Allegiant Travel (ALGT) Maurice J. Gallagher on Q2 2016 Results - Earnings Call Transcript

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Allegiant Travel Co. (NASDAQ:ALGT)

Q2 2016 Earnings Call

July 29, 2016 12:30 pm ET

Executives

Christopher Allen - Director-Investor Relations

Maurice J. Gallagher - Chairman & Chief Executive Officer

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Tom Doxey - Vice President of Fleet and Corporate Finance, Allegiant Travel Co.

Lukas Johnson - Vice President-Network & Pricing

D. Scott Sheldon - Chief Financial Officer & Senior Vice President

Analysts

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Richa Talwar - Deutsche Bank Securities, Inc.

Julie Yates - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Savanthi N. Syth - Raymond James & Associates, Inc.

Helane Becker - Cowen and Company, LLC

Rajeev Lalwani - Morgan Stanley & Co. LLC

Duane Pfennigwerth - Evercore ISI

Matt Morris - Wolfe Research LLC

Dan J. McKenzie - The Buckingham Research Group, Inc.

Steve M. O'Hara - Sidoti & Co. LLC

Operator

Good day, ladies and gentlemen, and welcome to the Allegiant Travel Company Second Quarter 2016 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call may be recorded.

I would now like to turn the conference call over to Chris Allen, Investor Relations. Please go ahead.

Christopher Allen - Director-Investor Relations

Thank you. Welcome to the Allegiant Travel Company second quarter 2016 earnings call. With me today are large cast of characters, including Maury Gallagher, the company's Chairman and Chief Executive Officer; Scott Sheldon, our Chief Financial Officer; Jude Bricker, the Company's Chief Operating Officer and SVP of Planning; Greg Anderson, the Principal Account Officer; Tom Doxey, the Vice President of Fleet and Corporate Finance; Lukas Johnson, Vice President of Network and Pricing; and Trent Porter, Vice President of Financial Planning.

In addition to the earnings release that went out this morning, we also included a presentation providing further detail on our acquisition of new Airbus aircraft. As such, Maury and Jude will have some brief commentary, followed by Tom Doxey providing some highlights of the aircraft presentation. After that, we will open it up for questions.

Before we begin, I have to remind listeners that this company's comments today will contain forward-looking statements and they are only predictions and involve risks and uncertainties. Forward-looking statements made today may include, among others, reference to future performance and any other comments about our strategic plan. There are many risk factors that could prevent us from achieving our goals and causing the underlying assumptions of these forward-looking statements and our actual results to differ materially from those expressed or implied by our forward-looking statements. These risk factors and others are more fully disclosed in our filings with the Securities and Exchange Commission.

Any forward-looking statements are based on information available to us today. And we are undertaking no obligation to update publicly any forward-looking statements whether as a result of a future events, new information, or otherwise. The company cautions users of this presentation not to place undue reliance on forward-looking statements, which may be based on assumptions and events that do not materialize. This earnings release, as well as the rebroadcast of this call, are available on the company's Investor Relations website at ir.allegiantair.com.

With that, I'd like to turn it over to Maury.

Maurice J. Gallagher - Chairman & Chief Executive Officer

Thanks, Chris, and good morning, everyone. Typically, as you've become aware, we don't have comments on our quarterly calls, but given the recent events, we felt it was appropriate to anticipate some of your questions and throw some comments your way. I'm going to take a few moments to talk about some of the events; Jude will comment, as Chris said, on some of the revenue; and Tom Doxey will provide some color on the deck as to the release.

I can't tell you how much I'm very pleased to announce that we've completed our historic first agreement with our pilots. First-time labor agreements are traditionally very difficult and time-consuming, usually taking years to complete, and that was the case in our situation. It took a great deal of hard work by our pilots' negotiating team, the IBT, and our management negotiating team. Our pilots' ratification of this five-year contract reflects the endorsement of the offer we put in front of them. It's a good deal for both sides and it will be in effect this coming Monday.

We've commented previously on the retirement of our MD-80 fleet. The MD-80 has served us well since our coming out party in 2002, but it's time to move on. We've known for some time we would have to make this transition. We introduced our first Airbus to that end in early 2013 and currently have 33 in service. We initially planned retirement of the MDs by the end of 2020 or into 2021. However, after more recent review, we've decided to accelerate this timeline to mid-2019. Historically, consumers have used aircraft and have become very efficient at sourcing and delivering them. But our decision to pull forward the retirement of our MDs requires us to source additional Airbus in the near-term to support this decision.

We are fortunate to be at a moment in time when Airbus had an attractive supply of Airbus 320s, with COs available for delivery during the next two years. To that end, we recently signed an agreement to purchase 12 of those aircraft. This purchase increases our in-service and future Airbus aircraft commitments to 77. And we are targeting approximately 90 to 100 aircraft when we finished the transition in 2019. This new aircraft purchase will represent approximately 10% of our planned fleet at that time. And this small sampling of new aircraft does not mean a change of direction or an altering of our model; we will still be a low-cost, low utilization carrier focused on weekly frequencies and providing the least-cost service to our leisure customers.

We also recently reported the results from our review by the FAA, what they term a CHEP inspection, CHEP. We and the FAA are partners in our efforts to offer safe air travel to our customers and team members. It's job one. Correspondingly, the FAA has a duty to make sure carriers are operating at the highest levels of safety, and we at Allegiant are committed to this level of safety as well.

One of the ways the FAA accomplishes this inspection goal is through periodic in-depth review of carriers. During the second quarter, there were approximately 30 FAA inspectors in and around our operations. Practically any carrier who has a review of this magnitude will have findings, and so did we. But as we've said in our note, all of our findings were characterized as minor or less than minor by the FAA. While we take all findings seriously, we were pleased, although not surprised, with this outcome. In the next 60 days, we will be responding to the FAA with a plan to remediate these minor findings.

Lastly, I want to thank all of our team members for their efforts during the past many months, particularly during the FAA CHEP review. You were cooperative and very professional, and your efforts to build this company to the highest levels of safety were definitely highlighted by this review. Jude?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Thanks, Maury. I wanted to give a little bit of color to help interpret our revenue results and guidance. First, we suffered higher than expected cancellations during the summer months, which will adversely affect second quarter and third quarter results by between 1 percentage point and 0.5 percentage point. Additionally, as many other carriers have spoken up about during this earnings cycle, we see close-in bookings underperforming our own expectations during peak periods, particularly in the late June period. We think this accounted for about 1 percentage point down relative to our own expectations.

As we talked about in previous quarters, we also continued to face some of the yield pressure that we've spoken about, including increased growth in off-peak seasons and days of weaknesses in markets that depend on cross-border traffic. We have a large presence in some middle (7:00) economies that are in decline and we're also getting some catchment area pressures when there is fare warfare in a big market where we have adjacent cities.

Also, we may get some questions on Newark, given we're currently flying Baltimore-Washington International. I just want to give a little bit of color on that. These are large markets, but we're selling them primarily as destinations and on non-competitive routes. New York and Washington are two of the largest leisure destinations in the U.S. and adding them is complementary to our total leisure offering in many of our cities. I think over time we'd like to originate traffic from these markets, but we don't depend on that in order to be successful. We look at it more like LA and Oakland, where we were originally selling it as an inbound product offering and then over time we think we will be able to originate into those markets because we're flying non-competitive routes.

Also before questions, I wanted to address recent market announcements by Frontier and Spirit. And while we're disappointed about the encroachment into our markets, the capacity adds, represented by markets announced in the last two weeks, really represent only about 2% of our total ASM. Throughout our history, competition has come and gone and we've never, though, seen a competitor come into a market that we were first able to establish a presence and then they were able to push us out. That's because we fly a schedule that focuses on peak times of day, peak days of week, and peak seasons, and combine that with a closed distribution model, it's very difficult for a competitor to come in, and over those long period of time be successful while adversely affecting us.

Finally, I talked a little bit on our operational issues. The initiatives that Maury spoke about, I think, are part of the healing process there and we're getting a pilot contract and a new fleet deal, putting the CHEP behind us. But to generalize our problems, it really comes back to the reliability of our MD-80 fleet, which underperformed our own expectations. And I think over time to solve that problem has to do with us replacing those aircraft. In the near-term, though, we're going to be investing in the way that we schedule the airlines specifically, over-sparing that fleet while it twilights and isolating it into just a few of our bases.

So, with that, I'd like to turn it over to Tom for some details on our fleet deal that we're announcing this morning.

Tom Doxey - Vice President of Fleet and Corporate Finance, Allegiant Travel Co.

Thanks, Jude. So, I'll just add a bit of additional detail to what Maury commented on in his introductory remarks and then briefly walk through the slides that were sent out along with the press release this morning. So, today, we announced an order for 12 new Airbus A320 aircraft; that will expedite the retirement of our MD-80 and 757 fleets. We now expect to have an all Airbus fleet by the end of 2019, which as Maury stated, has moved up from the 2020 or 2021 timeframe. We expect that that will reduce much of the complexity associated with operating our current mixed fleets. And this factory order for new aircraft is a notable first for the company and should not be read as a change in our strategy.

We have always been opportunistic buyers of aircraft to support our fleet and this transaction is certainly no exception. The deliveries begin next year and will be completed by mid-2018. The aircraft will have a high degree of commonality to our current A320 fleet, and the overall economics of the transaction are supportive of our unique low-cost, low-utilization business model. We continue to be an opportunistic buyer of low-cost aircraft and our focus will be on used A320s going forward. With this latest announcement, we now have added 27 incremental A320 family aircrafts so far this year. That's 15 used and 12 new, and in total, we now have 77 A320 family aircraft, either in service or committed for future delivery. We expect to add to that with additional transactions going forward.

So in the presentation, you can see on slide four, as we had previously discussed, which shows our fleet plan by type, by year. You can see the 757s out of the fleet by 2017 and you see the MD-80s fully out of the fleet by 2019. Also of note on this slide would be the number of new aircraft in 2019 being 12 of 99, representing a pretty small proportion of that overall fleet at that time.

On slide five, there are a lot of numbers relating to our utilization. I'm not going to walk through all of those numbers, but what you can see as you read through that, is that we're not making any assumptions about a change to our schedule or about a change to our network in order to justify the induction of new aircraft into the fleet. They fit well into the existing network and existing structure. Also of note would be the unit cost decreases that we should see as a result of operating these new aircraft, which of course will be new, which comes with a maintenance honeymoon, and also brings with it the Sharklet, which will result in a fuel benefit for us, as well.

Finally, you see in the last bullet there, we expect that we will be able to continue to have favorable financing terms proposed, and judging by the number of emails I have in my inbox this morning just in the few hours since the announcement has happened, I continue to be confident about that last bullet point being true.

Slide six, really what we want to show here is that the benefit here is largely in fuel and that going along with that unit cost benefit that is derived from fuel, I think folks would be surprised to see that the ownership change is not as drastic as one would expect. In fact, it's very slight. We've always been very conservative about the way that from an accounting standpoint, depreciated our used assets. And so I think what you see here is that there's not a very drastic increase in unit ownership costs even with the new aircrafts.

On slide seven, and I mentioned this earlier, we are not expecting to make any changes to our schedule or to our network to be able to justify these new aircraft coming into the fleet. These boxes are supposed to each represent a segment of the lines we're flying by how many hours per day, per aircraft, are flown within each of these segments. You can see that first segment, which is the red box, is a relatively high number of hours per day, north of 10 hours; even the second box, which is quite large, north of eight hours. So while we're overall a low-cost, low-utilization carrier, there are certainly areas of our network that are very high utilization. And these new aircraft with their low unit costs will fit very nicely there. Certainly, Lukas can answer any additional questions related to that.

And then finally on slide eight, this just gives some of our forecast related to ASMs which will be talked about later in the presentation.

With that, we'll turn it over to questions.

Question-and-Answer Session

Operator

Our first question comes from Joe DeNardi with Stifel. Your line is open.

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Hey, thanks very much. Jude, just a couple questions on kind of Spirit's commentary this morning around Akron, they indicated that they view the market as being served sub-optimally now, that it used to handle daily service and that it can now. Do you agree with that? And maybe this is for Lukas, how many more markets are there that you think could potentially be interpreted as capable of handling daily services?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Let me give you some – I'll let Lukas talk about Canton specifically and then other markets. We are very, very difficult to push out of a market because, whether or not there is unmet demand, un-served demand in the market or not, we're taking the highest yielding times of day, days of week and seasons. And so the effect of that is that, even if there is a competitor that comes in the market, and we've seen this with several markets throughout our network, they will yield significantly low average fares because they are having to fly a daily schedule that includes off-peak periods, whether it's Canton or anywhere else. Then I'll turn it over to Lukas to give some specific color to those markets.

Lukas Johnson - Vice President-Network & Pricing

Hey, Joe. In terms of the Canton, Akron, and Cleveland markets, there's a little bit of separateness between the markets, but it really is one large market. Seats in that market compared to six or seven years ago are up 25%, almost all of which are ULCC or LCC seats to Florida. Those are seats to Florida. Fares are down 20%, 25% in that period.

So, I don't think you can take the experience of when you had it out of Cleveland hub and high fares out of there, and translate it to the marketplace today. So, in terms of whether we're serving it suboptimally, to us, looking at our network and balancing it, we want to serve optimally to our margins. Whether another carrier has a different margin target and which used to have a lower margin by serving more frequency, that's up to them. But we do feel pretty confident in the amount of service that we have there and as we continue to grow throughout the region, I think we will expand that.

And in terms of your second question, how large can the overlap be? You're really looking at specifically some of the major Florida destinations to some of our midsized markets. Again, it's fairly limited. Something in the 5% of our ASM range could potentially be overlapped with more than two-week or three-week service. So, that's kind of bracketing the exposure.

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Okay. That's really helpful. Jude, just on the – or maybe Tom, on the aircraft order, did the new Airbuses open up new markets for you in terms of maybe transcon or longer haul or is it just the plan is to use them as you use the other 320s?

Tom Doxey - Vice President of Fleet and Corporate Finance, Allegiant Travel Co.

No, those aircraft for the next several years will be applied to routes and schedules that we already expect to operate.

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Okay. Thanks.

Operator

Thank you. Our next question comes from Mike Linenberg with Deutsche Bank. Your line is open.

Richa Talwar - Deutsche Bank Securities, Inc.

Hey, everyone. It's actually Richa Talwar filling in for Mike. Good afternoon. First, I wanted to follow up on a point, Jude, you made, about some of your yield pressure attributable to areas where – and cities next to larger markets that you serve where you're catching some of the price wars going on or the effect of the price wars going on? Can you elaborate on that? And which markets are you seeing some of the most egregious elements of that dynamic?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

I think what we've talked about before remains in effect where the Philadelphia to Florida market continues to have adverse effect on our adjacent markets around that region to include Allentown, Scranton, Hagerstown and Harrisburg and that would be the primary market. Everything else is sort of – there's definitely yield pressure in Chicago and that adversely affects Rockford, Illinois. Out west, we're seeing continued low fares for flow traffic into LA. While we may not have direct nonstop competition, we're seeing flow over Salt Lake City or even Vegas, very competitively priced. I think it's more generally speaking we're seeing that leisure fares remain very, very competitive across the U.S. domestic market. Just not a change of what we've seen in the past. I want to characterize it as being worse than it has been.

Richa Talwar - Deutsche Bank Securities, Inc.

Okay. That's very clear. Thank you. And then my second question is on the new pilot deal. Can you tell us how much cost inflation we should expect the pilot contract to add next year?

D. Scott Sheldon - Chief Financial Officer & Senior Vice President

Yeah, this is Scott. I think in the release we put out earlier this month we said it's approximately $44 million on a full-year basis. So, as Maury indicated in his prepared remarks, that starts August 1, so it gives you a data point to go off of.

Operator

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

Julie Yates - Credit Suisse Securities (USA) LLC (Broker)

Thanks for taking my question. Jude, do you have an update on the timing of the credit card launch?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Yes. We're still planning on launching it in September. It's on track.

Julie Yates - Credit Suisse Securities (USA) LLC (Broker)

Okay. Great. And just to be clear, we shouldn't expect any meaningful contribution until 2017?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

That's correct.

Julie Yates - Credit Suisse Securities (USA) LLC (Broker)

Okay. And then is there any other color that you can give us on the cadence of the months for the quarter, headwinds, tailwinds, anything we should be aware of, comp issues?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Are you talking about for third quarter, Julie?

Julie Yates - Credit Suisse Securities (USA) LLC (Broker)

Yes. Third quarter TRASM.

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Let me turn that over to Lukas.

Lukas Johnson - Vice President-Network & Pricing

Hey, Julie. September is outsized ASM growth for us this year. And that's in part, because that's where we had space to add. But, also due to some of the timing of the days of week, we added a Sunday and Monday, which is a peak two days for us, into September. So, in terms of where the capacity is being added, it's certainly being added into a lower TRASM month, which drives some of the overall lower quarter numbers you're seeing.

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Julie, just a little more color further out. In past earnings, we've talked about sequential improvement on a year-over-year basis. We still expect to see that. And going into 2017, because we are going to pull down growth significantly in support of the fleet transition program, we would expect to continue to see year-over-year sequential improvement.

Operator

Thank you. Our next question comes from Savi Syth with Raymond James. Your line is open.

Savanthi N. Syth - Raymond James & Associates, Inc.

Hey. Good morning. Just a follow-up on that, the slowing of capacity growth. What's the expectation on how that impacts cost and how we should think about next year?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Well, so ASM growth for 2017 and 2018, kind of while we're in the middle of this, we're guiding to a 5% to 10%. So think about high-single digit ASM growth while we essentially reload for future growth. And I'll turn it over to Scott for more specifics on cost.

D. Scott Sheldon - Chief Financial Officer & Senior Vice President

Yeah, I mean, there's definitely going to be some pressure. You're going to have the full-year 2017 with different pilot economics. I would say the flight attendants are out there and we're going to work through that as well. We are still struggling as we transition through back to the single fleet type of productivity for our flight crews. I think if you look at the in-state of a single fleet type versus three fleet types, there's a lot of inefficiencies in a lot of work groups. So, maybe that's a tailwind that we can expect.

The deferred maintenance treatment for the Airbus should help with the volatility within the maintenance line items. So you should start to see maintenance expenses come in as we forgo any heavy maintenance on the MD-80. And then D&A would start to tick up. But full-year 2017, there's definitely going to be some upward pressure from full-year 2016.

Savanthi N. Syth - Raymond James & Associates, Inc.

So, Scott, if you didn't have the pilot and any labor deals coming in, when you're growing that level given you're still flying multiple fleets at least through I think Labor Day of next year, are we talking about like low-single digit type cost pressures or how...

D. Scott Sheldon - Chief Financial Officer & Senior Vice President

Yeah. We'll give a lot more color towards the end of the year on our Investor Day, but low-single digits is a decent proxy.

Operator

Thank you. Our next question comes from Helane Becker with Cowen and Company. Your line is open.

Helane Becker - Cowen and Company, LLC

Thanks very much. Hi, guys. Thank you very much for the time. Will there be an acceleration of pilot training costs as you push pilots from the MD-80 to the new A320s? And is that included in cost guidance?

D. Scott Sheldon - Chief Financial Officer & Senior Vice President

Yeah. This is Scott. The run rate on pilot training costs and the costs associated with moving crews around to our facilities, basically that's baked in and it's a steady-state. And so you'll start to see that tail off as the two fleets that we're transitioning out of get smaller and smaller. So the run rate over the next couple years would be similar to what we're seeing now.

Helane Becker - Cowen and Company, LLC

Okay. And the on the new pilot agreement, maybe you can answer I think the question is more like does it enable you to retain more pilots? And what's the attrition rate looking like now?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Well, it just got ratified yesterday, Helane, so we don't really know. We have...

Helane Becker - Cowen and Company, LLC

No, I don't think that was what I meant to say. I don't think that was the question. It was really like, as you think about implementing the contract, does it enable you to retain more pilots? And how has the attrition been up until now?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Well, attrition increased at Allegiant in 2014, as we had some challenges implementing under 117 and we've basically been static on attrition rates between then and now. Since we announced the tentative agreement, we've seen 50% drop in our attrition rates. But that's a pretty short sample. We expect certainly to retain more pilots under the new agreement than what we had prior.

Operator

Thank you. Our next question comes from Rajeev Lalwani with Morgan Stanley. Your line is open.

Rajeev Lalwani - Morgan Stanley & Co. LLC

Hi, gentlemen. Thanks for the time. Jude, you previously talked about needing to spend about $1 billion to get out of the MD fleet and transition over to Airbus. Is that number still good?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

No, we're going to spend more than that now. The CapEx on the new aircraft is higher than what we would have expected had we done this with just used airplanes. What it does allow us to do, as Tom said, get out of the airplane earlier. And as we transition, this is a complicated exercise to transition from one fleet to another. And there's value in getting airplanes reliably on time, on spec, and with immediate increased reliability. And so there's a lot of value in these airplanes in addition to the fuel burn and the spec increases and the like. But, yes, they're expensive. We're going to increase that number.

Rajeev Lalwani - Morgan Stanley & Co. LLC

And so what should we look at or think about for annual CapEx for the next couple of years versus what we saw historically I guess?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Yes, because we're still working on some of the transactions that will support the fleet plan that Tom laid out, we're not ready to give CapEx guidance for 2017 and beyond today.

Operator

Thank you. Our next question comes from Duane Pfennigwerth with Evercore ISI. Your line is open.

Duane Pfennigwerth - Evercore ISI

Thanks. I wondered if you could put a finer point on the relative pricing between these new aircrafts. Was this a function of being incredibly opportunistic because you got just a great deal or is it more driven by you just can't find sufficient used supply?

Maurice J. Gallagher - Chairman & Chief Executive Officer

Yes.

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Yes, Duane I think our economics were very good. Obviously, we're not going to be overly forthright about exactly where they were, but we think that they're good and they will allow us to continue as I stated before to effectively execute on our low-cost utilization model. I might just leave it at that as it relates to the – I think it's worthwhile to stress the complexity of buying a used airplane; for financing it, for transitioning it into the fleet, which really limits our pace of taking on Airbuses. And when we're buying directly from the manufacturer with, as Tom said, a very supportive debt finance market, we're going to be able to increase that number. So it's not really whether or not we're buying used or new. It's whether or not we're buying new and replacing MD-80s earlier than would otherwise have happened.

Tom Doxey - Vice President of Fleet and Corporate Finance, Allegiant Travel Co.

And to your comments, Duane, on the used market and whether used market can support us, we've added 27 aircrafts, including the 12 new. We've added 27 additional commitments so far this year, and 15 of those 27 were used and I expect it will add additional used transactions as this year goes on. So as Jude said it's really about speed and it's really about our ability to transition when we want to transition, and then the opportunity from Airbus was opportunistic. It's something that was attractive to us.

Maurice J. Gallagher - Chairman & Chief Executive Officer

Duane, it's Maury. The other thing too is to come out the other end so that you recognize the size and what we are, you fit into the scope of where we need to be, and we felt we had to be in that 90 aircraft to 100 aircraft range and we're well on our way to getting there by the mid-2019 timeframe. And so all these components add up to a strategy that says get us ready to be there when we hit that timeframe as well as have the MD-80s gone. This all fits together in a nice jigsaw puzzle. We've got another piece or two to put in there, but we should be able to get there and execute and it will be work to get from there. But the airplanes are critical, obviously, to make the transition.

Duane Pfennigwerth - Evercore ISI

Thanks for that. And then just with respect to the tentative agreement and some of the noise and the chatter and operational impact. Have you seen any change yet or maybe improvement in your reliability since the TA was put forth? And to what extent does your guidance include the carryover of some operational impact, which we should expect to subside now that you've got this deal done?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

The guidance that we issued today includes the operational challenges that we have had through thus far in the third quarter and including through the peak period of operation which for us ends about mid-August.

On the other point, the issue that we're having is predominantly to do with aircraft availability and reliability. So the TA helps us in the sense that it stabilizes our staffing across multiple basis and types, and the challenges that we had on the staffing side often had to do with attrition that was unpredictable and lumpy, specifically to small bases. And I expect that to be a much better situation for us going forward. But I attribute most of our operational challenges not to any sort of labor action or anything like that. It wasn't that. It's really more of reliability of our fleet, which we're addressing.

Operator

Thank you. Our next question comes from Hunter Keay with Wolfe Research. Your line is open.

Matt Morris - Wolfe Research LLC

Hey, guys. It's actually Matt Morris on for Hunter Keay. Thanks for the time. Just to talk a little bit more about you said you guys were facing reliability issues mainly relating to the MD-80. Can you give us a bit more detail on how that impacted your operations this quarter and maybe you guys said you were planning to add more spare count in your network fix it. Is that something you can reschedule in near term? Is that more like a fourth quarter type event?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Hey, Matt, so, yes, so we have utilization, but in truth we have really high utilization on a couple days of week. And what that does is that our MD-80 fleet is fully allocated maybe four days a week, and in the summer months it goes to about five days a week, particularly in Florida. And what we've seen as the fleet has aged and now we're with some airplanes that are probably over 30 years old. And as we schedule the airline, which includes flights in and out of isolated areas with little to no support, that reliability level that we're able to achieve with that airplane doesn't support our network growth plan.

And so the MD-80 just really can't support the utilization that we need specifically on those days. So what's happened in our operation over the summer is we'll have an aircraft breakdown at an outstation or even at base and we'll be in a short scenario. We'll cancel the flight and put it off to the next day until we've consumed all our resources or flown the flight. And that recurring cycle has been a bad experience for our customers and it's quite frankly expensive to operate as well.

So to your next point about when we can put sparing into the system, it's really a next summer issue. We're going to continue to operate for the most part the schedule that we have loaded and we're selling until mid-February. And we'll start baking in some more conservative assumptions on the reliability of our fleet as we move forward, particularly as we schedule the next summer.

But the fleet plan will really facilitate that in the sense that we're going to be able to put MD-80s into fewer and fewer bases and we're going to be able to isolate the support required to operate that aircraft as reliably as can be expected.

Matt Morris - Wolfe Research LLC

Okay. That's helpful. Thank you. And if I could, just real quick on Savi's question, you guys said – she was asking about 2017 capacity. Could you give us something like the moving parts with when you expect to retire the MD-80 aircraft and is it still your expectation to fly the 767 through Labor Day 2017? I'm just trying to get back to how you guys read into ASM growth of 5% to 10%.

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Okay. So the 757s will be retiring at the end of 2017. More specifically, Honolulu as a base will shut down in August, or really Labor Day of this year and then will continue to fly only one Honolulu route out of Vegas for the full year, Labor Day to Labor Day into 2017. And then we'll be out of that fleet by the end of that year.

The MD-80 retirement is delineated on the fleet plan that we issued. But just keep in mind that an A320 coming in produces quite a bit more ASMs because of increased gauge and also higher utilization. So it's difficult to – if you take a look at the fleet plan of 2018 that's 93 airplanes relative to 91 airplanes in 2017. It doesn't mean that there's the proportional growth. There's a lot more growth than that in that number. So I think we'll be able to attain the high-single digits for those two years.

Matt Morris - Wolfe Research LLC

Thank you.

Operator

Thank you. Our next question comes from Dan McKenzie with Buckingham Research. Your line is open.

Dan J. McKenzie - The Buckingham Research Group, Inc.

Hey. Thanks, guys. Jude, I know you're not ready to talk about CapEx for the next couple years, but I'm wondering if you could provide some perspective on whether you want to own or lease the aircraft? And then Maury, related to that, I wonder if you could talk about how our new CapEx trajectory might or might not impact stock buybacks or dividends. How should investors think about capital returns going forward?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Hey, Dan. We intend to own our fleet as we have done in the past as of today, pending any changes to availability of aircraft or financing terms.

Maurice J. Gallagher - Chairman & Chief Executive Officer

Yes. On the CapEx, the interesting thing about the Airbus is, in many ways it can create as much or more cash than buying MD-80s, because they're very financeable airplanes. And so the way I look at our business, while it's called CapEx, it's an asset we need to go create income. So the new airplanes are certainly going to cost more, but we're looking at those as kind of double the life that we would otherwise do for a used airplane. So the ownership is the same economically and you'll be able to finance in them same, if not better, frankly, just because of what they are.

So, yes, the CapEx is going up, but the consumption of cash I don't expect would change. In fact, it might even be a little bit better in the absolute because of the ability to finance newer airplanes even more so than the used airplanes.

Tom Doxey - Vice President of Fleet and Corporate Finance, Allegiant Travel Co.

Dan, this is Tom. Maybe just one follow-up to Jude's comment would be that what we've seen in the financing markets is that the debt markets have been able to give us more credit I think for the balance sheet and the financial stability of the company than the leasing markets have. They just tend to price that in I think more efficiently.

Dan J. McKenzie - The Buckingham Research Group, Inc.

Okay. Well, that's all very helpful. Thanks. And then one final question here. The FAA findings, lots of minor stuff. Does the current cost outlook factor in potential cost pressures here from complying with the directives?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Well, there's not a whole lot of cost associated with that compliance requirement. So, you know...

Maurice J. Gallagher - Chairman & Chief Executive Officer

A lot of them are manual changes and it says do you do this, and technically we were doing it a little bit differently. So when you send 30 people around for 90 days in any organization, they're going to find stuff, as well they should. And we'll respond and adjust it. But there's nothing that operationally we're going to do substantially different or have to enhance, if you will, to conform or comply at this point.

Operator

Thank you. Our next question comes from Steve O'Hara with Sidoti. Your line is open.

Steve M. O'Hara - Sidoti & Co. LLC

Hi. Good afternoon. I was just wondering maybe your perspective on the industry and I think there's been some talk about the industry being in crisis with unit revenues on the decline. Just wondering your take on that and do you see the industry getting to maybe the lower long-term target margins by continually degrading unit revenue? And maybe if you could just give your thoughts on that. Thank you.

Maurice J. Gallagher - Chairman & Chief Executive Officer

We should have more crises like this.

Steve M. O'Hara - Sidoti & Co. LLC

Yeah, I agree.

Maurice J. Gallagher - Chairman & Chief Executive Officer

We're operating at – what was it? 30% on the second margin? Love was 23%, Spirit's running around in the low 20%s. This is terrible. People are acting rashly as management, unlike what we read in the press from most of the analysts. They should be expanding because they're making absolutely more money than they do not expanding. And so I think the other thing you have is that this is an era of management that's much more sophisticated, it's much more attuned to all the interest of the stakeholders, shareholders certainly. Look at the amount of shares being bought back. That's unprecedented.

And business is generating incredible amount of cash in this industry. So I'm bullish about it. Will there be ups and downs and this and that? Yeah. But I think the investors are substantially overreacting to what is reasonable, rational behavior by management and Board of Directors to optimize earnings per share. If fuel goes up 40% – in 2008, when fuel went to $147 a barrel, we were cutting ASMs like crazy. We will cut capacity if it is appropriate.

By the same token, we're doing pretty damn good right now. So fuel's already dropped back down to $41 a barrel yesterday. So these are good times. Crisis, I find it ironic that that word even enters the discussion. But it's a different look from a different side of the table.

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Yes, our largest shareholder is sitting in the room with us. And we run the business at his direction for long-term profitability. And that means doing things like adding September, even though it's going to have a negative effect on short-term unit revenues, which seems to be the focus of the equity markets today. I think it will be interesting. Lukas, do you want to give any color on what you see on the yield environment?

Lukas Johnson - Vice President-Network & Pricing

Yeah, if we could rewind this again a year-and-a-half ago before fuel prices had cratered, it took a little while for most of the other airlines to optimize for profits. And that's the capacity you've seen really now the last 12 months. And while unit revenues are a little bit lower than I think almost all airlines had expected, it's still higher profitability than the long-term target. Should we see a shift in the oil prices, I would expect that capacity to come out. I think a lot of other airlines are behaving pretty rationally about this. When you're making 23% operating margins, your variable margin for some open flight time on your plane is 50%, 60%. And so it's really hard not to add that as a management team in the short term.

So I do have faith that the other airlines are seeing this. And going forward in 2017 you're going to see probably some reductions in capacity guidance just due to the fact that unit revenues are down 5% to 10% from where everybody thought they were. So it will right itself. It's just part of the cycle.

Maurice J. Gallagher - Chairman & Chief Executive Officer

One other just historical comment, having been around this business for many years. Remember in the 1990s, the analysts, they focused on typically one variable of an equation, and it takes multiple variables to get an outcome. And back then it was CASM. I had a good friend of mine running a carrier, he just started flying bigger airplanes, longer distances and his CASM went down. Of course, he didn't make any more money, but that's just the nature of the beast that everybody is focused on as one unit, PC unit revenue and you need more than that to make the equation work. So anyway...

Steve M. O'Hara - Sidoti & Co. LLC

Okay. I appreciate that answer. And then just on the pilot deal, is there one-time hit in 3Q for signing or anything like that?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Yes. There is no signing bonus, if that's what you're alluding to. And so if you look at kind of on the costs trajectory through the back half of the year, it more or less offsets what the deferred maintenance CapEx is $17 million, $18 million. That's kind of the run rate incrementally for the pilot deal through the end of the year, with a bias towards the fourth quarter.

Steve M. O'Hara - Sidoti & Co. LLC

Okay. All right. Thank you very much.

Operator

Thank you. We have a follow-up from Thank you. Joe DeNardi with Stifel. Your line is open.

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Yes. Thanks. I just want to clarify. You guys have been speaking pretty positively on the call about the new aircraft to market. So I just want to make sure I understand. The plan going forward is to stick with used, is that correct? Or do you guys want to buy more new?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

Let's just be real direct about this. We are focused on buying used airplanes on a continuing basis. This is a moment of time for us to buy new airplanes. We look at this as any other spot transaction that we do, and it will augment our purchase of used airplanes, and it's not dependent on anything with the schedule or increased utilization, which would diminish our ability to draw down the schedule if we see any environmental changes that we need to react to. It's not a change in the business. We've been talking to Airbus, Maury, 12 years now?

Maurice J. Gallagher - Chairman & Chief Executive Officer

Give or take.

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

They finally met our price. I don't know what else to say. It's a small deal. They deliver closed in. They are quality airplanes, the ones that we already operate, so there's not a whole lot of challenges with inducting the fleet. This is going to be a good thing for us. If Airbus comes to us with more deals like this, I don't know what will happen then, but...

Maurice J. Gallagher - Chairman & Chief Executive Officer

Well, Joe, the other thing, too, is we're 25 airplanes or 30 airplanes and we bought 12 airplanes. That's a much bigger impact economically if you just worry about the cost factors. This will fit nicely inside of the size of what we operate to Jude's point earlier and Lukas, I mean, the scheduling and utilization can be take advantage of the newness of the airplanes and yet still maintain the overall dynamics of what we want to have in our approach to market's low utilization. We're running 5.5 hours, 6 hours. We've been there for years, probably dropped off a little bit in the last few years. We may pop-up a little bit more with these airplanes, but we're not going from 5.5 hours to 10 hours. This is not going to happen. So we will ebb and flow around those numbers, but it's a good move. It's a one-time move and our focus does not change off of used aircraft.

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Okay. Okay. Yeah. That's very helpful. And, then Maury, if we are entering a period perhaps where you start to bump into more ULCCs, does that change the way that you think about kind of the value that would be created or could be created by combining with some of them? Or is that kind of an overreaction to where we are right now?

Maurice J. Gallagher - Chairman & Chief Executive Officer

I think it's terribly premature to talk about those types of things, Joe. There's going to be activities ups and down as you always see in the marketplace. But we have got our head down doing what we need to do on our side of the wall. That's our focus.

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Okay. And then Lukas, just one more, I think you guys are growing September like 30% or so, correct me if I'm wrong, but what would 3Q TRASM be kind of without that growth, if September was more normal?

Lukas Johnson - Vice President-Network & Pricing

Yeah. So we are growing September 31%. It would improve slightly, roughly a point. But again, a part of that shift is due to Sunday, Monday, our two highest flying days or two of our highest flying days and September gets an extra Sunday and Monday just by the nature of the calendar. So it's a little lumpy. August is 11% because August loses that Sunday and Monday, so Sunday, Monday at the end of August going into September, so the unit revenue wouldn't have changed significantly too much off that.

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Great. Thank you.

Operator

Thank you. We have a follow up from Savi Syth with Raymond James. Your line is open.

Savanthi N. Syth - Raymond James & Associates, Inc.

Hey. Two questions on the ancillary revenue. I think the ancillary air was a little bit weak this quarter, wondering why that was, and as Hawaii flying starts to come down, if we're going to feel a bit more pressure in there just mapwise?

And then my second question was, can you remind me, I've been noticing that over the last year-and-a-half load factors have been coming down. Just wondering what's behind that and how should we think about it because generally with your business models, I figured high load factors would be better given that there's more ancillary purchases that way?

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

So let me address them in order. The air ancillary is correlated to the airfare and so while we've seen a decline, I am proud of how little it's declined, particularly as compared to the airfare declines. And so we have some initiatives that we're excited about to reverse that trend. We've talked about the credit card, but also this month we for the first time are doing multibrand testing on our website which allow us to test things like bundled products with airfare. And so that when we build those, we can be a lot more confident about the revenue results of those.

So I think we're in the right path there and our air ancillary production has outpaced those of our competitors and I think that's because we continue to focus on that. And then much of the things Spirit talked about this morning with bundles and yielding of particular products. We do all that already. And that's why our performance has been so good.

On Hawaii, yeah, Hawaii on a per passenger basis is some of the highest yielding ancillary fares in the network. So, as we pulled down Hawaii on a per passenger basis, our system ancillary per passenger production will decline, but on an ASM basis it'll be the opposite effect of that.

And then on load factor, we've had a lot of new markets. We've expanded into off-peak periods. And particularly, keep in mind, when we fly at peak time, very often combines a very weak flight with a strong one because we route the aircraft so that they come home every night. And so it's those weak legs in particular that have been challenged to fill and that's because in some cases there is no stimulatory fare that can put people in seats.

And that's still a rational thing to do, because (50:13) is so strong and with the current fuel price and the network is a lot more productive with that round-trip in it than it would be without it. Lukas, do you have anything else?

Lukas Johnson - Vice President-Network & Pricing

Yeah, just in term of the off-peak day of the week. For the second quarter about 26% of our flights were on Tuesday, Wednesday, Saturday. Last second quarter of 2015 it was 23% and going back a year before that, it was about 20%. So, you can see that's the nature of the shift the last two years as well as the new market growth were about 15%, 16% of our markets currently operating in the second quarter and third quarter, did not operate last year versus a couple years ago that was in the 5% range to 8% range, so. Just those two factors that you talked about are driving some of those lower loads.

As we continue to kind of mature some of those new markets and lap some of the year-over-year off-peak stuff going into next year, I think you'll see load factors return a little bit higher.

Savanthi N. Syth - Raymond James & Associates, Inc.

And especially as you slow growth, I'm guessing that will help this as well?

Lukas Johnson - Vice President-Network & Pricing

Yeah. That's correct.

Savanthi N. Syth - Raymond James & Associates, Inc.

All right. Great. I appreciate the color. Thank you.

Operator

Thank you. We have a follow-up from Steve O'Hara with Sidoti. Your line is open.

Steve M. O'Hara - Sidoti & Co. LLC

Yeah. Thanks for taking the follow-up. Just on the wind down of the MD-80s, 757's, should we be expecting one-time charges to just come out or I thought the MD-80s were close to fully depreciated, but I wasn't sure.

Jude I. Bricker - Chief Operating Officer and Senior Vice President of Planning

No. We won't have any specials.

Steve M. O'Hara - Sidoti & Co. LLC

Okay. Thank you.

Operator

Thank you. I'm showing no further questions. I'd like to turn the call back to Maury Gallagher for closing remarks.

Maurice J. Gallagher - Chairman & Chief Executive Officer

Thank you all very much. Appreciate your interest and your comments. We'll talk to you in another three months. Thank you.

Operator

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

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