Allegiant Travel Co (ALGT) 2010 Q2 法說會逐字稿

Welcome to Allegiant Travel Company's second quarter 2010 financial results conference call. We have on the call today Maury Gallagher, the Company's CEO and Chairman, and Andrew Levy, the Company's President. Today's comments will begin with Maury Gallagher followed by Andrew Levy. After their prepared remarks we will hold a short question and answer session.

We wish to remind listeners to this Webcast that the Company's comments today will contain forward-looking statements that are only predictions and involve risks and uncertainties. Forward-looking statements made today may include, among others, references to future performance and any comments about our strategic plans. There are many risk factors that could prevent us from achieving our goals and cause the underlying assumption of these forward-looking statements and our actual results to differ materially from those expressed in or implied, by our forward-looking statements. These risk factors and others are more fully discussed in our filings with the Securities and Exchange Commission.

Any forward-looking statements are based on information available to us today and we undertake no obligation to update publicly any forward-looking statements whether as a result of future events, new information, or otherwise. The Company cautions users of this presentation not to place undue reliance on forward-looking statements, which may be based on assumptions and anticipated events that do not materialize. The earnings release, as well as a rebroadcast of this call are available at the companies Investor Relations site ir.allegiant.com. At this time I would like to turn the call over to Maury Gallagher for opening remarks.

Thank you. Good morning. It's a pleasure to be with you again. As the narrator said, Andrew will be joining me today. We had another excellent quarter. Our 30th consecutive profitable quarter. We had after-tax income of $17.6 million. Total revenues grew just short of 14% or $20.4 million year-over-year to $168.4 million. Fuel expense increased as well during this period 49%, or $20 million, while non-fuel operating expenses grew 14%, or $9.7 million. These results produced a $28.1 million operating profit, or a 16.7% operating margin. Just a comment that revenues grew $20 million year-over-year or 14% increase and fuel grew $20 million year-over-year, 49% increase summarizes why our operating margin percentage declined.

I want to spend some time today examining the relationship between revenue and fuel. It will drive our growth decisions in the coming months. Unit revenues increased in Q2 on a year-over-year basis. The selling pair was up $8 or 12% to $73.15 while ancillary revenues increased $2.21 to $34.48, or a 7% increase. This combination resulted in a total average fare increase of just over $10 per passenger, or 10%, to $107.63. Longer stage lengths in the first half of the year compared to the same period in 2009 was somewhat muted the effect of increasing unit revenues. This can be seen in proportionally RASM and TRASM growth percentages for the same period. During this period our cost per gallon of jet fuel per scheduled services increased 36%.

We've been on quite a ride since 2007, what we considered our last normalized year. In difficult years there was the fuel spike in 2008 and revenue problems last year, and in hindsight have been beneficial to us. We've reacted and adjusted our system in a number of ways looking for additional revenues including one, moving to a 90% load factor as a norm. Two, pushing our ancillary revenues more aggressively than we otherwise might have. Three, actively micro managing our capacity. We continue this micro managing of our schedule to this day. We are continually adjusting capacity to optimize unit revenues and associated margins.

On the 90% load factor front there are a number of tangible benefits compared to our 2007 practices. First and foremost we have seen our TRASM increase 15%. In the first two quarters of 2010 as compared to the same period in 2007, even though the selling fare is down 11%, or $10 from $87 to $77 in this comparison period. The benefits from carrying 15 additional passengers per departure, 120 in 2007 versus 135 this year, are quite powerful. Secondly, the $14 increase in ancillary revenues from $20.60 in first half of 2007 to $34.75 in the first half of 2010 has more than made up for the decline in the selling fare. Additionally we have 15 more people on each flight paying us this higher ancillary revenue. Overall we are carrying 15 more people per departure at a $5 higher total average fare today than we were in 2007. Despite of the difficult economic environment which exists. This combination of higher revenues, more pass throughs per departure, and higher ancillaries per passenger has been critical to our achieving 20% operating margins during the past year and a half.

Second benefit from our 90% load factors has been on the cost side. During the first half of 2007 we spent $243 more per passenger for fuel, $42.57 versus $40.14 this year even though we spent $0.12 less per gallon in the first half of 2007 than the first half of 2010. Again, the power of the extra 15 people per departure is spreading fixed cost is substantial. With this is a back drop we continue to evaluate how we can maintain our 20% operating margin goal. Critical relationship is a balance between revenue we collect for customer and the amount we spend on fuel per customer.

While revenues have improved in the first half of the year compared to the same period in 2009, the increases have not matched the corresponding increases in the price of crude of jet fuel. As recent as April, crude was moving towards $90 a barrel while it has the slowing recovery in the economy and substantially ahead of our recovery and unit revenue needed to offset these increases in fuel. In order to bring the fuel revenue relationship ratio more to our liking, we will be taking a slower growth approach going forward in order to put upper pressure on yields. Andrew will have further comments on capacity in a moment. So I stated in the press release, we will limit our in service aircraft to 51 by year-end versus the 52 we had earlier forecast. While we have nine aircrafts in storage for future growth, we have not scheduled them for induction at this time.

Let me touch on some other points of interest, automation. We are moving ahead nicely in this area. We will have our database conversion that we've been working on for the past eight months included in the near future. Once the database is operational, the new database, we can begin implementation of new generation tools to aid our developmental efforts. As we bring online our enhanced automation platform focused on customers, we will increase the products we can offer, as well as improve the flexibility to change most of our offerings quickly without programming changes.

On the aircraft front, I'm happy to announce we passed a milestone in June. We added our 50th aircraft. When we began in the Summer of 2001 we had a single DC921 with 80 seats and a $5 million revenue run rate. Today with our 50 MD80 aircraft in service and an annualized -- we have an annualized revenue run rate approaching $700 million. Many people contributed to our success over the years and I want to thank all of our team members who continue to work diligently to bring our customers safe, reliable low fare service to small communities throughout the United States. Andrew?

Thanks, Maury. During the first quarter, we generated $36.5 million of EBITDA, $28.1 million of operating income, and $17.6 million of net income or $0.87 per fully diluted share. We ended the quarter with unrestricted cash and short-term investments of $185.4 million, down from $249.2 million at the end of the prior quarter. The decline in cash was due to $19.3 million in CapEx, payment of a $14.9 million cash dividend, $10.3 million used for the repurchase of common stock and the execution of an agreement with one of our key hotel partners for the prepayment of rooms as disclosed in a recent 8-K filing. We remain very comfortable with our liquidity and expect to continue to generate sufficient cash from operations to finance our growth. Our leverage ratio has continued to improve. Our debt to equity ratio is now 11% and our interest coverage is 41 times. Our return on equity is 22.1% and our return on capital is approximately 18.5%, both measured on a trailing 12 month basis.

Cost performance was good during this quarter. Operating expenses increased 27.3% on a year-over-year basis, mainly due to a 48.7% increase in fuel expense. Fuel expense increased year-over-year due to 9% growth in gallons consumed for our scheduled service and a 36% increase in the cost per gallon to $2.42 from $1.78 in Q2 2009. On a per passenger basis, fuel expense increased by $12 or 42% to $40.35 per passenger, from $28.38 in last years second quarter. Costs excluding fuel increased at a much slower pace with the exception of our other expense category. The majority of the year-over-year increase in this category, almost $1.3 million, is related to our proposed debt financing which we pulled due to poor market conditions, our entry into the 757 aircraft type, and our database and reservation system automation enhancement programs. These are non-recurring projects. However, we will have additional costs for the 757 and automation projects in the next couple quarters. Our cost per passenger excluding fuel increased 9.1%, as compared with Q2 2009 to $50.61, largely due to a 5% increase in stage length and a 4.3% decline in aircraft utilization. As noted in the release, we expect our ex-fuel cost per passenger to be between $52 and $54 during this third quarter.

Our revenue performance in the second quarter was strong. Total revenue increased year-over-year almost 14% to $168.4 million, driven by a 19.8% growth in scheduled service revenue and a 14% increase in ancillary revenue. Scheduled service revenue growth was driven by 6.7% increase in scheduled service passengers, and a 12.3% increase in the average fare to $73.15. Passenger RASM increased 9.4%, despite a 4.3% increase in average stage length. Unit revenue improvement was driven by a one percentage point improvement in load factor and an 8.3% increase in yield. We currently see a relatively stable revenue environment, and as such we do not expect any material improvement in the average fare during the third quarter of 2010 as compared with this second quarter that we're now seeing today.

Ancillary revenue growth was due to the increase in passenger count, as well as a 6.9% increase in the average fare to $34.48. On a per passenger basis, air related charges increased 4.4% to $29.61, and third party products revenue increased by 24.5% to $4.87 per passenger. Total RASM, the combination of scheduled service and ancillary revenue increased 7.7% and the total average fare improved to $107.63, a 10.5% increase as compared with Q2 2009. Fixed fee contract revenue increased 4.4% year-over-year to $9.9 million, primarily due to increases in flying under our Harrah's agreement and in the ad hoc charter segment. As indicated in our guidance, we expect fixed fee revenue to decline between 22% and 26% as compared with Q3 2009, mostly due to not having $2.5 million of revenue from two flying programs we had a year ago and that we do not currently operate.

Let me end with comments on capacity and our network. As the guidance in the release indicates, planned third quarter capacity growth is robust. In late May, early June, we added capacity to several routes in July and August which explains why our third quarter guidance is higher than what was included in our first quarter earnings release. At this point we are no longer adjusting the third quarter. Fourth quarter capacity growth is slightly lower than the third quarter pace and we still have the ability to further adjust our plans depending on the revenue and fuel environment. June year-over-year comps were strong with passenger RASM up about 15% and total RASM up about 14%. However, we expected better unit revenue performance based on very strong trends we saw earlier this year through April. May and June did not compare as favorably and the acceleration we saw in the first four months of the year have now stabilized. So we see strong solid demand, but we do not see any evidence of an improving fare environment as we look into the third quarter and while revenue has improved since last year, fuel prices have increased at a faster pace. Forward prices for jet fuel in the second half of this year are similar to current spot prices. Therefore, with our stated goal of running the business at 20% margins, we will reduce our planned growth rate.

The majority of our fourth quarter growth will be associated with new routes, not growth in same-stores. As noted in the press release, we have recently announced several new routes and plan to announce several more in the next few weeks. We believe our new capacity plan gives us the ability to better manage to our margin goals assuming fuel prices remain fairly constant. Of course, if circumstances change we will quickly adapt our business plan accordingly. As Maury noted in the release, in the very near future we'll have 51 MD80 aircraft in service and own nine other aircrafts, which will be placed in storage until we are ready to grow the fleet. We expect we will begin to add more aircraft again in the first quarter of 2011. Thanks very much and we are now ready to take your questions.

(Operator Instructions) Our first question comes from Duane Pfennigwerth of Raymond James. Please go ahead.

Hi, good morning, thanks.

Good morning.

Just with respect to the June quarter and maybe that fare improvement not having been as strong as we had hoped earlier, wonder if you could characterize sort of any segmentation of that or regional areas that may have been not up to expectations, or was it really across-the-board?

Yes, Duane, this is Andrew. I'd say it was largely across-the-board. June is going to behave differently in different parts of the country. I think that what we saw in the first few months was very, very strong unit revenue relative to comparisons of 2007 and 2008, and of course 2009 is a very easy comp, so we don't really pay much attention to that, but in fact March and April were as good as we've had in terms of total RASM comparing it to even 2008, which is very very strong revenue year.

May and June just didn't perform to that same level, and so the acceleration that we had seen in the first few months of the year really kind of stabilized and we spoke to that at a conference that we presented in a little over a month ago, and I think the environment just hasn't really changed. So I wouldn't characterize it as any particular routes or any particular part of the country. I think it's just a general kind of -- I don't know if this is a new normal, but I think the revenue strength that we saw and the acceleration is simply mitigated and right now we're in more of a stable environment, which is a very strong environment, very good environment, but we just don't see any evidence we'll be on an upward trajectory any time in the next few months.

Is there any feeling, Andrew, that is it all environment or is there anything that Allegiant could have controlled whether it's less capacity or whether it's maybe a slightly different revenue management philosophy? Do you feel that there's any improvement that you could have driven with some different decisions looking back?

Well, I think that you could always look back and there's never been a time where we couldn't look back and say gosh, I wish I had done this differently, or that differently on capacity certainly, and I think that this quarter is no exception. Obviously you make your capacity decisions based on your best information available to you and that's what we did and looking back, obviously there's some routes I wish we had less capacity in, but nonetheless, we're still disappointed we couldn't do a 20% margin, but I think 16.7% margin is nothing to be ashamed about either.

As far as our pricing approach and philosophy, we are making a lot of changes in that area and I think that we hope those changes will bear fruit in the subsequent quarters as we move ahead with doing things a little bit different. I don't want to get into a lot of detail in that area other than to say we're always looking to find ways to improve the business.

Okay, thanks. And then just lastly, can we quantify sort of the ramp up of Hawaii in the cost structure this year?

That's going to be one off right now. The airplanes aren't on certificate yet so we don't have any airplane expense in it. That's all being capitalized and on the operational side there's investment in consultants and personnel and stuff just to get ready to go through the FAA process and so that's the jist of it so far, and that will increase particularly as we get into training in the back half of the year with more people and get the crews and the flight attendants ready and the maintenance personnel. So that will be the jist of the expense.

But if I could add, this is Andrew. We're going to rollout the 75's very slowly so the initial cadre of crews for instance that we're going to train is going to be a very small number. I just don't -- look it's going to be there and until the revenue comes in, it will be a little bit of a cost drag, but I think it's fairly immaterial in the grand scheme of things.

Our next question comes from Michael Linenberg of Deutsche Bank. Please go ahead.

Hi, good morning, everyone.

Hi, Mike.

A couple questions here. Andrew, the capacity guidance that you gave us for the third and fourth quarter, what would that have been if you took delivery -- if you had that additional airplane in the system? I'm trying to kind of do sort of a before and after.

Yes, I think that the third quarter wouldn't have been any different.

Okay because it was coming later in the year so it was more fourth quarter?

That's right, and so it would have been similar to what we see in the third quarter, maybe even North of that and while we're bringing in a 51st airplane, that airplane will be basically unscheduled almost. So we'll have that there to either support the operation as a spare or to take advantage if we do see opportunities to perhaps add capacity at a later date. So we're really running a 50 airplane airline with a 51 airplane fleet in the fourth quarter, and obviously, we had over the course of the year, we had expected to be at 52 airplanes or even more, we had mentioned on prior occasions and that's where we're scaling it back. So it would have been a good bit more, Mike than what we're showing and so it's not a new -- this is the first time we've guided to fourth quarter capacity, but in our internal forecast it was at one point a good bit higher.

Okay, and then just on the fourth quarter, I think I don't know if Maury, you'd maybe mentioned that a lot of it was new stuff, right? You weren't really adding to same-store sales and when I listen to your commentary, there's definitely a note of caution. A lot of people are out there talking about a double dip. You see it discounted in the market. People are a little nervous. When you think about the new markets though, just by definition, given that there's a ramp up involved, they are a bit more riskier and it would seem that the environment that we're in right now is a more uncertain one and so there for it would be the type of market or the type of back drop where you maybe would be less likely to do a lot of new services and I saw you just announced some out of Long Beach and Phoenix, Mesa. What's your thinking on that or are just some of these new markets they look so promising or maybe they've been abandoned by others you want to move into them?

Let me give some general overview and Andrew can give more specifics on the markets.

Okay.

The general overview, we've seen slowing just an anecdotal people I've talked to in Las Vegas, the news clips you read, there's kind of almost two economies going on out there. A lot of your industrial types are reporting pretty good numbers as we speak right now and the stock market has been positive and the like in that regard, but you see the housing, Las Vegas a couple people I've talked to here in June was surprisingly slow.

June historically has been a very strong month for us, one of the top third in the top third and it's kind of backed off as a result of -- we can liken it to the peaks are still the peaks, but the shoulders that we're building up to the peaks have gotten somewhat smaller and leaner or just haven't come back yet. So with fuel in my mind is way ahead of where the economy is right now and the bullishness of it, so you've got that dichotomy that says we should try and push yields up and the best way to do that is to not grow as fast certainly and maybe even pull some capacity in same-store. As far as the new markets, the general statement, we're connecting the dots in many cases.

Okay.

So we're always known in these Markets so it's not that brand new go into a market who the heck is Allegiant type of thing, but rather we're able to go in and build on our existing relationship with the marketplace and I'll let Andrew take it from there.

And then you get a cost utilization benefit too, right? So that helps?

Yes, there is some of that, but yes, I think that we feel really good about the new markets we're adding. I understand why the kind of the traditional thinking would be new routes, more risk, ramp up, et cetera. We don't see it that way. It just hasn't played out that way historically for us and especially as Maury mentioned, we'll be adding a few small cities into the mix, but in most cases we'll be simply connecting the dots and speaking of our existing customer base and offering them another alternative and that in our mind is the least risky way to grow our business. And so we're funding some of that growth by pulling capacity out of same-store, and by the way just to be clear, we are going to have more capacity in existing markets. It's not zero, but the vast majority of the growth that we're posting in the fourth quarter will be associated with the extension of our network in the new routes that we did not operate a year ago.

Okay, and just one quick one I can squeeze, on the 757 ramp, is that going according to the original plan? Is it slower than plan or maybe progressing faster than plan and I'm just sort of with an eye towards just the regulatory process and how it can kind of throw roadblocks when you least expect it.

I like to use the analogy called half lives. If you got something to plan for a year, you take the half life of that, you get half way there it's probably stretched out a little bit. When we're dealing with the FAA while they are being very cooperative and are very supportive in what we're doing, it's just going to take a little longer. If I had to guesstimate we're a couple weeks behind where we ideally would like to be, but that's -- hopefully we can make that up in the not too distant future.

What we have to face though is the ability to get the over water authority maybe the most difficult part of the exercise and until we can have that authority we really can't announce service into the Hawaii's of the world because of future selling and uncertainties. So we'll have a lot more clarity on that certainly on the next call and by the end of the fourth quarter, but we've always stated we didn't want to plan on any service levels to Hawaii in particular before maybe conservatively mid next year. So we need 120 days selling period. So that's where we sit right now and on balance we're very bullish. The airplanes look very good. It's coming together the way we had planned.

Our next question comes from Bill Greene of Morgan Stanley. Please go ahead.

Yes, hi there. I wanted to talk a little bit about the MD80. You saw today American announced they are accelerating some of the retirements of their MD80s and since they are such a large operator, I would assume they kind of provide a bit of critical mass in terms of maintenance of those aircraft and sort of broad demand for those parts. So is it right to assume that as they become a much smaller operator over time, that that sort of forces your hand to make a decision about a replacement for them? Is that how we should think about the timing there or what's sort of your thought process if I'm wrong?

Well, Bill it's Maury. Certainly having more operators in the marketplace is a positive as far as just general trends, long term. Is the MD80 going to be around for 20 years? Probably not, but American moving out of the airplane at a faster pace is still going to take them quite a while to get from here to there with 250 airplanes give or take. As fast as they want to go they still can't do things, I wouldn't guess, much faster than six, seven, eight years if they were to do everything quickly right now.

Well I haven't seen the release so you have more information than I do, but what we also have as an incredible amount of parts in the marketplace. We have five, six, seven airplanes that we parted out. So we've got lots of support there. As far as the knowledge base in the industry to do work, we have multiple MROs that are willing to do our heavy maintenance work on multiple engine shops that are out there to do engine overhauls. So I think the support factor is not really an issue at this point. Could the costs go up as you have less activity? Possibly. But we're not seeing that at this point in time.

This is Andrew. Let me just add also, as you know, Delta Airlines is flying over 100 of these airplanes and they have, I think, made a lot of comments about how much they liked the airplane and they are at the moment adding a lot of the MD90s, which is a little bit of a different airplane, no doubt, but nonetheless I think that it's important to note that American is not the only large operator in the world of this aircraft. Delta is the second largest and they are right in our backyard in the United States. So that will help us continue to get the support we want to get from the Boeing Company in particular.

Okay, and then I want to ask a second question about sort of adding non-traditional leisure destinations like if we thought about cities like New York, DC, or Chicago. With those sort of in your thought process and if so should we think of those as being sort of lower margin like as you've added things like LA, I don't know if the margins are the same or different from some of your bigger markets where it's pure leisure.

Yes, Bill, we're not going to comment on the margins on any one system that we operate today. Of the three theoretical possibilities, you just mentioned, I think we've expressed on many oceans the view that we think New York is a very interesting leisure destination. I think last year it was the single largest leisure destination in the United States as a matter of fact. The other thing that makes New York in particular interesting is the hotel market there is very, very attractive for a lot of different reasons. So at some point in time, that will become the next highest priority, but that isn't probably for quite some time.

We also have a lot of opportunities outside of the United States that we think are very attractive and, again, at some point in time that will be the next priority. Right now we're focused on just simply connecting the dots in our network and obviously Hawaii is the main strategic focus we have as far as new destination opportunities that we're pursuing.

Thanks for the time.

Our next question comes from Helane Becker of Dahlman Rose. Please go ahead.

Thanks very much, Operator. Hi, gentlemen. I think at some point in the last few months you moved some capacity from one airport in Orlando to another. Could you just talk about how that's working out and if you think you would move the rest of -- I think you were leaving some at Sanford, moving some to international. Could you just talk about the mix there and what your thinking is? Thank you.

Yes, hi, Helane. So that's exactly right. We moved certain of our routes into Orlando MCO, kept a significant amount in Orlando Sanford International Airport. At the moment, we're going to keep the split operation in place. We're trying to gather data on the revenue side of the equation to see if we can see any notable increase in revenue at the Orlando International, whether it be from being able to charge a higher fare because some customers may find it to be a more desirable airport to go to, particularly those going to Disney World or if we can see any kind of improvement in either hotel revenues or transportation revenues associated with those customers. And we are continuing to look at the data and at some point in time, we will either decide to move everything one direction or the other or we'll decide just to keep it the way it is. So I think right now status quo is likely to prevail for the balance of the year and we will keep watching the data and the trends and we'll go from there.

Okay. Can I just follow-up? I think at one point you had a press release talking about Disney and I know that you're not a quote unquote Disney provider of rooms, but can you just talk about how that's worked out for you in terms of being able to be near Disney, or in terms of the hotel room rates and so on in that market?

Yes, Helane you're right. We do not sell Disney's inventory. We are in a dialogue with Disney and we hope one day that we are able to structure a deal that makes sense for both us and Disney, which we think would be very attractive. So today we do not sell their inventory. As far as any improvements in hotel, I think that's kind of what I was trying to refer to in my answer to the earlier question which is that we're at the moment trying to determine if in fact we do see an improvement, or a decline for that matter in the hotel revenue associated with our customers flying into Orlando International, which is in fact closer to Disney world as opposed to our customers using the Sanford International Airport at the moment. It's a little too early for us I think to draw any conclusions. So we're just going to keep an eye on it and we will go from there.

Okay, thank you. I appreciate that color.

Thank you.

Our next question comes from Gary Chase of Barclays Capital. Please go ahead.

Good morning, everybody. Wanted to see if I could get a little bit more color on the cost outcome that you drove for the quarter, which near as I can tell was a good bit better than where you'd expect it to be at least in mid June, and in particular, just curious if there's anything that maybe benefited the quarter that we should be thinking won't be helpful to the same extent looking forward.

Gary, this is Andrew. I think that in general, we just did a better job of managing the costs across-the-board than we guided to, but I think there's also a little bit of timing involved in terms of certain expenses that may have shifted from the second into the third quarter. I think that you see what our guidance is for the third quarter and so we're giving you some color on that, but yes, there's not any one thing that we could point to in the quarter. Maintenance can at times shift from one to the other, particularly like engines and seat checks and things of that nature and I think we probably saw a little bit of that as well.

Was there anything notable in sales and marketing?

I think that the only thing notable is that we're trying to drive that cost down as you can tell. Sales and marketing consists of payment costs and then the kind of customer acquisition costs associated with advertising and things of that nature and we have a very conscience effort to drive down the costs associated with acquiring customers and I think you saw some of the results of that in the good year-over-year decline that we see in that expense category.

Gary, it's Maury. You might make a note, we switched our payment processors back on July 15 or thereabouts to Chase Payment Tech and we expect that to have some benefits over time in our cost of processing cards. So that's a good move for us.

Okay, and then I also was curious on the third party ancillary that you outlined. You had another quarter where that showed some real growth, except, if I'm not mistaking in the first quarter you saw the margin on that business take a hit and that was not the case this quarter, you seem to do quite a bit better there. So just curious if you could elaborate a bit on what's changing there for the better.

I think that we have continued to put a larger focus on this part of our business and whether it be insuring that we have the best prices that we can get from our hotel and car rental partners, to making sure that we are pricing it appropriately to our customers and revenue managing it appropriately, and I think really what you're seeing there is just simply better blocking and tackling. I can't point to anything other than that at this point, but that's why we believe that with the improved focus in the area and resources we're putting into it, particularly human resources, but also automation tools that we should be able to continue to hold these margins where they came in this quarter or in that neighborhood and we do expect this area to continue to be a growth area, albeit it's not monumental growth in terms of absolute dollars, but it's very meaningful particularly as we look at it which is really pretax income. And it's a pretty decent size of the income that we generate as a Company.

Makes a difference with the margin. Just one very quick last one. Of the talk about capacity, between you and Maury raised a number of different points. I'm trying to get my arms around whether we should be thinking that there's a lot of shift in the way you're running your network in terms of your same-store business as you refer to it, or whether you're really just talking about tweaks. In other words, the growth rate isn't that much changed, but you talked about the potential you'd be shifting some capacity within existing markets. Is there anything material we should be thinking about?

There's nothing material at this point. This is just the philosophy change rather than just pushing growth, the 20% number as we've always said will back up if we can't get the margins that we're looking for and it's not kind of pull 20% out of the system or anything like that. It's just don't grow as fast and make sure you're pushing your margins and ideally yields in some of your same-store cities, so that you can offset some of the fuel increases.

Gary, I think it's business as usual. It's a bottoms up approach market by market. We look at what the fuel curve is telling us and where we think revenue will be and that's what drives our capacity decisions in existing markets. And in the current environment right now, we see -- we take a pretty conservative view on revenue, don't expect to see any improvement, hope there will be some, but we don't expect it. And on the fuel side we just look at the curve and the outcome suggests that in a lot of our -- of the markets we served a year ago that we should have fewer seats than we did a year ago, and so nothing different there.

Our next question comes from Bob McAdoo of Avondale Partners.

Hi. We've obviously seen, year-over-year, a nice increase in the total average fare or total fare including ancillaries per passenger, given what you're talking about doing in terms of rearranging things slightly, which it sounds like you say just kind of a further of what you talked about over the years, should we, as we look over the next quarter or two, what should we think about in terms of the total fare or the selling fare per passenger for the next quarter or two? Do you think that's going to be kind of at the current level? Is it likely to slip some? Should we just look at normal seasonality there? What kind of things should we be thinking about?

Well I think as a general phrase as Andrew said, we're seeing kind of a stable environment and whether or not we'll see increasing percentages, not comfortable with that. Should we see reasonable increases comparatively year-over-year for a quarter or two, probably. I think we start losing that growth if things don't improve by the end of the year going into 2011, but conservatively, when we started seeing back half of Q2 start to not come in as strong and July is good, but it's not where the acceleration that we saw in the first three, four months had pointed to, that's why we're backing up and reassessing in this situation.

When you say you didn't see the acceleration going into May and June that you saw in March and April, does that reflect itself and we talk about like a $10.50 more or less up to $107 a passenger, does that reflect itself in something that's starting to slip back down? Is that how that shows up?

Well, no. I think that you just aren't seeing growth back to what we might have termed to be "normalized" back in 2007, or 2008 would be our first call, but as you've mentioned, the $10 growth is a nice growth. June had a strong number in the general sense because it was so weak last year, but it's just not moving at the pace we thought it might be if you were to extend the dots out plotting January through April.

There's no downward trend, Bob, to be clear. That's not it at all. I think what we're just simply saying is that once upon a time maybe 90 days ago we would have thought instead of $73 we would have been able to achieve a fare that was several dollars higher than that, but that doesn't mean that we are going backwards either. We see June as the kind of the new benchmark and June was a very good month for us and July will be an excellent month as well. We're just not seeing that average fare creep up as we saw it doing in the first few months of the year.

Not creep up as much.

Yes.

(Operator Instructions) Our next question comes from Glenn Engel of Merrill Lynch. Please go ahead.

Hi folks. A question on the change in the distribution system. One, can you just go through that again and two, I'm assuming part of that is just as you get larger you need to have technology systems that are more scalable and I'm wondering whether there are other parts of your operations that as you get larger you're going to need to become more scalable and change to invest in technology.

Glenn, we've been working with the same database, a free one out there, My Sequel for since the beginning of time, and to your point of scaling is spot on. We do move into the more enterprise based systems. So we've adopted IBM DB2 system and we're moving on to that database architecture here as we speak. Hopefully we'll have that done in the next 60 days or less, but once there, the ability to scale the system becomes -- we have ultimate upper end capabilities that shouldn't be any issues for the foreseeable future.

The other piece that you get with these newer generation environments you get advanced tools that allow us to make changes in architectural enhancements that are much more efficient, particularly when we go to change or upgrade a product, an approach or whatever. Today it's very labor intensive with a lot of programming changes required as we move to new tools we can do this more administratively per se.

The other key change is we're doing database architecture change to make it customer centric versus flight centric. All of your airline databases are built around flights and what that means is that every transaction has to have a flight in it and as we morph into third party products and the like, we want to be able to sell things to customers that don't have flights requirements, not to say we're going to sell flights, but we want everything to be standalone as a product and then you create the shopping cart for example that you see in places like Amazon and the like. So that's the upgrades and the enhancements.

Lastly, operationally our systems integrated and we have support for all of our flight ops maintenance, all of the other types of things integrated into our system and again it will run on this DB2 system. So the enhancements for, not only the revenue side are going to be felt on the operational side as well. So we're very excited and pleased about this and we need another six months to a year to get through a lot of the architectural changes, but we'll start making upgrades hopefully in the back half of the year if not certainly in the early 2011.

And does this have much pressure on cost in the near term and then save money in the long term, is that it?

We're going to spend more money on the system, no doubt about it, but we're spreading it across a much wider revenue base. I would suggest what we spend per revenue dollar on automation is substantially less than a lot of other places, yet we have and live on our automation with 90% of our sales coming through our front end just short of that, but we're going to spend more on automation certainly, but I don't expect it to go up as a percentage very much, if at all of total revenues.

Thank you very much.

Sure.

Our next question comes from Stephen O'Hara from Sidoti. Please go ahead.

Hi, good afternoon. I was wondering if you could maybe talk about growth going forward in terms of might it be better to focus on the destination growth as opposed to the small city growth given, let's say the same-store sales growth currently is not as maybe sharp as it had been in the past.

Stephen, this is Andrew. I think that's really kind of been the case and will continue to be the case. I think you've probably noted in the last several years we've especially this year we've really added very few small cities. We will be adding some in the back half of the year, but connecting the dots by either taking an existing small city into an existing destination is a very, very effective way for us to grow or adding new destinations. At the moment though, we believe we serve about 11 different destination markets and we have lots and lots of opportunities to connect the dots and just staying on network, and again we think that's a very, very effective way to grow very low risk and very profitable way to grow. So that has been our focus and will continue to be our focus.

Okay, and I guess second, have you seen any discernible change in let's say take rates in Vegas, let's say over the last two years? And have you gotten better at capturing the customer or worse, maybe in rental cars and hotels and how that might translate to Hawaii?

In Las Vegas our take rate is relatively constant and that's an area that we do expect to see some improvement in the back half of the year through some different approaches to pricing. So we'll see if that in fact occurs, but the take rate is strong and constant. I think what we've done better is do a better job in terms of yielding that customer base and so we'll see how that goes in the back half. In the other locations, we have improved take rates on a percentage basis at a very, very substantial clip, obviously it's off of a small base. So the percentage improvement is less relevant in the absolute, but we are showing a lot of momentum and progress in that area.

We expect the Hawaii hotel opportunity to be very, very substantial and that's what makes Hawaii interesting to us. Without that opportunity we probably wouldn't be interested the marketplace quite honestly and based on our knowledge of the market and discussions we're having with hotel partners, or potential hotel partners in the Hawaii market, we have high hopes and we think that it will be a lot like Las Vegas in terms of the hotel production and a lot like Florida in terms of the rental car production. We do a lot in rental cars in Florida, not as much in Las Vegas of course, but it's that third party merchant model business that we think is what makes Hawaii really interesting for us.

Okay, so kind of the best of both world's I guess?

(Inaudible)

And then the new database, I remember listening to you at a conference in the past and it seems you didn't have a good amount of clarity in terms of maybe what you would target to certain customers. Would this help you in that? Will this kind of let you pinpoint certain customers for certain promotions and so forth and maybe really utilize that customer list a little bit better?

Stephen, that's a good summary. We have not really lined our database historically of customers and their preferences and the like. The architectural change that I talked about where we turned it into a customer centric database will certainly enhance that ability. We are also going to go backwards and work on our data mining skills as we move forward in the rest of the back half of this year and into 2011. So we certainly want to have a much deeper and wider profile as specific customers, we can target them with special offers that are more to their liking rather than generalizations, which we do today sending all people all types of hotel rooms wherever, if it's an upper end person why send them to lower end hotel product offering. Those are the enhancements to come.

Our next question comes from Daniel McKenzie of Hudson Securities. Please go ahead.

Yes, hi, thanks. I appreciate all of the network commentary. I'd just like to peel back the onion a little bit more and in particular as I look at the second quarter margins, just going back historically, they've really been all over the board from 3.6% to 25.5%, to the current quarter 16.7% and obviously get that a lot of that is driven by fuel price volatility, but one of the secret ingredients here in the recipe has been Allegiant's ability to manage its network and to fly to those end markets where the competitors don't. So just looking ahead philosophically, I'm wondering if you can provide a little bit more perspective on just that. As we think about connecting the dots, a lot of these dots are competitive markets, but would these be connecting markets where there is no direct or indirect non-stop competition today or how do we think about that competitive mix as we look to expand the network looking ahead?

Dan, yes, I guess I would disagree that a lot of our cities that we have competition. So I guess maybe that's the first thing I would say is I just don't agree with that characterization. I think we have non-stop direct head-to-head competition on I think about 10 routes. Some of it is with RJs, which we really just look at in a completely different way. So I'd start with that comment.

I think as far as strategically, there's no change to our business approach. We are trying to provide a product that doesn't exist in the marketplace. That's what makes it interesting for us to go try to do something that somebody else already does is not a recipe for high returns in the airline industry and our whole business has been built about, again going into markets and providing a product that's different and therefore, highly valuable to our customer out there and so we expect to do more of the same. Obviously, as you know, we do have a little more competition now than we did a year or two ago and a lot of that competition has come to us as opposed to us going to it. Our philosophy remains unchanged there. We think there's just an enormous amount of opportunities to grow our model with the exact same strategy that has been very successful to date.

Okay, very good. Thanks, appreciate that.

Thanks.

Thank you. This concludes the Q&A session. I would now like to turn the call back over to Maury Gallagher for final comments.

Thank you all very much. Appreciate your interest and your comments. If you have any follow on questions please give us a ring. Thank you again and we'll talk to you in 90 days.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.