negatively affecting unit revenues is our rapid expansion into new cities, rapid relative to what we've done in the past. The last two quarters of last year, we had about 4.5% of our ASMs generated in new markets – new cities, cities that we've been in for less than 12 months. In the third and fourth quarters of this year, we'll have 9% and 12% respectively of our scheduled service ASMs generated from new cities. Also, we're growing off-peak more rapidly. This is a response to lower fuel prices. Off-peak day of week are Tuesday, Wednesdays and Saturdays. Flying on those days has grown in the third quarter 66%, and in the fourth quarter that number will be about 50%. So for both of the third and fourth quarters of this year about 23% of our capacity will now be generated on off-peak days of week. Also, we're going off-peak seasons more rapidly than we are our peak periods, which puts pressure on average TRASM. In December, we're going to grow ASMs about 21.9% versus 27.5% growth in October and November in aggregate. December has the highest unit revenues. So as we look forward, December being the highest revenues for the fourth quarter, March being the highest revenues for the first quarter and June for the second quarter of next year, we're going to continue to disproportionately grow the other months and quarters, which will continue to put downward pressure on our unit revenues. Also, as we've talked about in the past, we implemented credit card surcharge in December 2014. That has about a two percentage point negative effect on unit revenues. We called it before we charged a higher fare for a credit card transaction through what we call the debit card discount, and that put the revenue – the fees generated from that in our revenue line item today. Credit card surcharges are treated as a contra-expense in our marketing expenses. Looking forward, we'll continue to have two percentage point impact this quarter – the third quarter, the fourth quarter. And then, those impacts will start to decline in the first quarter and won't be effective on a comp basis beginning in the second quarter next year. Also, as we've talked about in the past, we have the continued effect of the increase in 9/11 security fee, went into effect in July of last year. So for the third quarter of this year, we're having about a one percentage point downward impact in unit revenue as a result. And fourth quarter looking onward, we don't have any comp issues anymore. So adjusting for these factors, the ones we control and the 9/11 security fee as well, we think adjusted unit revenues would be down about 2.5%. So I'd consider that to be unit revenues in same stores markets with the same capacity allocation, same day a week, same seasonality. And we think that's really good, considering where the fuel environment's gone. So going forward, we're going to continue to do the same kind of initiatives that push down TRASM as we adjust the schedule to the current fuel environment. As you know, we operate largely without competition. So we're out there without consideration of what other airlines are doing trying to find incremental flying when at a higher fuel price those assets would be left idle. So the TRASM trend will continue through probably the second quarter of next year; in other words, the downward TRASM trend will continue, but that's accretive to earnings. It's the right thing to do and it's the right thing to right-size our business in response to the fuel environment. That's all I wanted to add, Maury.

[Maurice J. Gallagher:]

Okay, thank you. Operator, we'll take questions at this point.

[Operator:]

Certainly. Our first question or comment comes from the line of Savi Syth with Raymond James. Your line is now open.

[Savanthi N. Syth:]

Hey. Good afternoon. Just wanted to talk a little bit more about how you think about growth especially into 2016. Appreciate the color, Jude, on just growing more in kind of the off-peak months. But just how do you think about it from a – with so much of it done this month with flying more in the off-peak this year, just how much more opportunity is there next year and how might that change with the fuel environment?

[Jude I. Bricker:]

Well, traditionally, September capacity was about half of July capacity. So we've always been a very peaked carrier. And particularly if you look at day of week, Tuesdays we have almost no operations as compared to a fully allocated fleet on Sundays. So there's a long way to go. And we're really talking about just changing capacity allocation at the margin. So when you think about growth, I mean, we'll always be a carrier that responds to demand patterns, and that means flying more on Sundays than on Tuesdays. So there's no condition whereby we're a flat carrier; fuel goes low enough for that to happen. We're always going to be a peaked airline. And that's in responding to the demand environment of our customers. So I think really kind of what you're asking is when are we going to see the unit revenue declines lap themselves. And I would consider that to be in the third quarter of next year, where we have had sufficient time to adjust the current schedule to the current fuel price. We launch schedules about nine months in advance. It takes us about a year, maybe more, to adjust as we respond to the conditions. Does that answer your question?

[Savanthi N. Syth:]

It does. The second part of that was just how do you think about fuel and growth?

[Jude I. Bricker:]

Well, so...

[Savanthi N. Syth:]

In the sense that what level of fuel – I mean, how far does fuel have to go before maybe you to slow down in growth plans?

[Jude I. Bricker:]

Sure. We would slow – if fuel rose, we would slow down our growth plan immediately. The issue, though, really is that in periods of time where it's really good, the back two weeks of December, March, June, and July, we're fully allocated. And that wouldn't change even if fuel rose. Now, as you think about other periods of the year, the first two weeks of December, we get very granular on this. January and February, April and May, we would slow growth significantly if fuel was at a higher point.

[Savanthi N. Syth:]

That makes sense. And just a follow-up on the growth question. I did notice that some of the MD-80 retirements, I think there was one extra retirement this year than you'd kind of talked about in July and then maybe four more in 2016. And I'm guessing one is because of the additional aircraft that you got, but just any kind of additional color on the thinking on the MD-80 retirements?

[Jude I. Bricker:]

Yeah. We're growing overall capacity as fast as we can operationally manage. And we kind of plug for retirements in the sense that we're going to go out there and buy the A320s that are in the right spec and at the right price. We're going to add flying into the schedule to the extent that we can manage it in March, June and July. And then, as a result of those two inputs, we're going to retire the resulting MD-80s that we no longer need. So you're going to continue to see from us as we look forward retirements of our older airplanes as a result of deductions, but also just what we can manage in terms of total network growth.

[Savanthi N. Syth:]

Got it. All right. Thanks for the color. And I'll get back in the queue. Thanks.

[Jude I. Bricker:]

Thank you.

[Maurice J. Gallagher:]

Thanks, Savi.

[Operator:]

And our next question or comment comes from the line of Michael Linenberg with Deutsche Bank. Your line is now open.

[Michael Linenberg:]

Hey. Jude, on some of the – you talked about some of the PRASM weakness being self-inflicted. But, again, obviously, it's all about maximizing margins here. Anything on PRASM that was due to maybe weaker demand in some of the regions? I mean, I look at your route map and I count close to a dozen cities in the Dakotas and Montana. I think Delta's pulling out of Dickinson. I mean, are you seeing any sort of demand weakness in that part of the country or maybe in other oil patch states like Oklahoma?

[Jude I. Bricker:]

Yeah. Sure. Firstly, we're managing the business to earnings, so not margins as you said. But, yeah, I mean, let me just – sort of geographically, we've always kind of had shifts in our network. And we're still growing the East Coast much more rapidly than we are the West. And that's the result of the expansion that we've had over more than a year now in the Ohio River Valley, which remains a strong point for us. But your question about mineral dependent economies and the Bakken area and Dakotas and Eastern Montana, in particular, those that depend on also cross-border traffic, we have – yes, we have seen a slowdown in those markets with those characteristics. So our Dakota markets, our Western Montana – our Eastern Montana markets, all our markets that depend on Canadians crossing the border because that value proposition has declined with the decline of the Canadian dollar, have been negatively impacted recently. Yes.

[Michael Linenberg:]

Okay. Great. And then, just a question for Maury. I know that the pilots had sort of made an appeal to the NMB to declare an impasse. I mean, have we heard back? And where are we with the flight attendants?

[Maurice J. Gallagher:]

Yes, the pilots – teamsters sent a letter to the NMB. They call it a proffer, asking for relief, that there was an impasse. It's our belief that there is – it's not an appropriate request, that we're making good progress. We definitely have a lot of issues – not a lot, but we have issues that we have to deal with, and we're making forward efforts on that. In fact, we'll be meeting on Monday, Tuesday this coming week. Typically, it's been – I'm not an expert, but usually the – you don't hear back from the NMB. They won't say it's been rejected in particular. If they don't do anything, you just keep doing business as usual. So that's what happened on the last one. We never heard anything back on the March, April request – February, whenever it was. And we continued our efforts at the table. And we'll do that. On the flight attendants, we've been working with them and the NMB and the mediation based on their request. So that's a work-in-progress as well.

[Michael Linenberg:]

Okay. Great. Thanks for the update, Maury, Jude.

[Maurice J. Gallagher:]

Sure.

[Operator:]

And our next question or comment comes from the line of Rajeev Lalwani with Morgan Stanley. Your line is now open.

[Rajeev Lalwani:]

Hi. Thanks for the time. Two quick ones for you. I guess, the first, you talked about how by the, I guess, second half of next year, you're going to lap a lot of the pressures from the off-peak line. But does that take into account just the change in the fleet also since you're going to be doing a lot more on the Airbus side? And, obviously, there's some off-peak flying that comes with that.

[Jude I. Bricker:]

Yeah, it's a good point, Rajeev. We will naturally be at a higher off-peak utilization based on the transition of our fleet into an Airbus product. So this is – understand the Allegiant model is very important to understand the concept of how we choose to dispatch airplanes, how we choose to schedule airplanes. And we're making very granular decisions, particular days of week, particular times of day, seasons, for what the returns of that particular flight would be. So as the input costs drop, either because of that plane that's available is now an A320 whereas before it was an MD-80, or fuel costs drop, or whatever, we'll make the decision based on that. So then, more often than not, we will have opportunities during off-peak, yes. But the main impact remains that the fuel price is down substantially. And that is the biggest impact that we're seeing. But, yeah, you're right. I mean, we will have higher utilization just because of the transition to the Airbus. It's true.

[Rajeev Lalwani:]

Great. Thanks, Jude. And just the other question, as it relates to aircraft financing, you have that $30 million or so in September. Can you talk about more opportunity there and what you're likely to do with those funds given strong cash flow?

[Jude I. Bricker:]

Sure. So we manage the balance sheet towards a liquidity target of about $400 million in today's environment. And I buy airplanes and Scott buys shares. And between the two of us, if we need more capital, we'll pledge some assets to a debt facility that's secured with aircraft. The debt market is open to us. We have deals like the one we did in the third quarter that we can replicate, as needed. And we have, by the end of the year, 13 unencumbered aircraft on the balance sheet. That's $150 million to $200 million of debt capacity at 2%. So that's how we run.

[Rajeev Lalwani:]

Okay. Great. Thanks, Jude.

[Jude I. Bricker:]

Yep.

[Operator:]

And our next question or comment comes from the line of Joseph DeNardi with Stifel. Your line is now open.

[Sawyer Mckelvey:]

Hi. Sawyer McKelvey on for Joe DeNardi. When we think about the next phase of growth for you guys into some of these more medium-sized markets, can you help us understand the size of this opportunity maybe in terms of thinking about annual ASM growth in the 10% to 15% range? How many years worth of these medium-sized markets are there out there for you guys?

[Jude I. Bricker:]

It's not necessarily the number of medium-sized cities that there are. It's more – the capabilities for us to expand those cities once we're in them that that I think I'm most excited about. So as we sit today – as we look back in the third quarter results, Jacksonville could be considered midsize-to-midsize. But let's take that market out of it for a second, we really have only results from one midsize-to-midsize city to look at as being completed, and that would be Austin to Cincinnati. And based on that market, I'm really excited about the opportunity to expand in these midsize communities. The number of cities there, maybe 50 cities as we classify as midsize markets, everything from the 26th biggest city down to, say, the 70th, 60th, 70th, 75th biggest city. And connecting – not all those markets between themselves can generate sufficient route, but there's potentially quite a few that do. And we don't know how big that opportunity is that, I think, substantiates us growing the business and maintaining the current business strategy, which has close distribution and low frequency into non-competitive markets that don't necessarily have a leisure destination on either side of the route. This is something we haven't really considered two years to three years ago. But today, I think it's a big, big, big part of our growth strategy for the next five years.

[Sawyer Mckelvey:]

Great. And then, one for Scott...

[Jude I. Bricker:]

Do you have anything to add on? Lukas is here with me, who runs our Network.

[Lukas Johnson:]

Yeah. I think Jude summarized that pretty well that it's more about saturation of multiple markets out of these midsize and growing them bit quicker.

[Sawyer Mckelvey:]

Great. And then, one for Scott. When you look at next year from a cost standpoint, you've talked about seeing pretty favorable trends with D&A. Can you provide us some more detail there, maybe an initial expectation for what CASM mix could look like or what the major moving pieces are?

[D. Scott Sheldon:]

Yeah. We should be finalizing our full-year 2016 plan here in the next month and a half. We're still going through some of the network iterations. Specifically, as it relates to D&A, that should be a good guy next year. If you look at the aggressiveness in how we're depreciating our MD-80 fleet – for those of you who remember, our AIM project, which increased our seats from 150 seats to 166 seats, basically, we would have depreciated those improvements. So basically, the book value of our MD-80 fleet is roughly, call it, $45 million at the end of next year. So we continue to chew through it at a pretty high pace. In general, there are still some – obviously, some big ticket items out there that may or may not hit. Labor, obviously, can influence what next year looks like as well. So stay tuned. We should be putting out some color here in the next month, month and a half.

[Sawyer Mckelvey:]

Great. Thank you.

[Operator:]

And our next question or comment comes from the line of Duane Pfennigwerth with Evercore. Your line is now open.

[Duane Pfennigwerth:]

Hey, thank you. Maury, you've seen a lot in this industry over a long period of time. I wonder if you could comment on industry revenue trends more broadly. Not necessarily in your own markets, but are you seeing any pricing out there that's surprising to you? And is there any period like just before where basically we're not in a recession but you have one legacy carrier that is discounting walk-up fares so aggressively in some markets? Have you seen this before? And how do you think it plays out over time?

[Maurice J. Gallagher:]

Candidly, I'm surprised it hasn't happened sooner. If you go back 10 years, 20 years ago, you didn't go into a guy's marketplace and not face kind of a 2-by-4 across your forehead. I remember when Northwest – I think Reno Air went from Reno to Minneapolis. Not only did Northwest respond to that, they took some old 72s and put them in Reno and started running a hub out of Reno. So I'm – candidly, one of the great benefits, I think, that we see today is, is you don't have the response that you've historically had. So I'm not surprised at American's approach in particular. They seem to be the most aggressive at this. It comes down to when the good times are rolling, you can afford to do some of this more so than you might do when things are tighter. The high oil prices, I think, were a bit of a discipline that way. But each management team has got their peccadilloes where they want to be and what they think is important. And when you've got this much cash running around, everybody's chest falls out a little bit and we all feel real good, real smart and real tough in many cases. But having said that, the notorious events going on between Spirit and American and others, Spirit's making, what, 25% operating margin in their, quote, battle? That's a pretty good place to be.

[Duane Pfennigwerth:]

Really appreciate those comments, Maury, and that history. Just with respect to Allegiant, and I apologize for asking a general industry question. With respect to Allegiant and maybe you covered it in your prepared remarks, how should we think about sort of the trend relative to the 1Q capacity guidance that you put out there? Is there any range you could give us for kind of full-year 2016 capacity and cost structure at this point? Thanks for taking the questions.

[Jude I. Bricker:]

Well, on the revenue side, we're trying to prepare expectations that we're going to continue to face downward pressure. But, in my view, that's because of things that we're doing to ourselves, and they're earnings-accretive. And capacity-wise, we're going to continue to push the outer limits of growth in the off-peak periods where we have surplus pilots and crews. And then when the operation becomes challenge, we're going to try to go easy on those periods. So that's going to be the continued unit revenue story as we go into the first and second quarters of next year.

[D. Scott Sheldon:]

Yeah. This is Scott. I mean, just basic themes out there. If you look at the percent of ASMs that will be produced by Airbus flying, you should start to see a noticeable uptick in ASMs per gallon. Looks like we stall basically about $70, so you should see a nice benefit there. Labor, that's probably the hardest one to tie down. Maintenance looks like it's going to be a lighter year. So you should start to see those costs come in. Jude mentioned the credit card surcharge, which is a contra-expense, so that will be the full-year effect. So that line item will show a benefit. So thematically, it's shaping up to be a fairly good year as it looks right now. But like I said, we're still going through iterations of the network and some big ticket items we still need to nail down.

[Duane Pfennigwerth:]

Okay. So just, I mean, at this point, a full-year growth projection of mid-teens feels reasonable? Or should we be thinking about something more than that?

[Jude I. Bricker:]

Sounds reasonable.

[Duane Pfennigwerth:]

Thank you, guys.

[Operator:]

And our next question or comment comes from the line of Hunter Keay with Wolfe Research. Your line is now open.

[Hunter K. Keay:]

Hey, everybody. Thanks.

[Maurice J. Gallagher:]

Hello, Hunter.

[Jude I. Bricker:]

Hey, Hunter.

[Hunter K. Keay:]

Hey. Hey, Jude, you talked about – obviously, just to follow up on Duane's question and your comment, these revenue initiatives being earnings-accretive. Are you saying that, all else equal, it's fuel that margins are going to be sustainable? Are you talking about the stuff that just like drives profits and drives EPS, albeit, maybe it's accretive to their earnings and EPS, but it's dilutive to margins. Are you making a comment on sustained margins and earnings growth from these initiatives, even with negative TRASM?

[Jude I. Bricker:]

No. We're going to try to bring down our margins.

[Hunter K. Keay:]

You are. Okay.

[Jude I. Bricker:]

We're going to find opportunities to fly airplanes that add returns, but at lower margins than what we would otherwise schedule in a high-fuel environment. So as the fuel comes down, we find these incremental opportunities to dispatch airplanes. And that's going to bring down our margins and increase our earnings.

[Hunter K. Keay:]

Okay. That's cool. Just wanted to clarify. And then, real quick, just clarify the TRASM comment. When you said the downward trend will continue – just to wordsmith for a second, are you talking about the -

[Jude I. Bricker:]

Yeah. I'm sorry. I should be – I know, I should be more precise. Thank you.

[Hunter K. Keay:]

Yeah, yeah. No, it's cool.

[Jude I. Bricker:]

We're going to continue to have year-over-year declines in unit revenue in the first and second quarters of next year.

[Hunter K. Keay:]

I got you. All right.

[Jude I. Bricker:]

And we're not prepared to comment on the scale. But what we are trying to say is that the unit revenue environment is healthy enough. Same-store, same-capacity, et cetera, were roughly flat. We think it's down about 2.5%. Over and above that, we're going to go out and find these low-fare opportunities to fly airplanes that are accretive. And that's going to lower unit revenue. But it's going to be self-inflicted, we think, as we look into the first and second quarters. So we'll have year-over-year declines; great results.

[Hunter K. Keay:]

Yeah. No, I just wanted to make sure you weren't talking about like an acceleration of the decline.

[Jude I. Bricker:]

I got you. No.

[Hunter K. Keay:]

I know, okay. All right.

[Jude I. Bricker:]

Thank you for letting me clarify.

[Hunter K. Keay:]

Yeah. Yeah. No, you got it. And then, Jude or Maury, can you give us a progress on where you stand with the credit card? Orders for the current pacing items, albeit, from either a negotiation perspective or IT? And can you give us maybe if you feel comfortable a potential sense of timing? Could it happen this year? And then, can you help us – I know you don't want to give us an accretion estimate here, but can you maybe help us think about framing the magnitude so we can take a shot at doing it ourselves in terms of how it can impact the P&L? If you want to use another airline credit card as a guide, if you're familiar with that, be my guest. But anyway you can help us think about it?

[Jude I. Bricker:]

I would use a mature production from the credit card program at Allegiant. And judging the potential there, I would use Spirit's, which is about $2.5 a passenger segment. Now, that's mature. And how long we take to get there is really the variable we can't speak to. And as far as the launch of the program, we're still talking about second quarter 2016. Now, there are some very significant challenges with that date. And we'll bring them to you when we're ready to talk about them. But in the meantime, we have some negotiations with some vendors that we have to work through. And we're not ready to commit to a date, but the current plan is, as we talked about last time, second quarter 2016.

[Hunter K. Keay:]

Okay. Thanks a lot.

[Jude I. Bricker:]

Thanks, Hunter.

[Maurice J. Gallagher:]

Thanks, Hunter

[D. Scott Sheldon:]

Thanks.

[Operator:]

And our next question or comment comes from the line of Andrew Didora with Bank of America. Your line is now open.

[Andrew G. Didora:]

Hey. Good afternoon, everyone. Most of my questions were actually just answered. But, Maury, I kind of wanted to ask you a bigger picture question here. Allegiant has clearly done a great job in growing in markets where there is limited competition. At this point, with oil continuing to stay low here, do you worry that others may catch on and try to operate a similar type of model, particularly, as maybe some of their aircraft age a little bit more here? And if so, what would be – how would you think about responding? That's it. Thanks.

[Maurice J. Gallagher:]

There's always the possibility someone can come into – and airplanes are very fungible that way. You pick them up and you start flying them, and react accordingly. The last kind of big company we had that was active in this area was AirTran. They adopted a lot of our approach on the East Coast. Southwest, after the purchase, didn't feel that was appropriate and backed away from some of those things. We're not seeing anything to-date from certainly the ULCC level at this point. Candidly, operationally, it's hard to make our business model work when you fly weekly approaches versus daily approaches. If you need to have 12 hours, 13 hours a day, you don't want to be going to – taking one airplane and putting three or four cities at the end of that airplane. That's just a lot of overhead and management problems as compared to trying to do it at 5.5 hours, six hours a day, which we do. So I think that's a barrier to entry. I don't think you see the big guys coming back. Certainly, they'd be using their feeder companies to do the smaller cities. Mid-size cities, perhaps they can do some things. But, once again, we're only doing things twice a week. If the market supports it, we'll go up to three times or four times a week. But we still have 50% of our markets or thereabouts with twice-a-week frequency. No one else can point to that kind of approach that I'm aware of, and we're almost 300 markets. So, yeah, we all fly airplanes. But, philosophically, cost structure-wise approach, it's just cultural. It's going to be tough for incumbents to do it. Startup? Who knows? We haven't seen any startups. I don't know of any that are close. There's some people that have certificates recently, but we're not seeing anything that I'm aware of that's of any size or scope that would we be concerned. Jude, any other further comments?

[Jude I. Bricker:]

I don't worry about it so much. I mean, I think as long as we can maintain low cost at low utilization, then we're going to be protected from most of that. And the key there is that we have low utilization on average, but all our customers typically want to travel at the same time. So we have high utilization when people want to fly and zero utilization when people don't. And that's very difficult for anybody else to do operationally and at low cost as we have. So I think we have a pretty significant barrier to our business.

[Andrew G. Didora:]

That's great color, guys. Thanks so much.

[Maurice J. Gallagher:]

Sure. Thanks, Andrew.

[Operator:]

And our next question or comment comes from the line of Helane Becker with Cowen & Company. Your line is now open.

[Helane Becker:]

Thanks for the time. So I just – Jude, I think, you mentioned that if oil prices were to go up, you would pull out of markets. And we've seen you guys reduce capacity before. Can you just remind us how quickly you can make those adjustments?

[Jude I. Bricker:]

Well, let me be more precise there as well, which is to say that we would just change capacity allocation, which doesn't necessarily mean we're dropping markets. Our seasonality would change; our number of flights a week to particular markets might change as a response to higher fuel price. And there is – and every shade in between from a high fuel price to a low fuel price, anywhere in between, there's some incremental flights that are going to fall out of our hurdle rate. And so as we look at the schedule going forward, we have limited ability to at the last minute add flights to the schedule because the schedule is kind of a puzzle that is difficult to build upon once it's been loaded and is selling. But in response to a rapid rise in fuel price, if we needed to, on the other hand, go into the schedule and start whacking flights, as we've shown in, say, 2008 when we were going through that process, we can be very responsive. We'd like to not cancel anything within 90 days. But 90 days out, I think we can be very, very impactful in shaving capacity out of the schedule. I don't have any percentages to give you, but it depends on how extreme the conditions are. I think we can be very responsive.

[Helane Becker:]

No. I think that's very helpful. The other thing is, I know you guys don't guide to jet fuel, but is there any way you can say what you're currently paying for just fuel? And how accretive maybe on a – is your off-peak flying? Is there any way you can parse out for us accretive fly – the off-peak flying versus the peak flying in terms of margin or profits? I guess, if you're not guiding to margins anymore, you have to do it a different way.

[Jude I. Bricker:]

We're paying low-$1.80s right now, so $1.80, $1.82, $1.83.

[Helane Becker:]

Okay.

[Jude I. Bricker:]

Yes. I mean, we're not going to schedule anything that we don't think has a gross margin, which is all the variable costs over – under 30%. So because the existing flights already pay for the overhead, well, I guess, that number is more like 20%. Yeah. So we'll continue to add incremental flights. And I think on a operating margin basis, that's going to draw the operating margin closer to 20% to more of those incremental flights we have.

[Helane Becker:]

Okay. All right. That's hugely helpful. And then, my last question is actually for Maury. It's something you said in the press release. You said that you were – I think you said you're hiring additional people to support operations. We continue to enhance our management to support operations. So does that mean you've brought on additional people in that role recently?

[Maurice J. Gallagher:]

Well, I think, Helane, we're in the process – the continual process of evaluating management and systems and processes. And when we have 29%, 30% operating margins, the company's focus this year – I'd push this to really go in and make sure we have the resources and ability to grow this company to that 120-airplane business that we think – we've talked about we can get to. We're at 75, 80 now. So I would like to put the systems and the management and the resources in place to get there ahead of time. So some focus – continual focus on just doing a proper job and running a safe, reliable company.

[Helane Becker:]

Awesome. Thank you. Thanks for your help, guys.

[Jude I. Bricker:]

Sure, Helane.

[Operator:]

And our next question or comment comes from the line of Dan McKenzie with Buckingham Research. Your line is now open.

[Dan J. McKenzie:]

Yeah. Thanks. Hey, good afternoon, guys. That was actually my question as well. And I guess, I'm just wondering if you might be willing to elaborate a little bit further. And when you say new systems, how long would it take to put the new systems in, and I guess what does that entail exactly? And then, with respect to that, I'm wondering if you might be willing to talk about where you are operationally relative to internal growth. So where are you today and where do you want to be?

[Maurice J. Gallagher:]

Well, regarding new systems, we'll add this and that system, Dan. We're mainly enhancing our existing systems, automation, information management, things of that nature. We're just behind the power curve in a few areas and we want to catch up and get ahead. As far as new systems and things like that, we're taking a look at this and that. Tools from the outside, we develop our own stuff as well. So those are critical for us on a go-forward basis. But I'm excited about the opportunity as Jude's laid out, the market aspects that look real promising. So we just need to be able to perform and do a good, proper job to get there.

[Dan J. McKenzie:]

Got it. And then, operationally, where are you relative to your goals? Where are you at today? We do you want to be?

[Maurice J. Gallagher:]

Right now, our operations, for instance, we had a great September. We had a poor June, a poor July. And some of that goes to this evolution that I was chatting about and our ability to handle growth and to be there ahead of it. We're also – we have a complexity factor that – dealing with three fleet types. And our goal, as we talked about it in the release, is to simplify ourselves over time. That will help us to be able to better react and do things with older airplanes. I like to comment that we're a bit in the maintenance business more so than I'd like to be. The newer aircraft with – the Airbus will be just better technology, better engines, for instance, as compared to the JT8s. All those things will be enhancements to our ability to keep the operation top-notch, which is important.

[Dan J. McKenzie:]

Understood. My second question here, I guess, Jude, is following up on the weakness in the Canadian demand, I'm just wondering if you can help us understand what part of the demand picture does this comprise exactly, either maybe on a revenue or traffic perspective? And then, I guess, related to that, there's obviously an energy component. But is it possible to just separate out sort of a regular or an FX component tied to that Canadian part of the picture?

[Jude I. Bricker:]

I think it's too convoluted to draw any very clear comparison between Canadian dollar and unit revenue effect. The decline in the Canadian dollar would have been really bad for us five years, six years ago when we were much more dependent on Bellingham. But, as we sit today, Bellingham is a much smaller portion of the capacity that we fly. So honestly, I don't worry about it too much for us. It just becomes a redistribution challenge. So we had a lot of capacity in Bellingham, and that capacity needs to be reallocated to other markets in response to the conditions in that marketplace. I mean...

[Maurice J. Gallagher:]

I think, Dan, it's also fair to say over the years, we've always had strengths and weaknesses in our system. And we're very responsive to those. I applaud Jude, Lukas and their teams. We sit there, and we every month, every quarter look at the profitability by route. And if stuff is not holding up, we back capacity out of it up to and including going out of the market. If the other things are working well, we move towards it. And to Jude's point, we've seen the East Coast come on. And, candidly, when we started the East Coast in 2005, we had to relaunch. It was a pretty tough opening in May of 2005. But it's really come along real nicely. And Bellingham, right out of the box, was a very, very big market for us, big percentage-wise. And it's cooled off. But other places have picked up the slack. So the nice thing about our model is the United States is never kind of totally in one place at any one time economically, say, maybe 9/11. And as a result, we can react and move accordingly.

[Dan J. McKenzie:]

Very good. Thanks, guys.

[Operator:]

Our next question or comment comes from the line of Steve O'Hara with Sidoti and Company. Your line is now open.

[Stephen O'Hara:]

Hi. Good afternoon.

[Maurice J. Gallagher:]

Hello, Steve.

[Stephen O'Hara:]

Hi. I was just curious – I mean, I guess, it seems unlikely that it happens anytime in the near future here. But I'm just thinking about if fuel prices do rise, I mean, do you think – given the fact that you don't have as much direct competitive competition, at least nonstop, I mean, do you see maybe more pushback from customers in your attempt to raise fares? Or do you see it – just the industry kind of has maybe a fare problem that they have to solve and you guys have kind of the same issue later on?

[Jude I. Bricker:]

No, I would consider our markets to be isolated to the extent that we're charging fares sufficient to fill airplanes. And if those fares get too high such that, in the long-term view, we have too high margin, we'll add extra capacity and drive those fares down. So if you think about higher fuel as an input, there's just less marginal flying to do, we'll cut back on flying and raise the average fare by doing that and maintain our margins. Now what we have seen is a short-term effect on margins. So when fuel prices fell really rapidly, we had an expansion of our margins. It will take us a while to adjust the network to (43

[Stephen O'Hara:]

Okay. Maybe – I'm sorry.

[Jude I. Bricker:]

Well, I was just going to say, I mean, we really are operating in isolation here. I don't think many of the carriers look at it that way. And they're just trying to find utilization that they can fill airplanes at any price. We're reactive in that sense. So we allocate capacity where we have margin opportunities based on the inputs is all.

[Stephen O'Hara:]

Right. Okay. I mean, just maybe longer term, maybe what's your margin goal? Or is there, like, a longer-term margin assuming if fuel stays at current levels, would you be – you wouldn't expect to do anything less than kind of the current margin, I would assume. But then, if fuel goes back or rises, I mean, how do you think about margins – maybe normal fuel doesn't make sense anymore, but what do you think about your long-term margin profile in a normal fuel environment?

[Jude I. Bricker:]

I mean, I think we can – I think I'd like to get down to 20% operating margin based on the incremental opportunity to fly.

[Stephen O'Hara:]

Okay.

[Jude I. Bricker:]

So we would like to think about really long-term Allegiant 15% annual growth, 20% operating margin, and that will be up in the 30%s if fuel price falls like it has, we may be down in the mid-teens for operating margin, if fuel price rises really rapidly like it did in 2008. But over time, I think in a stable fuel price environment, we can build a network that's going to produce those margins consistently.

[Stephen O'Hara:]

Okay. And then, just on the Airbus that you own and I think you lease out, can you just tell me when those come off lease and come into the fleet? Is it 2018?

[Jude I. Bricker:]

It's 2018. Those airplanes are on lease to easyJet. There's 12 A319s. Those are on our balance sheet, and you see the revenue that those leases generate in other revenue line item.

[Stephen O'Hara:]

Okay. And then, I'm sorry. Just one more. I mean, Delta made some comments about bubbles and aircraft values. I would think that – and maybe that's spreading to the narrow-bodies. I would think that would be very good for you guys. Maybe you could just comment what you see and how you feel today versus maybe a year ago or so?

[Jude I. Bricker:]

I'm not ready to, like Delta did, give any price points. But we are very confident in our ability to buy the airplanes we need at the prices that we've been buying them at thus far. The strategy is pretty simple. We're going to buy CFM-powered A320s to the extent we can find those. And if we can't find those, there's probably a price point that we'll be willing to look at A319s. And to the extent we can't find either of those, we're going to keep the MD-80s on, all else equal, a little bit longer.

[Stephen O'Hara:]

Okay. All right. Thank you very much.

[Maurice J. Gallagher:]

Thanks, Steve.

[Operator:]

Our next question or comment comes from the line of Savi Syth with Raymond James. Your line is now open.

[Savanthi N. Syth:]

Hey. I just had two quick follow-up questions. One, on the ancillary air-related convenience fee, is much of the growth this year related to the convenience fee, and so that gets fully lapped as we go into 2016?

[Jude I. Bricker:]

Yeah. We raised the convenience fee by $3, and that has an almost 100% corresponding decline in the airfare. And that should be lapping this in December. Yeah.

[Savanthi N. Syth:]

Got it. And then, just the second question I had is now with having gone into some of these mid-size markets a little bit more, where you do have more competitors, have you seen any change in competitive behavior, either maybe adding competitors who haven't been in your markets historically, or just a change in behavior since you've gone into these markets?

[Jude I. Bricker:]

I mean, we just need to be careful commenting on that. I mean, the competitive environment is shaping up very nicely for us. One of the things that we would have talked about two years to three years ago would have been what Frontier is going to end up doing for their business plan. And they've been very open about their desire to find markets that are daily operations. They have a focus on utilization. They have a focus on operational consistency. So we sit here today, much less worried about what they're going to do than we were in the past. Also, we see a continued decline in regional capacity, which often in some of our small cities is the only alternative air service for customers. So those two conditions, I think, are really, really positive. The big fare pressure that's going on throughout the domestic network like Chicago, Dallas, Philadelphia, Orlando, Kansas City largely don't impact us because of our location that we're in, Kansas City and Orlando. But, for the most part, we're flying to places that don't have those kind of pressures. So I would consider us just over here in Vegas doing our own thing. And we haven't seen a lot of the crisis that are happening with fare wars all over the country.

[Savanthi N. Syth:]

Very helpful. Thanks, guys.

[Jude I. Bricker:]

Thanks, Savi.

[Maurice J. Gallagher:]

Thanks, Savi.

[Operator:]

And our next question or comment comes from the line of Hunter Keay with Wolfe Research. Your line is now open.

[Hunter K. Keay:]

Thanks. One follow-up and one back-of-the-queue type question. Jude, as a follow-up to the comment you made about the margins – and I just want to be clear, I thought that was a fantastic answer, so I'm not finding any fault with it. I just want to hash it out a little bit more about the 20% comment you made. I know that's not what you're saying you're going to do next year. Should we think about Allegiant as, like you said, a 15% to 20% margin airline going forward? When you said in sort of like a normal fuel price environment, are you saying jet fuel prices right now are not what you guys consider to be sort of normal? Because you said you were going to be adding some growth, which is a little bit dilutive to the margin next year. I guess, I'm trying to figure out, sort of how dilutive this off-peak stuff is going to be in the context of providing still obviously positive earnings growth. But when you give that 20% margin bogey, is that like a $2.25 jet fuel number? What's sort of the thought process behind that...?

[Jude I. Bricker:]

No, that's not what I'm saying. I'm saying that if it's over 20% for the system – if the operating margin is over 20%, there's a good – we feel very confident that there are flying opportunities that we did not take advantage of. So as we reschedule the airline in the same period the following year, we'll add those flying opportunities in driving down the margin. Okay?

[Hunter K. Keay:]

I got you. Yep, okay. Thank you.

[Jude I. Bricker:]

Now going below 20%, we would like to see a bigger buffer in our business. And so if it's below 20% for the system – operating margin below 20%, then there's probably incremental flying that we would cut, raising the margin by raising the average fare. But that process takes a pretty long time and fuel is a moving target. So we're up and down on our margins. But I think if you would look at us over an average margin over a really long time period, I think it's going to be pretty close to 20%.

[Hunter K. Keay:]

That's interesting. Okay, good. Thanks. And then, maybe a question for Maury, sort of, given the run we've had in your earnings multiple, which maybe makes the buyback a little bit less accretive here and the high chance that the cash you're going to generate in the operation is going to cover the money you need to sort of grow organically, would you consider maybe spending any excess cash you may have on – I don't know if you want to call it – sort of non-traditional things that maybe are indirectly related to the airline like – I don't know – real estate, or hotels, or anything that we would consider sort of the adjacent-type business investment, anything like that?

[Maurice J. Gallagher:]

Not at this point, Hunter. We are very focused on our opportunities at hand. We have lots of good stuff to do with our capital. And we certainly dabble in alternative products besides just carrying somebody from A to B and package stuff up. But there are a lot better people out there that know how to run these things than we do. We'll just be an agent for them and put together a good package for our customers.

[Jude I. Bricker:]

Nice try, Hunter.

[Hunter K. Keay:]

I heard someone laugh. All right. Thank you very much.

[Operator:]

Thank you, ladies and gentlemen. This does conclude the question-and-answer session of today's program. I'd like to turn the call back over to Mr. Gallagher for closing remarks.

[Maurice J. Gallagher:]

Thank you all very much. Appreciate your time and questions. We'll see you in 90 days. Have a good day.

[Operator:]

Ladies and gentlemen, this concludes the program for today. You may now disconnect. Have a wonderful day.