Alaska Air Group, Inc. (ALK) Q1 2018 Earnings Report, Transcript and Summary

Good morning. My name is Jesse, and I will be your conference operator today. At this time, I would like to welcome everyone to the Alaska Air Group’s First Quarter Earnings Release Conference Call. Today's call is being recorded and will be accessible for future playback at www.alaskaair.com. [Operator Instructions] I would now like to turn the call over to Alaska Air Group's Director of Investor Relations, Matt Grady.

Thanks, Jesse. Good morning, everyone. And thank you for joining us for our first quarter 2018 earnings call. On the call today are CEO, Brad Tilden, who will provide an overview of the business, Andrew Harrison, our Chief Commercial Officer, who'll share an update on a revenue results and outlook, and our CFO, Brandon Pedersen, will discuss our cost performance and cash flow. Several members of our senior management team are also on hand to help answer your questions. Earlier this morning, Alaska Air Group reported first quarter GAAP net income of $4 million. Excluding merger related costs, mark-to-market fuel hedging adjustments, and a special items Air Group reported adjusted net income of $18 million and adjusted earnings per share of $0.14 ahead of the first call consensus. As a reminder, our comments today will include forward-looking statements regarding our future expectations, which may differ significantly from actual results. Information on risk factors that could affect our business can be found in our SEC filings. On today’s call, we will refer to certain non-GAAP financial measures such as adjusted earnings and unit costs excluding fuel. And as usual, we have provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release. And now, I will turn the call over to Brad.

Thanks, Matt, and good morning, everyone. This is a very important time for Alaska's. We're getting through the most intense part of the merger and looking forward, in the near-term, to shifting our focus from executing the merger to realizing the value of it. I think it's well known to most of you that the integration is reaching a crescendo tomorrow night when we transition to a single passenger service system, or PSS. As we sit here today, we're encouraged by what we see. We're just 16 months into the merger. And while there is always something for us to learn and improve upon, we see a tremendous amount of strength and momentum. We have a single operating certificate and a single loyalty plan. We've integrated operational control of the Boeing and Airbus fleets in Seattle, and we have new market-based agreements in place for 80% of our collectively bargained payroll. We've also put in place new engine services agreements and other long-term contracts, that we will leverage across our flying as we move forward. We have an incredible team that's executing our cutover to a single PSS. And when that is done, the majority of our system's integration work will be behind us, enabling us to realize the benefits of this new and expanded platform. We are encouraged by the strength we see in our core markets. Same-store RASM, including legacy Airbus markets, is positive, versus being negative last quarter. And we see positive signs in the vast majority of our new markets. When we look at new store RASM, as a percentage of same-store RASM, we see sequential improvement. In those markets where we don't see adequate improvement, our team is tuning and refining the network, adjusting frequencies, departure times, block times and day, week patterns. Mileage Plan revenues exceeded plan by a substantial amount this quarter. The higher network relevance we now offer has made our loyalty program more attractive. And we were pleased to see the rapid growth of this program become a tailwind to our first quarter results. Guest loyalty is a key driver of synergies and, you we believe we're still in the early stages of harvesting the full potential of our combined loyalty program. As we complete our most important integration milestones during the first half the year, our future is bright. Our platform, which is 33% bigger than it was just 16 months ago and 100% bigger than it was five years ago, maintains the same competitive advantages it always has. We maintain an 18% cost advantage against the legacy airlines. And if you look at the data, our fares are now, and historically have been, on par with the majority of LCC seats in the market. We offer our first class product with the industry's best pitch, a great premium cabin experience and a loyalty program that our customers love and that was recently ranked Number 01 in the industry by U.S. News & World Report. Our people have been impacted by this merger, but they are resilient and they care about the company and our future. They're running a great operation and providing outstanding service to our guests, as evidenced by them recently winning that Number 01, position in the Airline Quality Ratings. As you know, this rating is based on on-time performance, completion rate, baggage handling and customer compliance. At Horizon, our operation is fully stabilized. The new leadership team, led by Gary Beck, hit the ground running and they have not had a single pilot staffing related cancellation in the last six months. Air Group's leadership team is simply the best in the business. They've been working their tails off and I want to publicly thank them now for the amazing things they have accomplished in 16 months. As we optimize our combined operation and realize the natural synergies that exist, we will continue to leverage our advantages to ensure we deliver strong returns to shareholders for the new Alaska, regardless of the economic or competitive environment. As I mentioned, our integration – our entire organization has been preparing for months to ensure that our transition to a single PSS goes smoothly tomorrow night. This event will mark our shift to a single brand and customer experience everywhere our guests interact with us. In addition, all Virgin America stations will transition to Alaskan branding, procedures and process. Many of you have asked how we're preparing for this event and what the risks are. One example of our preparation is the unique approach we designed for the cutover. Beginning last October, we required all reservations for travel after April 25 to be booked in the Alaska Reservation System. This allowed us to bleed down the reservations in the Virgin America system, and this simple step results in us having no actual conversion of customer reservations tomorrow night. Our cutover is really more focused on training our employees and operating the Alaska system throughout our expanded network. Shane Tackett and others who are leading this effort are hear this morning and happy to address your questions during the Q&A. PSS is the most critical milestone in our integration and it will be a key achievement for our team. I want to thank the hundreds of employees throughout our operation who are working tirelessly to get this done, especially Sandy Stelling, Rosalie Hollenbeck, Toni Freeberg and Jill Chin. With respect to revenue, Andrew will discuss a host of new initiatives that we're working on that we'll be rolling out over the remainder of the year. In addition to the network and schedule changes I mentioned earlier, we also plan to roll out a fair segmentation platform in the late fall, which is essentially Alaska's response to the industry's basic economy fares, which are now prevalent. We're also working on a number of other initiatives which Andrew will cover. With regard to costs, as we get through the merger, we're reenergizing our focus on productivity and proven overhead management. To ensure that the higher revenues we expect from new revenue initiatives and deal synergies flow to the bottom line. Brandon will provide more details on the cost front in a moment. In summary, our team is executing well against the plan we laid out on last quarter's call. Our capacity will grow just 4% in 2019 to 2020, as we continue to leverage our substantial growth of the last five years. In addition, we expect that our new revenue initiatives and deal synergies combined will produce an incremental $280 million of revenue for 2019. We are absorbing substantially all of the merger-related costs increases this year. With these profitability initiatives and with our new capital spending budget of $750 million for 2019 and 2020, we expect to produce substantial free cash flow in the next couple of years. As I close, I'd like to again thank our employees and our leaders for doing a great job in the midst of a complex merger and for moving our integration along in record time. I could not be more excited about our future. With that, I'll turn the call back over to Andrew.

Thanks, Brad and good morning, everyone. Total revenues for the first quarter rose 5.3% to $1.8 billion on a capacity growth of 7.5%. Though, our RASM declined to 2.1%, this result was two points better than our fourth quarter performance and nearly two points better than the midpoint of our Q1 guidance. Despite significant competitive capacity in our markets, our business showed resilience. Our outperformance, relative to guidance, was primarily driven by three things; network adjustments, growth in loyalty revenues and long hours by our talented revenue management teams. None of our outperformance came from any external industry dynamic or overly conservative estimates. Rather, it was solid execution and good old-fashioned hard work. I also want to acknowledge our frontline teams who took care of our record 10.5 million guests this quarter. Our overall first quarter RASM performance can be categorized as follows. First same store RASM. That's RASM for all markets in operation greater than 12 months. This was up 0.5% year-over-year. This compares to same-store RASM in the fourth quarter of 2017, that was down 1.5 points. The sequential improvement came from solid demand, which was supported by a more aggressive approach to seasonal cuts, particularly in the weaker January and February period, and further fueled by growth in our loyalty program. Mileage Plan membership and Affinity Credit Card sign-ups are tracking ahead of robust internal targets and credit card commission revenues in particular, outperformed plan. The second category, new markets or markets in operation less than one year. These markets did create a headwind, as we expected, especially during the tough winter season. New markets, which accounted for approximately 9% of our capacity in Q1, fully accounted for our two point RASM decline. We expect these markets to perform better as we enter the seasonally stronger demand periods of Q2 and Q3 and as they continue to mature. Since we started only a handful of new markets this year, the percentage of our capacity represented by new markets is set to decline to just 3% of ASMs by Q4. We estimate that these steps benefited Q1 results by about one point of RASM, and we effected that into our Q1 guidance, and that Q2 will be impacted by a similar amount. Given this, and the fact that both Alaskas and industry capacity growth will peak this quarter, we are guiding to a second quarter RASM range of down 2.75% to 3.75%. As we committed at the time of our last earnings call, we've undertaken significant steps to optimize our business model to ensure we generate strong returns on invested capital, irrespective of the economic and/or competitive environment. In fact, the current competitive landscape has only fueled a deep conviction to make the necessary changes that are within our control to generate higher unit revenues. So let's start with the network, as the capacity planning team has been hard at work to optimize our combined platform. Starting with Q1. We became more proactive in dealing with the increase in seasonality in our network since acquiring Virgin America through day of week adjustments and fringing on lower demand days. We also repurposed capacity that had been allocated to slot-controlled markets, namely Havana and Mexico City. We've exited Havana and returned two of our four Mexico City slots, freeing up aircraft for more productive uses. And we've also made several adjustments to the legacy Virgin America network. First, we're announcing this morning that we've received approval from the Department of Justice and have executed an agreement with Southwest, under which Southwest will lease out 12 within perimeter slots at LaGuardia and our eight within perimeter slots at DCA. The lease, which commences this October, enables us to monetize these valuable slots, while reallocating our flying from DCA and LaGuardia into Love Field, to more strategic and profitable opportunities of the West Coast. The lease runs through 2028, at which point we have the right to reassume flying using these slots, should we choose to do so. Second, we relocated two of our JFK slots, one each to Seattle and Santa Hose, while continuing to main robust JFK schedules from LA and San Francisco. And finally, we discontinued a couple of long haul, low yield markets, such as Los Angeles and San Francisco to Cancun, and Los Angeles to Orlando. The point, we are making leverage network adjustment that ensure we maintain our West Coast utility while driving improvement in both our unit revenues and pretax margins. As we move into the second half of 2018 our capacity growth moderates. We now expect to grow 6.5% this a year. That's a point lower than our previous guidance. Looking ahead to 2019, our growth rate should settle in at about 4% and become more consistent quarter-to-quarter. We also look forward to the opening of the expanded and modernized north satellite terminal, here at Sea-Tac airport, a terminal, which will be exclusive to Alaska and will house our new 15,000 square-foot rooftop lounge. We are the only domestic airline that provides paid, first-class guests complimentary access to our lounges. So, this will be a very well received by our premium travelers. We also expect to open our new lounge at JFK in Terminal 7 at the end of the month. We discussed last quarter how our transition to a single passenger service system will unlock our ability to begin capturing merger synergies. With the PSS transition happening tomorrow night, we now find ourselves on the threshold of this major inflection point in our integration, and one that will support meaningful improvements to our revenues. So speaking of revenue improvements, and the ones that Brad alluded to, we've been evaluating changes to our revenue model, and I'm excited to give you more definition around these. This fall, we will introduce a new option for our guests called the Saver Fare. This low priced product will be limited to seats assigned at the rear of the aircraft and guests will board last. Upgrades for Elites will not be permitted and the ticket will not be changeable or cancelable. We believe this new offering will generate $100 million in annual revenues for 2019 and is incremental to merger synergies. In addition, we are implementing a series of revenue product and policy changes, effective now through June that collectively, we expect to drive another $50 million in annual revenues for the full year of 2019. These include offering exit rows for sale, introducing dynamite pricing for our six million Premium Class seats per year, leveraging new technology to better manage revenue post sale and eliminating fee waivers for changes made outside of 60 days. We believe these changes provide guests with more options and reflects the significant increase in the value of our expanded network and product. While these initiatives will not hit their full run rate until next year, we do expect them to contribute approximately $20 million in revenue over the back half of this year. Our entire commercial organization is lined up to deliver on these initiatives as well as unlocking the substantial synergies from the combination of Alaska and Virgin. With that, I'll turn the call over to Brandon.

Thanks Andrew and good morning, everyone. Mentioned earlier, Air Group posted a first quarter adjusted net profit of $18 million or $0.14 a share. Our near breakeven results came during a time of merger integration activities, significant new market development, rising fuel prices, new labor agreements and continuing the areas of competitive pressure in our network. I want to underscore the very important message you heard in Brad's and Andrew's remarks. That is, we're not happy with our results and we're taking a number of meaningful steps to improve the profitability of our business. Q1 CASM, ex-fuel, rose 5%, near the low end of our initial guidance. Our initial guidance, however, did not include the $9 million impact of the new agreement with our flight attendants, though we did see some costs that we initially expected in Q1 shift into future quarters that basically offset it. The impact to the flight attendant contract and the pilot contract that took effect in Q4, accounted for two-thirds of the 5% increase. Our flight attendant merger agreement/contract is extension is another important step toward completing the full integration of our work groups. The contract aligns compensation for all of our fabulous flight attendants and gives us clean line of sight to achieving an integrated seniority list later this year. It also sharpens our labor cost visibility. As Brad mentioned, we now have 80% of our payroll that is represented by a CBA, under contract through April of 2020. We now expect our full year unit cost to be up about 3.5%. The increase versus prior guidance is largely explained by the roughly $30 million impact of the new flight attendant deal. The 1% reduction in capacity growth announced today does put upward pressure on costs, but our FP&A team has done a good job of identifying volume-related cost and pulling those out of divisional budgets. And we should be able to absorb a portion of the fixed cost by creating favorable variances elsewhere. For example, we accelerated planned post PSS headcount reductions from the end of this year to July 31. As a result, we only have two-tenth of a point of additional CASM pressure on a full percentage point of capacity reduction. In general, I'm seeing examples of great back to basics cost management across much of the company. The credit not – goes not only to our leaders, but also to our frontline employees from raising the need for productivity gains. Our airports and maintenance teams both get a shout out, both are tracking very well on productivity metrics year-to-date. We expect Q2 non-fuel cost to be up 4.5% on 8.5% growth. The new market-based contracts with pilots and flight attendants and higher maintenance cost arising from the power by the hour deal we signed last fall are large drivers of the increase. Touching on fuel, per gallon cost were up 20% and total economic fuel expense rose 29% or $93 million representing a significant margin headwind. Our fuel efficient fleet is saving us money. Our mainline fuel efficiency defined as ASMs per gallon, increased 1.5% this quarter over Q1 of last year. If we add last year's fuel efficiency producing current ASMs, our Q1 mainline fuel costs would have been $5 million higher. In addition, our WTI call options reduced our economic fuel cost by another $5 million this quarter. With WTI crude now at $68 a barrel, we're fortunate to have hedges in place covering 47% of planned consumption for the remainder of the year, with an average strike price of $64 a barrel. Turning to the balance sheet, we ended the quarter with $1.5 million of cash. Total cash flow from operations was $315 million, ex merger-related costs, which are actually pretty modest at this point. Andrew mentioned the strength of our loyalty program and affinity card and we're seeing it in cash flows as well. Our Q1 affinity card cash inflows nicely beat both Q1 of last year and our budget. Meanwhile, net CapEx for the quarter was $230 million, resulting in about $75 million of free cash flow, again, ex integration costs. Improving our free cash flow generation was a major reason we reduced planned CapEx to $1 billion this year and $750 million in each, 2019 and 2020. To accomplish our CapEx objectives, our fleet team restructured our three-year delivery skyline during the quarter. Kudos to them, and a big thanks to Boeing and our other partners for working with us. Our balance sheet continues to get stronger, with total on balance sheet debt declining another $120 million since year-end. With leases, our quarter end adjusted debt-to-cap stands at 53%, flat with year-end after adjusting for the book equity impact of adopting the new revenue accounting standard. We still expect to reduce on-balance sheet debt further over the course of the year and for debt-to-cap to improve to 50% by year-end. We remain committed to further improving our conservative investment-grade balance sheet. During Q1, we returned $51 million to shareholders via $39 million in dividends and $12 million in share repurchases. We still expect to repurchase $50 million of our stock this year, which, when combined with the dividend, will result in about $200 million return to shareholders. We have a lot of work to do to improve our profitability. Today you've heard about important revenue initiatives that should boost our top line. The eminent PSS cutover will unlock revenue synergies. We're refining the network and have a multiyear capacity plan that makes sense for our larger platform. We're going to aggressively control costs and we've lowered capital spending. This won't be easy. Few things in this industry are. But if we deliver on these plans, we'll generate much higher free cash flow in 2019 and 2020 and should have the ability to return cash to shareholders in the amounts that approach levels not seen since 2015. And with that, let's go to your questions, and then on to PSS cutover.

[Operator Instructions] Your first question comes from Jamie Baker of JPMorgan. Jamie, from everyone at Alaska Airlines, happy 50th birthday this week. Please go ahead.

Is Jamie there?

We are having a lot of troubles with our phones here. Can you hear me?

Yes, Jamie, happy birthday.

Okay, yes. Thank you. What do you think is driving the momentum in loyalty? I mean, you mentioned that it came in ahead of expectations. I'm curious if that speaks merely to having a conservative forecast or, I don't know, do you have an estimate as to how many Virgin frequent flyer members have signed up for Alaska cards? I’m just trying to gauge whether we're closer to the start or the finish in terms of current loyalty momentum. Anymore color on that?

Jamie, hi, it’s Andrew. I think the best way to answer that question really without going into too much detail is, what we're seeing and what we're sensing is that what we believed from day one is that the new combined network, our product, our fare structure, our people, everything about us that makes us so strong in the Pacific Northwest, we're seeing that the same people in California are very much sensing that and seeing that. And this is something different, something new for them. And it's very exciting. My personal belief is that this is just going to continue to get stronger and stronger as we continue to roll out our product.

Okay, appreciate that. And second, on saver fares, and I guess, this is a small point. But it sounds like basic economy to me. And I think consumers increasingly know what basic economy means. I'm just curious about the logic behind not calling it what most people are used to. Is there a trademark issue or something?

I don't know. I mean basic economy – I mean, I will tell you one thing that is very significantly different, which is really in the core of our brand, as when you book on Alaska Airlines, you get a seat assignment. And while that is not always the case today, if our flights are full but when you book the saver fare, you will get a seat assignment. I think that's extremely important to people. It's very important to our guests. And if you look across the structure of basic, Jamie, people have different rules and policies around it. And I think our structure here is one that I think meets the middle ground.

Okay, fair enough. Thanks so much.

Thanks, Jamie.

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

Hey, good morning, everyone.

Good morning.

Just on the – obviously, a lot going on yet even after kind of the PSS cutover. Could you remind me again about the, kind of the integration synergy, the timing of the rollout of those synergies, and when we will start to kind of see them as you go through this year and next year?

Hi, Savi. This is Shane Tackett. Yes, just as by the numbers, we had – in 2017, I think we quoted $35 million of synergies. In 2018, we've got $69 million. By 2019, we go to $195 million. And then ramp from there is to $300 million at the end of 2021. And we're basically on track for all of those, most of these are actually trackable. They are either cost or things that have to do with props leading or the interior configuration of the Airbus cabins, loyalty growth, cargo revenues. We can track all of those pretty closely. And we're feeling good about where all of that at right now and sort of unlocking this stuff now that PSS is almost behind us.

Got it. And then just with the new, if I might follow up kind of – bit of Jamie's question. On the new product, is that coming out in fall? Just any color around like the rollout if there is – just how the rollout might happen. I'm guessing if it comes out in the fall, it starts showing up two months later in the fare environment is that…

Yes, that’s correct, Savi. Essentially, we'll start roll out in the fall. We'll be smart about it and then sort of really beginning, January. And Shane and the team are working right now on the whole distribution and e-commerce side, which I'm actually really excited about. I think the industry has been working on this for a few years. And the beauty is we have hindsight here and looking at how everyone has done it and deciding on how we want to do it.

Make sense. All right, thank you.

Thanks, Savi.

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

Hey, everybody. Just couple of questions here, Andrew, back, you were talking about the leasing of the gates to Southwest, that LaGuardia, and DCA and you through Love Field into that. Now you just I guess, what – is it just from those two airports today, you fly only nonstop to Love Field, is that what that is? Is that what you were referencing?

That’s right, Mike. Both of those sort of within-perimeter slots, if you will. So we can only really fly as far as sort of Love Field or that part of the geography. So that's where we fly that today. And of course, we'll be discontinuing that come October.

The money that you'll get from Southwest – the lease of the, I guess, the gates and the slots. Is that, I mean, is that more of a rounding error or is that something like $5 million, $10 million per year? I'm not – how should we think?

You know, obviously, I can't comment on the magnitude. That's all privy to Southwest and Alaska. But what I will tell you is that being able to monetize important slots and move flying around and maintain our asset base for the future is really important for us.

And Mike, probably more important than the lease payments is just getting our network configured the way we want to have it configured. Our whole idea was to – is to build pockets of strength. You hear us talk about loyalty all the time and we have fantastic loyalty in the Northwest and we want to push this into California. And then fly, as folks out of those cities. Flying from Dallas Love Field to both LaGuardia and Reagan National, at this point in the company's history, was not strategic. And so we're happy to do this transaction, so that we can line up our aircraft and our assets with our strategies.

And then just Brad on that line about getting the network right, I mean, you did mention earlier in the call that with Horizon the pilot situation is now under control. And yet when I look at some of the route cancellations over the last, like call three to six months, there have been a lot of E175, longer-haul routes out of Seattle and Portland that have been cut. Is that – when I saw that, I thought that, that was either a combination of pilots and under-performance? But it sounds like it’s not pilots at all. It’s more about performance in getting the network right. Is that the right interpretation of those cuts?

Yes, Mike. This is Andrew. That’s exactly right. And I think we’ve had a lot of mid cuts of rounds stuff out of Portland just we’ve looked at that. And with rising fuel, we’ve decided to make changes.

Okay, great. Thank you very much.

Thanks.

Your next question comes from Darryl Genovesi from UBS. Your line is open.

Hi, guys. Good morning. Thanks for the time. Andrew, you gave us some color on evolution, the revenue model. I guess, I was wondering more about this year. I think back at year-end Investor Day, the last one that you had referred to, I think, incremental of $35 million or so. That was supposed to come through from the new premium product. Are you currently realizing that? Is that something that ramps up more in the second half? I think the process is fully available. Just wondering how the revenue generation is going.

That’s correct. In fact Shane the mastermind here, I’ll let him give some color on that.

Yes, Darryl. I think you’re referring to Premium Class, which we’ve finally got fully rolled out with all of our Boeing fleet reconfigured earlier this year. It’s been phenomenal. We started with kind of a three – an easy sort of price strategy, just three or four price for the entire country. We’re now moving price around based on demand and we’re well ahead of all of our internal sort of expectations announcement. It’s been a phenomenal product for us.

So you’re ahead relative to the $35 million number?

Yes.

Well, and then, Brandon, on the non-op. I don’t think you guided it for the full year. But you’re about $40 million in the first half. Should we think about the second half as being a similar number?

I think of it as being slightly less than that. We’re probably tracking to be, if I have to guess, at this point, probably $16 million a quarter in Q3, Q4.

Well, thanks very much guys.

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

Hey, thanks. Good morning, guys. Andrew, I believe the statistic is that 20% of the revenue is tied to business travel spend. And so first, what does an average business fare look like on Alaska? And how much has it deteriorated following the introduction of basic economy by the big three? I’m just trying to get some perspective on how this is going to reconcile with the $100 million estimate that you’ve given for saver fares and the premium economy?

Dan, I might – if Shane has any commentary on closing. Here’s what I would say and I’m going to probably provide more color. As you may have heard, we have a new Vice President of Sales, David Oppenheim. And it’s just been amazing working with him and looking at our sales structure, where it’s all coming from, our contracts and of course, of the new network. What I will basically says is that, I am very optimistic about where we can go with sales. Specifically to your question, I’ll let Shane comment on some of the closing stuff. But I just see upside on the sales side.

Yes. On closing fares, I think, we’ve been watching these for the last several quarters. It is – there are some that they’re sort of oddly low, just relative to what you would expect. We’ve had really good demand generally across the network. I think everybody’s kind of seen that. We’ve had really good demand across all APs. There’s been no fallout on the business side. So we would anticipate some of the fares on the low to data get to more normalized levels over time. But the real focus we’ve had is on things that we can control. And that’s why it’s more important to us to really focus on these new revenue initiatives that sort of don’t depend on the economic or competitive backdrop.

Got it. And then the down 25% to 30% in inter-California and transcon, how is that trending? Just relative to the question.

Sorry, Dan. Just what’s the – the 25% to 30% is from?

Yes. You had mentioned in the last earnings call that inter-California and transcon, walk up fares were down 25% to 30%. I’m just trying to get some perspective on how those have inflected.

Yes. That’s good. Some of they’re still – it’s moving around quite a bit honestly market by market. And I don’t recall the specific markets we were quoting before. But there are some that are still depressed California and transcon and others that have sort of rebounded and come back. So it’s pretty dynamic on the West Coast, just from a pricing standpoint today.

But I would say that, it’s basically not any worse. But if anything, it’s actually better than when we spoke in the last quarter. And again, as we move into the second and third quarter, I mean the stronger demand periods, I think we’ll continue to see the dynamic evolve one way or the other.

Got it. And then just a quick second housecleaning question here. Where we in terms of reconfiguring the Airbus fleet? How many planes do expect to have done in the second quarter and the third quarter? What’s the pace of that rollout?

Dan, this is Shane again. We start in September of 2018, we’ll get our first aircraft reconfigured. And we’re going to produce at something like five a month. Although, some are three, some are seven. So we’ll have about half of the fleet done by the summer of 2019. We’ll have the whole fleet done by the end of year 2019. It’s pretty ratable how we get through them. There is 70 aircraft to go through. So once we get going, it’s about five a month.

Okay. Thanks guys.

Thank you.

Thanks Dan.

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

Hi, Good morning, gentleman.

Good morning, Rajeev.

Brad actually a question for you. On the last call and this call too, you talked about just responding to the challenges associated with the Virgin deal and operations for [indiscernible]. Do you feel like you’ve made significant progress? And have line of sight that some of the stuff is behind you? And that you can maybe start beating some of the targets that you’ve laid out ahead of you here?

Thanks for the question, Rajeev. I certainly do. I will say that mergers are big deals. And it’s – you bite up a lot. And I think anyone that’s been through a merger would tell you that. But if you look at us today, we’re 16 months into it. The labor, the cultural side of it is very, very important. And we’ve got more work to do. But we do have 85% of our collectively bargained payroll. That’s got new market-based agreements. And that’s a great accomplishment. It sets us up to get integrated seniority list which sets up to sort of get the cultural stuff settled and moving forward. Systems, tomorrow night is a huge night. As you know, many, many systems cut over at the beginning of the year. But with PSS behind us, that’s a huge accomplishment. The loyalty stuff, all of the decisions with outside deliveries of airplane, receiving brand, onboard service all of that t stuff is done. And we’re now really in a position to begin to leverage it. So I think the fares we’ve shared are the – as of this moment, we think we’re 65% or 70% of the way through the merger. By the end of this quarter, by June 30, we think we’ll be 85% of our way through the merger. And last, just to really focus on taking advantage of this incredible network and incredible product that we do have. So, yes, I think we are in a really good position today. I appreciate the question.

Yes. Got it. Andrew or Shane a question for you. Just on the competitive headwinds that you’ve been seeing on capacity or pricing, what are you embedding in your 2Q RASM as far as the – associated with it? Obviously I’m just trying to get a sense of what the tailwind could be as we move forward. And then just on the tailwind in some of the development markets you were talking about, as far as how that’s improving. What’s the opportunity there from a RASM perspective? If you can hopefully provide it.

Yes, Rajeev. I’ll take a crack at this. Just, as Andrew noted on the script, and I’ll get to the pricing question. But the entire reduction in unit revenues for Q1 really was from new market. So I think the same stores have been very strong and resilient [indiscernible]. I think the real question, and I don’t know that – we do have a view on how much sort of the net total of competition and growth and pricing is impacting us. I don’t know that I’ll break all of that down. But the real question for Q2 for us will be closing pricing. I think that’s what makes – sometimes these quotes are hard to call because we don’t know until we get there. But right now, as we look at Q2, we see fares are sort of what we would expect them to be. And especially, as we get into June and higher demand months, they look to be holding up right now.

The other thing I will add is, as I shared in my prepared remarks is that the second quarter looks to be the high watermark obviously of out growth but also industry capacity growth. And I think as we move into three and four unless the world changes dramatically, you’re going to see a declining or a tailwind, if you will, as it relates to those two key factors.

Excellent. Sorry, on the development markets, can you guys provide a number as to what the hit was in 1Q or which you are expecting in 2Q?

Andrew, had mentioned this in the script. He quoted the entire 2.1% revenue reduction in Q1 was really the new market impact.

Got it. Very helpful. Thank you guys.

Thanks, Rajeev.

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

Hey, everybody, how you’re doing?

Hey, Hunter.

I’m sorry. Can you just tell us the Southwest deal again? Just lay it out for me one more time, I want to make sure I get it right. And then does it require regulatory approval particularly given what the DOJ said about Love Field when they approved your merger?

So, Hunter, it does require regulatory approval and we have that. We did have to take this to the justice department and we did have that approval. It is a done deal. It’s 20 slots from Dallas, Love Field, to both LaGuardia and Reagan National Airport. And their 10-year lease is 2018. They go through 2020, at which point they come back to Alaska. There is a provision with a couple of the payers, that if they were to become outside the parameter slots during this 10-year period, they could come back – Alaska could get those slots back. So those are the basic provisions.

Okay. Cool. And then as you consider – Andrew, I think you are the one that mention your work around – with Shane and some distribution stuff and e-commerce, but as you consider the new products segment here with Sabre – Sabre. Well actually this is a Sabre question with Sabre. Are you going to be in a position to where you might be able to push for a partial content agreement the next time your GDS contract is up to really drive home some customization and some ability to keep some of your content into the channels that you think is best for Alaska going forward?

That’s an excellent question. Honestly one we’ve really spent a lot of amount just with everything else going on. Content, obviously, is a big, big deal to us into the GDS, I imagine, it will be front and center and sort of future negotiations with them. Just so you know, we got a pretty long-term agreement with most of our GDS providers as we sit here today. So this would be, outside of a couple of years in the future if we were able to that.

Okay. That’s helpful. Thanks Shane.

Thanks, Hunter.

Your next question comes from Helane Becker of Cowen. Your line is open.

Thanks very much operator. Hi and thank you very much for the time. So my first question is as you think about the capacity adjustments that you made this year, when you go forward into fourth quarter and first quarter of next year, can we expect that there would be more seasonality in the route network and therefore, more seasonality or more adjustments and capacity or are you happy with kind of the changes you made this year.

Hi, it’s Andrew. I think we’re still working through the seasonality. We’re currently working on the fall schedule and were making additional adjustments there. And probably some final requirements so I think sort of over the back half into early 2019 the other thing I will share with you is, Ben Minicucci our President and myself and our teams are working extremely closely together to align our capacity adjustments with their staffing and how their work with us to make sure that this is very efficient and highly productive adjusting to our network.

But Helane, I do think we’re in a world where getting that capacity exactly right this is important than it’s ever been. So the stuff that we’ve mentioned about the day week adjustments the last light on Wednesday night or the last night on a Saturday night making those requirements is as important today in this revenue environment as it’s ever been and it’s we’ll be spending a lot of energy on going forward.

Okay. And then just my follow-up question, last time you talk a little bit about construction and at SeaTac and the limitations at the airport there because congestion. Can you just update us on how that’s going? And if capacity has been kind of adjusted, so that you don’t have the delays that you had in the past and what’s going on with cost associated with that airport. Thank you.

Good morning, Helane it’s Ben. Yes, Seattle, I will say Seattle is full, we have got gate constraints, we have got air space constraints. I will tell you it’s not uncommon to see 20 airplanes lined up for takeoff at peak times of the day. So taxi times have gone up. So cost at SeaTac to operate have gone up. SeaTac is full; there is construction to create hard stand positions to help during the situation. But there’s no doubt costs are going to up in SeaTac to operate at this airport.

Right. But what are you doing to mitigate that, I guess that’s really my question?

In terms of cost or operations?

Well, maybe both of them.

Well on operation side, so the taxi times are showing up 60% to 70%, the costs go up, because there are now part of block time so you’ve got to add that time at the block time so as you increase block times the cost to operate that market goes up. So, what you see is, the adjustments of block times and ground times actually go up. And of course the investments that you make in the airport get translated in rates and charges so.

Helane, this is Andrew, one thing I will, since the last quarter I believe is that we now have at least, the SeaTac which was a big deal five-year term, in that lease, it’s very clear on how many companies gets the ports will be taking back over each of the next five years which didn’t exist before, so we have a real sort of line of sight to the infrastructure and where it is all going and then again to Ben’s comments it gives us better ability to manage our operation going forward to be increasingly efficient over the time.

Okay, that’s really helpful. Thanks gentlemen, thank you for the time.

Thanks Helane

Thanks Helane

Your next question comes from Duane Pfennigwerth with Evercore. Your line is open.

Hey, thanks. Good morning.

Duane.

Andrew, as you’ve had more time to study the Virgin network from an optimization perspective what were some of the things they did from a planning perspective specifically with respect to seasonality that you see room to continue to improve from here?

Yes, I mean you’ve got to give Virgin America a lot of credit, just given their size and the markets, and I really didn’t have a lot of opportunity to sort of do any seasonality quite frankly. I mean they rent six flights a day JFK, Los Angeles, a lot of the year. And so I think with the permutations and combinations of our network in connecting and our new markets, and even connections beyond part and half. I think there is a real opportunity to reduce the seasonality, going forward and that’s what we’re doing, you see that with moving slots around, and we might be doing that directly.

Thanks. And just to stay with you with respect to the series of revenue initiatives that you talked about, exit rows, dynamic pricing, fee waivers, et cetera. I think you threw out $20 million number for the back half but obviously not all of those things get switched on day one. So how would you think about those combined on an annual basis? And thanks for taking the questions.

Again, on an annual run rate, 2019 the saver fare was about $100 million and the ones you just mentioned, we’ve put out about $50 million run rate at 2019.

Thank you.

Your next question comes from Joseph DeNardi with Stifel. Your line is open.

Yes. Thank you. Brandon or Andrew you guys made a change to the revenue side of your income statement. I’m wondering if you could just spend a minute or two just talking about what is in Mileage Plan and other revenue, what it represents. And then what – why you chose to break that? Why do you think it’s important? Thank you.

Yes, good morning it’s Brandon, I’ll take that one. So the Mileage Plan in other line has two things basically, one is the commission revenue that we earn when we sell miles to the banks, some might call it the marketing element, which is actually most of them in that line. And then the other is the net benefit if you will, having our members earn and excuse me – redeem for travel on other airlines minus the settlement costs that we pay to those other airlines that’s what that. In terms of the presentation, I would love to take more credit than work, but probably don’t actually deserve that much. We had always talked about that number in the footnotes and what we did Chris and his team decided to move that to the base of balance sheet and I think it makes sense. As you’ve been pointing out it’s a very important part of the business and we wanted to give it a little more visibility given its magnitude.

Okay. And then Brandon just another one for you on CASMex next year, can you just remind us what the goal is, with the 4% capacity growth is it down, is it flat and kind of how realistic are those targets at this point?

Yes, I think if you go back to last quarter’s call, we said we had a planning mindset of costs having to come or be flat to slightly down. It wasn't guidance but it was directionally where we thought we needed to go. I think if you look at our cost over the last couple of years, there's been some step changes in the cost structure. As we look at it, we have I think a lot of opportunities to do things with the cost structure. We are actively working, 2018 also we haven't even gotten to the point of thinking about the 2019 budget but what I will tell you is that there's been a fair amount of energy already thinking about initiatives that we are going to undertake this year so that we can really make sure to keep cost and focus going into next. And perhaps, we are mindful of the fact, costs have been a really big part of this company’s success, we are focused not only on the year-over-year change but on the absolute advantage we continue to maintain against our legacy competitors.

Thank you.

Your next question comes from Kevin Crissey with Citi. Your line is open.

Hi everyone. Thanks for taking the time. Maybe for Andrew, I wanted to talk about the $100 saver fare contribution, and maybe what assumptions go in there. I know you probably have limitations as to how you can describe it, but working in a general sense then maybe what assumptions get you to the 100 million percent of markets that's rolled out, how competition responds to it. Generally, I think the numbers that have been thrown out by other airlines haven't remotely been achieved at least in my opinion. So I want to understand what assumptions you've made in your $100 million? Thank you.

Yes, thanks Kevin. It’s Shane. I might not get into all of the specifics but I think you've got the variables right, we're sort of assuming a large percentage of the network and a good number of the fair classes would have this product attached to it. We probably wouldn't – I just if – I don't know what other people are seeing in terms of actual sellout rates, we know the numbers that are quoted, we're probably less than that, because we don't have as much business exposure. So we haven't assumed a level that we've sort of heard others quote.

Okay. Thank you.

It is fair to say competitively, this is in the marketplace today. So I don't think we expect a lot of incremental reaction to this. This is actually we are in the market place today and we are coming up with a product that is competitive with what other were offered already.

Yes, that’s entirely correct, yes.

Okay, thank you. And what was your capacity growth in those same-store markets, if your RASM was up 0.5%, what capacity growth was in those same-store markets?

I think same-store was, I think, down.

Slightly, we are basically flat, most of our growth is entirely in new markets…

Okay. Yes, I'm just trying to reconcile flat capacity and 0.5% RASM has strong demand that's kind of where that comes from?

Can you repeat that?

You've indicated that you have strong demand in your core – kind of same-store and that the weakness comes from the growth markets, but if you've got flat capacity in just 0.5% RASM in those markets that doesn't reconcile terribly well.

Kevin, I mean, the number is – the flat is really the Alaska capacity growth, we did have as you know significant competitive capacity in many other same-store markets, and that peaks in Q2 and then it starts to abate as we get to the second half of the year.

Ok, thanks for that. I appreciate that. Thank you.

Your next question comes from Susan Donofrio with Macquarie Capital. Your line is open.

Yes, good morning gentlemen.

Good morning.

Question on sales by channels, looks like there's been a nice ramp-up, if you look at direct to customer, 55% to 62% year-end 2017, I'm assuming given this strength of loyalty program, you could increase that even more and I'm just wondering if you're seeing that still and is there kind of a target that you're thinking of?

Susan, this is Shane. Yes, we've actually been very happy with the direct sales that we've had through mostly alaskaair.com and certainly our mobile app as well. It's I think also just given that we were starting to migrate reservations off of the virginamerica.com website on to ours, we didn't know exactly, how we would do getting all of those over but we basically increased our direct sales down in California as well. So we're feeling super good about it 60% to 65% we see our number through – in that range pretty typically, it’s a little hard to – just because of how business folks by their fares through agencies. But we continue to see some opportunity as Meda's coming and most of the Meda booking has ultimately ended up as direct bookings on air.com. So it certainly could go up from here and end up, we're ultimately focused on driving it if we can.

Great, thank you.

Thank you.

Your next question comes from Brandon Oglenski with Barclays. Your line is open.

Hey good afternoon and good morning everyone thank you for getting me on the call. So Brad, if I could just ask, in prior quarters I think the perception was that the core Virgin network was maybe facing some commercial challenges. And now that you're saying that same store sales are seeing positive inflection on unit revenue. Can you just talk about what has maybe changed since a quarter or two ago is it demand competition or internal merger related activities that you guys are managing better?

Brandon, I just think markets are dynamic. The stuff is moving around. I think when Alaska bought Virgin America and then followed up with 44 new routes or something like that and in 2017 a lots of others added a lot of capacity as well. I do think the capacity is getting to a more appropriate level given the amount of demand that's in the market, I also think as Andrew has talked about, I think that was the reaction to what Alaska brings has been extraordinary, we bring a fantastic loyalty program, amazing operation performance, great folks and we bring low fares. We've got a differentiated experience with fares that did match – basically they matched the majority of the LCC seats in the market. So I think as market places move around a little bit and I personally think things are settling down and I also think that customers are recognizing and appreciating the difference that Alaska brings.

Okay, appreciate that. And then quickly and a follow-up for Andrew, with your 2Q RASM guide down about 3% at the midpoint, I think you said that you can attribute the full 2 point decline in 1Q to new markets. Is there something else impacting the comp there? Is that Easter holiday placement or should we be thinking that new markets could actually have a bigger drag on 2Q, than they did in the first quarter?

I mean – there was you know an extra point of strength in the first quarter, so that comes out in the second quarter, so second quarter we have headwind of about a point. If anything new markets, if you just look at the nature of what we are serving, and they're pretty much all started basically in the third quarter. We started 20 new markets in one quarter these are all now coming into the demand strength period and the reality is that our RM team, our network, our marketing, all the levers and all the systems that we've been building together are starting to really take up steam. So, I personally just see continued maturity and strength as we continue to go forward with these new markets.

Thanks for the clarification.

Your last question comes from Adam Hackel with Imperial. Your line is open.

Hey guys thanks for squeezing me in here. Couple of quick questions, Just wondering sort of the Silicon Valley crowd, how have they taken to you guys? And, is that what is driving the strength on sort of sign-ups on the credit card side of things on the loyalty side?

I think given that getting into details, we're seeing I mean Silicon Valley we've been there a long, long time but we have been very much a big part of that community, but I will tell you that the loyalty and other aspects are across all aspects, not just saying one particular area.

Okay, great and then just last one from, just wondering and I'm kind of off peak period a little bit. One of your peers talked about actually adding some capacity on the off-peak, towards the back of the year, I presume that's probably the kind of post loyalty period. We were also talking about Southwest, talk about some weakness they saw in the first quarter in the off-peak side. I was wondering as to how that came in for you guys in the first quarter and how should we be thinking about that going forward Thank you?

I think if I understand your question it's really coming back for us to seasonality, the peaks are stronger and shoulders are a little softer, and we were very proactive late in the fourth quarter making significant adjustments. So, I think in general, with the industry capacity as it sits today, the shoulder over the top period even more difficult than the historically.

Great, thank you guys.

Thanks, Adam.

That's all the time that we have for questions today with that I'll turn the call back to Brad Tilden

All right, thanks operator, thanks everybody for choosing in today, we look forward to talking to you at the end of the second quarter. Thank you.

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