Virgin America's (VA) CEO David Cush on Q4 2015 Results - Earnings Call Transcript

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Virgin America Inc (NASDAQ:VA)

Q4 2015 Earnings Conference Call

February 18, 2016 12:00 PM ET

Executives

Stephen Shulstein – Director-Investor Relations

David Cush – President and Chief Executive Officer

Peter Hunt – Senior Vice President and Chief Financial Officer

Analysts

Michael Langenberg – Deutsche Bank

Savi Syth – Raymond James

Hunter Keay – Wolfe Research

Helane Becker – Cowen and Company

Joseph DeNardi – Stifel

Julie Yates – Credit Suisse

Dan McKenzie – Buckingham Research

David Fintzen – Barclays

Rajeev Lalwani – Morgan Stanley

Steve O’hara – Sidoti and Company

Operator

Good morning. My name is Chalsie I would like to welcome everyone to Virgin America’s Fourth Quarter and Full Year 2015 Earnings Conference Call. As a reminder, today’s call is being recorded. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]

I will now hand it over to Virgin America’s Investor Relations Director Stephen Shulstein.

Stephen Shulstein

Thank you, Chalsie Good morning. I want to thank everyone for joining today’s call to discuss Virgin America’s fourth quarter and full year 2015 financial results. Speaking on today’s call will be Virgin America’s President and CEO, David Cush; and Chief Financial Officer, Peter Hunt. We also have other members of Virgin America’s senior leadership team in the room here today, including our Senior Vice President For People In-Flight, Francis Fiorello; our Chief Operating Officer, Steve Ford; our Senior Vice President and General Counsel, John Varley; and our Senior Vice President of Planning and Sales, John McCloud.

In terms of the format of today’s call, we will begin with opening remarks and commentary followed by a review of our network performance, and we will conclude with a detailed review of our financial results and current outlook. At the end of these remarks, we’ll open to Q&A from analysts on the phone. If you have not yet received a copy of today’s earnings press release, please visit our Investor Relations site at ir.virginamerica.com.

At this time, we wish to remind listeners that the Company’s comments today will contain forward-looking statements including among others, references to our future performance, and comments about our strategic plans. Listeners should not place undue reliance on forward-looking statements and our actual results may vary materially from those expressed or implied due to many risks and uncertainties. These risk factors and others are more fully disclosed in our most recent 10-Q and other filings with the Securities and Exchange Commission. We undertake no obligation to update any forward-looking statements.

As this call will include references to non-GAAP results excluding special items, please reference this morning’s press release on our Investor Relations website for further information regarding forward-looking statements and reconciliations of non-GAAP results to GAAP results.

With that, I’ll now turn the call over to David to get started.

David Cush

Thanks, Stephen, and welcome everyone to the fourth quarter earnings call. Before we get into the fourth quarter, I want to start with a review of a couple of key points for 2015. First of all and probably most importantly, if we generated about $200 million of net income with a pre-tax margin of about 13.2%, so I’m very happy with those results. We also resume growth of the airline to five A320s in the second half of 2015 and I have put those into service. And even with that we believe the based on the recent – most recently available A4A data that we outperformed the industry and unit revenue production domestically with our PRASM down just about 1.5%.

We achieved a pre-tax return on invested capital of 17.9%, improving that by about 3.3 points from 2014. And then finally, we launched service to Honolulu and Maui from San Francisco, which is really a significant operational accomplishment for an airline of our size. In few minutes Peter is going to walk you through some of our fourth quarter financial results in greater detail, but I want to give you a brief overview. First of all, the fourth quarter net income excluding special items increased 90% to $53.6 million and our pre-tax margin was 13.7%.

As with everyone, the sustained downward trend we’ve seen in fuel prices played a large role in this improvement and our average fuel cost per gallon including hedges dropped by about 40%. As you may have also seen in our investor update that was issued earlier this month CASM excluding special items fuel and profit sharing increased 4.6% in the fourth quarter, which was a bit higher than the outlook we provided on our last earnings call.

First of all, I’ll say that we were disappointed in this result. We understand it but we are still disappointed. Peter will give into the detail a quite a bit in a few minutes. Before then, I’d like to give some context. First of all, I’d say the majority of this increase was driven by a number of unique circumstances related to restarting our growth after a few years of not growing. In a particular our initiation of service into Hawaii drove some cost we had not anticipated. We believe those are one-time costs that are behind us now.

We do not believe it reflects a structural cost problem and does not really impact our strategy going forward. We’re maintaining our guidance on CASM excluding special items fuel and profit sharing for 2016 to decrease between 1% and 2% and Peter will get into that also. On the revenue side, PRASM decreased 5.1% year-over-year and was negatively impacted by weaker than expected demand in December as well as a continued low fare environment we’re seeing at Dallas Love Field. And although, we’re not crazy about reporting a quarter of lower RASM, the fact that put us in the top half of the industry RASM performance despite the fact that we’ve just resumed growth and that we’re in a very toxic fair environment in Dallas reflects the underlying strength of our network. It also shows that our strategy of deploying new capacity in a mix of new and existing markets allows us to accommodate growth with lower risk.

Now on to get a bit more detail about our network performance and its ruling, as I would say a tale of two networks you’ve got Dallas and you’ve got everything else and it’s been that way really for a number of quarters. If you compare our fourth quarter results with the midpoint of the guidance we gave a number of months ago, about half of the reduction in revenue was due to Dallas.

Even though Dallas only makes up about 10% of our revenue. And that was really driven by a yield environment that we think is continuing to look for a bottom. When we analyze Love Field on the Dallas/Fort Worth market in general, what we see is a fair environment unlike anything I’ve seen before.

We analyze a third quarter DOT data on both Love Field and DFW and there are a number of things that jump out of it. And this is recent data that we just released last week by the DOT. And that is the most recent data but what I will also say is we’ve looked at third quarter versus fourth quarter our data. And we think, what was evident in the third quarter is continuing into the fourth quarter.

So what are we seeing in the fourth – in the third quarter for the first of all versus Southwest is our primary head-to-head competitor on routes from Love Field to LaGuardia, Reagan National, LAX and San Francisco, we think, we’re holding our own.

On average, we’re generating a 16% higher PRASM, while acknowledging of course that they’ve got to a density advantage to us. But what’s most interesting about that PRASM advantage is where it’s coming from. That is coming from a higher average fare. We’ve got about a 40% fare premium to Southwest in those markets. That’s offset by 14% point load factor deficit also in this fourth – four markets.

With a tremendous amount of inventory dedicated to fares as low as $50 and you can still buy $41 fare from Dallas to LaGuardia as an example, going into March. We’ve recently decided to sacrifice load factor rather than taking fares that approach our marginal cost of production. So the bottom line as we flew about a 75% load factor in these markets, while American in Southwest flew low factors in the 90%’s, which we believe is certainly generating some spill– and spill of very low fares.

We’ve make some adjustments to the Dallas schedule for the second and third quarter which should improve operating performance at Love Field. And also reduce our exposure in to depressed Dallas fair environment.

Turning to Hawaii flights, in the fourth quarter, we launched services from San Francisco to Honolulu and Maui and so far these routes have met our expectations and performed very well.

We’ve seen strong PRASM and performance on these routes and they appear to be maturing at a faster rate than most of our new routes. And importantly the average fares are very healthy which is what we expected. As the market continues to mature and load factors improve, it looks like we have some huge upside here. And that’s why earlier this month we announced that we would be further expanding our Hawaii service with Rails from Los Angeles to Honolulu and Maui.

We’re pulling some capacity out of Love Field to accommodate these new routes as well as some new capacity we have coming on and it will really hit right at the peak season for California to Hawaii, which is during the summer. As far as the rest of the networks go to New York transcons are performing well both in JFK and Newark, even with United change at Newark.

We’re doing better year-over-year and that’s going to continue – it appears to be continuing in to 2016. The West Coast short-haul market was good with positive PRASM. And we still see some weakness in Chicago and Florida from the West Coast as we’ve discussed in the past but that also appears to perhaps to be ticking up as we’re go into 2016.

On the ancillary front, we’ve made a significant investment in our ability to create and effectually price products in bundles that are valued by our guests and are profitable for the company. Our express seating product, which combines preferred seating, priority boarding and priority security continues to see increases in revenue with express revenue per guest up more than 30% in the fourth quarter when looking at it on a market-by-market comparison.

So, gives you ability to go in and variable price has yielded great results. But even with that strong performance. We’ve long felt there better ways to unbundle and bundle elements of it and just last week we implemented some enhancements necessary to begin selling a number of new ancillary products and bundles on our website.

And basically, what we’ve done is, we’ve taken the express product and unbundle it, so guests can pick and choose the different components ala carte so they can choose priority boarding or security or seat selections, any of those or all of those in the main cabin. We’ve also created some new products and one new bundle that we like to call Power Trip, which is focused on business travelers which bundles a number of amenities for discount including preferred seating, priority boarding and security change fee waivers and other things.

What we’ve seen as far as the uptake on that in the first week or so it’s been extremely encouraging. And we’re looking forward to further exploiting the automation capabilities we put in and we think ancillary is going to look good going into 2016.

Finally, a couple of updates on the fleet and the product in December, we announced a deal with GE Cap to lease 10 new A321neo’s, which we think is going to be a great airplane for a fleet. These aircraft are up to 20% more fuel and carbon efficient and the up gauging in longer range will lower CASM X fuel will put some additional seats in slot control of the highly profitable airports and will give us more options with our Hawaii flying.

The aircraft are slated to begin hitting us in the first quarter of 2017. They’ve got the best seat mile cost of any single aircraft on the market and probably the most important thing for us in ordering them is as part of the A320 family, we stay in a single fleet type and continue to benefit from the high crew productivity, lower cost and greater operational flexibility, that the single fleet single configuration gives us.

We also continue to work on our product with the launching of the latest version of the Red in-flight entertainment system across our network. We will have most of the fleet done before this summer, the rest of them done by the end of the year and it's a magnificent product if you haven't seen it. We've also successfully installed Viasat WiFi, connectivity on five airplanes thus far and we have five more to come in 2016. Viasat delivers the fastest internet in the sky and gives you the ability to stream content including from our new partners like Netflix, Spotify and the New York Times.

In addition to that we continue to sweep all of the awards most recently Condé Nast Traveler's Readers' Choice Award, which is the largest independent travel survey in the industry. So wrap it up I'll say that our fundamentals look strong. So our most profitable year ever and we believe we're better, we're well positioned for a strong 2016. We’re confident will be able to execute on our growth strategy while controlling cost and maintaining our PRASM performance relative to our peers. And as always I want to thank our nearly 3,000 teammates who not only make this a great airline to fly on for our gas, but a fun place to work for all of us.

And with that I'll toss it over to Peter.

Peter Hunt

Thanks, David, and good morning to everyone on the line. I'd also like to join David in congratulating and thanking all of our teammates for another great quarter with exceptional financial performance. I'm going to start with a more detailed run through of our financial results. This morning we reported net income excluding special items for the fourth quarter of 2015 $53.6 million, which is the year-over-year increase of $25.5 million compared to the fourth quarter of 2014.

On a GAAP basis, our net income was $190.9 million with $137 million difference attributable to special items related to the reversal of our income tax NOL evaluation allowance and a change in estimate related to our aircraft lease maintenance deposits. Total revenue for the fourth quarter increased 5.2% year-over-year to $391 million. Passenger revenue was up 4.6% driven by a 10.3% increase in capacity and a 5.1% decrease in PRASM.

As I mentioned on our last earnings call, PRASM in the fourth quarter of 2014 was benefited by a minor change in estimate that increased PRASM by approximately 1%. So if we look at PRASM on an apples to apples basis at the market level and excluding our minor adjustments our average PRASM was actually down about 4% year-over-year. Total RASM decreased 4.7% aided by the relatively stronger growth in ancillary revenue that David spoke about. And the increase in total revenue when combined with significantly lower fuel costs resulted in operating income adjusted for special items of $56.5 million, which is a 65% increase year-over-year.

Our operating margin excluding special items was 14.4%, which is a year increase of 5.2 points. Our total CASM, adjusted for special items decreased 10.1% compared to the fourth quarter of 2014 and this decrease, of course, was primarily driven by lower fuel costs. Our economic fuel cost per gallon, inclusive of taxes and hedges decreased approximately 40% year-over-year to $1.76 per gallon. Our CASM excluding special items, fuel and profit sharing for the quarter increased 4.6% year-over-year to 7.49 cents.

This is much improved from previous quarters in 2015, but it is still higher than the outlook we gave you on the third-quarter call. As David said, we're not satisfied with this result in the quarter. Let me walk you through some of the primary drivers for this increase. First, the largest driver of the increase was higher-than-expected marketing costs, particularly as it relates to developing markets in the network. We incurred most of this additional expense in December when we saw some temporary weakness in demand.

We believe this additional spending in key markets that have been weaker will position these markets for better performance at the start of 2016. Second, as David mentioned, we experienced higher-than-expected costs for crew training and travel related to new growth, specifically related to our Hawaii startup. Additionally we incurred some higher-than-expected professional and legal expenses later in the fourth quarter for the A321 lease transaction with GE Capital, and for some new operational projects that we launched to identify improvements in how we schedule our crews and for improvements to our website.

Finally, timing of maintenance activities and minor damage events also negatively impacted our CASM growth in the quarter. While the fourth quarter unfortunately was impacted by a confluence of a number of unexpected costs, most of them relate to investments we're making to grow the business and improve results in 2016. We've had a number of internal discussions with our entire leadership team around the importance of hitting our unit cost goals in 2016. And the entire Company is committed to our goal of a decrease of CASM, excluding fuel and profit sharing, of 1% to 2% for the full year compared to 2015.

Our net other non-operating expense decreased by $3.1 million to just $2.9 million for the quarter, primarily due to the decrease in debt and the restructuring of our balance sheet in connection with our IPO back in November 2014, also partially offset by the interest expense related to our new aircraft deliveries. Our fully diluted earnings per share adjusted for special items was $1.20, up 69% from $0.71 that we reported in the fourth quarter of 2014 on a pro forma basis after accounting for the IPO.

On a GAAP basis, our fully diluted earnings per share was $4.28. Special items in the fourth quarter of 2015 included a $36.1 million adjustment associated with deposits for future maintenance events paid to our lessors. As our network and fleet plan have changed, we’ve determined that certain maintenance events will no longer be necessary to be performed by us and thus we are immediately expensing these deposits.

While from a timing standpoint it means we incur these costs now instead of in the future when the maintenance event would have occurred, avoiding these maintenance costs during the lease term is still the most economically beneficial outcome for us. The avoided maintenance events or the cost for those events is expected to be greater than the deposits we’re paying and that the lessor will retain at the end of the lease.

Going forward, we expect slightly higher aircraft rent expense as a result of this change in estimate as we will continue to expense the portion of maintenance deposits associated with these avoided maintenance events. The second special item was $173.5 million gain related to the release of our income tax evaluation allowance.

We now expect to record VOC taxes at a rate of approximately 38.5% in 2016, but we do not expect to be a cash taxpayer in the near-term as a result of the approximately $690 million, the federal NOLs that we have on our balance sheet, and also due to the aircraft deliveries in 2015 and 2016 which provide us with significant tax timing benefits.

Turning to cash flow, our operating cash flow for the quarter was $23.8 million and we generated nearly $200 million of operating cash flow for the full year. This was primarily a result of our strong underlying financial performance. Cash used in investing activities during the quarter was $134 million, and that was primarily for the acquisition of three aircraft that delivered during the quarter.

Cash generated from financing activities consisted of $117 million in borrowings for our three aircraft deliveries and these net changes resulted in our year-end cash balance of $496 million. Turning to our fleet plan, we announced in December that we will be taking delivery of 10 leased Airbus A321neo aircraft beginning in 2017. As David mentioned, these aircraft will allow us to pursue new revenue opportunities, while also maintaining our single fleet type and low cost structure.

While the underlying lease terms are proprietary, I can say that due to the competitive process we went through with lessors and with the manufacturer, and due to our significantly improved credit profile, we believe we’ve obtained leases with very competitive economic costs. Further, with major improvements in fuel- efficiency and the benefit of larger-gauge aircraft, we expect these A321neos to have a noticeable CASM advantage compared with our core A320 leased fleet today.

Now I’ll spend a minute on our outlook before we turn it over for questions. Capacity in the first quarter of 2016 as measured by available seat miles is expected to be up between 14% and 16% compared to the first quarter of 2015. And, of course, this is primarily driven by our new aircraft deliveries that we’ve taken in the second half of 2015 as well as in the first quarter of 2016.

Based on what we’ve seen in the first half of the quarter, plus our projections on the rest of the quarter, we now expect PRASM in the first quarter of 2016 to decrease between 3% and 5%, versus the first quarter of last year. This outlook assumes no material change in a soft pricing environment that we saw in the fourth quarter, particularly in Dallas. And we expect for the first quarter 2016 that our CASM excluding fuel and profit sharing will increase between 2% and 3%, primarily due to our previously announced pay and benefit initiatives that were implemented in April of 2015, and also due to higher year-over-year maintenance costs in the first quarter from planned heavy maintenance.

As I said earlier, we still expect our full-year 2016 CASM excluding fuel and profit sharing to decline between 1% and 2% as we benefit from growth.

With respect to fuel costs, based on our hedge portfolio and current market prices for aviation fuel, we expect that our economic fuel cost per gallon, inclusive of taxes and related hedges, to average between $1.55 and $1.65 for the first quarter of 2016. This would be a decrease of $0.85 per gallon year-over-year at the midpoint of our guidance which represents a 35% decline.

Our guidance is based on current jet fuel forward curves and is subject to change based on prices throughout the quarter. And just a quick note on our hedging philosophy, as a smaller airline we do believe it is prudent to mitigate volatility related to fuel prices and that’s why we continue to hedge and we’ve not made any material changes to our hedging program in this low fuel environment Our program delays the full impact of changes in fuel price by approximately six months.

And with that, I will turn the call back over to Stephen to open up for questions.

Stephen Shulstein

Chalsie, we’re ready to take questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from line of Michael Langenberg with Deutsche Bank. Your line is now open.

Michael Langenberg

Yes, hi. Good morning, guys. Couple of questions here. The A321neo’s that are coming early next year. What’s the configuration, and have you considered maybe having slightly larger front cabin, maybe using some of those airplanes in Transcons, I mean, what’s the configuration mission, et cetera?

Peter Hunt

Hi, Mike, good morning. Our expected configuration is 185 seats. We’re going to have the same sized first class cabin, eight seats. So the additional seats will all be in the main cabin. We actually think that – having that kind of smaller intimate eight seat first-class cabin is the right size for us in most of our markets. So we’re retaining that, it gives us consistency throughout the fleet as well.

Michael Langenberg

Peter, what about your middle cabins? Is the same size in that middle cabin or do you have a slightly larger middle cabin on the 321neo?

David Cush

Actually we will add a row in main cabin select. So we will have more seats available for upgrades there, paid upgrades as well as, upgrades for our most loyal premium traffic.

Michael Langenberg

Okay. That’s helpful. With respect to your tax rate, so you’ll book at 30.5, should we assume that your cash tax rate will be right up against 0% or is there going to be a small portion tied to some of the things that you cannot deduct? I mean, how should we think about that you mentioned also that the aircraft purchases and getting the benefits against the timing differences?

David Cush

Right. We don’t expect any material tax payments – cash tax payments in 2016 or really for the next few years.

Michael Langenberg

Okay, great. If I just can squeeze in one more. You mentioned PRASM, the guidance down three to five for the March quarter. How much is your stage length out with the new Hawaiian stuff coming on and the fact that it is going to be fund by some of that shorter Dallas flights in mid-con flights going away. Is that on the back of a stage length increase?

David Cush

There is – I don’t think, there is material change in our stage length in the first quarter, really a material change plan for 2016. You mean, it is absolutely true that Hawaii is a much longer stage length. But it’s balanced with other changes in the network, other editions, Deborah for example coming on the spring to where overall, the average stage length is going to be relatively constant for the first quarter and the full-year.

Michael Langenberg

Okay, great. That’s all, my question. Thank you.

Operator

Thank you. And our next question comes from the line of Savi Syth with Raymond James. Your line is now open.

Savi Syth

Good evening, everyone. Just on the bundling programs that you’re introducing. I’m wondering does that create a shift between passenger at some point or will the unbundling and bundling so fall in the ancillary portion?

David Cush

Yes. Hi, Savi. It’s David. It’s supposed to stay relatively the same. We have not – we do not plan on going in and introducing a economy minus or whatever people are calling it these days the type of product. So we’re not unbundling everything to that extent which I think would drive revenue for on passenger revenue to other revenue. This will really just be on top of it.

Savi Syth

Okay. Got it. Thanks David. On the West Coast I wonder if you can elaborate a little bit on what you’re seeing. Sounds like the trends are improving? Is that ultra low-cost carrier? I’m just kind of curious some of the weakness that you’re seeing in certain areas? and then also just any extended thoughts on short-haul West Coasts was one of the options as you resume growth is that still an attractive option here?

David Cush

On the West Coast short-haul. It hasn’t really begin impacted by the ULCCs that could come certainly in the future. With spirit going into Los Angeles to Seattle which is a head-to-head market will see some of it there but, what I say is the market looks robust. The demand is good. The fares are actually better on the West Coast than they are in most of the country at the state stage length. So, thus far West Coast seems to have been insulated and is doing extremely well for us.

Savi Syth

And, I guess David, the comments on Chicago and Florida. Where is that softness coming from? And did I hear it correctly that maybe that’s pretty abating as we head into 1Q here?

David Cush

Yes. That is certainly coming from ULCC competition Frontier from San Francisco and Spirit from Los Angeles. And I think part of it is just the market settling down, that there is a lot of disruptions, one in U.S and see goes into the market initially. So, quite a bit of [indiscernible] the market kind of shaking out. The other thing is, we have seen some minor but important capacity reductions, especially from Frontier going into Chicago. So, we think that may create some stability also.

Savi Syth

Got it. All right, that’s helpful. Thank you.

David Cush

Thanks.

Operator

Thank you. And our next question comes from the line of Hunter Keay with Wolfe Research. Your line is open.

Hunter Keay

Hi, guys, thanks a lot, I appreciate it. So, I just [indiscernible] talk about Dallas more David, when you look at the revenue that Southwest is putting off, and you mentioned the risk factors, and the most successful airlines in the world usually, I think usually kind of stick to what they know and play where they can win, and ignore the temptation of growing the CASM down, and it’s pretty clear that the competitive dynamic in Dallas, it is permanently and structurally altered and it’s not going to change anybody’s planning horizon. So, what is so special about Dallas and why not just leave and why not just focus on markets that you know you can win and have an advantage right on this providing on unbundled skill traffics? What is – why do you guys maybe even be there?

David Cush

Well, we have been in Dallas since 2009. And this has been a – long been a highly profitable market for us. We didn’t just go and win the right amendment expired, now we did go into the East Coast markets when Dallas got expired. And I think what I will say Hunter is, that we do think long-term that these are very good. Dallas is I believe the fourth or fifth largest corporate market in the country. Historically it has been very lucrative. I’ll also say, this is my view, but as I look at Dallas, I think the two dynamics going on. One is a supply and demand dynamic which I think was certainly disrupted when right amendment expired, when Southwest added all their capacity when we went into new markets.

But if you look at the numbers that we’re seeing from the DOT, the carriers are running 90% plus load factors. At the same time they’re willing to sell fares that are in the double-digits. So if you look at American and Southwest and LAX and LaGuardia as an example, roughly half of their fares were under $100 according to the DOT data. That is not a supply and demand driven situation there. The fact that they’re running 90 % plus load factors and they sell half the airplane for under $100 is not explained by supply and demand. So clearly what we’ve got is a market share going on, were going on in Dallas and in other places as much as we hate to talk about it more market share emerge that is certainly what’s going on.

So it’s a very long-winded way of saying that if it were supply and demand only I think the market would be sorting itself out by now, but there are other competitive dynamics working there but are very difficult to predict. That being said, look we are a small airline but everywhere we go we face this competitive reaction and its part of going in and carving out a little slice of the pie for yourself. So we’re not going anywhere in Dallas we’re going to adjust things to make sure that, while the market is settling out that we minimize the financial impact to us and when it finally settles out we’ll have a nice little footprint there.

Then one of the thing I’ll add in is that – its not just Love Field that even when we look at the fares out of DFW. The in the third quarter again and we extrapolate this to the fourth quarter using art data. That Dallas fares in these markets, DFW fares were down 30% also. So it’s really across the board.

Operator

Thank you. And our next question comes from the line of Helane Becker with Cowen and Company. Your line is now open.

Helane Becker

Thanks very much operator. Hi, gentlemen thank you for the time. So my first question is Peter can you just tell us what percent your hedged out for each quarter. And either the range of prices or how you are hedged?

Peter Hunt

Well let me explain how the program works Helane. Because it’s a dynamic program, it’s rolling, it changes weekly because we’re trying to always target to be hedged at the same level at any given point in time. And the program starts with hedging nine months out hedging about 30% of our exposure in months seven, eight and nine. So here we are sitting in February we would be talking about October and November – September, October, November kind of timeframe that we would be laying on hedges up to 30% of the volume for those months.

Then for months kind of three through six we increase that hedged volume up to 50% and then when you get to months two and months one out from today we move up to a 70% level which generally matches how much revenue we book for the month when we get to the front month, we get to the beginning of the program. So any given point in time for the next nine months we’re roughly 40% hedged on a 12-month basis, that's more like low 30s that where hedged, but it's rolling all the time because were always kind of layering into this program. And it gives us that it kind of mitigates the volatility we've seen in fuel, it spreads out that volatility a little bit and it just delays the impact for six months which we think is prudent for us as a small airline.

We are 1.5% of industry revenue, we won’t really be the leader in the industry in terms of figuring out how the industry reacts to higher fuel prices, and so we think we need that insurance of that extra time until the industry does react if there's a fuel price spike which is why we do it.

Helane Becker

Okay, great. And then just one point of clarification on the first day of the month, you would be 70% hedged. So do you look at the average fare of the tickets you've sold already, and then determine your hedge, would you weigh in then, how do you think about that versus the pricing for the first and second months?

David Cush

Well, I wish that we could say that fuel and revenue could be directly tied like that, they are not directly tied. Obviously there is an indirect impact but really what we're thinking, is that as we are selling tickets for the current month, we want to lock in the fuel costs that at the same time that we’re selling those tickets. So, we’re not actually trying to target a hedge ratio based on ticket prices, but really more on ticket volume. So we start the month, we sold out at about 70% of our revenue, we have about 70% of our fuel costs hedged.

Helane Becker

Got you. Okay, that's perfect. Thank you very much. And then just one question on ancillary, is there any other than currently ala carte in the unbundling of some of the products you were talking about David, is there anything else on the horizon that we should think about, or announcements that may be forthcoming some time during the year of other things for ancillaries?

David Cush

I wouldn’t say anything, any new products. There may be some different bundles that are put out, but if you look at the ala carte menu we have now, those are likely to be the only products that we have out in 2016. I would say two things that will drive the revenue up, though one again is the capability of pricing more precisely. The second is, as we can get more of these onto the website, and ultimately onto the app, then that will make them a little bit easier to purchase, but product wise we think we are where we want to be for 2016.

Helane Becker

Perfect. Thank you very much gentlemen.

David Cush

Thank you.

Operator

Thank you. And our next question comes from the line of Jamie Baker with JP Morgan. Your line is now open.

Unidentified Analyst

Hey, good morning, guys. This is actually [indiscernible] on for Jamie I want to ask you a question about the transcon market. And as we are aware, United Fluids last PS flight from JFKbackin October and there are multiple competitor directions around that. So if we combine both JFK and Newark, has there been any change to your transcon strategy since then and then any change perhaps in the transcon RASM you guys have experienced?

David Cush

Well. Transcon RASM has actually been I would say fairly stable that since United made their change, we've seen improvements in Newark somewhat surprising perhaps and still some slight weakness and JFK, but not like we’ve seen in the past. So what we saw on the fourth quarter and what we see looking forward and publicly available information is the that transcon is pretty stable right now when you combine the two.

Unidentified Analyst

And just thinking on growth in Newark relative to JFK remains pretty unchanged compared to what we saw before United pulling out of JFK.

David Cush

Well. We like where we are in JFK right now. We fly six times a day from LA five from San Francisco. We’ve got good coverage so we like that position. We’ve been interested in growing in Newark for some period of time. In particular, growing an additional flight to LA would be nice an additional flight to San Francisco would be nice, but as it stands right now we don't have access to the slot. So if there were a way for us to get slots – it is likely we would like to start one more in each of those markets some time in the next 12 months.

Unidentified Analyst

Okay that is very helpful. And then switching gears to kind of the aircraft strategy going forward and thinking about owned aircraft versus leased. I mean you guys are remain concentrated in the narrow-body 20 segment and I'm wondering given a lot of discussions in the marketplace about the civil aerospace cycle and asset values and lease rates, I’m wondering if over the past couple of months you guys have given further thoughts perhaps switching the biased from own to leasing or vice versa for incremental aircraft orders in the out years?

David Cush

Well. I’d say all things being equal, the current market still favors owning not leasing. I mean interest rates are still very, very low. You just look at the economics of owning it looks a lot better to us. Having said that, we did just sign up for 10 aircraft leases because things are not always equal. And looking at the opportunities we had with the manufacturer with other lessors, and ultimately what we ended up doing with GE Capital that was the best economic decision for us. Taking into account, how you could finance aircraft taking into account tax benefits of ownership, all of those types of things. The A321neo is we're getting from GE Capital that was the best economic deal for us.

Peter Hunt

Just on new versus huge, I’m huge proponent of new aircraft for a small airline of our size, that runs relatively high utilization. I think you got a big airline like Delta or United to have big complex systems already in place that can support multiple aircraft derivatives for lack of a better term, then its less of hurdle versus us having to build those systems. The second thing I’ll say if you are in airline like Allegiant that pretends to fly low utilization kind of in and out networks that gives you some flexibility on taking used aircraft. So we think it’s the right strategy for us given our network and given our size right now.

Unidentified Analyst

Yes, we wouldn’t disagree and I think it’s a opportunity to be looking at both owning and leasing equation this point in cycle. So appreciate the color guys. Thank you so much.

David Cush

Thanks.

Peter Hunt

Thank you.

Operator

Thank you and our next question comes from the line of Joseph DeNardi with Stifel. Your line is now open.

Joseph DeNardi

Hi, thanks good morning. I got on the call little late, so sorry if you addressed this already. I’m wondering if you could just talk about capacity for the full year and then also kind of given the fleet transaction you announced what that points do for capacity growth in 2017. I mean are we in kind of 10% to 15% growth phase at this point. Just any color there would be helpful.

David Cush

Sure, so for 2016 full year we still are around 14% to 16% which I think is what we have talked about before that we be in the mid teens that’s our expectation. All the aircraft coming in the first half of year, but the 2015 deliveries came in the back half of 2015. So we’ll continue to have capacity growth right up through the end of 2016.

When you look at 2017, the delivery slots are little more spaced out, we have a couple of them coming in the spring and then the other three come in the fall. So it will be a little lumpy quarter by quarter but generally for the full year we think we’re in that kind of longer-term 10% target capacity growth rate that we’ve talked about before that we think is optimal for us. And I would expect 2018 similarly somewhat close to that 10% target growth rate.

Joseph DeNardi

Okay. And then just looking at 2016 capacity I think previously you guys have kind of broken it out into I think in the last call between Hawaii back filling markets that you have pulled out previously and then newer markets. I’m just wondering if you could update us of the 15% growth in 2016 where that’s falling between Hawaii and kind of everything else. Just given what would you pulled out at Dallas?

David Cush

I would say when you add in the LA service roughly half of the new capacity is going into Hawaii the remainder of it is replacing supply and that we have put out as we said primarily some trance not flying, to JFK from LA and San Francisco and a few other bits and pieces. But I would say roughly half of its going into new markets.

Joseph DeNardi

Okay, thanks very much.

Operator

Thank you. And our next question comes from the line of Julie Yates with Credit Suisse. Your line is open.

Julie Yates

Good morning. Thanks for taking my question. David, how should we think about the rate of growth for the other revenue line in 2016 just – as you start to reap some of these benefits from the changes in how you are selling the various components of Express?

David Cush

Well, what I’ll say is we’ve got – I may let Peter talk about – let me just backup. Because I think – there, a couple of elements of this. One is in our internal forecasts, I would say that we have a fairly conservative rate of growth planned in our numbers. That being said, as we look at the early results of the last week or so, of what we’ve seen from the unbundling and the rebundling. It looks like that rate of great could be higher. So, my expectation is it will certainly grow faster than passengers and faster than ASMs. I don’t think we’re ready to give specific guidance on how much faster just based on one week of data

Julie Yates

Okay. And then what’s your expectation just in terms of how quickly that new program starts to flow – like when you will get fall – kind of a fall run rate?

David Cush

I think that, the things that we get last week, I think will spill very quickly. Just in a matter of weeks actually. We’re already seen it date-to-date start to build. So I think part of it is – just education of people. So, my expectation is that – if that was successful, and we think it was, that we should see some marginal improvement or benefit from it in the first quarter and full benefit by the second quarter.

Peter Hunt

Yes, let me just add to that Julie. The reason we’re not quite ready to give very specific guidance on – total other revenue is that with new market growth, there is different dynamics on – that piece for passenger and things like that in new markets, and we want to see how these new markets play out before we can see what the totals is going to. We certainly saw with new markets like Dallas last year, we saw a declines in revenue per passenger, and we want to see how that plays out in 2016. But the insulated pieces David is talking about, we think there’s going to be some really solid growth.

Julie Yates

Okay, very helpful. And then just a clarification on Dallas, are you guys saying that the pricing actually got worse in the fourth quarter or it did – just not improve as you might have expected, as the [indiscernible] capacity started to anniversary?

David Cush

Yes, in the fourth quarter from – what we’ve seen internally and what we’ve seen from publicly available data that the price environment got – was either flat or marginally worse, it certainly did not see any improvement in the fourth quarter. And actually, if you look in to the first quarter with – again publicly available data, it does not look like we hit an inflection point in the first quarter either.

Julie Yates

Okay. Got it and then I think in the past year actually given PRASM in Dallas, are you able to provide that for Q4?

David Cush

Yes. I am that PRASM and Dallas, year-over-year right, sorry, we are just confirming. PRASM and Dallas was, actually down only 3% in the fourth quarter, year-over-year but again, of course that had half a quarter of right amendment impact in it already. So the comps are looking a little bit better. But we had hoped that Dallas would turn positive in the fourth quarter given the fact that the costs were a issue.

Julie Yates

Okay, got it. And then…

David Cush

But on a sequential basis it did not improve.

Julie Yates

Got it. One last one, just – Peter what’s the impact of Easter you have embedded in your Q1 PRASM guide?

Peter Hunt

Roughly 3 points or 4 points of RASM shifting, because of Easter.

David Cush

On a monthly basis, not a quarterly basis.

Peter Hunt

On a quarterly basis, from April to March

David Cush

Yes, for the month.

Peter Hunt

Right, for the month, yes, that’s correct. It’s 3% to 4% for the month, roughly 1% for the quarter.

David Cush

Right.

Julie Yates

Okay, great. Thanks so much.

Operator

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

Dan McKenzie

Hi, good morning guys. I’m wondering if you can provide some perspective around growth going forward. So specifically, how should we think about growths from new markets versus existing markets and perhaps growth from large versus medium size cities?

David Cush

I think, in the past we’ve generally see, we were like 50% to two-thirds of our new capacity to go into existing markets. We think our footprint is big enough, and also where existing markets can sustain that rate of growth. And then, despite one-third, one-half of growth to go into new markets.

Peter Hunt

I would say, as far as big versus medium cities, by virtue of the fact that we are now in the top ten cities in both San Francisco and Los Angeles as of June. We’re not at the top ten in Los Angeles, but we are – new cities will start to be a little bit smaller. So there will be kind of midcontinent stuff, a little bit thinner routes. So we will probably serve with less frequency than would on the big thick routes.

Dan McKenzie

Got it, okay. And I know it’s early, but I’m wondering if you can talk about same store sales versus new market sales. Just I’m wondering specifically how PRASM in the new markets trending relative to your point, that’s been in place for, say more than 12 months?

David Cush

Yes, the new markets – the key new market we have of course is Hawaii. And what I will tell you is, the average fares has exceeded our expectation thus far, and again, we have only got a few months of data, but the average fare has been quite good, the loads have been a little bit lower than we expected, but on balance that has come out positive versus our forecast. What I will say, the result, very encouraging to us, is as we look at load bills going into – in February going into March and April, bode for us as well as for the industry. The Hawaii looks to be a market that is actually strengthening. So those are the key new markets we have. We look at Denver, which we haven’t started yet. It’s building as we would expect. So I’ll get back to my original comment. The PRASM performance is not really been driven by new markets, the new markets are actually in line with PRASM performance in the rest of the network. It really is very much focused on Dallas performance.

Unidentified Analyst

Understood. Okay and thanks for the time, guys.

Peter Hunt

Thanks.

David Cush

Thank you.

Operator

Thank you. And our next question comes from the line of David Fintzen with Barclays. Your line is now open.

David Fintzen

Hey. Good morning everyone. I just wanted to come back to transcon for a moment, not the New York, but you’ve seen Boston and both you’ve seen Boston have some capacity growth. If I look at DCA it seems like more bulk, so I’m curious if that has a pricing in fact and then you can get to America and Delta in Boston just – particularly through the Spirits bringing 1Q, in some of your Boston transcon bit of a drag relative to the…

David Cush

I think we’ve missed the last part of that question on Boston transcon.

David Fintzen

I don’t know on this – should we be thinking of Boston is a bit of a drag on this – so I’m just giving what some of the platform dynamic is there at least over the next four months or so?

David Cush

Yes. I think – I think that’s fair to say that capacity is up in Boston that it is a market that is heavily seasonal market. So certainly in January and February that capacity drags on everyone, I’m guessing. As we get into the summer, it will be up toward that capacity. So we think the Boston market will be fine. As far as the Washington market goes, DCA is essentially unaffected by BWI but IAD can have some impact from BWI. And what I would say as of now as we haven’t seen an impact on the pricing side, little bit of softness on the demand side from LAX specifically but not anything to be alarmed about. We don’t think BWI is having an outsize influence on the other airports.

David Fintzen

Okay. That’s very helpful. And then maybe just a quick one, just to clarify on Hawaii versus forecast. But with your forecast is little more optimistic as a new start for routes and maybe other routes. I mean that’s Hawaii has done a pretty strong starter for most carriers. Is that moving up faster than your typical new market?

David Cush

Yes. It’s certainly is moving up faster than other markets we have started and its actually and we expected it too, but it’s actually you know I’d say is moving up faster than even our projections were, so it’s a market that once you under for 90 days or so and you’ve been operating during the entire selling cycle and things turned out pretty quickly.

David Fintzen

Okay. That’s very helpful. Thank you.

David Cush

Thanks.

Operator

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

Rajeev Lalwani

Thanks for the time gentlemen. Just two questions for you. The first as it relates to your CapEx profile in the next couple of years. Just given the leases you announced, I'd imagine it's looking pretty good. I was just wondering how we should think about your deployment of any free cash flow going forward?

Peter Hunt

Well, we had free cash flow in 2015 and just given where fuel prices are and our expectations and analyst expectations for 2016 even with the growth looks like we will have free cash flow in 2016. This is a big discussion topic for the board right now I mean we are discussing this and analyzing alternatives. If we build a lot of excess cash, the uneconomic thing to do is sit on in them. So we're not going to do that but we haven’t made any decisions around specifically what we would do to redeploy that capital. I would love to find ways to deleverage I think I talked about that on earnings calls before, unfortunately most of our leverage is tied up in operating leases and so those are hard to deleverage. And we will look to returning capital to shareholders too.

David Cush

Yes, I think just to echo what Peter said what we're not going to do is sit on large piles of cash that are undeployed. The real question is how we are going to deploy them.

Rajeev Lalwani

Okay and what’s the timeline for maybe coming to analyst what something more definitive?

David Cush

Well, I think if things materialized as we expect in 2016 and the fuel prices stay low in the first half by the middle of the year will be thinking about, that will have excess cash at that time point of time. So I would think sometime in the next one or two quarters, we will make some decisions around that.

Rajeev Lalwani

Okay. That’s helpful. And then just switching gears on the PRASM side, can you just talk about what’s driving the I guess sequential improvement when you look at 1Q versus 4Q particularly given what others in the industry are saying and the fact that you’ve got capacity growth accelerating and some of the December softness you talked about so just some color there?

David Cush

Yes, that’s a tough question to answer just because I don’t know what the other guys are seeing. What I will say is if we look at ARC revenue going forward into the first quarter and the second quarter. What we are seeing is that our industry revenue looks like it’s going to be down perhaps 4% to 5%, which I think it’s in line with others who areguiding, part of it may have to do with – again our kind of underlying network strength that always come back to in the fact that we are trimming some exposure in weak markets. That’s giving us a little bit of mix benefit. The other thing of course has to do with the fact that our new capacity is actually coming on at or even slightly above the system RASM.

So that’s giving us a little bit of benefit too. What I will say in terms of the general market is the kind of 3% to 5% guidance that others have been given is not out of line with what we’re seeing in ARC data right now.

Rajeev Lalwani

Great, very helpful. Thank you.

Operator

Thank you and our next question comes from the line of Steve O’hara with Sidoti and Company. Your line is now open.

Steve O’hara

Hi, good afternoon. Thanks for taking my question.

David Cush

Hi, Steve.

Steve O’hara

How are you doing? I was just curious about with one of your competitors expanding the lie-flat product and I am just wondering how you feel and you compete against that product now I mean versus maybe when it first came out has there been any shift in demand or maybe further degradation in the transcon first class revenues and then maybe an argument as to why you wouldn’t pursue a similar type of product?

David Cush

A couple of things and maybe I’ll actually start on the cost side. the reason we have not pursued that product very simply is because we believe that ubiquitous fleet has a tremendous cost benefits, some of which are identifiable, some of which I think are systemic and complexity related cost that are maybe a little bit more insidious and more difficult to recognize.

So we are a big believer and single fleet types, single configuration and if we had a lie-flat seats those would be airplane would have to be isolated to certain routes. On the revenue side what I say it’s a – we’re actually quite happy with how our performance is stacked up versus JetBlue. All we can look at is publicly available data but we know a couple of things, one is that our yield and our RASM I should say year-over-year in the third quarter and particularly in the fourth quarter in these markets has improved. So some of the impact we saw in the marketplace has been digested and now we’re seeing improvement in JFK – in the JFK market.

Second thing I will say is with publicly available information we are still running at roughly PRASM parity to JetBlue in JFK LAX and JFK San Francisco. At the same time we’ve got a significant density advantage that they are running 159 seats on A321, and we’re running a 149 seats on A320. So we think that on balance on the cost side the benefit is pretty clear. But even on the revenue side we think the fact that we’ve got a smaller cabin that we been able to take a higher average fares has actually benefited from us. And then of course the other thing we look at is what's going on in the marketplace and there are still plenty of 7.99 fares out there in first class transcon. And our math just can’t justify a lie-flat seat for 7.99.

Steve O’hara

Okay. Thank you very much. And then just on the neo, I mean is there a few I mean does the decision to take the neo in 2017 depending – depend on fuels returning to normalized levels to kind of offset may be the higher aircraft costs, or is it the economics are so much better than kind of what the competitor has? And then maybe, once the industry transitions to maybe more economical fleet overall, how do you retain that benefit as opposed to maybe just passing it along to the customer, which – some of which certainly seems to be happening with fuel right now?

David Cush

Well. I'll start on the question on the aircraft [indiscernible] versus neo. We went into the marketplace. We look for pricing on both [indiscernible] and neo’s and there are still a number of new [indiscernible] delivery positions available out there, but the lease rate differential between the two, was not that significant. I think there is a lot of supply of neo’s, lessors have a lot of aircraft on order in 2017, 2018, and 2019, particularly in 2018 and 2019.

And the incremental cost of the neo was not as great as you would think. It's not based on fuel prices returning to some normalized levels something higher than where we are today, even with the low fuel prices we have today. So lease rates we've gotten the CASM on this is still going to look really strong.

Peter Hunt

I’ll just chime in on whether we will just give away the fuel benefits. I think that’s an industry phenomenon and a single aircraft type or have been a single carrier would not necessarily influence that. What that would says as a positive thing whether it's what we're doing, whether it's even with our competitors like Southwest is doing in terms of upgrading their fleet. I just think at this points to a healthy future for the industry that we actually have cash now to go in and make sure that we are efficient as an industry in future years should feel go up.

So we’re kind of buying a natural hedge for lack of a better term by upgrading our fleet. And I think the fact that people are doing it even with low fuel prices it is a bullish sign for the industry going forward.

Steve O’hara

Okay. Yes, thank you. I mean when I look at some of the A4A charts on inflation and adjusted airfares and so forth it’s pretty stark in terms of how performed over the years. And I guess, it would seem to me that airfares are still pretty good bargain based on the capital and costs and complexities of the business. So I would really hope that the things move up. Thank you very much.

David Cush

Thank you.

Operator

Thank you. And our next question is a follow-up from the line of Hunter Keay with Wolfe Research. Your line is now open.

Hunter Keay

Hi, thanks a lot for follow-up. I appropriate it. Just two quick ones here, really been a quick one, but David, can you talk a little more about Dallas and how you expect to find some equilibrium there, as you have a bunch of airlines chasing the same passengers over time. May be it’s a longer-term question, but how do we find an equilibrium in that market over time?

David Cush

Well, I think, – you know Hunter, one of the things that we've decided is that we are not going to fly passengers when we can’t at rates that will not make money. And there have been $30 fares from Dallas to the West Costs, there are $41 fares from Dallas to LaGuardia in the marketplace right now, and we simply are not matching those fares. So what we're going to do is to make sure that we get our average ticket value up to a point where it’s sustainable and where it can earn a return, and will take a hit on load factors. So that's how we're going to manage things going forward.

And of course, there are others, that two large carries that impact of market much more so than us. But I want to come back to my other point is, this is no longer a supply and demand issue as it originally was. When all the new supply came into Dallas everything we saw was to be expected. If you got somewhat static revenue demand a lot of new capacity coming in. [Audio Gap]

Hello?

Operator

Ladies and gentlemen please stand-by, your conference call will resume momentarily. Once again, thank you for your patients and please stand-by.

David Cush

Guys?

Hunter Keay

Guys, hello.

David Cush

Hey, Hunter you there.

Hunter Keay

Yes, I can here you now.

Peter Hunt

I set a whole lot of really insightful stuff when we are cut off.

Hunter Keay

I’ve build out.

Peter Hunt

But anyway, look I want retread everything. I’ll say as if you were supply and demand driven as it was initially when the right amendment expired. It's a little bit easier to predict, but given the high load factors, given the willingness of competitors or so, half of their airplanes at $100 fares. It is just tremendously difficult to understand when things are going to equalize. Everyone is feeling the pain. As I said Dallas, DFW fares and these markets are down 30% year-over-year or so. We are not alone in it. I think at some point, it will take a change. It goes beyond supply and demand to fix this so I’m just trying to be very careful here.

Hunter Keay

Yes.

Peter Hunt

But all I'm saying is it's not as clear as perhaps other markets are in terms of figuring out when things will hit the bottom and settle out.

Hunter Keay

So do you think maybe then David, that as the segmentation evolution evolves and maybe some of these $41 payers are not consumed by people that are not supposed to be buying them or consumed by the less loyal passengers and the less sticky passengers that maybe things, is it fair to say that’s going to be beneficial for Virgin even though it’s not your initiative, that as the market gets sort of tidied up and not just in Dallas this is a broader comment too. As the industry continues to evolve a segment in customer price point, is that going to be something that's positive or neutral for you guys, or it just somehow possibly worth for you guys that you are going to find new way to compete.

David Cush

No. It’s definitely positive for us. That – part of the problem right now is not only the fares, but also the rules around the fares. You’ve got to walk up there for double-digit in some of these markets. So if your thesis is that the other big carriers are going to go in and create this economy minus product or whatever you want to call it, and then not only segmented by product, but now more actively segmented by advanced purchase another things and that's tremendously beneficial for us. Because what we decided to do is just ignore that segment of the market. It’s much more difficult on the load factor much more painful on the load factor than ignoring that segment against an American airline that has a full-service product. If American and others go in a strip down their product and that's what we're ignoring then certainly were going to be able to compete a lot better.

Hunter Keay

Thanks a lot for the time and the color. I appreciate this.

David Cush

Thanks.

Operator

Thank you. And this concludes the question-and-answer portion of our call. I would like to turn the call back over to Stephen.

Stephen Shulstein

Thank you, everyone. We appreciate your questions and for taking the time today. If you have any further comments or questions please reach out. Thanks again. Have a great day. Bye bye.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.

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