Spirit Airlines (NASDAQ:SAVE)
Q4 2015 Earnings Conference Call
February 9, 2016 8:00 AM ET
DeAnne Gabel - Investor Relations
Robert Fornaro - Chief Executive Officer
Edward Christie - Chief Financial Officer
Thomas Canfield - General Counsel
John Bendoraitis - Chief Operating Officer
Ted Botimer - Senior VP of Network and Revenue Management
Rajeev Lalwani - Morgan Stanley
Julie Yates - Credit Suisse
Duane Pfennigwerth - Evercore ISI
Savanthi Syth - Raymond James
Jamie Baker - JP Morgan
Hunter Kay - Wolfe Research
Michael Linenberg - Deutsche Bank
Joseph DeNardi - Stifel
Helane Becker - Cowen and Company
David Fintzen - Barclays
Dan McKenzie - Buckingham Research
Kevin Kaznica - Citigroup
Welcome to the Spirit Airlines Fourth Quarter 2015 Earnings Conference Call. My name is Ellen, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.
I will now turn the call over to DeAnne Gabel. Ms. Gabel, you may begin.
Thank you, Ellen and thanks everyone for joining us today. Presenting today will be Bob Fornaro, Spirit’s Chief Executive Officer and Ted Christie, our Chief Financial Officer. Also joining us for the Q&A session today are Thomas Canfield, our General Counsel; John Bendoraitis, our Chief Operating Officer; Ted Botimer, our Senior Vice President of Network and Revenue Management, and other members of our senior leadership team.
This call is being recorded and simultaneously webcast. A replay of this call will be archived on our website for 60 days. Today's discussion contains forward-looking statements that represent the Company's current expectations or beliefs concerning future events and financial performance. Forward-looking statements are not a guarantee of future performance or results and are based on information currently available and/or management's belief as of today, February 9, 2016, and are subject to significant risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements, including the information under the caption Risk Factors included in our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q. We undertake no duty to update any forward-looking statements.
In comparing results today, we will be adjusting all periods to exclude special items. Please refer to our fourth quarter 2015 earnings press release for further details regarding our assumptions for the reconciliation to the most directly comparable GAAP measure.
With that, I’ll turn the call over to Bob.
Thanks, DeAnne and thanks to everyone for joining us. 2015 was full of new challenges and I applaud our team members for delivering solid fourth quarter and full year results. I am thrilled to have been selected to lead this innovative team.
While I only recently joined the management team, I’ve had the pleasure of serving as a Board Member for a couple of years and had first-hand knowledge of our team members overcoming challenges and adapting the operating environment that’s changed.
In 2015, we grew capacity 30%, increased adjusted diluted earnings per share by 35.3%, and delivered a pre-tax return on invested capital of 28.2%. All via our total average revenue per passenger segment decreased by over $15 or 11.6%.
The model works. We are able to offer our customers even lower fares and grow shareholder earnings as the mix of lower fares, lower fuel and lower ex-fuel cost drove an increase in our margin reduction.
Before I share my thoughts about what we hope to accomplish together this year, here is Ted to recap the quarterly results.
Thanks, Bob, and again, thanks to all of you for joining us today. For the fourth quarter of 2015, we reported net income of $73.3 million or $1.2 per diluted share and a pretax margin of 22.4%.
Total revenue increased 9.6% driven by a capacity increase of 30.5%, which was largely offset by a decline in average operating yields with slightly lower load factors. Total revenue per passenger segment for the fourth quarter 2015 declined $16.13 to $111.78.
This decline was driven by a $15.69 decrease in ticket revenue per passenger segment, which is a result of continued competitive pricing pressures in our markets, as well as a higher percentage of our markets being under development compared to the same period last year.
Non-ticket revenue remained relatively stable, declining only $0.44 to $54.26. Once again proving the value of this stream of revenue in volatile pricing environments. As for operations, for the fourth quarter, our system-wide controllable completion factor, that is excluding weather-related cancellations was 99.7% and our system-wide on-time percentage averaged about 74.5%.
There were several times in 2015 where we struggled with delivering consistent operational performance. On the whole, we improved year-over-year, but our goal is to deliver reliable service in any environment and we recognized we fell short of that mark in 2015.
As discussed last quarter, we are slightly reducing our utilization in the peak period in 2016 towards the goal of improving our operations and we have made a number of adjustments to our staffing and operating system since June that have already helped us with a number of events including the most recent storms on the east coast.
In addition to being important to improving the customer experience, aircraft downtime and passenger re-accommodations are costly. For these and various other reasons, we are 100% committed to improving our operational reliability.
Turning now to costs, Spirit’s cost performance throughout 2015 should be a source of pride for all our team members and I thank them for their diligence in improving our cost structure. The fourth quarter 2015 was no exception as CASM ex-fuel decreased 8.2% to $5.15.
Our full year 2015 CASM ex-fuel decreased 6.5% to $5.05. Our fourth quarter CASM ex-fuel came in 70 basis points or about $2 million lower than the guidance we gave in mid-January driven by a bunch of small items that came in better than expected as well as a few items that pushed forward into 2016.
The year-over-year improvement in fourth quarter CASM ex-fuel was driven primarily by lower aircraft rent and lower labor expense on a per ASM basis. The decrease in aircraft rent per ASM was driven by a change in the mix of leased and purchased aircraft. Labor expense per ASM was lower primarily due to scale benefits from overall growth and from larger gauge aircraft. These decreases were partially offset by higher depreciation and amortization expense related to the depreciation of owned aircraft.
In the fourth quarter, we recorded $1.6 million of interest income primarily related to our EETC funds held in escrow. In 2016, we expect to record about $1.7 million of interest income related to the escrowed funds with $700,000 in the first quarter which will trail off to approximately $160,000 in the fourth quarter.
During 2015, we spent approximately $99 million repurchasing approximately 1.5 million shares under our share repurchase program. In October of 2015, our Board approved an additional $100 million repurchase authorization.
As we were with our first authorization, we will be opportunistic with this program. We believe in the long-term investment thesis for this company, but our growth requires diligence with our cash.
Given our significant aircraft capital requirements, there is a delicate balance between the decision to invest in the company’s equity and to invest in funding our growth. In the fourth quarter, we took delivery of three new A321 ceo aircraft ending the year with 79 aircraft in the fleet.
Turning now to 2016 guidance. Capacity in the first quarter 2016 is expected to be up approximately 27.5% year-over-year. The year-over-year percent change in capacity is expected to trend sequentially down throughout the year. We have been advised to anticipate several months delays for one or more of the A320 neo scheduled for delivery in 2016.
We are working through a couple of contingency plans including the pacing of scheduled fleet retrofits, to cover capacity growth shortfall should this happen. So we still estimate our full year 2016 capacity will be up about 20% year-over-year.
The pricing environment has been fairly stable since October. Revenue trends have been tracking to our forecast and they indicate the pricing environment hasn’t gotten worse, but it hasn’t materially improved either. Fares in our markets remain very low and we expect them to remain very low in the first quarter 2016 as the pricing environment remains competitive.
To the extent fuel moves lower, we anticipate our fares will see even further downward price pressure. Our team has done a great job as the pricing environment has evolved taking an aggressive approach to revenue management and continuing our surgical adjustments to capacity, which has benefited our revenue performance.
If the current pricing environment holds, year-over-year key RASM decline in the first quarter should be similar to what we experienced in the fourth quarter. We anticipate the year-over-year key RASM declines will sequentially improve as we move through the year, as fares were lower in the second half of 2015 than they were in the first half, but again, with lower fuel prices, this dynamic could change.
We currently have no fuel hedges for 2016. Based on actuals to-date and the forward curve as of February 4, we estimate our fuel price per gallon for the first quarter will be $1.25.
For the first quarter of 2016, we estimate our CASM ex-fuel will be down approximately 2.5% to 3.5% year-over-year with the largest driver of the decrease coming from lower aircraft rent per ASM and for the full year 2016, we are targeting CASM ex-fuel to be flat to down about 1%.
Te biggest cost headwinds we expect throughout 2016 are related to aircraft return conditions recorded to supplemental rent and higher depreciation and amortization driven by an increased number of heavy maintenance events, as well as aircraft depreciation related to our purchased aircraft. These items will act as a partial offset to lower aircraft rent per ASM driven by a change in the mix of fleets and purchased aircraft.
For clarity, in 2015, we performed one engine shop visit, while in 2016; we are scheduled to perform 21 engine shop visits as we begin to do the second round of heavy engine events on many of our older 319s. The exact timing of each maintenance event is fluid and that may drive some volatility in our CASM ex-performance in each quarter.
In general, we expect CASM-ex will be down more in the second quarter 2016 than the first quarter of 2016, up slightly year-over-year in the third quarter and up mid single-digits in the fourth quarter. We will do our best to update you as we move through the year.
I’d like to emphasize that the pattern in CASM-ex throughout the year is not a trend, but is instead a timing issue and we expect year-over-year 2017 CASM ex-fuel to be stable to declining as well. Our ultra-low cost structure is the foundation of our competitive advantage which provides us the platform to define our future. We remain focused on improving our CASM ex-fuel costs.
I am confident that we can continue to achieve stable to declining unit cost for the foreseeable future. However, in any given calendar year, this may not hold true due to timing issues. So when you sum this all up, you get to the first quarter operating margin of between 19% and 20.5%.
With that I’ll turn it back to Bob.
Thanks, Ted. I know many of you are anxious to hear my vision for Spirit and changes that maybe forthcoming. I do not feel I need to make sweeping changes, but I do have a few ideas and how we can further improve. One of the primary areas we are focused on is improving the overall customer experience and we have made this a top priority for 2016.
This includes improving our on-time performance and maintaining a high completion factor as well as improving our customer service metrics. We’ve previously discussed some of the changes we’ve undertaken to improve our operational reliability and recoverability such as slightly reducing utilization in peak periods, increasing our aircraft sparing ratios and increasing crew management staffing levels.
In addition, we are exploring a few other changes that might prove beneficial as well, and we will be happy to discuss those once we have time to fully analyze their potential impact.
As for improving our customer service metrics, that does not mean we are changing the business model. It’s already proven successful business model and there is no need for a full makeover. We know that when customers understand the model, they find great value in our ultra-low fares.
Over the past year-and-a-half, we made good strides in increasing the transparency as to how customers can save money flying Spirit. But there is still room for improvement. There has been rumor circulating that I have pulled back on our growth plans. We do not expect to repeat a 30% growth rate in the future, but we are very comfortable with the growth rate in the range of 15% to 20%.
As a normal course of business, we are in the midst of updating our five year fleet plan, which begins with a detailed review of gauge and mix. These discussions are about whether or not which A319 should remain as well as evaluating the gauge and timing of future deliveries, all of which are intended to enhance the company’s flexibility in the current operating environment.
Of course, as we continue to get large or a percentage of growth may slow because it’s offered by higher base, but I fully expect and support Spirit being a high growth carrier for many years to come.
Spirit is a really great airline and does a tremendous job serving the segment of the market that wants the needs ultra-low fares. Some of the criticism we have received is warranted and we know we can do better. We also know a lot of people who love the model and don’t want us to change at things.
That said, there are areas we can deliver. We can smooth out some rough edges and deliver a better overall customer experience. A good way to summarize the way I am thinking about it is to refine and improve a very successful story.
Now back to DeAnne.
Thank you, Bob and Ted. We are now ready to take questions from the analysts. We do ask that you limit yourself to one question with one follow-up. If you have additional questions you are welcome to place yourself back in the queue and we will allow for additional questions as time permits. Ellen?
Thank you. [Operator Instructions] Our first question is from Rajeev Lalwani with Morgan Stanley.
Hi, thanks for the question and then I guess, congrats, Bob on the new role. First question I had was just on M&A. Just your thoughts there and where Spirit gets in, is you are a buyer or a seller?
Hey, good morning Raj. How are you? Well, there is not really much to report on that subject. I think, I mean, that’s really mostly speculation that’s been out in the marketplace since I joined the company. So there really is nothing to report and I just said I am certainly aware of what’s going on in the marketplace, but there really is nothing for us to deal with or discuss at this point.
Great, and then, just another question for you, Bob. As far as, just being on the Board of Spirit and observing some of the pressures over the last years, so, I mean, what do you attribute it to, what would you have done differently potentially?
Well, I think, we’ve talked about the underlying operations and in many ways the company is running far flung in its route network. And so we have roughly one flight in every market. We cover the entire US and then what we get off schedule, it’s very difficult to recover.
And so, I think, we need to look at our operation perhaps differently than almost any other airline in the country. Over time, if we don’t step in and find a way to make this more reliable and probably more recoverable, we will continue to fall behind. So, I think what we are going to focus on is ultimately, make the right moves now to get us again to – become a solid operating airline, again with good performance metrics and make sure as the company scales up for growth, we are making operational improvements that will allow us to continue to provide good service. But I think that’s the key. We need to move faster.
And I guess, quite frankly, we have something good going on here. We played very good offense with the business model. I mean, customers only pay for what they want and the cost structure is fantastic, what we need to do is provide a seamless, more efficient operating experience for the customer.
Great, thank you, sir.
The next question is from Julie Yates with Credit Suisse.
Good morning. Thanks for taking my question and congratulations on the new role Bob.
Couple questions. Just first, Ted referenced a stable pricing environment and do we interpret that that even with the 30% decline in crude since early December that there has not been a corresponding let down in fares, but if there is further decline in crude, we should expect one?
Hey, Julie, it’s Ted. Yes, we are basically giving you our view as of today with current prices. So, stability implies that. But, there is always volatility with lower oil and those things can change going forward. But, based on what we are seeing today, that’s what we would say.
And, Julie, I think, just what I think, we are comfortable dealing with it and I think for a couple of years, pricing in the industry was very stable because of – I’d say reduced capacity in the marketplace and so we’ve been dealing with this now for basically nine to 12 months and I think the best thing that we can do is make sure to keep our cost low and improve our operation and our ability to manage through with will be enhanced.
Okay. And then, Bob, any variant view of how SAVE is growing? I know you said that, really the growth trajectory is unchanged, but just in terms of targeting large markets was up two times daily frequencies, we’ve seen other ULCs starting to target more of the mid-sized markets with perhaps less than daily frequencies. Is there any desire to do that or – in the future?
We don’t have all the detail and one of the things that the – we won’t do is, make a dramatic schedule change for the summer. Summer is one of our best operating periods and quite frankly, again, I see a very strong performance, no matter what we do, but I think going forward, we are going to much more open to a broader view of routes and again, over the last couple of years, we focused on mostly big markets to other big markets which really put us in legacy carrier hubs.
And I think over time, we will be just as interested in looking at mid-size markets and small markets to leisure with. So I think, in terms of the playbook, I think, we’ve always had the capability of doing that, but I think, you will see more focus on a broader section of routes going forward.
Okay. Very helpful. Thanks so much.
The next question is from Duane Pfennigwerth with Evercore ISI.
Hey, good morning, Bob. Welcome back. Nice to be speaking with you again.
Can you talk about any areas of focus you’ve had since joining Spirit as a Board Member?
In terms of areas of focus, like I said, I think we’ve got a very good Board and a Board that’s involved. So we’ve always had a very good conversation and debate about strategy and performance. Well, let’s just talk about the performance area. In 2015, we created, actually a new committee which was safety and oversight and we spent a lot of time focusing on the operation and perhaps more so than you’d see at most other carriers.
So our discussion about improving the operation has been going on for sometime and I think the team is even late last fall, talked about a number of improvements that was making. And I think in terms of emphasis, I think there is just going to be more. I think in terms of – we are a sizable company.
We’ve got a fleet plan that’s going to take us into – in excess of 100 airplanes in a couple of years and with that, we need to make sure our planning, operational planning is in sync with the fleet plan, rather than perhaps being behind. So I think, again the focus on performance – again it’s important, reputation does matter and I think if we can provide low fares, with the positive reputation, it will be good for business.
I don’t think it’s much different at Spirit than it is at other carriers reputation does matter and if you view a more competitive environment going forward, reputation will mean a lot more. So I think an area of focus remains in the operation. And at the same time, as we think about the future, the market has clearly gotten more competitive over the last year-and-a-half versus the prior three or four years.
Larger carriers that’s got stronger balance sheet and there is more growth across the board and I think that means we need to have a more flexible approach to route plan. And again, over the last couple of years, we have great margins and we expect them to continue in the future, but we are also planning, we need to plan for a competitive environment.
If the competition wants to match our prices, we need to make sure we’ve got strategies that allow us to compete vigorously. So, I think, we’ve always talked about being flexible and nimble and I think you’ll see more of that flexibility going forward, because – again, 2012, 2013 and 2014 were very, very unique times in the post-merger period.
But we are going to plan on an environment, we are going to plan on a more competitive environment and we think that’s the best place to be. If we are wrong in the marketplace that’s less competitive, we will be very happy with that outcome.
That’s really helpful color. I appreciate that. And then, one for Ted, what capacity growth are you expecting in the fourth quarter underlining that mid-single CASM guidance? And certainly appreciate one of the changes at Spirit I think was more conservatism around your guidance, your future guidance points.
But I wonder if you could comment on, is that mid-single CASM growth in the fourth quarter consistent with internal targets? It doesn’t really feel that aggressive to us. Thank you.
Thanks, Duane. We are just taking a look at getting you some data on where Q4 capacity guide is. I’d say, just like I’ve always said with our CASM targets, we are always aiming for accuracy. So, I would imagine that we are consistent in that regard. So, we are focused on delivering on the kind of flat to down one for the year and we feel like that’s the appropriate trajectory for the company in any given year.
The timing throughout the year is more around what I alluded to in my comments associated with maintenance events and when they fall, which means as you move through the year, you hit more and more of those pushing through your D&A line which is just penalizing the backorders more than the front orders.
So, it looks like whereby the way we are targeting capacity change to fourth quarter kind of in the mid-teens and so, with that, that CASM number, feels about right to us.
Okay, thank you very much.
The next question is from Savanthi Syth with Raymond James.
Hey, good morning.
I was just wondering if you could kind of take a step back and given the business model you have, talk about the levers that you have maybe in the slowdown or recession and what have appeared on is, given the cost structure, is there kind of the right lever in a recession to use price system at least at leisure demand or are there kind of other opportunities like – better opportunities kind of showing growth or utilization. I just kind of wondering, there is a slowdown or a recession, just how the model adapts to that?
Well, Savi, I get a couple of points, because you never know what a slowdown can look like, a slowdown, we’d say, high oil prices and low demand might be treated differently. Certainly, at today’s fuel prices, absolutely you have a lot of flexibility.
We are in a situation now where we have high utilization and in this environment with a lower fuel prices, we are able to run a lot of red eyes in a period of time when you have high fuel prices, that could change. But I think there is always the ability to adjust utilization but we need to be careful that we don’t create inefficiencies. I think, the key thing for us in almost every situation is the relative cost advantage versus the competition.
The more we can retain it or maximize the gap between Spirit and others, creates unique competitive position. It gives us more time when perhaps others need to take more action. Again, we are down at $0.05 a mile. That’s a very unique place to be and I think if we can improve the reputation on a regular basis, I think, we could actually improve our business in certain periods of time again, with the low cost structure and positive feelings from customers, but generally speaking, we are going to focus on managing the cost structure and improving the business model and with that, we can make adjustments. We’ve got a young fleet.
We have – as I learn, we have the youngest fleet in America and that’s very unique position. We want to be known for that than perhaps other things, but we’d be obviously – that does not mean we are going to take our utilization down a couple of hours. Generally not a place that we want to go, but ultimately we do have flexibility. We are at 13 hours of the day, 13 hours per day and that creates some option for us to adjust capacity in certain markets.
That’s helpful, thanks. And Bob, if I may follow-up on your comments about, maybe looking at a broader spectrum of markets, I know, in your AirTran days, you did well in kind of pursuing some of the smaller markets and kind of stranger to intense competition. So, am I understanding it correctly that, just the premise here is that, right now, the hubs are being more aggressively type descended and that’s what causes can maybe a potential shift in those types of markets that you are looking at? I am trying to understand, maybe either lessons on what has changed that maybe broadens the type of market that you would look at?
Well, I think the environment has – again has changed, but, again a little bit. We were in a – for several years, we were in a very unique period of time where capacity was well below, let’s say, the previous peak which was 2008. A couple of carriers were going through post-merger integration. Another carrier was still coming at a bankruptcy and it created perhaps a reduced competitive environment.
And so, many of the opportunities that we chose were in hub-to-hub flying and it produced very good results. It still produces very good results. But at the same time, we’ve seen more aggressive magic. Our results are still very good and I don’t see any major changes in some of those markets. But there are also other markets to focus on, and again, our cost structure is portable.
It’s not tied to any one particular segment and I think, some underserved markets exists outside of other carrier hubs. So I think it’s – again, it’s a matter of focus, again, I am personally very comfortable with those kind of markets. I am used to operating in an environment where cost are 50% to 60% below the competition. It’s a pretty good place to operate and there are opportunities, I think, across the board.
And so, what we are going to do is, again, I think we’ll be less predictable going forward. Again, all of this takes time, but you’ll see less predictability in the way we pick routes going forward.
All right. Thank you.
The next question is from Jamie Baker with JP Morgan.
Hey, good morning everybody. Bob, you talk about not meaning of fore makeover to the business model. I realize your plans remain under wraps, but in the case of Ryanair , they are having pretty considerable success having softened the edge of their product to the point that they now attract the higher demographic including corporate travelers.
That doesn’t strike me as a full makeover, to use your words more of just an improvement what was already in place. Is this the sort of the thing that you can envision Spirit emulating or is what Ryanair has done actually, your example of too much change hence something you’d avoid?
No, I actually think there are many ways, they are very similar. If – with an improvement in reputation, I think you’ll see a – lot of business flyers or corporate flyers who pay their own ticket. I think there is a real opportunity there and again some of it has to do with reputation.
And I think, that’s an area where you are all familiar with a different carrier where we did make inroads, not, not necessarily with large global companies where you have to compete with corporate contracts, but there is a high percentage of the business market where customers pay their own ticket.
And if we are offering reliable service, there is going to be takers for that product. But it really is a matter again, ultimately of reputation. I think that’s an area that we can fill. That’s a need that we can fill in addition to the price-sensitive customer. So, again – I guess, really moving along the same scale.
We still like our answer early model, I mean, it’s very, very robust that’s allowed us to compete in a very difficult pricing environment. So I feel very comfortable with that. But, again focusing on friendly service, making ourselves more efficient, clean airplanes, some of the things that you would say are basics, they need to be – they need to happen everyday.
And again, we want to make air travel uneventful and perhaps maybe a positive experience. So, I think, we are all on the same spectrum as perhaps what Ryan is talking about.
Got it, got it. Thank you for that. As part of the first quarter guide, you talked about the potential for pricing to remain stable, but the fact is Spirit sat out an industry fare increase in January, you sat out another opportunity last week. I believe you sat out the flurry of fare activity that occurred last June.
I know better than to ask you to comment on future pricing, but, when was the last time you made any sort of substantive across the board revision to the fare structure?
Jamie, I mean, absent, if we are getting the discussion of levels of pricing, I think, one of the key objectives here, because we are slightly different with large ancillary revenue per customer is, make sure we want the planes full. So we are more load factor-driven than most carriers.
But at the same time also, I think, what we are trying to do at least today is somewhat different and I think, adjusting base fares a couple of dollars one way or the other, really don’t fit in with what we do. I think for the most part, we are driven more by supply and demand and competitive response. And so, I think we are less likely to view what’s going on in the industry as a guide for what we should do from a pricing perspective.
Got it. That helps. Bob, it’s good to have you back. Thank you very much.
The next question is from Hunter Kay with Wolfe Research.
Hey, good morning.
Hey Bob. So, we did a survey with some of our clients late last year, and we asked how familiar - with a lot of people how familiar were they with you, and on a scale 1 to 10, it came in at a 3. So there is lot of people that don’t know you, don’t know about your style. So can you maybe just tell us, what should we expect from you as CEO, your styles being a CEO?
What should we not expect from you, from the investment community? And then, for the 3 at a 10 that do know you, have you had any opinions that have evolved or changed or philosophies that have maybe more so a bit since you were CEO of AirTran and we should expect something different?
Well, I think, I am going to be in New Hampshire tonight. So I’d like to talk to you about those surveys and whether they are accurate or not and whether they are predicted. But, so let’s talk about style. I would just say from my perspective, my background, because I am not new to the industry. I generally approach the business as a planner and a strategist.
And that’s where I had the bulk of my training. But at the same time, I ended up doing a lot of operating. So I ultimately – the way I think about the business is, how do you put together a defensible network at the lowest cost and I think the way I approach the businesses around those kind of metrics, and at the same time, a key ingredient is, we have to operate a professionally-run, high metric airline.
So it’s network at the lowest cost with a high operating standard and I think what we need to do is make sure that the schedule can produce something that we are proud of from an operating perspective. So, I am not kind of person that sits in the office and again, really looks at the window. I tend to get involved.
I am very comfortable weighing into issues in detail to really make sure that we make the necessary improvements. At the same time, I am comfortable giving credit where credit is due and I think to start with that, I think we’ve got a great business model and I did not invented the model, but I’d say, it’s hard to do what Spirit has done and I thing a key go is to protect it, but again make it better.
And I think, probably in terms of style, what I do understand is the value of a low cot structure. I am very familiar with it. I know how to protect the structure not over a year or two, but over a decade. And a lot of that – it’s a matter of, again, how you structure the business, but also there is a lot of elbow grease in terms of making sure there is a need or a justification for every cost.
And I personally plan on spending a lot of time making sure I understand the cost structure and ultimately we’ll manage towards a reduced cost structure wherever possible. But, I understand the competitiveness – it’s very little, I can say that I haven’t seen.
I’ve been away for a few years, but I watch the environment. I have worked to competed with all the CEOs. So I know who is sitting in the other chairs. I know how they largely think and I know how they compete. So, I am not unfamiliar with where we are right now and I am very comfortable in a competitive environment. And I think I understand how to make sure that we can manage in a competitive environment. Again, that’s going to be our goal.
Again, going forward, we are going to plan for every contingency and again ultimately decide, again, if the environment gets better, that’s a high-class problem. But if the industry is competitive, we are going to meet those challenges. You won’t hear us debate what other airlines should do or not do. We are going to plan for every contingency and if somebody believes that we are at competitive threat, go act accordingly and so what we. So, I think our focus will be to just take care of Spirit, make sure we have a robust plan going forward.
Okay. That’s a good segway as you think about sort of managing through these contingencies, there has been some debate with the investment community about the impact of the big three rolling off around basic economy concepts and as to whether or not, I’ve literally heard of this is either good for Spirit, it’s bad for Spirit or neutral for Spirit and I’ve had very robust debates on all three.
So what is your thought on that? Is this going to be an opportunity on a net basis or a threat for you guys? And then maybe a little bit to follow-up to Jamie’s question, as you think about competing against the basic economy products, is there investments that you may have to make to bring your product maybe up a little bit as they sort of – for a lack of better term, bring their product down a little bit.
So really, it’s two-part question. Either an opportunity or threat and how would you guys respond to it? Are there investments you have to make? Thanks a lot.
Well, I think, I didn’t ask others on the Spirit team to comment, but it’s not clear whether it’s a threat. I think, if you are looking at it from a legacy carrier, if you want to compete with us today, you are getting hammered trying to match our fares, because you don’t have the cost structure.
So it’s a very, very expensive proposition just to match by opening up all your pockets and trying to match our prices. So I think ultimately, it’s from – by definition, if the carriers move into basic economy, there is probably going to be a little less price competition. You need to look at it from their perspective rather than ours. Rather than, let’s say, dilute half the airplanes, they are going to try to limit it to a certain percentage of the market.
And from our perspective, we have to see whether we can manage against it. I think the key thing for us is to make sure our reputation improves. I think it’s a matter where we have a lot of complaints for a number of reasons. We have – again, the issues of recoverability.
We’ve had two out of the last three summers some very difficult times. We need to make sure we can recover better and if we don’t fulfill our promise with the consumer, we need to step up to it. But I think, and make sure again that we have the proper spares, proper block times, whatever the proper tools will be. So, as those carriers come down to – let’s say match us, I think what they are going to see is a corresponding improvement in our operation and I think, in that environment, we’ll do fine.
I don’t believe that anybody can take all our customers, especially, when we’ve got a seat mile cost of $0.05 a mile. That’s a pretty tough proposition, but I guess, and for us, we are just not going to continue to focus just on large carrier hubs, we are going to focus on a broader array of routes as well. I am not sure I got the second question in there, but…
That’s helpful. I appreciate it. That’s good.
The next question is from Mike Linenberg with Deutsche Bank.
Hey, Bob welcome back.
Good morning, Mike.
Hey, I’ve just a couple here. Back to your point where you talked about competing against the majors and how they get hammered competing against you. You call them out, but, how does that differ when, say, competing against other low cost carriers not - or even ultra-low-cost carriers, but like low cost carriers like a Southwest or Spirit, we’ve seen some examples of where you’ve been in head-to-head competition and then over time, you’ve ended up moving out of the markets.
And in the past, it may be just that there is a better alternative for the airplane, but some of these markets are pretty viable. And I am just – I am curious if it’s a function of whether or not, the JetBlue or the Southwest either have more heft or better service product and if Spirit maybe had a better product that one have been the end-game there or the outcome there. I mean, just thoughts in competing against those carriers rather than just the big three?
Well, in terms of price and reputation, today, both those carriers, Southwest and JetBlue have stronger reputations with the customer that could be extra leg room, it could be no bag fees. So there is certain parameters that we have to consider. But, I think, if we explore markets, I think, last year or the every four we went in the Kansas City and those markets were not exceptionally tailored to really what do at Kansas City.
It’s not an exceptionally strong leisure markets, so let’s say Florida and we were basically competing in business routes. It’s really not a good place to be for us. But, perhaps in Baltimore, it might be a different situation, because, there is a lot more leisure business, much more suited towards price. And so, I think there can be certain markets, again, we’ll contrast Baltimore where we are growing versus let’s say some small mid-western market that perhaps isn’t as strong from a leisure basis.
But again, in terms of the product, I mean economics are really very, very important and the – taking seats out of the airplane, and trying to provide more comfort is a real big risk for an airline that’s got 20 plus percent margins. And not clear I mean, is there any benefit at all.
So, we are sitting here, with about the highest margins in the business and equally as good as them. So, to make a change on the product, which could take years and you may or may not be successful, that’s not the first place that I would look. That’s really more down on the west.
I think in terms of the real basics which may sound kind of try, but if the airplanes are clean, we are more on-time, we are taking care of customers, it really does go a long way towards creating a good experience because that’s ultimately what we need. That needs, that’s the part of the bargain that we really haven’t fulfilled. And so, if you got a low price with a good experience, I think we can be in really good shape, again, you get on a Spirit airplane, someone may have an issue with our reputation, you work on the airplane, that changes right away.
The newest fleet and the biggest spins, all those things, that’s an opportunity for us to – again, to retain a customer. If we can just deliver that service. So, I think the best place to look again, is in – really in the basics, which we could argue, maybe they should have been here, but we are going to take the opportunity to make sure they are here. We are not going to win in every route situation.
But I think our cost structure will allow us to go into markets head-to-head with these carriers. Perhaps not necessarily in their hubs, but in more markets, where their, let’s say – what’s the right word, exposure is less, but, Midwest, the Florida, other leisure markets, good service and low prices really wins in that environment. And so that’s – I think we are going to stay in that area over the next couple of years.
And then, just one more on the strategic front or along those lines, you had mentioned about being that less predictable in your route selection going forward. Would that also include, maybe a rethink of frequencies in markets? Historically you’ve been one or two, would you consider that more and I’m asking that also you had said something about gauge and also rethinking sort of the gauge of the aircraft that you are considering taking delivery of and in sort of one breath, you said that maybe, you’ll need less A319s on one hand, but on the other to go into some of these mid-sized or smaller markets, it would seem you’d want airplanes with less seats, maybe not more. So maybe that argues more for that A320 versus the A321. So it’s sort of a combination of gauge and frequency, how you think about that?
Yes, and I may not have been clear, because I think I tripped over my notes a little bit on the – when I was reading, but I think, if we are going to participate in more mid-size routes or smaller routes, the leisure destinations, we would need to keep or retain 319s and focus more.
So, again as the fleet size – the airplane size gets bigger, and we are not a carrier that’s really focused on tariff, it naturally keeps us in this one flight a day environment, but if we dial that back, and start focusing on other markets, perhaps shorter haul markets, you may see a corresponding increase in frequencies. But again, as bigger gauge takes us away from that.
So again, I want to create – again as part of our fleet review, which is we’ve been working on for the last four, five weeks, and we are moving very fast on it, because I think, we got a good team here. We are fast on our feet. We’ve got a pretty good idea what’s going on in the marketplace and I hope in the next couple of weeks we’ll actually have some answers and some direction on some of these items.
Great. Thanks, Bob.
Take care, Mike.
The next question is from Joseph DeNardi with Stifel.
Hey, thanks. Bob, I am just trying to understand your comments about trying to improve the customer experience. It sounds like, operational improvement is the first area you are looking at. You don’t really want to change the product you mentioned. It would seem like one of the other areas of complaints would be the fee structure. So I am wondering if that’s an area that you are looking at to change.
Well, let’s go back to the fee structure and I think, we need to break it into pieces. I mean, bag fees are a key component of our ancillary business and so, we are going to continue to charge with it. Now, which may mean – we may end up with more complaints, because someone says, well, there maybe pay for the bag, well, that’s actually a point that we can accept, because that’s part of our business structure.
The kind of complaint we want to remove is, when we lose the bag and we don’t recover or when we have a four hour delay and we don’t get the customer where they need to go, something like that. So we have – there are going to be, again, complaints that in effect come with the territory, because, right now, many customers believe airlines are one-size fits all.
And, from that perspective, we are at a disadvantage. But, there is a whole array of other complaints and things that we just need to be good on. Have nothing to do with the structure. And so, for some reason, we’ve been rolling to the customer, we need to correct that. And we are going to correct it and we should be no different than any other airline that you ask whose goal is to provide good service.
So, I think there is going to be a differential there. Again, but fundamentally, the basic model of ancillary fares, it served us very, very well. We are exceptionally hard to compete with and so, it doesn’t make sense for us to drift away off the core strategy. We just want to make it operate better. Okay?
Yes, thank you and then, as I look back at fourth quarter, you guys very well obviously beat the RASM guide that was given and part of that was, I think, you guys regaining some control over your own destiny by reallocating some capacity pretty effectively. I am just wondering if that’s an opportunity going forward. Is that an area of upside for the first quarter guidance or how should we think about that?
Well, I can start off and go to have Ted and others chime in, but, I mean, right now, I mean, the route plan doesn’t change obviously till April. And so, whatever we are out there selling is going to take us through the Easter period then we are going to begin to make changes.
And again, I can’t necessarily comment on what we would change or not in the past, but I think, as far as I am concerned and I believe the team the same way, everything is on the table and I think we are going to be very flexible. I know there has been the conversation about whether in the past, we haven’t been nimble enough by getting in that routes to some degree, we haven’t had to, I mean, generally speaking, numbers have been very, very good.
That’s typically not the situation where you are canceling routes. But, I think the number for last year was eight and maybe in 2014 it was more than that. But, when you are ending up having pretty good margins, that’s less conducive to taking action. What we will be honest about is, when we go into a route and we miss casually and we think a certain number is going to appear and it doesn’t which will happen from time-to-time.
So when we make a mistake or misjudge a market, we won’t stay there for price sake. But really going forward, we are moving into the strong season. Our focus is going to be primarily on making operational improvements and as we move into the fall, we could take out a greater focus on the types of routes that we fly, but the summer is, summer travel is very predictable.
It’s fairly strong east west. And I don’t think this summer we won less east, east west capacity based on what we see. But once we move past late August, I think some of the other opportunities, we will get a closer look.
The only thing I’d add, this is Ted, is in the quarter, we did take control over our revenue production to a greater extent because, being the size that we are at today affords us a certain luxury. We have the ability to be more interactive with the way that we manage our inventory and we manage our routes. And that’s an advantage that Spirit has today.
And we plan to exercise that advantage aggressively going forward. While the views – the benefits associated with what we saw in the fourth quarter are baked in right now, we are fluidly managing this environment and that will continue into the first quarter and I think our team has done a great job doing just that. So, that’s our view as to what’s baked in anyway.
Okay, thanks, very helpful.
The next question is from Helane Becker with Cowen and Company.
Thanks very much operator. Hi, team, and Bob, welcome back. I am sort of sorry retirement didn’t agree with you, but, I got it.
So, here is my question. A couple of years ago Spirit focused very aggressively on improving operations and really did a good job for a while there and then things seem to have back fled last year. So, I don't know if you were involved with the company then, but what changed in the past year that things kind of got off-track?
Well, I think there was a period of time where there was some improvement, but I can’t say, and I’ll let anybody speak, I don’t think we felt we made consistent improvement and as the company begins to scale up, I mean, I actually think – again, if you are growing, that creates a rhythm.
And it should be relatively easy with the fleet plan, and I might say, easy, but the process should be one where we need to get ahead of things. We are in a situation where as we go into airports, we are generally the last person in the airport with the worst gate and that creates some unique situations for us and what we need to do is if we are going to decide to operate in those environments.
We got to create some cushion for us to operate in those environments or we are going to get difficult results, but we have a tendency to kind of get squeezed in and what we need to do is push the process out, so that, I think, we are going to have a pretty good idea what we are going to be doing two or three years down the road and what we need to do is we put it together our options and our plans before the fact rather than after the fact.
So, that’s just a general comment. But, I think in terms of companies can get going through ups and downs, I can’t say whether we’ve had the sustained focus, perhaps we thought we did. But, again, as I sit here and I have pretty good understanding of what it takes to run a good airline.
Even though we are small, we have some very unique complexities that we have to manage because, again, the way we have structured the airline with high utilization and one flight a day in a lot of cities, it does creates some complexities for us that we need to step up to.
And really until we do that, what we’ll do is, we’ll have good months and bad months and so what we need to do is make sure that we plan for those difficult months with more resources. But, again, I would say, it’s always been a focus, but I think that the focus has been a matter of degree and I’d say today, it’s going to get a high degree of focus.
Okay, that’s very helpful. Thank you. And then, I know you guys have a pilot contract that’s open. Have you engaged with them? Perhaps they don’t – perhaps they are not in a rush given the industry contracts that are open elsewhere, but, I am kind of wondering what their response to you has been?
In terms of answering the question and that may – I have someone else comment, but first of all, again, I have met with the pilot leadership and just discussed familiarization, but we have had an open agreement since July and we are in negotiations. I mean it is a complex period, because we are in kind of unique times, there is a lot of agreements that have been voted down which is perhaps surprising, but Bendoraitis, do you want to add anything?
No, I would just add that, we have been in discussions with the pilots for about a year, the contract became amenable at the end of July. We are scheduled to meet again this month. That’s an ongoing process and I would say, both parties are at the table with the desire to come to a completed deal. But these things take time and we will continue to meet and work toward an agreement.
Great. Thanks for your help.
The next question is from David Fintzen with Barclays.
Hey, good morning everyone. Bob, a question, you mentioned sort of having a defensible network and I am guessing, - when I think of Spirit historically, it’s been sort of very wide, very thin being a 5% or 10% player in a lot of routes in a given city. I mean, do you, when you think about that model, I am obviously very – fairly different than AirTran, Do you think of that as a defensible network or does that have to evolve over time?
Well, it’s defensible – our current network is defensible to the degree we manage our cost structure. And I think – but, then you can decide whether it’s a bottom was pit and whether you want to continue to focus down this path. I actually, again, I believe, there is no one style that works forever and I think, ultimately, there is – we are capable of flying less than daily operations and we have the ability to set those up.
We have the capability or should have the capability to fly two round trips in a market from somewhere in the Midwest to Florida and do well with that at all. And I think for us, we would like to create the ability to compete really in all those areas. And that’s not to say we will walk away from what we are doing because, it’s pretty good. But, I guess, the marketplace will evolve over time.
The competitors we speak against are stronger. I think what it cause, we just to have a more varied way of looking at our routes, but again, it’s $0.05 a mile and actually in long routes, even less than that, I mean, it’s a good place to start, but I think, we can make it more defensible by being able to participate in a wider variety of routes.
And then, when you say the – sort of the capability, do you think you have the capability to be up four, five a day frequency in a business market or is that kind of where things change?
I think that’s less likely. I mean, and that could be really a unique change in strategy for us. It’s not to say there isn’t a single route where you can have very high multiple frequencies. We have a handful today, but, we are unlikely to be focused on tariff the way a traditional carrier which focus on tariff or even the way AirTran focuses on tariff. I think the marketplace is different.
It’s evolved, but there is still, we get pockets of opportunity. I think, certainly what we are doing in the long haul markets makes a lot of sense, but there is also lot of opportunity in under the 1000 miles where our cost structure is still very, very relevant and that should become part of the playbook as well.
Okay, and if I could just sneak in one little tactical one, I am obviously talking about pricing stability in the first quarter. Is there anything you are seeing just in terms of some varied dynamic economy, lots of puts and takes geographically.
Are there cities like, maybe, even I am thinking like a Houston where you are just seeing a macro need to make some changes and shift some things around. Or can kind of – just what are you seeing in the short-term in terms of capacity changes that may need to made from a pure macro standpoint?
Well, it’s – it really is hard to say, like I said, because, again, read the same stories, and I can remember – if you can remember back in 2008, 2009, Houston was in a very unique situation because it was booming which probably is the only city in the country that was, but, there, we are not a big business player. But we got a number of red eye to South America and we got a very diverse set of routes where we are mostly focused on leisure traffic.
So, we haven’t seen any fundamental change in our business other than the competitive pricing that we saw last year. But that’s perhaps is different than what some of the larger incumbents might experience.
Okay, now this is all, that’s all very helpful. I appreciate it and welcome back.
The next question is from Dan McKenzie with Buckingham Research.
Hey, good morning guys. Thanks for squeezing me in. Bob, welcome back and congratulations on answering the call of duty here.
With respect to growth over the coming years, the commentary sounded pretty confident. Is the implication that Spirit believes that can consistently earn a return on invested capital over the same timeframe and what I am really getting at here is, how you are balancing growth with returns. Is there a minimum target return level that will guide, say, Spirit’s growth, whether it be 15% or 20% as we just look at over the next two years?
Well, in terms of, again, philosophy, obviously, you have the opportunity to adapt the current philosophy or change it, but, I think what Spirit has talked about and to go look at what’s actually talked about 15% returns over for a long period of time and we are above that today.
But, so I think in terms of a target, I don’t think the company has ever changed the target and perhaps, many men have thought we were heading well above that, but in terms of the target, I mean, I think that’s a nice target to keep. I don’t see any read or right now even have the capability to really say, it should be different, other than it makes a lot of sense to me about how to create discipline for an airline going forward and use that as a basis to make capital decisions.
And I can also tell you, the culture here, we will assure that we stay there, I mean, it’s – it is - the culture is very strong and people are very bottom-line focused. And so, it’s – it would be very difficult for one guy to change that because people expect high returns. So, I think that’s a real good byproduct of the restructuring eight, ten years ago at Spirit.
The IPO, the mindset is still very, very positive. So, I don’t feel any need at this point to say, it should be something other than that. It’s a very, very good target to have and I think all of the things that we are looking at right now are consistent with that target.
Very good. Great. I’ll go ahead with another comment or?
Okay, good. Bob, in your prior life you were a fan of first-class service. So just, following up on the opportunity business-class markets, is there a possibility that you would consider replacing couple of rows with the bucket or business-class seats that Spirit has used in the past or is the thought that the strategy should be less complexity and more Ryanair like longer-term?
Well, we do have the big front seat, which is a pretty good product and if we felt the need to have a few more seats, I mean, I think we would consider it, again, it’s certainly part of what we do and if we improve the reputation, and made inroads, more inroads with that small business flyer, it might be an option for us.
Again it’s - what we do with the big front seat isn’t that much different and perhaps what AirTran did with the business-class, because we were basically selling space with that product and if we feel that we can leverage that by taking a couple of seats out of the airplane, we might consider it. But again, I think that the full position is maintain the high cost per seat mile – low cost per seat mile, thank you.
But, like I said, if we felt there was a need, we would certainly consider it. But, again, we like the $0.05 a mile as our going in proposition.
Very good. Thanks, Bob.
Ellen, we have time for one more question.
Our final question for today is from Stephen O'Hara with Sidoti. Mr. O'Hara, your line is open. Perhaps you’ve muted on your end.
Go ahead, is there another question after Stephen O'Hara?
Yes, we have a question from Stephen Trent with Citigroup.
Hi, good morning guys. This is actually Kevin Kaznica filling in for Steve, and thanks for squeezing within at the end there. Pretty comprehensive call, but, just, we are wondering as your views on capacities in Latin America considering the strong dollar and now I guess any implications from the Zika virus. I know you guys are kind of mainly focused on the Caribbean. Just wondering what your take on that is?
Well, in terms of – I can make my comments, because, again, I haven’t been focused on it that much here, but, I don’t think from a currency perspective, there is really any impact for us. I mean, most of our sales are in dollars. And our primary focus in Latin America is really the ethnic travel, which has stayed very strong. In terms of our exposure to the virus, I think it’s, in theory, 3% to 4% of our capacity.
But beyond that, we haven’t seen any impacts. But, again for the most part, again, we are not dealing with deep South America and the currency impact that markets, again most of our business is in dollars.
Okay, thank you very much.
Ladies and gentlemen, thank you. This concludes today's conference. Thank you for participating and you may now disconnect.
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