Hawaiian Holdings' (HA) CEO Mark Dunkerley on Q3 2016 Results - Earnings Call Transcript

| About: Hawaiian Holdings, (HA)

Hawaiian Holdings, Inc. (NASDAQ:HA)

Q3 2016 Earnings Conference Call

October 18, 2016, 04:30 AM ET

Executives

Ashlee Kishimoto - Senior Director-Investor Relations

Mark B. Dunkerley - President, Chief Executive Officer

Peter R. Ingram - Executive Vice President & Chief Commercial Officer

Shannon L. Okinaka - Executive Vice President & Chief Financial Officer

Analysts

Michael Linenberg - Deutsche Bank

Hunter Keay - Wolfe Research

Julie Yates - Crédit Suisse

Joseph DeNardi - Stifel Nicolaus

Helane Becker - Cowen & Company

Andrew Didora - Bank of America

Stephen O'Hara - Sidoti & Company

Michael Derchin - Imperial Capital

David Segal - Honolulu Star-Advertiser

Operator

Greetings, and welcome to the Hawaiian Holdings 2016 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. An interactive question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Ms. Ashlee Kishimoto. Thank you, you may begin.

Ashlee Kishimoto

Thank you, operator. Welcome, everyone, and thank you for joining us today to discuss Hawaiian Holdings' financial results for the third quarter of 2016. On the call with me today are Mark Dunkerley, President and Chief Executive Officer; Peter Ingram, Chief Commercial Officer; and Shannon Okinaka, Chief Financial Officer.

Mark will begin with some overview comments. Next, Peter will take us through revenue performance. Shannon will follow with a discussion on costs and the balance sheet. We will then open the call up for questions, and Mark will end with some closing remarks.

By now, everyone should have access to the press release that went out at about 4 o'clock Eastern Time today. If you have not received the release, it is available on the Investor Relations page of our website, hawaiianairlines.com.

During the course of our call today, we will refer at times to adjusted or non-GAAP numbers and metrics. A detailed reconciliation of GAAP to non-GAAP numbers and metrics can be found in our press release as well as on the Investor Relations page of our website.

Before we begin, we'd like to remind everyone that the following prepared remarks contain forward-looking statements including statements about our future plans and potential future financial and operating performance and management may make additional forward-looking statements in response to your question. These statements are subject to risks and uncertainties and do not guarantee future performance and, therefore, undue reliance should not be placed upon them. For a more detailed discussion of the factors that could cause actual results to differ materially from those projected in any forward-looking statements, we refer you to Hawaiian Holdings' recent filings with the SEC, including the most recent Annual Report filed on Form 10-K as well as reports filed on Forms 10-Q and 8-K.

And with that, I'd like to turn the call over to Mark.

Mark B. Dunkerley

Thank you, Ashlee. Aloha, everyone and thank you for joining us today. Our third quarter adjusted net income per share grew to $1.92, which is $0.63 ahead of last year. Our adjusted pretax margin for the quarter was 24.6%, and our pretax return on invested capital was 33.1% for the 12-month period ending September 30.

At the end of last year and in contrast with the messages being beamed out of the rest of the industry, we indicated that 2016 would be a stronger year for us. As we enter the home stretch all of us at the company take satisfaction in knowing that we are delivering on the expectations that we set. We've executed our financial and operational plans, delivered both earnings growth and margin expansion, and in so doing we have strengthened our balance sheet.

Low fuel prices and moderate industry capacity growth in our markets have, of course, contributed to our outstanding results, and we have enjoyed robust and resilient demand for the Hawaii vacation. For what has set our performance apart from that of our peers has been the improvements in the day-to-day execution of our commercial and operational activities and our superior understanding of the Hawaii market.

Our leisure-oriented product, optimally configured aircraft and the exceptional hospitality delivered by our frontline team distinguishes us from the rest of the industry. So I'd like to thank all of my colleagues at Hawaiian for their relentless efforts in delivering our brand of exceptional service. By every measure, they are the industry's best.

We flew a record 2.9 million guests this quarter while maintaining our position as the industry's operational performance leader. Let me share some highlights since we last spoke in July. Our dispatchers represented by the TWU ratified a new five-year contract extension. Under its terms our dispatchers are receiving meaningful wage increases while the company gained important savings in such areas as benefits.

At long last, we've cleared the major hurdles to our executing a lease with the State of Hawaii for our new maintenance and cargo facilities. There is a long and not terribly edifying story behind this, but once the ink is dry on the lease, we will step in to complete the construction of the two facilities. We should be moving out of the aging buildings we currently inhabit and into the new state-of-the-art facilities sometime midyear 2017. When we do so, there'll be some increased costs which we expect will be offset to some degree by productivity and efficiency improvements.

The launch of our daily Narita service in July has been a signal success. The performance of the route is comfortably exceeding our expectations. So it’s a good harbinger for the upcoming launch in late December of our second daily Haneda flight which will be split between extra frequencies to Honolulu and a new service to Kona.

We reached a milestone in our A330 premium cabin redesign program earlier this month, launching the sales of our fully lie flat seats on a selection of international routes for flights beginning in December. In addition to the upgrade to the premium cabin, the modification also adds 28 extra comfort seats per aircraft. The modification program remains on schedule. We expect to have six aircraft completed by year-end and the entire fleet in early 2018.

Starting in the middle of next year, we will take delivery of the first of our 16 Airbus A321neo aircraft. A great deal of preparatory work is already underway. We're also considering adjustments to our current fleet plan to bring forward some minor increases in capacity. Among other benefits this would also allow us to consider whether to exit the Boeing 767 fleet slightly ahead of current plans. What will remain the same is our expectation that capacity will grow in the low-to-mid, single-digit range for the foreseeable future. We expect to share more detail on our capacity plans for 2017 and beyond at our Investor Day on December 5 in New York City.

With the delivery of the A321neos and the interior modifications to the A330s complete, we will have the optimally configured fleet for our markets. The capabilities of these aircraft will suit our network and the interior layout of each type will be tailored to the needs of our guests. Meanwhile, the investments we've made to the back office infrastructure that supports our business will help make us better able to grow our slice of the pie of demand for the Hawaii vacation and to be more productive in running our business day to day. All in all, it has been a great quarter and a good year so far. We're looking forward to the fourth quarter and the opportunities that our recent success will permit us to seize in the years ahead.

And Peter is now going to talk us through the revenue.

Peter R. Ingram

Thanks Mark. Third quarter revenue performance was at the better end of our original expectations with solid demand throughout our network. We're pleased with our results this quarter with improvements throughout our business, a successful launch of our Narita service, and another record quarter of sales for our extra comfort seat product. My thanks go out to everyone on our commercial team for another period of solid execution and to all of our front-line employees for delivering Hawaiian's trademark hospitality.

Expecting another period of positive unit revenue growth in the fourth quarter, our performance should again significantly outperform our domestic competitors. Domestic PRASM, which includes our North America and Neighbor Island flights, was up 2.3% on solid demand and balanced industry capacity. Our North America routes posted a fourth consecutive quarter of year-over-year PRASM gains, and we continue to produce a unit revenue premium on the routes we serve.

Importantly, in recent periods this premium has expanded. For the past two quarters, industry capacity growth on our routes between North America and Hawaii has been minimal; and looking ahead, we continue to see relatively flat capacity in the fourth quarter and the first quarter of next year based on public schedules. We are executing very well in this part of our network and looking forward to another quarter of year-over-year PRASM expansion in the fourth quarter.

In the Neighbor Islands, our PRASM was down a couple of points from last year as we continue to lap the entrance of a competitor into the Lihue and Kona markets in the second quarter. As we noted during the last call, we have several initiatives underway that took effect late in the quarter which are starting to yield benefits. Looking ahead, we expect to see a sequential improvement from the third quarter to the fourth.

As noted previously, we're expecting the delivery of two additional 717s next month which will begin flying in the first quarter of 2017. As a reminder, these aircraft will provide us with the flexibility to redistribute more of our neighbor island flying to the peak midday connection window and our highest demand days while trimming some off peak flights. Overall flown capacity will remain relatively stable with these changes.

Our international results in this quarter were a highlight as we turned the corner with PRASM swinging positive by about 1 percentage point year-over-year. Excluding the effects of foreign exchange rate changes, net of hedge losses and year-over-year differences in fuel surcharge revenue, our PRASM would have been up almost 8%. These results reflect solid market performance improvements from last year as developing routes continue to mature and we further lap the negative foreign exchange and fuel surcharge impacts that have weighed on results for several quarters.

As Mark noted, we launched service to Narita in late July and its performance was immediately accretive to international PRASM. Looking ahead industry capacity is expected to grow moderately on the international markets we serve with some puts and takes. Increased capacity is due to upstaging from our competitor in Auckland and the lapping of the entry of a new competitor in South Korea late last year. Offsetting this, our only competitor in Brisbane is scheduled to leave this route later this month.

We expect to build upon the improved third quarter results and we anticipate our international routes will continue to improve sequentially in the fourth quarter. We are growing capacity in markets where we have a strong competitive position and the early success of our Narita route gives us confidence in the launch of our second daily Haneda frequency in late December.

Our value added revenue per passenger grew this quarter to $23.37 up $1.85 from last year based on growth in our already successful products like extra comfort and sales of Hawaiian miles and we expect these products to finish the year strong. The air cargo industry remains challenging and in the third quarter our results were down slightly compared to last year with continued weakness in outbound cargo markets in Asia partially offset by solid performance in the Neighbor Islands. For the fourth quarter, we expect the tough macro environment for airfreight to continue, with cargo revenue down slightly from last year.

Looking ahead to the remainder of the year, in the fourth quarter, we expect our capacity to grow 3% to 5% from last year, primarily driven by our growth in Tokyo, with the launch of Narita in July and Haneda at the end of December. The deceleration of expected capacity growth in the fourth quarter is due to the continuation of our A330 interior modification program that took a pause during the summer, allowing us to maximize our flying during the summer peak.

For the full year, we have narrowed our range and expect our capacity to grow 3% to 4%. We expect another quarter of positive RASM, with a range of up 0.5% to up 3.5% year-over-year, which, at the midpoint, represents a sequential increase from the third quarter result, driven by steadily improving passenger revenue.

As I've suggested throughout my comments, we expect positive PRASM for both our domestic and international geographies in this period. These results should comfortably outperform our peers again and would represent a third consecutive quarter of positive year-over-year system RASM. Solid demand for travel to Hawaii, manageable industry capacity and strong execution by the team underpin these expectations.

Other revenue will be affected by the continued weakness in the macro cargo environment, which is expected to result in a quarterly RASM improvement that is a little lower than the PRASM gains. With another quarter of exceptional results, we are poised for a very strong finish to 2016. Demand for Hawaii travel is unwavering, and we're growing our capacity in markets where we compete strongly. We are well positioned for the future, with a balance of capacity maturing in developing markets, an optimal fleet for our missions, travel products specifically tailored to our guests and award-winning hospitality. We're pleased with our performance and excited about the future.

I'll now hand the call over to Shannon to discuss our costs and the balance sheet.

Shannon L. Okinaka

Thanks Peter. Our third quarter results represent another record-breaking quarter, with earnings growth, margin expansion and a strong balance sheet. This has been a terrific 2016 so far, and we're enthusiastic about what's ahead. The third quarter ended pretty much as we expected, with operating expenses up $21 million due to cost headwinds from wages and benefits increases, aircraft rent and purchase services that were partially offset by lower fuel costs. Interest expense this quarter was $5 million lower than last year as we continue to benefit from the prepayments of debt earlier this year. We're still expecting $19 million in interest expense savings for the full year.

We contributed $16 million this quarter to our pension plan, for a year-to-date total of $27 million, well in excess of our minimum requirements. These contributions provide important tax savings and lower our future pension liability. We made scheduled principal payments of $22 million, which lowered our leverage on an adjusted debt-to-EBITDA basis to 2.0x. In addition, we repurchased about $4 million of our shares this quarter.

Our cash position remained strong, with $694 million in cash, cash equivalents and short-term investments. We continue to expect positive free cash flow, allowing us to execute our capital allocation program, which includes strengthening our balance sheet, opportunistically repurchasing our shares, investing in our business and funding our pension plan.

Turning to our outlook for the fourth quarter, we expect CASM ex-fuel for the fourth quarter to increase 2.5% to 5.5% from last year, which does not include any assumptions for the amendable contract with our pilots union. Negotiations with our pilots are progressing, and if necessary, we'll update our expectations after an agreement is reached.

We expect year-over-year CASM ex-fuel headwinds totaling about 4 percentage points coming from the following: wage increases and benefits increases for health care premiums totaling 1 point; aircraft rent due to the A330 delivered under ease in June and the additional two 717s under leases beginning in November totaling 1 point; rate increases at airports in Hawaii and Los Angeles totaling about 1 point; a 6-year heavy maintenance checks on one of our A330s totaling 0.5 point; and purchase services from investments in IT and other initiatives as we continue to invest in our business totaling 0.5 point. We're balancing investments in our business, including compensation for our people, with productivity, efficiency and cost control.

As Mark mentioned earlier, we're close to executing a long-term lease for new maintenance and cargo facilities and expect completion of construction to conclude mid-2017. From the signing of the lease to until completion of construction, we expect our cost to be minimal and have already been factored into our CASM ex-fuel guidance for the fourth quarter. Once construction is complete next year, we expect our cost for the facilities to increase, which we expect will be partially offset by productivity and efficiency gains. We will share further details once we have a clear line of sight to the end of the construction process.

For the full year 2016, we have narrowed the range and expect our CASM ex-fuel to grow 3.5% to 4.5%. Based on the fuel curve as of October 11, our economic fuel cost per gallon forecast for the fourth quarter and for the full year is expected to be between $1.50 and $1.60. As of September 30, we hedged approximately 50% of our projected fuel requirements for the remainder of 2016, and we expect our fuel hedges to settle at a gain position of a couple of million dollars as we begin lapping the drop in fuel prices last year.

We continue to maintain a disciplined approach to our hedging program to manage our operating and economic risk. For the fourth quarter, we expect our fuel consumption to increase in the range of 4.5% to 6.5% from last year and for the full year, we narrowed the range to up 3.5% to 4.5%. As we begin to lap the decrease in fuel prices last year, we expect our year-over-year economic fuel savings to decrease. Based on the current outlook, we expect our year-over-year economic fuel savings net of hedges and volume increases to be about $10 million in the fourth quarter and $106 million for all of 2016.

Based on our current fleet plan for the full year 2016, we continue to expect our CapEx to be in the range of $160 million to $170 million as we continue to make pre-delivery payments for upcoming aircraft deliveries and invest in our business. As a reminder, we're taking delivery of two additional 717s under 6-year leases next month. And as Mark mentioned earlier, we're also considering adjustments to our current fleet plan, and we'll provide an update on our capacity plans for 2017 and beyond at our Investor Day in December.

Based on our current outlook and fourth quarter guidance, we are anticipating our full year 2016 adjusted pretax margins to increase about 5 points from last year's record adjusted pretax margin. The year is unfolding as planned with margin expansion, earnings growth, and a stronger balance sheet. We continue exiting to our plan and we're excited about the feature and remain committed to growing long-term shareholder value and investing in our people and business.

This concludes our prepared remarks and with that, I'll turn the call back to Ashlee.

Ashlee Kishimoto

Thanks, Mark, Peter and Shannon. Also thanks, to all of you for joining us today and for your continued interest in Hawaiian Holdings. We are now ready for questions from the analysts first, and then the media if time permits. As a reminder, please limit yourself to one question and if needed, one follow-up question. Operator, please open the line up now for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Michael Linenberg from Deutsche Bank. Please go ahead.

Michael Linenberg

Hi, hey good day.

Mark B. Dunkerley

Hi Mike.

Michael Linenberg

Hey, good morning. I guess two questions here. Mark or Peter, you talked about putting in the new lie-flat premium seat, what are you seeing with respect to your ability to price up? Are you seeing a premium versus what you had in the market before? I mean, I realize it's early, so I'm sure there's - you're still sort of gathering data and you don't have a lot of history with this new product, but whatever you could tell us would be great.

Mark B. Dunkerley

Okay, yes. Peter do you want to answer?

Peter R. Ingram

Yes, I'd say Mike really we're not yet in a position where we're realizing the benefits because with only a couple of airplanes flying in service as of right now, we can't on any individual route yet commit to have the product there on a day-by-day everyday basis. We did recently announce the first route starting in December that we will begin committing to have the airplane on every day, and those are our routes in Australia, New Zealand and our Narita frequency will be the initial ones to get the lie-flat every day. And the pricing approach is - it really varies a little bit by market depending somewhat on what the competitor set has.

So if we had -- if we compete with someone that had a lie-flat already, we might have been at a discount before, and we would adjust that to be at less of or no discount, and if we are in a route where we have the only lie-flat product that might afford us an opportunity to take a premium. So it really is sort of a market-by-market approach.

Michael Linenberg

Okay great. And then just a question on the costs, Shannon you called out, I think you said 4 points of cost increase next year, and you talked about the aircraft piece. And I just, was it two 717s and what were the other airplanes that are driving a point, I think?

Shannon L. Okinaka

Yes, it was two 717s that we'll be getting in November, and it was the one A330 that was delivered this past summer in June. So it's the lapping of that. We're still not lapped on that.

Michael Linenberg

Oh okay, then well, here's the question. So you're taking the A321neos. They are coming in what next year, is that?

Mark B. Dunkerley

Yes, they're coming in July of next year, the first one.

Michael Linenberg

So, are there induction costs associated with that as you bring in a new airplane type or are you able to capitalize them?

Shannon L. Okinaka

The aircraft itself is capitalized. But you're right there are other induction costs that we'll be facing such as, you know training costs. We have a whole bunch of people, pilots, mechanics, to train on the new aircraft type. So, that will start earlier in the year.

Michael Linenberg

Okay, okay, okay…

Mark B. Dunkerley

Some of those costs are, frankly, already hitting but not at a material level. I think by the time we get to Investor Day, we'll be able to articulate a little bit more clearly how we expect those costs to impact us next year. But you're right, I mean, there will be some induction costs that will hit us next year that are not present with us this year.

Michael Linenberg

Okay, good that's helpful. Thanks Mark, thanks Shannon.

Operator

Over next question comes from Hunter Keay from Wolfe Research. Please go ahead.

Hunter Keay

Hi thanks everybody and how are you doing?

Mark B. Dunkerley

Hey Hunter, yep we're well.

Hunter Keay

Good, good, Peter I can't stop thinking about that comment that you made there, a conference in May about how like 45% of tourists to Hawaii are actually ending up staying in hotels and how that number continues to kind of go down secularly. You guys are in a position to do a lot of very unique things given the competitive dynamic of your markets. And I think you're willing to just think a little bit out of the box on some IT initiatives like the bidding system and the auction stuff.

So is there a scenario that makes sense for Hawaiian to think about a more robust partnership with Airbnb or a VRBO-type thing just given the uniqueness of your network or it’s something that is unlike maybe anything that we've seen in this industry outside of sort of a traditional package-type relationship?

Mark B. Dunkerley

Yes. First of all, I think we're always open to looking at those sorts of things. We, I think, you sort of -- at the core, the foundation of your question is a valid point, which is we do know this marketplace better than our competitors do, which at one level sounds very boastful, on the other hand, it's kind of what we do, so we’d better understand it better. And I think we are in that situation. How we fully benefit from that is a sort of varied thing, and I'll let Peter address the question of whether a VRBO or Airbnb is part of that framework.

Peter R. Ingram

Yes, and, Hunter, as you know, we do have a vacation package product as many carriers do, but I think there is some greater opportunity in Hawaii certainly than a lot of markets, and that is working with primarily hotels. But we have explored and we continue to explore the opportunity to figure out ways to partner with the people who are doing vacation rentals in a way that is good for expanding our business and building our ticket revenue and also building a deeper relationship with our customers.

Hunter Keay

Okay, thanks. And then, Mark, I think I saw something in the media lately that you didn't totally rule out the idea of maybe acquiring an A380 or two. Rather than asking the questions the way that would make sense, why don't you answer the question as to why it would not make sense because it seems to me like you can get that plane very cheap these days, relatively speaking, of course.

You already operate a complicated mixed fleet, if you will and I think there's a couple of markets that outside of some of the connecting flows where it wouldn't make sense just from an O&D perspective, you could probably fill that thing fairly easily. So all things considered, can you tell me why it would not make sense for you guys to acquire it? And why haven't we started talking about this already?

Mark B. Dunkerley

So, I - thanks, Hunter. Yes, I mean, I think you're right at one level. We do have a number of very small - we've got a small number of discrete markets that have enough demand where a large capacity vehicle would make some sense. I think arguing against it is complexity the fact that a fleet size would necessarily be very small indeed to look after these markets.

I think in general, we're always interested in finding out more about what the manufacturers are producing in terms of aircraft, what their capabilities are because I think we learn a great deal that way. So I mean, I think in that sense, we're always interested in finding out more. But the A380 would be an extremely large airplane in our network and it would necessarily be limited to two, maybe three routes.

Hunter Keay

All right, thanks very much.

Mark B. Dunkerley

You bet.

Operator

Our next question comes from Julie Yates from Crédit Suisse. Please go ahead.

Julie Yates

Thanks for taking my question.

Mark B. Dunkerley

Sure Julie.

Julie Yates

Mark, I think there were some comments in the media recently that you guys would potentially be interested in Europe services at some point. Would the A330neos range satisfy that mission or would you need to look at more at an A350 or 787 to make that market work?

Mark B. Dunkerley

The short answer is we don't know yet. The A330-800s is an aircraft that does not yet have final performance figures and therefore, it's unclear to us whether it does or does not have the range to make it to Europe. And if so and what sort of passenger configuration, because if you identify the cabin which had some cost advantages, it adds weight to the airplane and so it can't go quite as far. So I think that question is yet unanswered and we will find out more as we work with Airbus, as 2019 approaches and the A330-800neo delivery dates come closer.

Julie Yates

Understood. Got it. And, Shannon, just have you guys disclosed whether you have any hedging positions for 2017 yet?

Shannon L. Okinaka

Yes, generally, our program hasn't changed very much, Julie. So we rather in on the fuel side, we're out about a year and we add about, say, 15% every quarter. So it generally hasn't changed. I don't know the exact percentage for 2017. My guess is maybe in the 30 percent-ish. We can get the number to you, but the program hasn't changed.

Julie Yates

Okay, great. Thanks so much.

Mark B. Dunkerley

Okay.

Operator

Our next question comes from Joseph DeNardi from Stifel. Please go ahead.

Mark B. Dunkerley

Hey Joe.

Joseph DeNardi

Thank you very much. Hey Mark. Shannon, just to clarify, the 4 points as CASM ex pressure you talked about, that applies to fourth quarter of this year not next year, is that right?

Shannon L. Okinaka

Correct. That's this year.

Joseph DeNardi

Okay. And then, Mark, just on your comments about pulling forward some capacity growth, I'm just trying to, I guess, reconcile the two comments you made that you want to pull, maybe accelerate some ASM growth but get out of the 6, 7, a little bit earlier. How would that work? I would imagine you're thinking about pulling some 321neos into next year from 2018 and maybe some - the 6, 7, retirements would slide into 2018?

Mark B. Dunkerley

Yes. Again, I think we'll be in a position for more specifics in December. But what I would say in general is that if you look out just by dint of when C-checks happened on our 7, 6s plus when you look at our exact delivery positions, there is some lumpiness to our capacity growth going forward. And what we're going to try and do is to smooth that out.

And so there's I think it will probably be a mix of moving, trying to move some positions, trying to figure out when C-checks take place and when might be a good time to think about getting out of the 767s. But we're sort of we're solving for a desirable capacity growth of low to mid-single digits, and we're trying to make fleet decisions that deliver that rather than the other way around.

Joseph DeNardi

Okay, okay, and then, Peter, maybe just a strategic question for you. It would seem like given the, what the schedules show from an industry capacity standpoint into why that - the market is underserved. I would imagine that demand is more than flat year-over-year. So how do you balance maybe addressing some of that underserved demand while being prudent from a capacity standpoint? I mean, at what point does mid single-digit PRASM grow from the North American route in spite competition?

Peter R. Ingram

Yes, I don't know that you can conclude that the market is underserved just by looking at one year of industry capacity changes. Because I think if you backtracked a little bit, you would have a period where we were about four quarters of double-digit industry capacity increases. So I think that over time, this is a market where capacity finds its level. It's a big relatively mature market. It's got a growth that should be some close relationship with GDP in North America.

What I would say in terms of where we are right now is next year, with the new Japan route starting and particularly in the first half of the year, we are a little tighter on capacity than we would like to be. But it is not sort of grossly out of balance. And I think to echo a comment that Mark made a call or two ago, I think it is generally in this industry better to be at an aircraft short than a couple of aircraft long in terms of your overall fleet position.

Joseph DeNardi

Okay, thanks very much.

Operator

Our next question comes from Helane Becker from Cowen & Company. Please go ahead.

Mark B. Dunkerley

Hey, Helane.

Helane Becker

Hi guys, thanks for the time. Can you hear me?

Mark B. Dunkerley

Yes, yes, I hear you fine.

Helane Becker

Yes, very good. So I guess the White House and the Department of Transportation are going to announce new rules tomorrow for advertising with the purveyors of transparency and pricing and so on. Just kind of wondering, does that affect you guys that kind of regulation affect you guys at all or are you already comfortable with the way you advertise your products?

Mark B. Dunkerley

Yes, obviously, we're waiting to see what comes out of the briefing. So it's a little premature to be able to comment on it. The only thing I would say is that the buying of airline tickets is about the most transparent consumer transaction that exists in commerce today. That's kind of - that's the starting point. We'll see what comes out of the White House briefing.

Helane Becker

Yes. I can't imagine what new things they can require of you guys. But just on another subject, I know you're negotiating with your pilots and I know you don't want to do so publicly and that's not my question. But is there a sense of urgency among them that you need to get this contract done in a more timely basis?

Mark B. Dunkerley

I think it's a sense of urgency among us. I mean, I think we are very desirous of getting this behind us and moving on into a sort of regular contract period. Negotiations, however, require both parties to agree and we are at remediation at the moment I can't comment much beyond that but beyond saying that we'll be very happy, once agreement is reached and we can move on.

Helane Becker

Just one quick one do you need a side letter or an absolute agreement for the A321 aircraft, the neos that are coming in or does the existing contract cover new equipment types?

Mark B. Dunkerley

The preexisting contract covers the A321neo. We already have a side letter, so that's not in play.

Helane Becker

Perfect. Thank you. Thanks for the time.

Mark B. Dunkerley

You bet.

Operator

Our next question comes from Rajeev Lalwani from Morgan Stanley. Please go ahead.

Unidentified Analyst

Hi, this is Davis [indiscernible] on for Rajeev. I just have a couple of questions, I guess and the first, can you discuss the prospects figure international network? And I'm thinking more in the context of bilateral agreements that are nearing caps over the coming year in 2017?

Mark B. Dunkerley

Yes. I think the - so by and large, the places that they fly have relatively liberal bilateral provisions that airlines of either partly can fly. The exceptions, that is the U.S. China bilateral agreements, which has limitations on the number of frequencies, we don’t see that in the short term a particular concerns to us. There is a separate sort of side letters of the U.S. and Japan bilateral agreement, which is otherwise liberal but has some constraints around access to Haneda.

We just finished Haneda negotiations. They were a total of six routes provided for the airlines of both sides into Haneda between Haneda and the United States. We were fortunate to secure two of those six. Elsewhere, I think the biggest issues that we've run into aren’t sort of bilateral per se, but infrastructure issues. So if you go to airports like Sydney, for example, they have a very hard curfew. That means that our schedule is not entirely desirable. But it's a curfew that applies to everybody, so it there's not much of a basis where we uniquely can complain about it. It tends to be those sorts of restrictions rather than bilateral ones.

Unidentified Analyst

Got it and then I guess just pivoting to the fleet adjustments that you had referenced earlier. How would you reallocate the growth profile was pulling forwards the neo deliveries and pushing out the 767 retirements? And is there any impact to CapEx that we should think about?

Mark B. Dunkerley

So again I would say that we're going to be able to provide a little more detail of this, I think, in December. But generally, we're smoothing things out. So it isn't a question of us ending up at a sort of net higher place or lower place. If it is it will be within and it will be something like 1 percentage point, but some very small incremental difference on a kind of rolling two to three years basis. There will be some smoothing, which is what we're talking about. As to the CapEx impact, again, I think that has to await developments and we'll talk about that is December.

Unidentified Analyst

Great, thanks for the time guys.

Mark B. Dunkerley

You bet.

Operator

Our next question is from Andrew Didora from Bank of America. Please go ahead.

Andrew Didora

Hi, everyone. Mark, and another strategic question here. I guess, given your success in Japan, what do you view as the biggest obstacle that is preventing you from growing out China more aggressively if the bilateral aren’t holding you back at all?

Mark B. Dunkerley

By far and away, the biggest problem that we have in China is the lack of awareness amongst the Chinese consumer about the Hawaii vacation. I mean, we've got - I think I'm right in saying, just to give you a sense of context, I think I'm right in saying that the second-largest long-haul international city pair in the world is Honolulu to Tokyo. That's after London-New York. We have something like I want to say 12 to 14 wide bodies a day in that city pair alone. That gives you a sense of scale of the attraction of Hawaii for our Japanese travelers. At the same time in China, obviously much larger potential market, there are 10 flights a week.

So it makes us very excited about the opportunity that China represents. We do think that looking down the road, China is going to actually not only dominate Hawaii travel and tourism from, frankly, global travel and tourism. The issue is how do we get from here to there, and a good starting point would be if as a community, we can promote the benefits of Hawaii in the Chinese marketplace to a consumer base that's large but as yet does know much about Hawaii.

Andrew Didora

That's interesting and good color. Shannon, I just wanted to follow up on CASM. Your capacity growth is kind of sitting out here in that low to mid-single-digit range. How do we - how should we think about core CASM growth going forward ex any kind of headwinds or tailwinds from onetime items like a pilot deal or incremental aircraft deliveries?

Shannon L. Okinaka

Yes. Thanks, Andrew. So for what the call running the business cost, we're focusing - focused on targeting very low single-digit CASM ex fuel growth. And then as you said, we also then make sure that we're continuing to invest in the business, and we do have, we will have one time cost headwinds, like you said, labor agreements and just other things that come up that we decide that we invest and but for the running the business piece, we're continuing to target that flat to low single-digit CASM ex fuel growth.

Andrew Didora

And are there any headwinds or tailwinds that you will be able to call out for 2017 right now?

Shannon L. Okinaka

We haven't talked much about 2017 other than we did talk about the trainings, the 321 induct ion costs. We have also talked about the hangar cost. As soon as the construction is complete, we will be being a higher lease rent for the hangar and then of course, any labor deals but outside of that, we haven't talked much about it. And we'll talk more about 2017 cost at Investor Day.

Andrew Didora

Okay, that's it from me. Thanks.

Operator

Our next question is from Stephen O'Hara from Sidoti & Company. Please go ahead.

Stephen O'Hara

Hi, thanks for taking my question.

Mark B. Dunkerley

You are welcome Steve.

Stephen O'Hara

I was wondering, just if you look at the industry, I mean it seems like from the airlines that have reported thus far there seems to be a little more confidence that they are at least getting closer to the inflection point on unit revenue more maybe they see the light of the end of the tunnel. And I mean, how do you think about that relative to your PRASM and your unit revenue? I mean, might that add a little fuel to the fire for your own ability to maybe improve fares or grow fares or improve PRASM or I mean, I guess, maybe what's the best way do you think about that?

Mark B. Dunkerley

Well, I'll make a general comment and then pass it to Peter for any specifics. I think the general comment I would make is that we look at the capacity growth on our particular routes because we have had situations in the past where what's going on in the industry has been actually different than the reality that we have experienced. And so, sometimes they correlate, sometimes they don't correlate. So overall, we don't think there is necessarily a strong correlation. Looking out into the future, we've already indicated at least based on published schedules, we continue to expect to see moderate industry capacity growth in our markets. But I'll turn over to Peter, if you want more…

Peter R. Ingram

Yes, just to echo that a little bit, I think Mark is absolutely right that we don't necessarily, we don't have the same network mix as a lot of the other carriers you look at. And so, the sort of macro factors that affect our business are often out of sync. And we talked a little bit earlier about if you go back four or five quarters, we had double-digit capacity growth in North America.

We had some of the same international headwinds that other carriers have had with fuel surcharge and foreign exchange impacts. And, in fact, those - the foreign exchange impacts are in some ways more exacerbated for us given that our point-of-sale is disproportionately in those foreign markets as opposed to Hawaii, which is more of a destination than an origin.

The positive news for us is that we passed our inflection point a few quarters ago. We are not looking back. We're optimistic about where we are going, and we have a number of initiatives to further build on that that are really of our own doing to improve our commercial execution, and we think that will power us from a revenue performance side through the fourth quarter and into 2017.

Stephen O'Hara

Okay. But I mean, just from a maybe a market standpoint, I mean, assuming that the capacity is relatively benign, I would assume that higher overall fares in the industry might allow higher overall fares to Hawaii as maybe consumers get used to paying higher payers over time. I mean, does that make sense or no or is it simply there's more capacity in Hawaii no matter what fares are going down if there is less it is going to be up?

Mark B. Dunkerley

Well, clearly over periods of time, there is a relationship between demand, capacity and the level of fares. It's difficult for us to speculate on specific pricing trends going forward for competitive reasons we've got to be careful about what we say about future pricing. I think if you look at the detail of some of our results recently, a lot of our gains and particularly in North America, have been less on yield improvements or pricing improvements and more on doing a better job of execution in terms of filling our airplanes consistently. And so there's a mix of factors to consider all the time. But we're - as I said a moment ago, we are really confident about how we're performing right now and how that sets us up for the fourth quarter and into next year.

Stephen O'Hara

Okay, and then lastly just quickly, if you mentioned it I apologize, but just on the wages and benefits, that was up 15%. What was driving that kind of versus the capacity growth, is that just the new contracts?

Shannon L. Okinaka

Yes, so this is Shannon. The IM contracts were signed - we ratified two contracts earlier this year, IM clerical as well as mechanics. We also have some contractual rate increases with our flight attendants. But I think part of it is also our profit sharing is up year-over-year as well as some of our benefits costs, our medical benefit cost.

Stephen O'Hara

Okay. And maybe just a follow-up on that, a lot of your competitors quote CASM ex fuel kind of ex profit sharing. I don't think you do that, but I mean, is your - would you consider doing that in the future?

Shannon L. Okinaka

No, you're right. We don't do that, and I believe, it's part of the compensation we pay to our employees as part of our cost of business, so cost to conduct our business. So no, I don't think we would do that in the future as well.

Stephen O'Hara

Okay, thank you.

Operator

The following question will be the last from our analysts today. [Operator Instructions] And our next question comes from Michael Derchin from Imperial Capital. Please go ahead.

Michael Derchin

Oh yeah guys. Great quarter I must say.

Mark B. Dunkerley

Thanks Mike.

Michael Derchin

So, I was a little confused on our unit revenue comments. I think you said that domestic was up about 2% in the quarter and international was up about 1%. But the international would have been up 8% if it wasn't for - I didn't get what if it wasn't for...?

Mark B. Dunkerley

If it wasn't for the sort of fuel surcharge impacts year-over-year and the foreign exchange net of hedge losses.

Michael Derchin

Okay and so where do you see those going into - I guess you're saying it looks like from your guidance that you expect either unit revenue growth to be stronger in the fourth quarter than the third quarter. Is that because of this, what you just said about the fuel surcharges and FX maybe being more of a tailwind here in the fourth quarter or is it something else?

Mark B. Dunkerley

Sorry, you're right. Our guidance suggests sequential improvement from the third quarter into the fourth quarter and it's really a mix of factors. Domestically, we've continued to have positive momentum and we're looking for sequential improvement in the domestic entities. Internationally, we get a full quarter benefit of the new Narita route, which is helpful to us.

The fuel surcharge is really sort of flattened out by this point year-over-year, so that is less of a headwind. Foreign exchange is a bit of a mixed bag where we've got a benefit from the yen year-over-year, but that's offset by some of the hedges that we layered in over the last year and we're sort of flattening out in some of the others. So net-net, that puts us in a position where we expect sequential improvement on the international as well.

Michael Derchin

Great.

Peter R. Ingram

And Mike, let me add just a color for really, obviously, really on the call. One of the reasons why we do talk about what our unit revenue improvement would have been without the effect of exchange and without the effect of fuel surcharges, is to give you a sense of how we are doing as a brand selling into markets that are so relatively new to us. And one of the great resources of encouragement we take from our performance even during the period of times this last year we have that these headwinds from foreign exchange and from fuel surcharges is that in these markets where we started out without brand presence, without sort of independent reputation, we have sort of uniformly been able to increase our unit revenues in market in local currencies.

Michael Derchin

Great, thanks very much.

Mark B. Dunkerley

You bet.

Operator

Our next question comes from David Segal from Honolulu Star-Advertiser. Please go ahead.

David Segal

Hi, Mark.

Mark B. Dunkerley

Hi Dave.

David Segal

I had a question to ask about the A321neos and also one on the pilot situation. Regarding the A321s, its best if you can explain at this particular point in time what are your initial plans for the markets or the type of markets you're going to use those for when they start coming in the middle of next year?

Mark B. Dunkerley

Okay, so Dave on that, we are going to be using them initially to fly between Hawaii and North America, points in North America. We have not yet announced the specific routes that we'll first see the A321neo, and we will obviously make an appropriate release when we do.

David Segal

What's the seating capacity on those aircraft?

Mark B. Dunkerley

It is 186.

Peter R. Ingram

189.

Mark B. Dunkerley

189.

David Segal

Okay. And then regarding the contract negotiations, the Delta and Southwest pilots recently received some nice percentage increases. Does that put additional pressure on your company as it negotiates with the, as you negotiate your own pilots, the fact that these other contracts have already come out and does that complicate matters or put more pressure on your negotiations?

Mark B. Dunkerley

No, I don't think so. I mean, I think we've always had an expectation of where other contracts would settle out and I think that's been baked into the way in which we've approached negotiations at the table. I can't give you details because we're in mediation at the moment, but I don't think those agreements came as overwhelming surprises to us.

David Segal

Is there any obviously you want to get to settlement as soon as possible. I mean, as you look ahead, do you think there's any possibility you could get it settled by the end of the year or do you think this will spill into next year?

Mark B. Dunkerley

Again, we're in mediation so I really am constrained about what I can or should say. We'll just have to let that process run.

David Segal

Okay, all right, thank you.

Mark B. Dunkerley

Okay, very good. So, thank you, everybody, for joining us today. This has been, as I mentioned, a great quarter and a good year so far. Our investments over the past several years are now paying off. Demand to Hawaii remained strong which when combined with a favorable operating environment makes us excited about the future. Please save the date for our upcoming annual Investor Day in New York City on December 5. We're looking forward to seeing you there. Aloha.

Operator

This concludes today's teleconference. Thank you, for your participation. You may disconnect your lines at this time.

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