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Allegiant Travel Company (NASDAQ:ALGT)

Q2 2008 Earnings Call

July 24, 2008 10:00 am ET

Executives

Maurice J. Gallagher, Jr. - Chairman, Chief Executive Officer

Andrew C. Levy - Chief Financial Officer, Managing Director - Planning

M. Ponder Harrison - Managing Director - Marketing & Sales

Analysts

Michael Linenberg - Merrill Lynch

James Parker - Raymond James

Kevin Crissey - UBS Securities

Bob McAdoo - Avondale Partners LLC

Stephen O’Hara - Sidoti & Company

Operator

Welcome everyone to Allegiant Travel Company’s second quarter 2008 financial results conference call.

We have on the call today Maury Gallagher, the company’s President, CEO and Chairman, Andrew Levy, CFO and Managing Director of Planning for the company, and Ponder Harrison, the company’s Managing Director of Marketing & Sales. Today’s comments will begin with Maury Gallagher followed by Ponder Harrison, then Andrew Levy. (Operator Instructions)

We wish to remind listeners to this webcast that the company’s comments today will contain forward-looking statements that are only predictions and involve risks and uncertainties. Forward-looking statements made today may include among others references to future performance and any comments about our strategic plans. There are many risk factors that could prevent us from achieving our goals and cause the underlying assumption of these forward-looking statements and our actual results to differ materially from those expressed in or implied by our forward-looking statements. These risk factors and others are more fully discussed in our filings with the Securities and Exchange Commission. Any forward-looking statements are based on information available to us today and we undertake no obligation to update publicly any forward-looking statements whether as a result of future events, new information or otherwise. The company cautions users of this presentation not to place undue reliance on forward-looking statements which may be based on assumptions and anticipated events that do not materialize.

The earnings release as well as a rebroadcast of this call are available at the company’s Investor Relations website at www.ir.allegiantair.com.

At this time it’s my pleasure to turn the call over to Maury Gallagher for opening remarks.

Maurice J. Gallagher, Jr.

[Audio silence] and Andrew will wrap up with comments on aircraft plans, network activity, expenses and our balance sheet.

During the past three, four, five months virtually every comment we’ve seen in written press and many cases verbal have been about companies such as ours with gas guzzling MD-80s and catering to the leisure soft demand environment that seems to be plaguing the US. We in spite of these labels are proud to sit here today and tell you we had a very good quarter. We were profitable again.

As we go forward though we should comment on fuel somewhat. Since December, in only six months, we have seen our fuel increase over $1.00 per gallon from an exceptionally high base of $2.64 at the end of last year to over $3.70 through June. That $1.00+ increase has cost us almost $45 million in the past six months. Yet even with this substantial increase we’ve managed a $19 million operating profit through the first six months through June. These results have confirmed our strong belief that we can manage in a high fuel environment; we just need some stability and have time to catch up to the ever-accelerating costs that seem to have been plaguing us the past six months.

On the revenue front our revenues increased 48% to $132 million on just 36% increase in departures. Unit revenue growth has been the driver of our profitability in recent years, particularly our ancillary revenues. Our $27.75 per passenger amount is a 32% increase from last year’s second quarter and a $2.00 increase over Q1 from $25.75 per passenger in that first quarter. Ponder will have further comments in a moment on our ancillary activity and revenues overall.

Many of the trends talked about in our first quarter call continue to aid our results including emphasizing short-haul flying and our increasing passengers for departure. During this past second quarter we have eliminated more long-haul flights such as Rockford and Fort Wayne to Fort Lauderdale and added service to new shorter routes such as Monterey and Santa Barbara to Las Vegas.

We flew an average of 881 miles in our scheduled service system this quarter versus 921 miles in the same quarter last year. In June our scheduled service stage length in particular was reduced even further to 867 miles. The shorter stage lengths reduced our growth in fuel requirements. We only had a 29% increase in our gallons of fuel consumed on our 36% increase in departures.

Our passengers per departure have increased as well. We averaged a 90% load factor for the quarter or 133 passengers per departure. This is up 10 passengers per departure from last year. As we reported we averaged as well a 94% load factor in June or 137 passengers per departure, up eight passengers during the same period in 2007.

While revenues certainly benefited from these improved densities, our costs did as well particularly fuel. We only consumed 17.7 gallons per passenger during the quarter, down from 19.6 gallons last year. Higher densities allow us to spread our fixed trip fuel over greater numbers. Our cost per passenger ex fuel declined as well although frankly not as much as I would have liked. Our maintenance expenses were above the norm during the quarter impacting our cost per passenger totals. Andrew will have further comments in just a moment.

The increased fuel costs, the pace of which they have come on, are forcing our industry to remake itself. There have been numerous announcements of capacity reductions in a number of our world class leisure destinations, in particular as of October there are 15% fewer ASMs for sale in Las Vegas, 11% fewer in both Orlando and Phoenix. What hasn’t been publicized however are the reductions in service to small cities. The 50-seat RJ does not do well in a $130 fuel environment. Major carriers have been aggressively removing RJ capacity from small cities and in a number of instances suspending services altogether.

Some examples of the pull downs as of October include Eugene, Oregon a 26% reduction in flights, 37% in ASMs. US Air has exited the market in total eliminating trips to both Las Vegas and Phoenix. Green Bay, a 14% drop in flights and 16% in ASMs. Delta has exited the market. Lansing, a 19% drop in flights and a 22% in ASMs. Again, Delta has exited the market. With Allegiant there is only service from Northwest to Detroit and Minneapolis and United to Chicago. Toledo, a 49% drop in flights and over 60% in ASMs. Both Delta and Continental have exited the market. And but for us there is only American to Chicago and Northwest to Detroit.

Throughout our history we have had minimal direct competition. Going forward we will have even less. By mid-September we will have only one direct competitive route in our system: Fresno to Las Vegas. Additionally growth opportunities are improving substantial for the coming years in our opinion. We have acquired six aircraft during Q2 which are on lease to a European carrier. These aircraft are scheduled to be returned to us late this year and during 2009 and will provide us growth availability for 2009.

We’re encouraged by the strength in our markets as well. The 94% load factor in June was a key component of our 23% increase in scheduled service RASM during the month. Our small cities have an excellent economic profile. Recently a national magazine published a credit ranking of 100 cities in the US. We serve six of the top 10 most credit worthy cities including Billings, Sioux Falls, Fargo, Lincoln, Bangor, Maine and Wichita, Kansas. On balance it’s our belief our smaller communities in the US have not been impacted nearly as much by the slowdown in consumer related activities. We believe our near-term results support this conclusion.

At this point let me have Ponder follow up with comments on revenues and Andrew will finish up with our expenses and such.

M. Ponder Harrison

Unfortunately revenue gains in the quarter didn’t increase with the same velocity as fuel prices but the durability of our leisure focus business model was once again tested. With something as fundamental and uncontrollable as fuel costs when it grows as much as it did, increasing revenue is the only possible recourse. Fortunately we were able to raise it enough to ensure our 22nd consecutive quarter of profitability.

Now let me touch on some of the broader top line numbers and then as Maury mentioned move further into the details.

Total revenue for the quarter grew almost 48% year-over-year coming in at just over $131 million. For the six months ended in June total revenue was approximately $265 million growing year-over-year by more than 52%.

During the second quarter scheduled service revenue increased year-over-year by 34% generating $87.6 million and contributing 67% of the total revenue for the system. Ancillary revenue which drove just over $29 million was up over 84% year-over-year and contributed again just over 22% of total system revenue. Comprising the bulk of the balance, 10% of system revenue, our fixed D flying generated just over $12 million for an increase of 67% year-over-year. This increase is reflective of the addition of two aircraft in Tunica, Mississippi for our Harrah’s charter program along with increased lift for other charter operators during the quarter like MLT and Associated Ad-Hoc Operations.

Continuing the generally positive momentum for the first half of the year scheduled service revenue grew 45% year-over-year while ancillary revenue increased by almost 100% growing at 97% for the first half of the year.

Looking deeper at the drivers for these positive revenue results, significant increases in both passenger volume and departures coupled with shorter stage lengths all helped to produce a winning outcome. In the second quarter scheduled passengers grew as Maury mentioned 39% year-over-year. Departures were up 29% and ASMs increased by 24%. These metrics are consistent with what Maury already indicated, namely that we’ve driven the number of passengers per flight up while reducing our stage lengths. For the quarter we were able to increase passengers per departure as mentioned previously to 133 passengers. Year-over-year that’s an increase of approximately 8% and our revenue per departure more importantly grew by an even greater amount, up 11%.

The numbers above were delivered in great part by our outstanding scheduled service load factor results posted for both the quarter and for the first half of the year. Demand indeed remained strong in the second quarter despite economic concerns and the potential pressures negatively impacting discretionary consumer spending.

In fact we flew more than 90% full in the second quarter while exceeding 94% for the month of June. This reflects year-over-year increase for both periods of just slightly more than five load factor points. To our knowledge this represents the highest second quarter load factor in the US domestic industry for those carriers that report. We suspect also that it might even be an all-time record for a scheduled carrier but quite frankly we have no way of knowing that.

Similarly strong customer demand produced load factor results for the first six months of the year which were equally as impressive as we filled just north of 88% of our seats, an increase of again almost five load factor points on a year-over-year basis.

So you may ask, “Is volume our new creed?” Well, not exactly. In any business volume for its own sake is certainly no formula for success. What we’re doing here is seeking to fill all the seats all the time but importantly at the right price. Given our destination focused, leisure oriented point-to-point nonstop route network, Allegiant clearly has a unique opportunity to drive load factor and more importantly overall revenue in a way that more traditional airlines may find quite difficult particularly given the consistency of our ancillary revenue growth which coming in at $27.75 for the quarter on a per passenger basis was up 32.5% year-over-year or as Maury mentioned almost $7.00 per passenger. Sequentially ancillary also improved nicely from the previous quarter growing by $2.00 per passenger and as a percent of our average scheduled airfare in the second quarter ancillary came in just over 33% of that absolute number.

Most traditional low-cost carriers and legacy airline networks are not built to perform efficiently at load factor levels as high as ours. Hubs, connections, interline agreements and numerous other structural impediments prevent carriers with more complex business models from taking advantage of our all-the-seats all-the-time philosophy.

Flying our aircraft at or even near capacity, though it can be challenging operationally, is a maturing strategy we certainly intend to continue pursuing. These extraordinarily high load factors also reflect close coordination between our planning and pricing groups in first, tailoring capacity to demand and then secondly, pricing it at the market clearing level so that it is appropriate to maximize revenues. This combination of higher load factors and higher fares that we saw in June has continued into July, perhaps even more so.

And speaking of average fares, though our average schedule airfare of approximately $83.00 for the second quarter was in fact down 4% year-over-year, it really was essentially flat on a stage length adjusted basis declining by the same percentage as the reduction in our average length of haul. However when combined with this quarter’s ancillary production, total average fare per customer actually increased just over $3.00 moving to slightly more than $111.00 from $108.00 in the first quarter.

And further, because of the healthy passenger volumes air RASM in the second quarter grew by more than 7% year-over-year, ancillary RASM increased by more than 48% year-over-year, and as you would suspect total RASM or the acronym we like to refer to as TRASM accelerated by an impressive 15% year-over-year. It’s also worth noting that Easter occurred in March this year which certainly didn’t help average fares for anyone in the second quarter. However on a positive note, the average scheduled airfare in June as I just mentioned exceeded $89.00, up $3.00 year-over-year in combination with what we had previously described as record traffic volumes for the month.

The point is that we remain confident in our ability to continue raising average airfares over time without sacrificing passenger volume.

Let me close by touching on what’s happening to the leisure business especially in two of our more important destination markets, Las Vegas and Florida.

As you know casinos are under pressure in Las Vegas. Business is down, room rates are down, scheduled airline capacity in the fourth quarter as Maury mentioned of this year is down significantly by more than an eighth in seat terms in Las Vegas, and all of this occurs against the backdrop of about 8,800 new rooms being added to Vegas by the end of this year with another 16,000 to be added in 2009.

While we regret that our casino partners are having a tough time, frankly this is actually a good thing for us. We are already enjoying far lower wholesale rates and much greater availability on casino rooms than we had last year and we’re pressing our partners repeatedly for even better rates. More generally the cost of a Las Vegas vacation is coming down again bringing it back into the frame for people who may have been priced out of the market as Vegas room rates increased during the past several years. This is a big factor in allowing us to increase Vegas airfares on a go-forward basis.

For example we have a number of promotions to Las Vegas during the year where essentially two can fly for the price of one when you purchase a hotel accommodation. We’re currently in the middle of our second of such promotions to Vegas this year and all of our metrics are substantially up over last year including significantly higher underlying airfares and substantially higher overall hotel revenues. Also encouraging is that similar to a prior fly free promotion earlier this year there is a distinct and clear trend towards buying a better class of hotel. Our customers are taking advantage of lower hotel rates to upgrade themselves to an even better vacation experience.

We’re also taking advantage of a similar dynamic in the car rental business. As you can appreciate, with airline seats down substantially in Florida and in Vegas rental cars are going begging. This is driving rates down and also allowing us to get a better wholesale deal with our exclusive rental car partner Alamo. Again we regret the tough times for them but it’s frankly working to our advantage and it’s another thing that is helping drive down vacation prices.

So there’s no question that the leisure industry in Vegas and Florida is facing hard times overall but it’s something that’s working to our advantage, and by allowing our customers to take advantage of terrific bargains which is helping us drive volume on our flights we believe that we can succeed going forward.

And now I’ll turn it over to Andrew to review our market planning activities as well as fuel and financial details.

Andrew C. Levy

We are proud to report our 22nd consecutive quarter of profits. We’re pleased that our 3.6% operating margin and 3.2% pre-tax margin lead all of our US industry peers that have reported to date. While our 2Q08 profits fall short of our goal of double-digit pre-tax margins, we remain confident we can return to that level of profitability if fuel prices stop increasing or at least increase at a slower more manageable pace.

Remember in the last four quarters our average fuel prices increased from $2.32 in 3Q07 to $2.64 in 4Q07 to $2.88 in 1Q08 to now $3.52 in the second quarter of 08. We remain firm in our belief that we can produce strong profit margins at any fuel price as long as we have time to adjust our network routes and capacity, but when fuel prices increase rapidly as they have in each of the last three quarters there’s little ewe can do to impact the short-term results. So for perhaps the fifth time since last October, we have recently adjusted our network and capacity to account for the latest shift in fuel prices. Our network and capacity planning decisions are being made with the assumption that crude will remain at $140 range.

This past Monday we extended our schedule from December 15 through the end of January. As part of this process we will be exiting a number of routes to Fort Lauderdale that we do not believe can be profitable at current fuel prices. There are a few other routes we are watching closely and may have to take similar action in the coming weeks. Fortunately the vast majority of our routes are performing well and we believe if we offer the right number of seats for sale at any given time, we can earn healthy profits. We have continuously refined our capacity planning to give our pricing team the best opportunity to fill up airplanes at fares sufficiently high enough to produce acceptable returns.

Apart from appropriately managing our own capacity, we believe the capacity reductions from other industry participants will accrue to our benefit since many of the reductions have been aimed at both ends of our network, leisure destinations and small cities. So despite using “gas guzzling MD-80s” to exclusively target leisure customers we feel very confident about our business. And if and when fuel prices move sharply again whether up or down, we will react quickly and take full advantage of our competitive advantages: Highly reliable but inexpensive assets that we can choose to fly only when we can generate acceptable returns, a proprietary and flexible automation platform that can be quickly tailored to meet our needs, and our ability to generate substantial ancillary revenue both from unbundling the traditional airline product or “a la carte pricing” or from the sale of hotels, cars and other products valued by our customers but provided by third party suppliers.

Turning to costs, we continue to be pleased with our cost management during the second quarter 2008. Despite a decline in average stage length of 7%, both salaries and benefits and sales and marketing declined year-over-year on a per ASM basis. Unit costs for station operations and other were basically flat year-over-year. Aircraft lease rentals increased by only 12%. Only fuel up 60%, maintenance and repairs up 57%, and depreciation and amortization up 26% increased faster than the 16.5% increase in total system revenue per ASM.

As indicated in the press release the sharp increase in maintenance and repairs expense was due primarily to more scheduled air frame maintenance visits, seven in this quarter versus three in 2Q07, and more engine overhaul events, three in this quarter versus one in 2Q07. The two-year average cost per ASM for maintenance and repairs has been $0.77. Last year during the second quarter our expense was $0.61 which was our lowest quarterly unit cost in that timeframe. So second quarter 07 had unusually light maintenance and repairs expense while this past quarter was unusually heavy coming in at $0.97 per ASM, the highest in eight quarters. We expect to see a [revergent] to the mean in the next few quarters. As we’ve indicated on prior occasions, we will continue to see lumpiness in this expense line since we do not have a very large fleet and have not entered into more predictable but more expensive powered-by-the-hour maintenance agreements.

The increase in depreciation and amortization is much more simple to explain. We ended the quarter with 39 owned aircraft compared with 24 owned aircraft that we had at the end of the second quarter of 2007.

Let me also touch on our balance sheet and liquidity. We ended the quarter with $153.8 million in unrestricted cash and short-term investments, down from $188.2 million at the end of the first quarter. Key transactions during the quarter included: The purchase of our 37th aircraft for $5 million with $3.6 million of seller financing; the refinancing of five aircraft formerly on capital lease using $10 million in deposits held by the owner, $8 million of new debt, and $3.5 million of cash; the purchase of one engine for $1.4 million; the purchase of six aircraft and three engines for $25 million that we currently have leased to another airline; other miscellaneous cap ex purchases of $4.8 million; scheduled principal repayments of $4.6 million; the early retirement of $700,000 of debt to pay in full one aircraft financed through mortgage debt; we raised $25.9 million by refinancing 10 MD-80 aircraft; and total debt increased by only $4.2 million despite the addition of seven aircraft into the fleet.

Additionally our air traffic liability declined by $14.9 million due to the seasonal reduction in capacity we plan each year starting mainly in early to mid-August to coincide with the significant decrease in demand for travel to Florida at that time of year.

We are very comfortable with our liquidity position. Several different metrics are used to compare US airlines in terms of the adequacy of their cash balances. Regardless of which one you may prefer, we compare very well to our peers. Most importantly we continue to generate profits and cash despite the difficult environment we are experiencing.

Lastly let me touch on our guidance issued in the press release and how we are viewing future capacity growth going forward. Our third quarter capacity guidance indicates a slowing of our growth perhaps beyond the expectations of some observers. Let me provide some color.

Each year during the third quarter we sharply reduce our capacity to Florida markets coinciding with the decline in traffic demand that starts to occur in mid-August and is most prominent in September. This year’s seasonal cuts have been more severe than last year’s due to the current fuel price environment and it also includes the elimination of a few routes into Fort Lauderdale which do not work at current fuel prices.

We have made capacity reductions in our Phoenix system as well but we target these reductions to start on July 1 so the entire third quarter shows a seasonal reduction in capacity in Phoenix.

Also last year during the third quarter we started several long-haul routes into Las Vegas, all of which have since been eliminated due to the sharp run up we’ve seen in fuel prices that started in the early part of the fourth quarter of 2007.

We are also being more cautious about starting service in new small cities due to the broader economic uncertainties as well as what’s been happening with fuel prices. So our 10+% growth in departures that we expect during the current quarter is down but it is not down because of concerns about demand or lack of future growth opportunities. We are being cautious appropriately so we believe.

Our corporate focus is on generating profits and we’ve stated many times that we will sacrifice revenue growth to ensure we remain profitable. We believe it is prudent to do so at this time until we have a clear picture about the macro environment particularly fuel prices and the impact of the large capacity cuts that have been made by other industry participants concentrated in our key leisure destinations and many of our small cities are better understood.

We expect many new opportunities to present themselves in the coming weeks and months as leisure routes continue to be abandoned by those whose business models do not enable them to profit in this environment but work very well for us. We have the unique ability to be very nimble primarily due to our inexpensive aircraft and can add capacity very quickly. We will have at least 37 aircraft in service by the end of the year, many of which will have spare capacity available on them. We also have six aircraft leased out that will start coming to us at the end of the year and we plan to add to the fleet starting in the first quarter of 2009. These six aircraft will drive most of our 2009 growth.

How substantial that growth rate is in the fourth quarter and beyond will be dependent on what opportunities there are for us to grow profitably. We do not have to make those decisions today and therefore we will not make those decisions today. We will however continue to run our business for the benefit of our shareholders with a longer term perspective in mind.

Thanks. And we’re now happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Michael Linenberg - Merrill Lynch.

Michael Linenberg - Merrill Lynch

Can you give us a sense of what your daily utilization will be on the airplanes in the third quarter and how that compares to the second quarter and then how that compares to what the utilization was during the third quarter in 2007?

Maurice J. Gallagher, Jr.

Last year our daily utilization of airplanes in Q3 was six block hours a day with about 2.59 departures per aircraft per day and we have a fleet of 29 airplanes in place. I’d have to dig a little bit if somebody will give me the utilization for our Q2 as well. But as we go forward I think you’ve hit on a key point on the growth side. Q3 for us is our slowest quarter of the year. Last year we certainly cut back more than we did the previous year of 06 and this year given the headwinds of: How much was fuel going to be going up? What is going on in our general markets? All of those aspects suggest that we should be even more conservative in Q3 going into this year. So hence you see the numbers there.

Let me also make one other comment. ASMs, I’m not terribly impressed anymore with ASMs from our perspective. Certainly it has bearing on maybe some cost aspects but with the stage length going down as much as 5% to 6% our ASMs are going to decrease disproportionately. Departures are very important to us, passengers per departure, cost per departure; that’s your metrics of making a buck.

By the way, Q2 had 6.4 hours of utilization this year and Q1 was 7.5. Andrew I think has some other follow on comments.

Andrew C. Levy

I think that your spot on Maury. We have unused capacity in this fleet right now. We’re flying the airplanes fewer hours albeit similar numbers of departures and we think that we have lots of ability to drive that number higher to something that is more closely approaching historical numbers and beyond that if the opportunity presents itself.

Maurice J. Gallagher, Jr.

You’re certainly I think going to see a fleet reduction Mike. Just do the math on 10% growth. With airplanes you can back yourself into 10% to 12% reduction in block hours per day at a minimum in our fleet as a total going into the third quarter.

Michael Linenberg - Merrill Lynch

In the past, maybe I’m going back a year or a year and a half, the number that I recall being thrown out was something on the order of like 30,000 room nights a month I think was what you would sell and I believe at that point in time it was predominantly Vegas, maybe there was a little bit of Orlando. Can you just give us maybe even just rough numbers where you are now and as you look out over the next couple quarters, and I realize there are some seasonal adjustments here, where you think that could grow? How much that could grow based on the pullbacks or the withdrawals by the other carriers for many of the leisure markets and yet these hotels, they’re fixed assets, they’re not going anywhere and in fact as you indicated I think Ponder Vegas is set to add a significant number of rooms in the coming 12 months?

M. Ponder Harrison

Yes Mike, let me try to touch on that just in general terms. We feel confident that we can begin to move our overall hotel production up whether it be monthly, quarterly, even with respect to seasonal upturns or downturns. We’re in ongoing negotiations as we’ve stated before with our hotel partners right now to look out not just over the next couple of quarters but really look out over the longer term horizon as they have capacity coming on and try to really work strategically in terms of what benefits them and us best.

Really when you look in the quarter at Vegas in particular our traffic, because we pulled a number of our long-haul markets out of Vegas, the markets we served in the previous year that we did not serve. Maury I think had touched on it a little bit, Topeka, Lansing, some of these longer-haul markets. In fact some of the longer-haul markets were real good hotel markets. Kind of length of haul proportionately drives hotel take rates from time to time. But at the end of the day our productions remain fairly flat. Traffic’s fairly flat for Vegas even though the loads are up because ASMs are down. But again our hotel production was fairly flat too.

What we’ve seen is we’re seeing a shift though oftentimes with customers moving into higher-end properties because the price points are coming down; we’re able to take our margin up; we’re able to enjoy better rates from the hotels; and what we have seen is that customers can enjoy a better experience by moving into a more premium product. I think as we’ve always mentioned we’re working on web initiatives, distribution initiatives, and again real strategic initiatives with the hotels to increase our percentage of capture.

Bear in mind one real strategic asset we believe we have and I think the hotels realize this too is that we are absolutely in control of a very unique distribution group. Our customer base is very discreet, very unique and really the only path to get to them is in fact coming through Allegiant.

So again just to reference your question, the 35,000 number; I think our number as probably just slightly north of that in the second quarter, probably around 38,000. Again up slightly and we are real encouraged that we can move that number north going forward.

Michael Linenberg - Merrill Lynch

And the 38,000 that’s all of your hotel rooms; that’s Vegas plus Orlando, Tampa, etc?

M. Ponder Harrison

Yes. But certainly the vast majority is centered against the Las Vegas market.

Operator

Our next question comes from James Parker - Raymond James.

James Parker - Raymond James

Andrew, a question for you regarding the maintenance and the higher maintenance expenses. You say that it was very abnormal in the second quarter. Can you tell us third and fourth quarters what’s coming up here in terms of shop visits and overhauls that you might have?

Andrew C. Levy

Jim, we can’t make forward-looking statements. That’s not allowed is it?

James Parker - Raymond James

You have it scheduled. I wouldn’t see why you couldn’t reveal that.

Andrew C. Levy

No, we’ve been talking about how to provide perhaps better guidance in this area because it is lumpy. But as you noted some of it is predictable. There can be unscheduled engine events which can move the numbers certainly. The third quarter we expect that there will be a slight increase in maintenance expense per ASM. When we get to [inaudible] it’ll be very small we believe compared to last year. And the fourth quarter will be the same we think. So we’re going to see I think more normalized maintenance expenses in the third and fourth quarter this coming year barring any unforeseen rash of unscheduled engine overhauls or anything like that that we just can’t predict.

James Parker - Raymond James

So in the second quarter there weren’t any unscheduled events?

Andrew C. Levy

In the second quarter, there were. I think one or two of the engine overhauls that we did in the second quarter where we had three this year were in fact unscheduled.

James Parker - Raymond James

Looking at your absolutely terrific load factor 90.5% and your ancillaries were up nicely. Is there a chance that maybe you overdid this a bit on the load side in order to maximize RASM?

Maurice J. Gallagher, Jr.

No one’s ever told me I overdid my load factor to maximize RASM before. Ponder?

M. Ponder Harrison

One of the things we’ve looked real hard at is the fact, Are we spilling traffic or aren’t we? And we do not think we are. We’ve looked very hard year-over-year. And one of the interesting things is just when you look at the number of our flights sold out for the quarter seven days prior to departure, I mean it’s a very interesting statistic to observe year-over-year and that is significantly down actually this year even with a higher load factor than it was last year. What that reflects is a real focused and strategic shift in the way we’re pricing our product and the way we’re monitoring overall total revenue demand and more importantly load demand as we move up to and including the departure date. We don’t think we’re spilling. A couple of things I think we mentioned too was the positive momentum in average airfare movement particularly in the month of June and we have seen that continue well into the month of July on a month-to-date basis. We didn’t have Easter in the second quarter so fares will suffer slightly from that also to May being a shoulder month. Your point being if we bought traffic in any month, I’d say that we didn’t but certainly average fares were probably lower in May than they were elsewhere in the quarter. But again we’re starting to see the real fruits of our ability to move pricing upwards and we think that momentum will continue even at the high load factor levels.

Maurice J. Gallagher, Jr.

Jim, one other thing. We’re entering unique territory here because of the ancillary. You may buy load factor to a point of revenue but each one of those guys in the second quarter was giving us over $27.00, close to $28.00, of incremental revenue that presents a very unique opportunity to move the needle. The other thing too and it’s very, very impressive when you see the ability to spread your fixed costs across these folks because unlike a lot of other people our marginal costs for adding a passenger, for direct costs anyway, certainly may have some indirect slip to stationary activity and the like but it’s marginal because it’s really just credit card fees and perhaps an extra station cost per passenger type of thing. Those are very powerful incentives to both lower costs and improve revenue base.

Operator

Our next question comes from Kevin Crissey - UBS Securities.

Kevin Crissey - UBS Securities

A question on the ancillary revenue. You spend and I think it’s kind of good IR work to talk a lot about the hotel portion of ancillary, but at least it looks like on the DOT numbers the bulk of the growth and the bulk of the overall ancillary revenues, and correct me if I’m wrong, comes really more from the air side. Can you talk about what’s going to change in the Q3 through the next four quarters or so on the air side to think that this kind of ancillary revenue growth will continue?

M. Ponder Harrison

One of the changes that we have made that we didn’t reflect on the call is just the continued movement in certain of the overall absolute price points of ancillary products specific to the air side; so say baggage and seat assignments and things of that nature. When the industry went to $15.00 we’ve now moved our web checked bag to $15.00; we’re charging $25.00 for a checked bag at the airport; in fact to the extent its outside our dimensional limits at the gate we’ll charge $35.00 for gate checked bags. So again I think as you know our protracted booking curve to some degree takes a while for these to really ripple through and be realized at the flown level. So what we’re reporting are flown revenue statistics. We are still seeing the momentum in movement of these price increases rolling through. So we do anticipate that ancillary revenues perhaps could be bolstered as a result of these types of changes. And again I would point to bags because those are an obvious and easy category.

I think maybe a more subtle category that’s not as easily understood is our seat assignment. Again you point out that a number of the ancillary efforts come against those items related to airfare apart from just third party products. But we’ve made substantial strides in terms of our ability to yield certain components and areas of the airplane, premium seating; we’ve got some initiatives that perhaps would bifurcate priority boarding from advanced seating and seat assignments; we do not yet even have an online check-in aspect for our product and we certainly intend to roll that out. So we have a number of additional items we think attributable just to the airfare side that can continue to move this number even against large passenger volumes on a go-forward basis.

Kevin Crissey - UBS Securities

How about on the new aircraft side? It may not be the time to be thinking about it or maybe I’m wrong, maybe it is the time to be thinking about it. What are your thoughts on a second aircraft? I know it’s been bounced around a bit. Where do you stand?

Maurice J. Gallagher, Jr.

We certainly have tremendous faith in the MD-84. On a go-forward basis this airplane has really done a yeoman’s effort for us and we’ll continue to work strongly with it. Having said that, I think as we grow green initiatives, things like that, perhaps FAA related pronouncements with ADs all those drive you towards potentially looking at newer airplanes. At this point the market place historically has been oversold and it’s been tough to even get attention from those folks. We have been in this environment for years. We continually shop the market looking at Boeing, Airbus, anybody else that may make sense for us. But at this juncture we have nothing specific to report. We probably have to do a new airplane at some point in our future. There’s no doubt about that. [Inaudible] thoughts.

Kevin Crissey - UBS Securities

Are you closer to that decision or farther away given what’s happened with fuel?

Maurice J. Gallagher, Jr.

Well fuel has certainly pushed us up the ladder to look at things. I think if the world slows down here, with our balance sheet and things like that those become incentives if the pricing improves that make it more attractive rather than less. But we have no specific calendar or timeline to do anything at this point.

Kevin Crissey - UBS Securities

And it would be new versus used?

Maurice J. Gallagher, Jr.

Yes. We really don’t have a specific answer on that. We’ve certainly done well with used airplanes but as we grow one of the things we’d also like to see ourselves have is a consistent fleet. Same type of airplane. So fleet types would be important to us as well.

M. Ponder Harrison

Kevin I’d just add one thing. We think, as you can see from our load factors, we’re pretty confident that we can handle more seats on the airplanes. So as we look to what might be the best airplane going forward, we’d look at larger gauge narrow bodied equipment and also the possibility of adding seats into the MD-80. That’s something we’re studying at the moment. We think that’s the right move for us to get more seats and it’s just a matter of the right economics and moving when the time is right. So it’s something we study continuously and have for several years, and when the stars align we will look to do something. And when that is we’ll see.

Operator

Our next question comes from Bob McAdoo - Avondale Partners LLC.

Bob McAdoo - Avondale Partners LLC

On your P&L you show a $2.2 million other revenue that looks like a new line item. What is that?

Andrew C. Levy

That is the lease revenue associated with the airplanes and engines that we purchased at the start of the second quarter.

Bob McAdoo - Avondale Partners LLC

These are the ones that are leased out to somebody else?

Andrew C. Levy

That’s correct. And we’re taking revenue there; we’re also seeing on the expense side in depreciation and amortization and expect to see some on the maintenance and repair line as well in the future. We have some reserves we’re collecting for that but we have the potential to have to pay in excess of that under the agreement.

Bob McAdoo - Avondale Partners LLC

You talked a lot about some of the things that are going on in ancillaries. The $7.00 incremental piece of ancillary from last year, can you kind of give us more color on what really grew to get this extra $7.00?

M. Ponder Harrison

A couple of products that we put in over the past 12 months that we obviously didn’t have. Our trip flex product, and we’ve spoken to this on previous calls, that’s why we didn’t really highlight it because the same effect essentially was in place in Q1, but our trip insurance product has matured nicely and it’s a tremendous benefit to the consumer. It allows our customers to change their itinerary essentially for no additional charges on a virtually unlimited basis, the one caveat simply being that we won’t give them their money back on a refund basis. But they can change names, change their flights, change their itinerary, change the number in the party size, and clearly they pay an uplift in fare if the itinerary were more expensive. But that’s been a real driver for us.

Furthermore we instituted a product call web loyalty here in the last year-over-year period and what that is it begins to monetize the traffic on our website. Our website continues to be extremely robust. The number of monthly unique visitors continues to escalate at a far greater pace than even our traffic or any other growth metric. We are a household name throughout the heartland of America in the 40 states we serve. And what this particular piece does is it pays us really in our ability to monetize that traffic at the end of our booking flow.

So those two were very nicely additive overall on a year-over-year basis. Again we’ve continued to see upward realization in dollars coming to us from baggage charges as well as our seat assignment revenue.

Bob McAdoo - Avondale Partners LLC

What do you mean the web loyalty thing pays you at the end of the booking process?

M. Ponder Harrison

It’s not dissimilar from paid advertising for anyone on a banner ad or any other kind of website. If you go through our booking flow, you will see the web loyalty offer that occurs at the end of our flow and in conjunction with our confirmation screen.

Bob McAdoo - Avondale Partners LLC

Could you give us a little more color on the MLT cancellation? Was that a surprise to you or are there any other things like that that might be popping up down the road where somebody has an option to cancel?

Maurice J. Gallagher, Jr.

MLT I think was a bit of a surprise I suppose. I’m not surprised that they’re having trouble with fuel at these levels but shortly after we entered into the agreement we got the notice of cancellation. So it was disappointing. We don’t think it’s a big deal quite honestly. It would have been a good piece of revenue. It’s predictable and profitable. But we think also that as long as fuel sits in a stable environment that we can probably generate greater returns putting that airplane into our scheduled service.

Bob McAdoo - Avondale Partners LLC

So for us to hold out to people that your revenue per airplane, your bottom line per airplane on your own operation even though there’s more risk to it is a higher return than some of the -

Maurice J. Gallagher, Jr.

Yes. There’s no question about that as long as we have fuel and a stable environment. This past quarter flying which is not at risk for fuel obviously was a better proposition than at-risk flying with what we saw fuel prices moving by just leaps and bounds. That can’t go on forever and hopefully we’ve seen it kind of stabilize. It’s obviously gone down a good amount in the last couple of weeks, which is great. But as long as it kind of sits around the $140 range which is what we’re using, then we think going forward especially as you look into the fourth quarter and beyond where we’ve had sufficient time to adjust our network in terms of capacity and pricing, yes I think that we’d rather put an airplane in our scheduled service than in charter.

As far as other, the other agreements we have are primarily with Harrah’s and there are certain abilities for Harrah’s to get out of those agreements. That’s always been in there and I’m sure will continue. Two of those agreements expire at the end of this year and we’re in negotiations at the moment to try and extend that agreement. And we’re optimistic that we’ll be able to do so.

Bob McAdoo - Avondale Partners LLC

Is there a difference between Harrah’s and the MLT in that Harrah’s is using your airplane to bring people in to gamble where as MLT was actually trying to sell to the public?

Maurice J. Gallagher, Jr.

I think Harrah’s has the gaming revenues so they’re looking at it obviously as the entire trip proposition; the cost of getting them there as well as the cost of keeping them in their hotels versus the revenue they derive from all the different revenue streams including the gaming. I think MLT and Apple Vacations and many other tour operators do the same thing. They don’t have gaming but they make a great amount of their money by selling hotel rooms in the destinations they serve. So a different model but for whatever reason the MLT is just not able to make it work at the moment and Harrah’s continues to be able to do so.

Bob McAdoo - Avondale Partners LLC

In your list of markets and whatever that you talk about, you point out that in terms of things that you’ve started you’ve got some Bellingham to destinations other than your major leisure destinations, the San Fran-San Diego. What prompts you to get into connecting two points that are not in your top five big city list like that and what makes something like that attractive? And as you think about other places like that, is that something that’s likely to become a bigger piece of your business?

Maurice J. Gallagher, Jr.

Yes Bob. I think the answer to your last question is yes. I think it is likely to become a bigger part of our business. What we’re able to do by basing airplanes in Bellingham is to do a lot of experimenting with places like San Diego, like San Francisco, and there are a couple of others we’ll likely add in Bellingham in the coming months. We get a chance to understand not only the economics of that particular route but also whether a place like a San Diego or a San Francisco might be good future new larger destinations where we would in fact base airplanes in five to multiple points. The ability to have the base in Bellingham gives us the opportunity to explore new possible destinations, some that are going to be small but others that could be quite large.

And I think we can do the same thing in other parts of the country. There are a few places on the East Coast that as we look into the future we think we will likely base airplanes in and be able to do kind of the same thing, try out some other destinations that could have great potential.

We’re pleased with the results by the way we’ve seen so far from Bellingham to San Diego and San Francisco. And we continue to be pleased with Palm Springs which we’ve been flying now for a year and a half, almost two years. In fact we’re now doing Palm Springs on a year-round basis, and our service to Reno which we’ve been doing out of Bellingham for about a year. So all that has worked very well for us and I think we will see more of that to come in other parts of the country.

Bob McAdoo - Avondale Partners LLC

How long have you been doing the San Diego-San Fran?

Maurice J. Gallagher, Jr.

We just started that in June Bob. So July is the first full month.

Operator

Our next question comes from Stephen O’Hara - Sidoti & Company.

Stephen O’Hara - Sidoti & Company

I just wanted to quickly go over the load factors so far this month. Are you saying that they’re on par with what you saw in June or for the June quarter?

M. Ponder Harrison

I think the comment that we made was that month-to-date load factors for the month of July are on pace with what we saw in the month of June, which arguably would be again in excess of what we saw in the quarter.

Stephen O’Hara - Sidoti & Company

In terms of the third quarter, how fast can capacity come back in to your system if the environment improves fuel-wise or anything like that?

Maurice J. Gallagher, Jr.

We have the airplane time certainly. We have crews perhaps from our [inaudible] that are limited but I don’t believe that’s the case since we were flying much heavier utilization with them in the first half of the year. Crews and airplanes are about it as far as adding things back.

Andrew C. Levy

Just one comment on that. I don’t think that at this point we are going to add capacity in the third quarter. We’re just too far into the quarter for that to be very expected. But certainly for the fourth quarter there’s ample time especially when you consider that really Vegas is year-round demand and Phoenix is showing signs to be pretty similar actually. But certainly Florida is very seasonal and even in the fourth quarter it’s a good quarter for Florida. But the peak periods of demand at that time are really centered around the Thanksgiving and Christmas holiday seasons. So that’s a long way away. We think that if we’re in an existing route, 60 days is ample time in most cases to add more capacity if we think the demand is there to warrant it.

Stephen O’Hara - Sidoti & Company

You guys have talked a lot about stable prices being very important to your model. My question is why haven’t you guys revisited the hedging?

Maurice J. Gallagher, Jr.

Steve, everybody needs stable prices.

Stephen O’Hara - Sidoti & Company

Right. They’re falling.

Maurice J. Gallagher, Jr.

The hedging thing from our perspective was something that we just felt we were paying an incredible amount of premium last year. Our timing probably could have been better when we decided to move away from it frankly. But running the business and using our assets to hedge if you will, moving in and out of markets using capacity, expanded, contracted, those types of things are certainly real important to us. We haven’t foreclosed the possibility of doing more hedges. I think one of the things that has been rather eye opening over the last nine months to myself is just the pace and the speed with which fuel can move and the impact it can have on you. So you may have to pay a premium to certainly ensure your top line doesn’t get eaten up instantly the way it has particularly in the last 90 days. Andrew has run that program for us over the last couple of years since 02 but we’re always looking at it and we’ve never foreclosed it.

Operator

Our next question comes from Michael Linenberg - Merrill Lynch.

Michael Linenberg - Merrill Lynch

When you look at the small cities that you serve Maury and you look out into the future and the past, you’ve talked about opportunities of upwards of 100 cities. And with the high fuel prices and the cutbacks by the other carriers, I think the ATA is out there saying that maybe 100 cities have already lost service and you could see another 100 cities that lose service. So sort of a two-part question. One, are you looking at a much bigger list now of cities that could utilize your service since it seems like some pretty decent size cities are losing some pretty significant service? And the second piece is, what’s the response from the airports knowing that they look around, they read the papers, they see the cuts by the incumbents, by the bigger carriers and their regional partners. Are they coming to you and looking to strike a deal? Are there opportunities really to reduce your airport costs?

Maurice J. Gallagher, Jr.

Let me make some overview comments. Andrew deals more day-to-day with these things. Certainly the capacity is coming out of the markets. I made those direct comments in my opening statements. The small cities certainly present opportunities. On kind of the short side though we’ve lost some we think long-haul opportunities here in the near term because of fuel prices and the ability to make long-haul work. But over time I think if this thing stabilizes, those will become available to us again. Certainly the direct competition is down, our ability to increase frequency I think will come back to us in a number of markets, and last but not least just expanding into markets we’ve got 30 to 35 cities on our list at a minimum that we want to continue to look at and move into over time. As far as the airports I’ll let Andrew make some comments. He’s closer to that aspect.

Andrew C. Levy

Mike, I’d say that to reduce that line item is certainly tough when you’re talking about existing airports. We think there’s a possibility but we’ll see. They’re certainly very pleased with our service and I think maybe more appreciative of what we bring to the table.

Maurice J. Gallagher, Jr.

Mike, let me interject. I think practically with the reduction in capacity, the ability for airports to spread their costs is going to get tougher and I would think if we can hold our own on a practical basis that’s probably doing a pretty good job.

Andrew C. Levy

I think Maury’s right about that. I think as far as new small cities that we would enter into, new airport deals, I think that first of all these airports have been very aggressively chasing our service for quite some time and it seems like that pace is accelerating and certainly any new airport deals that we would enter into we would look to be even more aggressive than we have in the past. And we think that those opportunities are presenting themselves. So when you average the two together between existing and between new, hopefully we can at least keep that line item constant if not perhaps even maybe get a slight decline over time.

Operator

Our next question comes from James Parker - Raymond James.

James Parker - Raymond James

Bob asked my MLT question. Perhaps on Fort Lauderdale, other than seasonal softness in business to South Florida anything else going on in why you’re taking service out of some of those markets?

Andrew C. Levy

Jim, Fort Lauderdale has been maybe the weak link in the network year-to-date. There are some routes that work very, very well and there are others that have just simply performed very poorly. And it’s a combination of obviously very high fuel prices but also the inability to get the fares up to levels that are appropriate particularly when you compare it to Orlando and Tampa with the additional length of haul from our markets to fly a little further south to Fort Lauderdale. We’ve had a tough time in certain cases to get that fare up to the level where you would compensate for the additional stage length. Really our plans for Fort Lauderdale are to basically cut it back likely to one airplane and then build it back up again by adding some new services to small cities that are perhaps too close for air service to Orlando but we think would do very well to Fort Lauderdale. So that’s what we hope to do going forward. But the routes we got out of just simply weren’t working for us and we thought we should reallocate our assets to other parts of the business that are working very well.

Operator

Our next question comes from Kevin Crissey - UBS Securities.

Kevin Crissey - UBS Securities

My follow up was asked. Thanks.

Operator

Our next question comes from Bob McAdoo - Avondale Partners LLC.

Bob McAdoo - Avondale Partners LLC

Given what we’re seeing with fuel coming down this last week or two, what has to happen for us to see a serious tailwind that kind of looked like the serious headwind we’ve had?

Maurice J. Gallagher, Jr.

I’m kind of like that fellow that walks on hot coals. You think they’re getting cooler. But until we see some stability Bob, because of the lead times to put stuff in albeit we’ve got capacity now we didn’t have last year that we can turn on I think at a faster pace, we’ll step on the gas. Certainly I think by 09 we’ll see a more stable environment. Personally I believe that. But this third quarter there’s no reason to as Andrew said jump into anything here in the near term and we don’t have to make decisions on Q4 for another 30 to 45 days.

Bob McAdoo - Avondale Partners LLC

I wasn’t actually thinking so much about additional capacity as much as I was thinking of people who bought tickets when gas was at $140 and it’s not at $125. That kind of a tailwind.

Maurice J. Gallagher, Jr.

In my personal opinion, we weren’t able to catch up with $140 gas very much so we’re probably at $120 gas through most of the second quarter, although June was starting to get there. We’re certainly more comfortable at $120 or $125 that the loads will come and we’ve not really seen any slowdown yet in our traffic. Perhaps a bit of a compression in the booking curve but our customer base as I said, small cities seem to be missing a lot of the problems that are plaguing others in the country. At this point it’d be nice to kind of have a stable environment $125 and we certainly will see improving margins.

Operator

Mr. Gallagher, having no other questions in queue at this time, I’ll turn it over to you for closing remarks.

Maurice J. Gallagher, Jr.

Thank you very much. We appreciate your interest and support. If you have any follow on questions, give us an individual call and we’ll be glad to react and answer those as best as we can. Thank you again and we’ll talk to you in 90 days.

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Source: Allegiant Travel Company Q2 2008 Earnings Call Transcript
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