Alaska Air Group Inc
NYSE:ALK
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Alaska Air Group Inc
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Good afternoon, my name is Fiya, and I will be your conference operator today. At this time, I would like to welcome everyone to the Alaska Air Group's Second Quarter Earnings Release Conference Call. [Operator Instructions]
I would now like to turn the call over to Alaska Air Group's Vice President of Finance & Controller, Chris Berry.
Thank you, Fiya, and good afternoon everyone and thank you for joining us for our second quarter 2019 earnings call. It's good to be back with you all.
In today's prepared remarks, you will hear updates from our leaders Brad Tilden, Ben Minicucci, Andrew Harrison, and Brandon Pedersen. Several other members of our management team are also here to answer your questions during the Q&A portion of the call.
This afternoon, Alaska Air Group reported second quarter GAAP net income of $262 million. Excluding merger-related costs, mark-to-market fuel hedging adjustments, Air Group reported adjusted net income of $270 million and adjusted earnings per share of $2.17, ahead of the first call consensus. These results compare to adjusted net income of $206 million and adjusted earnings per share of $1.66 in the second quarter of 2018.
Our adjusted pretax margin expanded 300 basis points and our earnings per share grew 31%. We generated $735 million in free cash flow and we paid down an additional $140 million of debt during the quarter, bringing our total debt payment up to $1.2 billion of the $2 billion we borrowed for the Virgin America acquisition. This quarter marked great progress toward our long-term goal of 13% to 15% pretax margins.
And as a reminder, our comments today will include forward-looking statements on our expected future performance, which may differ materially 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 cost excluding fuel. And as usual, we have provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in today's earnings release.
And now I'll turn the call over to Brad for his opening remarks.
Thanks very much, Chris, and good afternoon, everybody.
We're now two-and-a-half years past our acquisition of Virgin America. The vast majority of the integration work is now done and we're beginning to realize the benefits from our significantly expanded network and the synergies for bringing the two airlines together. We've integrated our work groups, our reservation system and our back office functions faster than any other major airline integration.
And with our relentless focus on low fares and low costs, best-in-class customer service, the industry's most generous mileage plan, a fuel-efficient fleet, a well loved brand, and a fortressed balance sheet, we are well set up to move toward our targeted annual growth and our targeted pretax margin of 13% to 15% over the business cycle.
We made great progress executing our plan this quarter with a 300-basis point improvement in our margin and we're implementing initiatives that we shared with you at our Investor Day last November to drive further margin expansion in the quarters and years ahead.
As you know, we as a leadership team are fully committed to producing the right margin and returns for our owners, given the $8 billion of capital that you've invested so that we can invest in our growth and provide the right benefits for all of the people who depend on us.
Our long-term formula of focusing on high productivity, high asset utilization, and low overhead is working. I want to thank our operating division leaders for their cost performance relative to plan so far this year. In fact, given solid cost savings from plan, our team was able to maintain our full-year cost guidance even after adding back the cost of new labor deals.
And on that topic, we were really proud to announce two new labor deals this quarter. First, a two-year extension with our aircraft technicians which allows all of our Alaska mechanics to work on all of our mainline aircraft. And this is an agreement which has been both negotiated and ratified.
And second, a five-year extension with the 5,200 employees, represented by the IAM, which is being voted upon as we speak. We're pleased to come to these agreements with the finest employees in the business and we're hopeful that the agreement with our IAM represented folks ratifies in the coming weeks.
On the revenue side, I thought we also had a good result this quarter. I want to thank our teams in revenue management, e-commerce and marketing who had the best improvement in unit revenue that we've seen in the past 30 quarters.
We're currently in the middle of the busy summer travel season, and our people are running an excellent operation and taking great care of our guests. Genuine and caring service is what makes Alaska different and we're also proud of our 22,000 folks at Alaska and Horizon for earning their 12th consecutive JD Power Award, along with other recognition we've received from the American Customer Satisfaction Index, Cardenas, Travel & Leisure, WalletHub and many more. It's clear that our folks are doing a terrific job.
The JD Power Award is especially gratifying this year as we passed the 800 point mark for the first time in our history. And as it was the final award in the traditional network category, carrier category as the categories have changed going forward.
Our results for the first half of the year make us optimistic about the rest of 2019 and beyond. As you all know, we're running our business so that this will be a great place for our people to work, a great place for our customers to fly, and very importantly, a great place for our owners to invest. We've got more work to do to execute our plan and we are fully focused on getting that work done.
And with that, I'll turn the call over to Ben.
Thanks, Brad, and good afternoon, everyone.
In the second quarter, total revenues grew 6.1% to $2.3 billion and a 1% increase in capacity as unit revenues increased 5.2%, well ahead of our initial guide of 3.5%. Our pretax margin was 15.8%, 300 basis points better than prior year and our adjusted earnings per share improved 31%.
As Brad mentioned, we still have plenty of work ahead of us, but the momentum is encouraging. For example, the recently ratified transition agreement and integrated seniority list with our technicians brings our Boeing and Airbus mechanics together and provides a two-year extension giving our technicians in the Company more certainty through 2023. The agreement recognizes the high caliber of our maintenance team with pay increases, signing bonus, and enhance productivity.
This integrated agreement is a significant milestone at Alaska, as we now have joint agreements and integrated seniority list with all of our work groups, and less than three years from the date we acquired Virgin America.
It is a huge accomplishment and allows us to come together as one team, continue to build on our a strong culture and fully leverage the synergies we planned from the acquisition.
I also want to thank our 5,200 IAM represented employees for their absolute professionalism over the past several months, as we've finalized the recently announced tentative agreement for a new five-year collective bargaining agreement. With our last deal signed over five years ago, this group was the furthest out of market amongst all of our labor groups and represents about 25% of our employees.
We won't know the results of the vote for a few more weeks but I'm excited to get these well deserved raises and improvements to our folks who represent Alaska so well and deliver outstanding guest service day in and day out.
These two agreements will increase our wages and benefit costs by approximately $50 million annually, and about $48 million this year, including one-time signing bonuses and other costs of approximately $24 million.
The impact of these new agreements is included in our cost guidance today. We are pleased to come to these agreements and we want to thank the IAM and AMFA for their continued partnership as we work together to provide great wages and benefits for our people and set the stage for a successful financial future.
Our focus over the next few years is on implementing the initiatives on our road map to build brand strength, improve our product and guest experience and to strengthen our financial muscle as we strive toward a best-in-class investment for long-term owners.
Looking back on the second quarter, here are some of our biggest accomplishments. First, as Brad mentioned, our employees were awarded with our 12th consecutive JD Power Award, a true testament to the exceptionalism of our people. I couldn't be more proud of the hard work they put in every day to take care of our guests and run a great operation.
Second, we are now realizing the full run rate of the $330 million of revenue initiatives and synergies we launched over the last several months. This includes the increased benefit from the cross-fleeting of our higher gauge lower unit cost Boeing aircraft into the most capacity constrained markets with overflow demand. We should see the biggest impact from these changes during the peak summer travel season in Q3.
Third, we completed the painting on all of our Airbus aircraft and we are 25% through the interior renovations, which will provide more premium seating and increased revenue per aircraft.
Fourth, after a rough operational start to the year, due to the Pacific Northwest storms, we have claimed our way back to first place year-to-date for on-time departures and second-place in DOT on-time arrivals and I'd be happy to address the nuance of these two measures in Q&A. For the second quarter, we were first among the top carriers in both of these categories.
And on the regional side, Horizon is topping the leader board when it comes to operational performance, number one in the regional industry year-to-date by a wide margin. I want to give a shout out to the entire team at Horizon for a complete turnaround in their performance over the past couple of years.
Each of these along with the everyday accomplishments of our teams across the Company is pushing us to be better tomorrow than we are today. We talk a lot of run here about turning the dial, a little each day to make incremental improvements. We are always pushing ourselves to be better. So as we continue to turn the dial and with the win now at our back, I'm confident in our team's ability to outperform.
And with that, I will turn the call over to Andrew for his commercial updates.
Thanks Ben. And good afternoon, everyone.
My comments this afternoon will focus on the second quarter revenue performance, guest-facing initiatives and revenue guidance for the third quarter. The 5.2% improvement in unit revenues was a welcome result of what was a volatile revenue environment in the first quarter and represents our best unit revenue improvement over the past seven years and our best absolute Q2 RASM in the past three years.
Industry pricing stabilized for the most part as we ended the second quarter, which included the dissipation of low close-in fares. As we ended this year, we had a goal of outperforming industry RASM by approximately 200 basis points.
We beat industry RASM by approximately 190 basis points this quarter. Ex-MAX related unit revenue outliers for some carriers, our revenue initiatives and synergies delivered on that goal. Breaking Q2 down further, I'd like to provide a bit more detail on the year-over-year unit revenue increase. First, in terms of challenges. Although not as impactful as the first quarter, we continue to see softness in Hawaii pricing due to the significant year-over-year growth in overlapping weighted competitive capacity of 6% to 7%.
We also saw increased industry capacity from the Lower 48 into the State of Alaska putting some pressure on our long-haul Alaska yields. This competitive capacity continues through the peak summer period. These two regions represent about 22% of our system, with unit revenues negatively impacted by about 50 basis points, which is less than what we had originally guided to.
Turning to the positive, our strong unit revenue performance was driven by the following key areas. First, our synergies and initiatives continue to ramp and they reached their full run rate during this quarter.
These initiatives improved our Q2 RASM by 350 basis points, which we guided to on our first quarter call with Saver fares the largest contributor to this improvement. We continue to feel confident in the $330 million of combined 2019 initiatives and synergies we guided to at Investor Day last November.
Second, we had tailwinds of about 100 basis points from the Easter shift and another 100 basis points from changes in our award redemption structure that had negatively impacted RASM in Q2 last year after our reservation system cut-over when redemptions got away from us.
Third, underlying pricing stabilized and steadily improved through the quarter. Nine of our 11 operating regions representing 88% of our capacity experienced positive year-over-year unit revenues including California transcon markets that were significantly impacted by pricing actions in Q1.
A quick note on transcon markets. I want to thank all of our operational and commercial teams that have rallied around improving our performance in this region. We've made several changes including more focused marketing, cross-fleeting and a concerted effort to improve both cancel rights and on-time performance.
Most importantly, our station and in-flight crews have been focused on delivering consistently great guest service, all to help improve the financial performance and guest experience of these important routes and it's working. Although we have a ways to go, we did experience significant improvement in RASM and double-digit increases in California transcon margins year-over-year and we see continued momentum as we head into Q3.
And lastly, we continue to see strength in our loyalty revenues, which increased 5.7% on flat passengers. The percentage of our flyers during the quarter that were Mileage Plan members and credit cardholders improved 2.7 points and 1.2 points respectively, which is very encouraging. As we mentioned in previous calls, the commercial team is focused on a number of network and product enhancements this year that our guests have embraced.
First, our Alaska Global Partners network is expanding again with our new partnership with EL AL with new direct flights out of San Francisco to Tel Aviv. This is in addition to the direct service to Hong Kong, Tokyo, Singapore and Dublin and have all been added or announced from Seattle by our partners. With our 17 global partners, our Mileage Plan members can earn and redeem miles to more than 900 destinations worldwide.
Second, as Ben mentioned, we are installing new cabin interiors on our Airbus and 737-700 aircraft that both align and improve the guest experience. We've completed 25 so far. Each Airbus renovation increases total seat count and builds in a greater mix of First and Premium Class seats. These are beautiful aircraft and our guest reaction has been extremely positive.
Third, we have now completed satellite Wi-Fi installation on 44 of our mainline aircraft and the feedback from our guess has just been fantastic. This, along with our in-flight entertainment boasting the most movies in the sky, provides our guests with a top-notch in-flight experience. In fact, our entire regional jet fleet is also equipped with Wi-Fi and on-board entertainment.
And finally, two weeks ago, we opened Phase 1 of a stunning new wing of the North Satellite terminal here in Seattle featuring our new 16,000 square foot flagship lounge for our guests. We've also started construction on a rooftop lounge in San Francisco that we expect to open next year.
So looking to Q3, our capacity growth picks up modestly to approximately 3% and our Q3 RASM guidance our range is 2% to 5% reflecting the benefit of our many revenue initiatives and merger synergies, our expectation of stable pricing through the peak summer season, offset by continued pressures we are seeing in Hawaii and long-haul Alaska flying that I mentioned earlier. We are designing our product, network and revenue management processes to enable growth with the financial objective to achieve our 13% to 15% long-term pretax margin goals.
In fact, we recently announced that we are implementing a new state-of-the-art Amadeus Revenue Management system, which will be fully deployed by next year - by the middle of next year and will result in better revenue performance in our 2020 and beyond. With the structural changes we've made to our revenue model, we continue to feel confident in our 2019 objective to outperform industry RASM and look forward to building on this solid platform for used accounts.
And with that, I'll turn the call over to Brandon.
Thanks Andrew, and good afternoon, everybody.
Our second quarter adjusted net profit of $270 million and earnings per share of $2.17 were both 31% better than the second quarter of 2018. This marks our second consecutive year-over-year improvement in quarterly margins and is the largest year-over-year margin increase since Q2 of 2016. It's evidence that our plan to improve returns is working.
Andrew touched on the revenue performance. So I'll touch on cost performance for Q2 and the outlook for the rest of 2019. We set up this year with an aggressive plan to keep unit cost growth to between 2% and 2.5% on a roughly 2% increase in capacity, no small task given the cost pressures we faced and before the impact of any new labor deals.
Teams across the Company have risen to the occasion and managed costs in the first half of the year in such a way that we've been able to maintain full-year cost guidance that falls at the low end of our initial range even after absorbing the impact of the AMFA and IAM deals that Ben talked about.
These agreements will add approximately $50 million annually, with approximately $48 million impacting this year, including $24 million in the back half of this year base wages and $24 million in signing bonuses that we expect to pay in Q3. For the full year, we now expect non-fuel unit cost to grow by 2.2% all in.
Looking at the quarter, unit cost ex-fuel rose by 2.3%, much better than our initial guidance of plus 5%, much of the beat is solid execution, although some of the outperformance as a result of certain costs shifting to the back half of 2019.
Pilot training costs are a great example, as cross bidding between mainline fleet types is now happening, but a little later than expected, this will put pressure on pilot productivity shifting up to $15 million of training cost into Q3 and Q4, from the first half of the year.
Nevertheless, we continue to see encouraging improvements in productivity and our ability to control overhead costs. Let me provide a few examples. First, Horizon's overall productivity measured by passengers per FTE is up 3.3% this quarter and unit cost ex-fuel are down 16% on 20% capacity growth.
Productivity in the Flight Ops Division is a particularly bright spot as training costs have declined significantly and hard time has improved, especially on the E175. I want to congratulate the Horizon team on these fantastic results.
Second, as we mentioned on our last call, our supply chain team has been working a plan to lower prices we pay to our vendor partners. The results have been outstanding. We expect to save more than $30 million this year positively impacting costs across many divisions.
A third example relates to flight attendant premium pay. During the transition, we had a heavy reliance on premium pay to make sure our flights were all covered. Today, our in-flight team is having to use much less of it because of a much more normalized operation and better processes in the department.
And finally, overhead is down by more than $15 million or about 5% so far this year. Over the last year, we've made changes to the size of our management staff not only to save payroll costs but more importantly to improve our speed and agility and reduce the number of layers between our leaders and both our customers and our frontline employees. These changes are important as we seek to more positively and tightly manage our Company towards the future that we are seeking.
Looking to Q3, we expect CASM to be up approximately 5% on a 3% increase in capacity, which given our full year guidance would imply a 1.2% decline in unit costs in the fourth quarter. The third quarter increase reflects the cost shifts I mentioned, timing of expected variable pay accruals and the impact of the new labor agreements, including our expectation that we'll pay as I said earlier $24 million in one captive time cost during the quarter.
July marks the beginning of our annual planning process. As we think about 2020, we're mindful of our need to continue to aggressively manage our unit costs in a way that maintains or expands our competitive cost mode versus the legacy carriers. Doing so ensures that we can offer low fares, grow, and achieve our 13% to 15% long-term margin target.
Turning to the balance sheet, we ended the quarter with $1.6 billion in cash and marketable securities. Total cash flow from operations for the first six months of the year was nearly $1.1 billion ex-merger related costs, while net CapEx was $330 million. This resulted in $735 million of free cash flow again ex-integration costs which was nearly $400 million higher than the first six months of 2018.
At consensus, full-year operating cash flow would be about $1.5 billion and free cash flow would be about $775 million assuming CapEx of $725 million this year. That's more than 3 times the amount we produced in 2018, the result of the direct outcome of our decision in early 2018 to reduce capital spending in order to improve free cash flow.
We've produced free cash flow now for nine years in a row and positive operating cash flow for more than 30 consecutive years. Maintaining this track record of positive free cash flow is an important part of our capital allocation strategy.
A fortressed balance sheet was also a hallmark for this Company - of this Company for many years and we're quickly back to that - moving quickly back to that position. We've repaid $280 million in debt so far this year, including some repayments that were made in June that will offset with some new borrowings in the third quarter as part of our broader effort to take advantage of the low rate environment, lower our borrowing costs, and move to more fixed rate debt, given the tight spreads and inverted yield curve.
I want to give a shout out to our treasury team for the work they've been doing and thank our banking partners who have adjusted rates downward. We're on pace to reduce our debt balance by about $350 million in 2019 and we've already paid off $1.2 billion of the $2 billion we borrowed for the merger. With leases, our quarter-end adjusted debt-to-cap stood at 45% and we're on track to end the year at about 42% and reach our 40% goal sometime in 2020.
We have 100 unencumbered Boeing NGs and Embraer E175s and $400 million of undrawn lines of credit. We have returned $110 million to our owners via the dividend and share repurchases, we set a plan to return $220 million to shareholders this year and will hit it, which is a nice way to close.
You've heard today, a number of examples of where we set a plan and we're executing on it. The results are encouraging. We're delivering industry-leading operational performance and our customer service is award winning.
On the financial side, we have revenue and cost momentum and our balance sheet is strong and if we continue to execute our plan we'll be in the top quartile in the industry for profit margins, balance sheet strength, and free cash flow generation.
And with that, let's go to your questions.
[Operator Instructions] The first question will come from Savi Syth with Raymond James. Please go ahead.
A bit of an unfair question because you just look to be delivering a really good 2019 on the cost side, but what have you done for me lately, just as we think about 2020, I wonder if you can walk through some of the headwinds and tailwinds that you're seeing in 2019 and how they progress through 2020?
Savi, it's Brandon. I'll start and then maybe Shane can jump in. That's a super important question as we start to think about the 2020 plan. As I mentioned, we're already waiting into that process. We recognize that low costs are a super important competitive advantage that we've had for a long time and will continue to be an important competitive advantage as we go forward.
And it's going to be a big part of us getting to our 13% to 15% margin goal. A lot of the initiatives that we have in place will provide benefit into 2020, we walked through a bunch of that at Investor Day, I think we've got a lot of momentum as I said on that stuff. Shane, you want to?
I might only add something. I'll be a little generic. I think the biggest sort of specific challenge we have going forward is just all these lease returns. There's a lot of complexity that goes along with that. However, there is a lot of opportunity to continue to save cost out of the operation and out of the Company.
There's tons of stuff we can do on productivity, utilization all of those things we talked about at Investor Day, we really haven't fully tapped yet. I would say this year is really more about getting the muscle to manage costs back and in the next couple of years, it's starting to manage those down more aggressively.
And then on the network side. This unit revenue guide is really good. I was just wondering if you could talk a little bit about as you understand the network changes and how that's affecting your seasonality - if we should know - now how we should think about if those kind of you're going to have a peak year summers here and 1Q being kind of a much weaker, how we should think about kind of the network and how that affects the quarters?
Savi, it's Andrew. I think this comes back to opportunity and when we acquired Virgin America it actually made us more peakey, now Q1 and Q4 were deeper problems in Q2 and Q3 were stronger. So what you'll see is sort of the traditional pattern, Q2 and Q3 very solid, Q1 being the worst, and I think as we move forward as we look at our network for 2020, we are working hard on how we make Q1 much more balanced and much stronger going forward.
And so not necessarily in place for 1Q '20 but just going forward, is that fair?
There's already changes being implemented in the first quarter and we're continuing to finalize those. So we are in the process.
The next question will come from Jamie Baker with JPMorgan. Please go ahead.
You spoke enthusiastically about loyalty in the quarter. I assume that was a consolidated observation, why wouldn't it have been. Would you be willing to discuss loyalty returns - loyalty returns, excuse me, in the Seattle market specifically. I'm obviously curious if you're losing any share there as your primary competitor pushes its own loyalty scheme. I've got to imagine California is what's really driving aggregate loyalty improvement, but I'm curious if Seattle is declining?
This is Andrew. Thanks for your question. Although we don't normally talk on specifics, what I can tell you without absolute question is that the Pacific Northwest loyalty continues full steam ahead. Certainly we have a lower base in California and the percentage-wise increases are obviously larger there, but actually all of the things that have been going on has just only pushed us to work harder and stronger here in the Pacific Northwest. And we continue to see solid growth in Mileage Plan members and credit cards and revenues in the Pacific Northwest.
Excellent. Second question, I know there have been several industry attempts to raise Hawaii fares as of late, as near as I could tell, they have not succeeded. Is that the correct interpretation? Or did we get some fare increases during the quarter? I'm just curious if there is any cause for pricing optimism, given that you're still calling that out - that market out as challenged as a RASM headwind in the quarter?
Yes, I think for - on the Hawaii side, there has been marginal attempts at pushing things up a little bit. There has been nothing major at all. I think what really we're fighting here is significant seat increases year-over-year in this marketplace. And so, but we are filling the airplanes although you know at cheaper fares.
But again, that's one of the assets that we have here with First Class, Premium Class and new Saver Fare product, all of these things are working to help, in some cases, overcome some of the softness in the fares.
The next question will come from Duane Pfennigwerth with Evercore ISI. Please go ahead.
Given your informal outlook Brandon for north of 6 bucks and free cash flow this year, what would you need to see to get more aggressive again on the buyback?
You just did the math based on the numbers I used in the script?
Yes, sir.
Here's what I would say is we've been really focused on what we've called re-deleveraging the balance sheet, as I said in my prepared remarks, a fortressed balance sheet has really been a hallmark of this company for a long time. Our balance sheet is super, super strong. I think right now we're really going to keep deploying capital to getting the balance sheet to exactly where we want it, and then think about broader return to shareholders once we get there.
You've been very clear and consistent on that. And then just for my follow-up piqued my interest with the Amadeus RM system upgrade middle of next year. What specific capabilities do you think this will provide for you? And is there any sort of transition risk around that as you rotate over to that system? Thanks.
This is Andrew. That's a great question. We always worry about transition risk. We're working off honestly 20-year-old technology and we've had to design and build a lot of technical reports to manage around that. So this will be next generation state of the art. It will also allow us to do O&D pricing, which today we just don't have any capabilities for and it's also going to be allow our analysts and our teams to be much more focused on the macro matters, and the system will take off a lot of the heavy lifting there doing at the individual analyst level, so we can get better results.
So we'll talk to you more about that as we move into 2020, it's an initiative we have real revenues tied to that. We're not ready to share that yet. And then on the revenue risk is always risk, but the team has a fantastic plan as they are going to start to layer in markets independent from the system, so a little bit of an overlap, if you will. And so we're going to do this in a measured cautious manner, so that we don't expose ourselves to any real significant revenue risk.
We're not going to go to true or O&D pricing out of the gate, we'll stick with - change vendors but go to segment pricing and then in time, we'll move to a --
O&D will be later on when we are ready to pull the trigger on that and we'll start with certain regions and will turn those on, in the new system and then we'll just continue to roll them out.
The next question is from Catherine O'Brien with Goldman Sachs. Please go ahead.
So just a couple of questions on your cost outlook here. First, I wanted to clarify, does your CASM outlook include the signing bonus from your recent contract gratification, meaning you're not as seen as special item some of your peers do?
Cathy, it's Brandon. Yes, our cost guidance includes the signing bonus.
So - there are my math. The new rates and the signing bonus are about 90 basis point headwind here to your CASM outlook for the year. So I mean and in your new CASM outlook including that is only 10 basis points better than what you were previously forecasting.
So I guess what's driving that improvement, I think my math that leaves most of that made up in the June quarter. I know you guys talked about a few things that are trending better than expected. But in the back half, is there an opportunity to see some of that cost strength continue and maybe even trend down, despite the new deal?
Cathy, it's Shane. Thanks for the question. I'll sort of reiterate what you said and what we said on the prepared remarks. The team did a fantastic job managing costs in Q1 and Q2. I think we may have even surprised ourselves a little bit how well we managed them.
And I think that if we continue to do that, there is opportunity in the back half of the year. There are some costs that we know are shifting, Brandon mentioned those, some of the pilot training costs and a few other areas, but we're still seeing real strength on managing overhead, managing productivity, managing selling expenses, as an example, in the quarter, revenues were up 6%, selling expenses were down 3% which is just a really wonderful result.
Usually those correlate together and go up at the same rate. So we're finding areas to marginally improve the Company all over the place and we'll continue to mind that in the second half.
It really impressive because, at least, on my math fully offset just by the June quarter better performance there, the new deal. And then maybe one for Andrew. We keep hearing about how Saver fares is trending better than expected, but I don't think we've officially gotten a raise that $100 million annual target. Any comments still waiting for more testing there or should we be expecting [indiscernible] there at some point?
Katie, I would not hold your breath because we don't plan on giving out specifics and updating that other than to tell you that the 330 that we shared, we feel very solid about. Saver fares has actually performed better than we had thought, some others a little bit less though, but we're just going to stick to the high level numbers versus go into all the details, but it's doing very, very well for us.
The next question will come from Rajeev Lalwani with Morgan Stanley. Please go ahead.
Andrew, a couple of straightforward questions for you. As far as the MAX, what sort of benefit or impact are you seeing there, whether it's in your third quarter guide or your second quarter guide? And then your latest read on competitive capacity and how that's trending? And then finally, any color on development markets and maturity there and whether or not there is much more opportunity ahead of you?
Yes, thanks. The best way for me to talk about the MAX is just to really look at the industry seats and what we're dealing with and as is very public knowledge we saw a number of closer in pull downs by carriers to accommodate the MAX. So we've sort of been a recipient of that. If you look forward though, our competitive capacity on a weighted basis is actually down 0.7% in the third quarter.
And again I think that's in no small part to the industry capacity coming down, which I think brings good things for everybody when capacity discipline is carried out that way. The other thing I would tell you is that on the new markets in the maturity, we still have, we've seen really good improvement. Some were on average I think up to about 85% of normalized yield and they continue to improve and a little bit some of the California markets especially so. So there is still upside for us as we continue to mature these markets.
Can you quantify maybe that last one. I mean, how much you've seen so far or how much more there is to go?
As it relates to the guide no, what I think, what we continue to want to see in our developing markets, which were much smaller percentage of our network now, but we still want to see high single to double-digit unit in our revenue increases in those markets, but I don't have a dollar figure our RASM number to quantify that for you.
The next question is from Helane Becker with Cowen. Please go ahead.
So, I had two questions. My first question is related to what field and what are you doing there and will you not be serving that market anymore? Is that the way to think about it?
Helane, this is Andrew. No, we are absolutely serving Love Field. I think what's got little confusing on all of that, is that, we have as you know there's a lawsuit going on. I'll let Kyle touch on that in the second, but we have to gauge there, there is a lawsuit going on and we have 13 flights a day.
What we've done is, there is uncertainty around how that lawsuits going to end up on what's happening. So, we had scheduled more flights. So, what we're doing is holding to our 13 flights a day. What we're doing is concentrating now on full markets, which is Seattle, Portland, San Francisco, and Los Angeles. And that's sort of what we are going to be flying here for the foreseeable future. Then Kyle, did you want to comment?
Sure, hi Helane. Yeah, the litigation really just applauds on, it scheduled to go to trial in September, we'll see if that sticks or not. In the meantime the judge has been very active and keeping up settlement discussions among the carriers and the city and I'm afraid to say there so far not been much progress there although people are talking.
Okay, and then my second question was on transcon. So I think in the first quarter that was a kind of a problem and I didn't hear you mentioned whether that was improved in the second quarter and how that looks for the summer?
Thanks Helane. Yeah, it was, it was a real problem in the first quarter and in the prepared remarks and just what we've been sharing as we are very, very encouraged with what's happened there. We have significant unit revenue increases in those during the second quarter was pricing stabilized that's continued into the third and we have seen double-digit margin increases in those transcon routes and in part, notable part that our employees of really rallied around those markets, around the guest service both in the aircraft, on the ground, we're making sure the satellite flights get on there, SoC has done a magnificent job getting the 99.5% completion rate, so we are just all in focusing on the guest experience and it's making a difference.
Okay. And then, could I just follow that up with one MAX question. Would you consider keeping A320s to backfill the MAX?
Helane, this is Brandon. I'll take that one. You know, we have three A319 plus 320 airplanes that are due to be return between now and the end of 2020 and we're going to stick with that for the time being. Those are already in process to one degree or another.
We do have MAX is coming in next year, our MAX exposure was pretty darn small, we were supposed to get three in the last few months of this year. It's perhaps one now. Those two that we are not going to get this year, will probably come if things play out like we're hearing they might play out in the first quarter. So, the capacity issue for us isn't nearly as acute as it is for some other MAX operators.
The next question is from Michael Linenberg with Deutsche Bank. Please go ahead.
Yes. Hey, Andrew, you called out the improvement in pricing indicated it's stabilized and improved through the quarter, could you just give us maybe some additional color to show how things trended and then is that continuing, that trajectory continuing into the third quarter?
Yes, I think really around the pricing environment, I would say it's - our biggest problem is obviously close in fares and business fares, we're very, very low during the first quarter. So those are substantially going away in a stabilized.
The fare environment I would say in a number of areas are still sort of down a little bit year-over-year, but stable and again, the way we've overcome that of course is with all these new revenue initiatives and a lot of the changes we're making to the business.
So, for me personally, the way I would describe the fair environment for Alaska is one of stability and we are working with that and we're not seeing any real changes in demand and demand continue is actually to be quite robust.
And then just the second question. And Andrew, this is to you as well. I realize it's early with the Paine Field operation, but how has the start-up been and when you look at the clientele, are these passengers who formerly flew out of Seattle, are they, are they new customers, may be coming from other carriers, what can you make of the Paine Field start-up, just curious about how it's going.
I don't remember about, starting, you know, what we did in Pain with eight new markets and starting off with 18 frequencies has been quite amazing, other than Portland and Seattle, we probably got a little too much, excuse me, Paine port and we got to probably a little too much capacity there.
But on the whole, all of these markets are well into our average load factors now and the yield is working its way up. And I think we couldn't be more impressed and excited with how the startup of that operation only after three months has gone.
I will say that we probably seen a lot of our non-frequent flyers actually are flying at a Paine Field on, my initial got would be a lot of the loyal customers will and they are, some habits are hard to break. But what's really exciting is we're seeing a lot of non-core loyalty members taking advantage of the close location of Paine Field and demand has been very, very good.
The next question is from Hunter Keay with Wolfe Research. Please go ahead.
Brandon, you sound very excited today by the way, I just want to mentioned that, and appreciate you guys not pulling out the signing bonuses special item that's really good stuff, it's noticed. I do have a question for you on selling expenses. I know this is Shane or Brandon. How is it down so much? I know that some of that's accounting reclassification but even if you take that away adjusted. It's still down by tens of millions of dollars over the last couple of years. Is this something you like renegotiated with Virgin? What are you doing to get that down? How much more is there to go? Thanks.
Hunter, this is Shane, yeah, you pretty much noted, we did get an opportunity to renegotiate a lot of deals that Virgin had that got closer. Our rates and a lot of those cases we are able to actually bring our rates down at the same time, so that stuff that has taken place over the last year or two, it includes not only the cost of distributing tickets like through travel agencies and GSSs and medic partners but also our core passenger service system. We basically renegotiated all of those in the last three years are really attractive rates of the Company.
So there is such a thing as a merger synergy then?
There you go.
Okay, good. And this is a little bit more of a high-level question, but I know if you've noticed, but the market to Hawaii has changed a lot over the last 10 years and there's a lot more sort of long-haul narrowbody fine with neo's and for time MAX is where, there's more outer Island destinations being served from smaller communities that was not previously really able to do without these neotechnology and MAX technology.
I feel we're starting to see that a little bit in Alaska. You mentioned some overflow of Seattle, you're seeing American put for example a 321 neo at a Phoenix into in the Anchorage, are you prepared for this? How are you thinking about over fly being a permanent issue as more Airlines get the neo's, and are you prepared to sort of cannibalize your own connecting traffic with the MAX’s if you need to do that sort of like Hawaiian is doing with their neo's.
Yes, I do Hunter, it's actually, you're observation is spot on. I think the way that we look at it is, the opportunity for others is the same equal opportunity for us. I mean we fly all of those East Coast destinations from Seattle. We have a strong, obviously network actually in the state of Alaska including strong feed. We fly into Chicago. So I think a couple of things. I think there could be opportunity for us going forward, given the aircraft type to do some of that our self.
There will be occasions where there is true over fly and traffic that we might have challenges getting, but at the end of the day, we have a very, very strong network up there, a very, very strong loyalty proposition, and we will continue to fly where Alaskans need to go on a non-stop basis and as we go forward.
Yeah, Hunter, something like two out of three Alaskans are members of our Mileage Plan. And I would agree with Andrew, if there is a desire for more longer distance flying into Alaska hubs, we should be competing for that.
The other thing I'd just note is just the relationship between the economies in the State of Alaska and in Seattle in particular is extraordinarily close, whether it's government, or fishing, or timber, or whatever, tourism whatever industry we might be talking about, a lot of those business connections are here.
If someone doesn't want to go to Houston for oil or something like that, that's a customer that we are going to have to compete for if they're doing mortgages since flight. But I think a lot of it actually is Seattle business.
And a lot of it's just really just been in the peak summer season as well.
That's exactly right.
The next question is from Joseph DeNardi with Stifel. Please go ahead.
Andrew, just on RASM performance in 2Q, up about 5%, 3.5 points or so from the initiatives. So 1% increase in capacity led to maybe a 0.5 increase in core PRASM if you want to call it that, like why is that a good result? Why isn't there more traction in PRASM given your kind of modest capacity growth?
I mean, the way the simplistic way I look at this is, firstly, what we've committed to, is number one, we want to grow unit revenues in line with the industry and the industry also has initiatives and revenue initiatives in there and if you look at our revenue and synergies that's about 400 basis points. So what we're really saying is we're going to grow at the right, the industry is that includes their initiatives, plus another 200 basis points on top of that.
So that's how we are thinking. We think that's a very strong result. I'll also, I think our stage length increased by about 1.5% during the second quarter, which also puts downward pressure on unit revenues and we're also seeing significant increase in stage length, even in the regional business as well as their mix gets more, a little bit long haul.
So overall, and then the last thing I'll just point to is our margin. We have close to a 16% margin for the second quarter and we have powder left in both our cost and revenues. So overall, what you're seeing is a track that we're headed to a 13% to 15% margins and so you're right, it can be better and it will be better as we continue to move this thing forward.
And then, Andrew, I guess I was a little bit surprised given how important revenue generation is doing airline business that you're using 20-year-old technology. I would have thought that that his upgraded a little bit more frequently, so why is that? And what is the revenue opportunity from that?
So again, we have a system. And again, it's just all priorities. And I think when we acquired Virgin America, much of what we're looking here massive step change in the size and complexity of our business. So we definitely it's time for a new system. We will be sharing with you as part of our outlook for 2020 what our revenue initiatives will be, including the revenues there. So we're not prepared to speak to those today.
Yes. And is it material?
Yes, yes it is.
Thank you.
Its revenue management, leadership, analyst and we have the top-notch commercial analytics team that that makes up maybe a little bit for us upgrading the systems.
And it's all it's with the vendor where we’ve now, it's not like to have an updated software, but it's a new platform that we are moving to. Good. I think Kevin Crissey might be next.
Kevin Crissey with Citigroup. Please go ahead.
Yes, thank you very much. And I just continue on with the Amadeus quickly, why choose Amadeus is my understanding is it the best aspect of that is the international component, does that suggest maybe a more of an international focus going forward or was there some other reason for that vendor selection? Thank you.
Without going into details. We did a very starrer RFP looking at all the vendors and it came down to cost, it came down to capabilities, it came down to what our RM Team needed and wanted for our network today and our future network. So that's, that was the decision.
But to be clear, I don't think new international service. I don't think that was a big driver.
Not long haul service, no.
The next question will come from Brandon Oglenski with Barclays. Please go ahead.
This is actually Matt Wisniewski on for Brandon. So I know it's early for 2020. But as growth starts to ramp in next year, I mean, turn to a return to growth. I'm wondering if you could share any kind of attributes on what are the priorities for growth are and what, how we should be looking at that. And then as a secondary in the context of the 4% to 6% growth how much flexibility would there potentially be in that, specifically in the context of the margin targets? Thanks.
Matt, it's Brad I might jump in here. I think the first priority, we've got just in the incredible economic engine in the Pacific Northwest. So the first priority would be feeding that engine and doing everything we need to do to sort of defend and grow markets out of the state of Washington, in the state of Alaska, the state of Oregon.
I think the second priority we've got some important new geography in the State of California and San Francisco and LAX, in particular, I think it would be doing the flying that we need to do in those markets to provide just the important base utility for business travelers and others in those markets.
And I think after that. I think there are. And Andrew sort of hinted at this. There's opportunities for us to do a better job of connecting the different parts of our network in strategic ways. And so I think that would be the third priority.
Finally, we've always got an opportunity to make sure when we have multiple frequencies in a city pair to make sure those flights are well timed to make sure that we're flying back and forth from the West Coast to the middle of the country that are times are friendly to West Coast customers. So, those are in my own mind, those are sort of that would be sort of a top to bottom sort of priority about how we would think about future growth. Sounds like Matt might be off the line.
No, thank you. I appreciate it. That's really helpful.
The final question is from Dan McKenzie with Buckingham Research. Please go ahead.
And not many as question as well, presumably that gives you more merchandizing capability versus what you have today. Is that a fair characterization?
Dan, it's Shane. I'll just take this, because I have them to be the person who installed the merchandising system. We actually have one. We use fare today. Amadeus has a really good one as well. We're super happy with our partnership with Fair Logics as well, but if there was an opportunity to move to Amadeus. We could do that, but we've got a really good robust merchandising platform today.
The other sort of technical question here with respect to the increased premium seats coming from the reseat, the Airbus, can you revenue manage these seats real time as they come online or is there some conservatism on that until you reach a critical mass, either in terms of aircraft or as you think about the plaintiffs?
Dan, this Shane again, I launched PC. So I guess, I'll take this one too. The only real conservatism is making sure that if we sell the seat the PC seat shows up. As you know, we don't really assign a specific shell to a market until we're closer in. So trying to sell a seat six months ahead of when we actually assign the aircraft that's always, that's the calculus, we try to go through. So there is a little bit of a ramp up period as these come online, but it doesn't take that long for us to be able to, to pre-sell through the entire window.
So on a new aircraft comes on these premium seats maybe don't sell at a premium for like the first month or how would you characterize the delay?
Yes, the way we do it, just not to get too technical , but we have like 20 planes coming then we might sell 10 planes worth for about a quarter and then the next quarter we'd sell 15 planes worth next quarter we sell 20 planes worth so might take two or three quarters to burn in.
And then one final question here, I wonder if you could talk about the Airbnb restrictions that were recently passed in Hawaii. How are you thinking that might or might not impact travel to or demand to Hawaii?
Yes, I think you know we like everyone are watching that, I think, my understanding is about 5,000 units of inventory coming offline for a Hawaii only. It may result in people flying to the other islands for a better availability and costs and we flight all of those four islands. But again, that's something we'll be watching over time. Our bigger focus obviously is how many seats going into Hawaii, because at the end of the day, Hawaii is about supply and demand.
Okay. I think we're not going to hear from the operator again. Thanks everybody for tuning in today for our second quarter call. We look forward to speaking with you all again in 90 days time. Thank you.
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