阿拉斯加航空 (ALK) 2003 Q2 法說會逐字稿

Good morning.

My name is Jodie, and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Alaska Air Group's Second Quarter Earnings Release Conference Call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question and answer period.

If you would like to ask a question during that time, simply press star, then the number 1 on your telephone keypad.

If you would like to withdraw your question, press the pound key.

Thank you.

Mr. Tilden, you may begin your conference.

Thanks very much, Jodie.

Hello everybody and thank you for joining us for our second quarter conference call.

Before we get started, I'd like to mention that we have a number of folks with us here today, including Bill Ayer, our Chairman and CEO, and Jeff Pinneo, Horizon Air's CEO.

We also have Glenn Johnson, who you might have seen.

We announced as Alaska's new VP-Finance last Wednesday: George our EVP of Operations and Gregg Saretsky our EVP of Marketing and Planning.

In addition, Amber Post our Treasurer;

Terry Moppin (ph), Controller; and Rudy Schmidt, Horizon's VP-Finance are also here.

So we should be in good position to answer your questions.

As you've seen by now -- also before we start, we'd like to give you our normal reminder that this call may include forward-looking statements and our actual results may differ materially from those statements.

You can refer to our SEC filing for additional information on risk factors affecting our business.

As you have seen by now, thanks to $71.4 million of government assistance, we reported net income of $45.2 million or $1.70 per share for the second quarter, and that compares to a loss last year of $2.9 million or 11 cents per share.

The 71.4 million of government assistance was the reimbursement of security fees remitted and carrier fees paid to the TSA under the Emergency Wartime Supplemental Appropriations Act.

It would exclude the government compensation which was $44.3 million on an after-tax basis.

We essentially broke even this quarter with net income of $900,000 or 3 cents per share.

And this again compares to the loss last year of $2.9 million.

On a year-to-date basis, our comparisons are affected both by the government compensation we received this year and by a goodwill charge that we took in the first quarter of last year.

If we exclude both of these, our net loss was $55.4 million or $2.08 per share for the first half of this year versus a loss of $36.6 million or $1.38 per share last year.

We have a table in our press release which will help you compare these figures to our GAAP figures.

At this point, I'd like to turn the call over to Bill.

Thanks, Brad, and good morning everyone.

Well, as Brad said, excluding the government compensation we essentially had a break-even quarter at the Air Group level with a net profit of roughly $900,000.

But all things considered, we were pleased to report a small profit; but as you know, we have a seasonal business, and we're obviously not at a point where we're producing a profit on a full-year basis.

Excluding government compensation, Alaska Airlines reported a pretax profit of $6.8 million, which represents a 1.3% margin versus a loss of $100,000 last year.

And Horizon Air reported a loss of $3 million, which represents a negative 2.6% margin, which was essentially the same as their pretax loss last year.

There are three general themes I'd like to talk about before we get into a specific review of this quarter's results.

First, I'd like to review the seasonality of Alaska's business, which we believe is more pronounced than the other major airlines, so it is important in analyzing our results.

We experience seasonal trends on both the revenue and cost sides of our business.

Our revenues and profits historically peak in the summer months for several reasons: One, the underlying demand on our route system driven by the State of Alaska and West Coast vacation travel is very much skewed to the summer months.

Secondly, we produce more ASMs in the summer months.

And we do this by timing our heavy maintenance so that a higher percentage of maintenance is completed during the fall and winter, which means more aircraft can be scheduled during the summer.

And also, the higher summer demand enables us to schedule flights earlier in the day and later in the day, including seasonal red-eye flights which increase aircraft utilization.

And on the cost side, we have a lower CASM in the summer, as we have more ASMs to spread our expenses over and because of the lower level of maintenance activity.

So we're glad to go moving into the summer months where we do expect to make some money; but as you'll recall, we dug a pretty big hole in the first quarter and we expect to lose money in the fourth quarter.

So it's unlikely that the third quarter results will be enough to offset these losses, particularly if exclude government compensation.

The second general theme is the importance of our product differentiation and how it helps our revenues.

Looking at second quarter data for Alaska, you can see that our yields were under continued pressure, they were down 2.6%.

But we were encouraged to see that our load factor was up by 2.2 points; and, as a result, we were able to show a small improvement in RASM for the second quarter.

And our continuing trend of traffic and load factor gains gives us confidence that our customers value the product we offer and that the right position for Alaska in the marketplace is a notch above the low-cost carriers.

Our strongest load factor markets this quarter were the transcon routes which include an average load factor that was 7 1/2 points above our system average.

And we believe that these markets with stage length of about five hours are markets where our product resonates very well with our customers.

And the third topic I wanted to cover is what we're calling Alaska 2010, which is a reference to the year 2010.

It's an initiative to secure our future and to position Alaska to emerge as a winner from the turmoil that is currently underway in our industry.

And this vision builds on our existing strengths and addresses each of our key constituencies.

From an employee standpoint, we intend for Alaska to be one of the best places to work in America with excellent job and retirement security and common benefits and incentive compensation for all employees.

For customers, Alaska will be widely known as providing outstanding value.

And that's the best combination of price and product, and to be one of the most respected brands in the country.

And from an investor standpoint, we're targeting growth in the 8 to 10% range and pretax profit margins of 10%, which will help insulate us against economic downturns.

One important aspects of this vision is reducing our CASM X fuel to 7.25 cents by the beginning of 2005.

As we said in our 8K, this is an important goal for us; but there's a lot of ground to cover between where we are today with our CASM and this target.

So we wanted to caution you again to not interpret this target as guidance for the near term at this point.

We're committed to a collaborative approach in achieving this vision.

We spent the last couple of months discussing this plan with our union leaders and employees.

We believe it's in everyone's best interest to push Alaska toward this vision, but very important that we maintain our unique culture and customer loyalty along the way.

The final point I would like to make is to acknowledge the efforts of our people in helping us manage to our plan again this quarter.

Almost all of our divisions came in under plan for the quarter, and we were able to achieve this quarter's 5 to 6% growth in both capacity and passengers with an employee base that was almost 1% blow last year and 2.5% below plan.

So a big thanks to all of our folks who made this happen.

Now, before I turn the call over to Brad, I'd like to quickly take you through a couple of other areas.

Operationally, we continue to run well throughout the quarter, which is another tribute to our employees who are staying focused on providing excellent customer service.

On- time performance for the first five months of the year was ahead of last year, and that's a continuing trend.

And we continue to have the lowest rate of mishandled bags in the industry.

Our customer satisfaction remains high, so overall we believe that we're meeting or exceeding our passengers' expectations for operational performance.

Looking ahead, we're projecting that our ASMs will grow this year by 7%, and the breakdown by quarter as is follows: 9% for the third quarter, and the last guidance we gave you was 8.5% for the third quarter; 7.5% for Q4, and I think last time we talked we said 8%.

So 7.5% for Q4, which puts the full year at 7%, and the last time we talked about 6.5%.

And the growth is coming from the carryover of additional service that we started in 2002.

It's coming from added frequency, both in some of our newer markets as well as some modest frequency add-backs in our West Coast markets and, of course, additional destinations, including Orlando and Guadalajara.

As of now we're planning up to 5% growth for 2004, which will be largely the result of a modest increase in planned utilization and the annualized effect of this year's fleet additions.

Finally, I'm pleased to say that we continue to maintain a relatively strong cash position.

We ended the quarter with $722 million in cash and short-term investments, which is up $86 million from the beginning of the year.

Our cash position has been helped by the convertible bond offering that we completed last March and the government assistance.

At this point I'd like to ask Brad to take you through Alaska's results.

Brad?

Thanks very much, Bill.

As Bill said, if we exclude the government compensation, Alaska produced a pretax profit of $6.8 million this quarter versus a loss of $100,000 last year.

We had 5.7% ASM growth, and on that our revenues increased by 6.7% and our costs increased by 4.9%.

So both revenues and costs are beginning to move in the right direction.

Although as Bill says, we've got a lot of ground to cover before we get to where we want to go.

Substantially all of our ASM growth was represented by growth in the transcon and Denver markets.

This flying represented a little over 10% of our capacity this quarter versus 4.5% last year.

Just to recap some of that service: Newark, we started that last October, we added the second flight on June 8th.

Boston, we started last year.

We added a second flight on April of this year.

Dulles, we added a second flight in June of last year, which was growth for this year.

Denver-Seattle, we added a fourth flight on June 8th of this year and Denver-Portland, we assumed two flights from Horizon in June of this year.

And then we started service to Miami last November and Orlando this May.

So lots of growth there; and it has, as we say, become 10% of our business.

Overall our passenger revenues increased by 6.2% over last year versus a 7.4% decline for the industry.

If we compare it to 2001 to take out the effect of 9/11, our revenues were up by 6.1% while the industry's revenues declined by almost 26%.

This is clearly a function of capacity reductions by our competitors, but we believe this also reflects better traffic and yield performance by Alaska than our competitors.

Our yields for the quarter were down 2.6% versus a 3.6% decline for the industry.

And we might note that our declines were a 9.1% traffic growth and a 4% increase in average stage length.

Comparing it to 2001, our yields are down 5.1% versus a 13.6% decline for the industry.

We know you might be interested in how revenues develop throughout the quarter.

If you look at a high level of RASM, our RASM was up 2.1% in April, it was down a tenth of a percent in May, and RASM was up 6/10ths of a percent in June.

So that led to the RASM increase of .9% for the quarter.

So I think we can say that we don't see a big RASM increase year-over-year in June that wasn't there in April and May.

But that does mask (ph) some of the capacity growth.

We grew the airline 9.1% in June versus 3.2% in April and 4.6% in May.

So I think our view is that we're beginning to get into a period here where we're having a lot higher capacity growth, and we're doing an okay job of holding the line with RASM on this growth.

Looking at revenues by region, we saw slight decreases in load factors in our Alaska and Canadian markets, slight increases in California, and more significant increases in our transcon routes in Arizona and the Pacific Northwest.

In terms yields per RPM, we saw some strength in Alaska with increases in the low single digits offset by decreases in Arizona and Canada.

Additionally, the growth in our transcon routes, which obviously have much higher stage lengths and a result lower yields for RPM, has had a downward effect on our system wide yield for RPM.

Looking forward, we generally see year-over-year increases in our advanced book load factor even given the 9% increase in flying that Bill mentioned.

Our thoughts are that these increases will continue to come to some extent at the expense of yield.

We do see particular strength in advanced bookings for our transcon markets, which are showing the highest future load factor of any of our markets.

One of the surprising things about the transcons is how seasonal they've been.

They were strong last summer and they appear to be strong this summer, but they were less so during the fall and winter months.

Looking at other revenue line items: Freight and mail revenues were ahead of last year by $1 million or 5%.

We're seeing improvements in mail and freight volumes compared to last year, which were up 6% and 13%, respectively, but some of this volume growth is coming with lower yields.

Cargo revenues do continue to expand as we add new markets and as known shippers are added to our database.

Other revenues grew nicely, up 15.5%, and that's largely mileage plan related.

We had increased proceeds from our mileage plan partners and increased mileage plan redemptions which have driven more recognition of deferred mileage plan revenue.

Turning to expenses, as Bill mentioned strong cost management all around the company has helped us with our unit costs.

Our total operating cost [INAUDIBLE] for the second quarter fell 8/10ths of a percent to 9.64 cents.

And if we exclude fuel, unit costs for the quarter fell 1.2% from 8.41 cents last year to 8.32 cents this year.

The number is a bit lower than both our operating plan and the 8.4 cent guidance that we provided in our 8-Ks.

I'd like to provide a bit of detail on a few of our expense line items that either had significant or unusual variances from last year.

Starting with wages and benefits, we experienced an increase of $17.5 million or 10% for the quarter.

Of this increase, as we saw last quarter, 12.9 million is due to an increase in benefits and the remaining 4.6 million is due to wages.

Pension costs related to our defined benefits plans have increased on an annual basis from $40 million last year to $71 million this year, so they're responsible for $9.7 million of this quarter's increase.

Health insurance increased by 2.6 million and workers' comp increased by 1.6 million this quarter, accounting for the remaining benefits increase.

Wages themselves were up by 4.6 million, which is about 3.5%.

Our FTEs were actually down by about 1%, and that means our average wage rate increase which, of course, factors in both scale and step increases, was about 4.5%.

Our fuel costs increased by 4.9 million or 7.6% on ASM growth of 5.7%.

We were helped significantly by our fuel hedge contracts which contributed about 16 cents per gallon on the fuel hedged or about 5.8 cents per gallon on an overall basis.

I think we consumed just under 100 million gallons of fuel this quarter, so it was 5.7 or $5.8 million of benefit from the fuel hedge agreements for the quarter.

Our average price factoring in hedges was 82 cents this quarter versus 78 cents last year.

Looking forward, 35% of our consumption is hedge for the rest of this year with crude oil swaps at prices below $22 a barrel.

For 2004 we've got approximately 12% of our fuel hedged with a combination of crude oil swaps and caps at prices around $26 a barrel, and we have 5% of our '05 fuel hedged at prices around $24 a barrel.

Aircraft maintenance costs increased by $8.5 million or 23% due to more engine repairs and seat checks this year versus last.

We had 22 engine removals this year versus 17 last year and 14 outside seat checks versus 10 last year.

We also had higher wheel and brake costs this year due to some credits we received in the second quarter of '02 that did not recur this year.

Looking forward, we're expecting maintenance costs to be closer to the $36 million we saw.

For the third and fourth quarter of this year we're expecting maintenance costs to be closer to the $36 million figure we saw last year than this year's maintenance costs, so we are expecting them to go down in future quarters.

Aircraft rent was down $600,000 or 1.9% because of lower lease rates on five 737-400s, one MD-80, and a 737-200 that we extended during 2002.

The year reductions are all offset by three new 737-700s that we took delivery of earlier this year.

Other selling expense decreased by $4.5 million or 16.2% compared to last year.

The decrease was due to a couple of items.

We've deferred some of our advertising spending until the fall when we'll be doing some TV advertising.

Also, again mileage plan redemptions are higher this year which offsets this line item.

The increase in redemptions is due primarily to our efforts to make more seats available for mileage plan redemptions than we made in the past.

Other operating costs decreased by $3.2 million or 8.5% compared to last year.

This line item includes insurance, which is down 1.7 million and property taxes, which are also down 1.7 million.

We continue to see improvement in customers using our electronic ticket and check-in options.

We had very strong sales on alaskaair.com this quarter, nearly 27% of our tickets were sold over the Internet.

Again, we're targeting 50% of sales over our own web site by 2005.

And we had 89 percent of our tickets sold for the quarter with electronic tickets, and actually 90% for the month of June and this is versus 73% last year.

And finally, 42% of our customers checked in either via the web or via a kiosk.

Looking below the line at nonoperating items, I think most of these amounts will be close to what you'd expect with the exception of the other net line item which had a credit balance of $5 million this year.

And this line item had a balance of $5.1 million last year, but it's typically close to zero, close to nothing in that account.

This year we had a $3.1 million recovery of legal fees associated with Flight 261 and a $465,000 recovery associated with the earthquake Seattle experienced in February of 2001.

The balance of this account in 2002 is largely represented by gains from the ineffective portion of our fuel hedges.

Our current projections for unit costs X fuel for the remainder of the year are essentially in line with our previous guidance.

And that is for the third quarter we're projecting 7.9 cents, which is down about 4%; and for the fourth quarter we're projecting 8.4 cents, which is down about 5%.

For the full year we continue to project CASM X fuel of 8.35 cents, which is down about 2% from 2002.

As we've done in the past, we'll continue to update you with any changes in these projections through the 8-Ks that we file each month.

At this point, I'd like to turn the call over to Jeff, who is going to take you there Horizon's results.

Great.

Thank you, Brad.

And good day everyone.

As reported, Horizon had pretax earnings of $15.7 million for the second quarter as compared to $2.8 million loss for the same period last year.

Excluding the $18.6 million we received through the Emergency Wartime Supplemental Appropriations Act, we lost $2.9 million on a pretax basis compared to a $2.8 million pretax loss last year.

Revenues for the quarter were up 7.4% or $7.6 million, and our operating expenses were higher by 6.1% or $6.5 million.

All of this was on a 4.3% increase in capacity.

Our unit revenues were higher by 2.9% in conjunction with a noticeable recovery in traffic levels and yields stemming from the end of war in Iraq and the beginning of the busy summer travel season.

Our load factor for the quarter was up 1.6 points.

And on the expense front, after adjusting for change in where intercompany charges are booked, our CASM excluding fuel was actually flat the last year.

We're encouraged by these results as we head into what has traditionally been our best quarter, a period in which we expect our load factors, schedule reliability, on-time, and baggage handling performance to all exceed last year's positive numbers.

As I've mentioned before, while we've yet to turn an operating profit following 9/11, our people are doing a fabulous job of keeping us in the game.

Their work in retooling key processes, driving down unit costs, and most importantly in delighting customers is really paying off.

This past quarter they worked together to raise our scheduled reliability to 98.9 percent, a full 2.3 points higher than last year.

Our on-time performance, measured as arrivals within 15 minutes, was also significantly higher than last year at 91.1%.

And our employee productivity on an ASM basis improved by 6.6%.

My hat is off to them all.

For the quarter, our passenger revenue grew by 9.4% on a 6.9% increase in traffic and a 2.4% increase in yield.

Much of the traffic increase is attributable to a higher percentage of longer trips.

Our average stage length grew by 5.7% as more 70-seat jets and turbo props came online.

In addition to replacing flying we used to do with the F-28, we've used our new equipment to both start new service as well as to compliment Alaska Airlines in markets where a mix of aircraft sizes is desirable.

In that regard, we introduced additional CRJ-700 service in the Portland-San Francisco market and new service complimenting Alaska's between Portland and San Jose.

We also replaced our own nonstop service from Portland to Tucson with one-stop service through San Francisco to Tucson, and we subbed for Alaska and Seattle-Palm Springs market with a daily nonstop flight, a move that has allowed Air Group to keep a year-round, nonstop service pattern in the market.

The Alaska aircraft time freed by these moves has been quite productive in replacing us in the Portland-Denver market, as well as in filling in a peak time slot in Seattle-Boise.

On July 1st we began our new service from Seattle and Portland to Santa Barbara, California, with three daily CRJ trips; and we're quite encouraged by the early returns.

Our load factor four the quarter was 1.6 better than last year and 1 point higher than what we had planned in late December.

While our yield was 2.4 percent higher than last year our raw passenger yield, net of incentives and adjusted for stage length, was about flat with last year in spite of a fare sale we initiated in early April that was aimed at and successful in stimulating weak demands in the quarter due to the Iraq war.

While still a small piece of our revenue pie, freight and mail was 7.7% ahead of last year due to the increased handling of Alaska freight by Horizon stations.

Small package delivery, our highest yielding cargo business, is down nearly 30% due to security restrictions that have really impacted our ability to add new business.

Other revenues are lower by $1.6 million because we are no longer receiving any manufacturer credit.

Looking ahead we're projecting to grow by 7.7% for the full year, which is slightly higher than our last projection.

The breakdown for the next two quarters is: 7.5% for the third quarter and 4.5% for the fourth quarter.

This growth is due to the full year effect of capacity we added in 2002, higher fleet utilization, which for the second quarter was up 4% over last year, and the delivery of two new CRJ-700s late in the fourth quarter, one of which is expected to be in service before the end of the year.

As I noted earlier, total operating expenses were $6.5 million higher than last year.

Of this increase, $4.4 million is due to increases in maintenance and aircraft rent.

Our maintenance expense was up only $1.1 million over last year despite a significant increase in the number of Q400 and CRJ heavy jets, which had been anticipated.

The quarterly increase in aircraft rent expense is due to fleet mix and charges associated with using spare engines from General Electric and renting spare aircraft from Bombardier.

Last year we were flying six owned F-28s and two fewer leased CRJ-70s.

We retired the F-28 4000 fleet earlier this year.

Beginning in June, we rented two additional Q400s to support schedule reliability in response to parts availability problems.

Looking at some of the other significant expense categories, our total wages and benefits were up by $3.3 million or 8.9%.

Much of this was due to increases in health care and other benefit costs.

In addition, we booked $1.1 million in retroactive profit sharing associated with last year's restatement of earnings.

For the period, our total employee complement was down 2.2% to 3,342.

Our fuel expense was flat with last year on a 3.4% increase in price per gallon, net of fuel hedge, and a 4.1% decline in the amount of gallons consumed.

On an ASM basis our fleet operating efficiency continues to improve with an 8.5% increase for the period.

Depreciation and amortization was lower by $1.9 million due most exclusively to the February retirement of the F-28 4000 fleet.

At that time, we stopped charging for expendable parts obsolescence, capital parts, and F-28 4000 airframe depreciation.

Our landing fees were up 16% for the periods on a 2% decrease in departures.

The effective 18% increase in rates results from a combination of prior year airport adjustments billed to us in the second quarter, current year rate increases, and a large percentage of this year's departures at larger, higher-priced airports.

The prior year adjustments are mostly due to other airlines reducing their schedules, which has forced many airports to increase their landing fees and rental rates to remaining carriers to compensate.

The latter are up 21% in our system this year.

Looking ahead, we are now forecasting a 15.8% unit cost X fuel for the full year, which is slightly better than our last projection and equal to our 2002 rate.

For the next two quarters our CASM X fuel forecasts are: 14.7 cents for the third quarter and 15.9 cents for the fourth quarter.

As we've done in the past, we'll continue to update you with any changes in these projections as part of the Alaska Air Group AK.

Now, let me turn it back over to Brad who will review the Alaska Air Group balance sheet.

Brad?

Just a couple of quick remarks here.

As Bill said, we ended the quarter with a strong cash position, $722 million compared to 636 million at the end of 2002.

For 2003 we're projecting capex of approximately $400 million, and this number excludes five aircraft that we'll be taking on operating lease arrangements.

As you know, 2003 is a year of significant fleet activity for Alaska as we're adding 11 new aircraft and retiring four MD-80s for a net increase of 7 units to 109 at the end of the year.

As of now, we have three 737s left to delivery and four MD-80s to return, and most of this activity will occur during September and October.

We planned a much lower level of activity with our fleet in 2004 and 2005.

After the recently announced deferral, our plan is to take delivery of one 737-900 in '04 and two in 2005, and that is the full extent of our commitment with Boeing.

We'll return one MD-80 in 2004 and depending on the outcome of lease negotiations, we could end up returning some additional 737-400s.

Horizon is currently committed to take delivery of two CRJs later this year, six in 2004, and six in 2005.

Our adjusted debt-to-cap ratio adjusted for operating leases is 79% as of the end of the quarter.

While this has grown in the last couple of years and while we're really focused on returning the company to a normal level of profitability so we can drive the number back down, we believe the number still compares somewhat favorably with the rest of the industry.

At this point, I'd like to turn the call back to Bill so we can address your questions.

Okay, Brad.

And I'll turn it back to Jodie, who will solicit the questions.

At this time I two like to remind everyone in order to ask a question, please press star then the number 1 on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Ray Neidl from Blaylock.

Was that the champagne I just heard pouring?

Just water, Ray.

Oh, okay.

Not yet ready for the champagne, right?

No.

Just in very much in general terms, you're making progress as a lower cost carrier this quarter, you'll probably make money in the third quarter, then you warned about the slow winter quarters.

What is the company doing besides waiting for an economic recovery?

What's the company doing, say, over the next 12 months to, on one side reduce your costs as other carriers reduce their costs, and on the other side trying to enhance your RASM?

Ray, this is Brad.

Maybe I'll address the cost side first.

This 7.25-cent number that Bill referenced represents a cost reduction of a little over $300 million, if you compare it to when our costs peaked in 2001.

A big piece of that is stuff that's underway and that we're getting quite a bit of confidence with.

We think that we'll see $80 million of savings in the books in 2003 as we close the books.

And this is things like getting the utilization of our aircraft up, better balancing the flying between Alaska and Horizon, simplifying our fares and mileage plan program provisions.

We've got some initiatives to get our insurance costs down that are having some effect.

Better the scheduling of our customer service agents and ramp service agents and line maintenance mechanics at the airport, a little bit better procedure to process passengers through the gate.

So it's many, many initiatives; and we're beginning to see some good movement on them, and basically getting some confidence in that piece of it.

Bill mentioned we are talking to our labor unions, as well, about an employee contribution to this program, and we're in the midst of that and there's not really a lot that we can say about it at this point.

And then there's another -- even to get to the 7.25, beyond those two, there's another piece that we just need to continue to look at and see if there aren't changes that we can make in our processes or procedures or efficiency or in our product to squeeze out a little bit more of our cost to get down to this 7.25-cent number.

It's going to be hard for us to get there, but we just think looking at the industry and all the competitive forces on our revenues that it's going to be important for us to get to that number to have the kind of profitability the company should have.

And Ray, we're certainly not giving up on the revenue side of the equation.

It's just that given, you know, the opportunities out there, there's more opportunity with costs, it appears.

But we are working very hard, making sure we have the right product, we've got the right airplane in the right market at the right time, we've got the fares that are selling.

It continues to be a very difficult revenue environment.

And we continue to try to sell up where we have high load factors; and we're having some success with that, I think, in the summer, but there's nothing very material to talk about there.

It's still very much a depressed revenue environment; and customers will travel at a certain price, and if you go beyond that, it's like turning the tap off.

We keep trying.

We've got good tools, we've got a good revenue management team that's looking at all the numbers and continuing to work it.

But we'll work hard on that, but I think that the cost is where the big opportunity is for the near term.

Yeah, Brad, you know, following that up, can the company help reduce their costs by looking at the seasonality of the system?

Are there going to continue to be major adjustments in that area?

And I guess the second thing is, Horizon seems to be kind of a drag on the overall company earnings.

What can you do there to return that, you know, a more profitable enterprise?

The seasonality question is a good one, and it is one that we do look at.

We've looked at it recently, and I think we have come away from that recent review feeling like our current schedule is appropriate.

The reality is that the demand, particularly in the State of Alaska, essentially explodes during the summer.

Some of those markets are twice as big in the summer months as they are in the winter months.

And so it's hard -- I mean, there certainly would be cost benefits if we were able to depeak our seasonality; but to date we haven't seen big benefits in doing that.

On the Horizon, we might ask Jeff to talk about that a little bit.

They've got aggressive plans to work on their company's profitability just as Alaska does.

But maybe we'll ask Jeff to elaborate on that.

Yeah, thanks Brad.

Hello, Ray.

Hi.

Our game is the same as on the Alaska side in aggressively pursuing strategies that are appropriate to our circumstances, and if you look at what's the same, we clearly have to balance out, you know, revenue and cost equations in the same fashion.

Our problem is characteristically different in that it's more revenue-impact following 9/11 and our susceptibility to, as a short-haul carrier in particular, to other alternatives.

So while we've got great work going on in the cost front, our own initiatives through traditional budgeting exercise and then beyond that even in a more extreme version that's resulted in another million and a half or $2 million of savings in this year alone, really what we're trying to do is align our fleet and deployment of it against, you know, the right kinds of opportunities going forward.

So you're seeing us doing -- we're placing a lot of emphasis on restoring the economic health of the shuttle products, which we're very encouraged to see the payoff there.

We're making it a very predictable experience.

That's always been an engine for us.

And then beyond that, doing more work through harmonized schedule planning with Alaska and, you know, taking these relatively expensive new assets on the point-to-point front and eminating from Seattle and Portland, finding niches that work well with the equipment type itself.

So that's our challenge going forward.

We're learning a lot.

I think we're at the point where we're applying a lot of what we have learned recently and seeing some good results going forward.

Jeff, it sounds like you're planning on coordinating your operations a little bit more with Alaska Airlines as they build the Seattle hub; but have you given any thought to maybe trying to get some contracts with other carriers on a cost plus basis, or are you allowed to do that?

Well, we've absolutely given thought to any revenue stream that would be contributive to Alaska Air Group's welfare; and that's certainly one model out there that we've taken a hard look at.

And as a regional carrier, we've had discussions with other carriers about what we might be in a position to do.

It's not a model that we have a lot of experience in, so right now I'd say we're evaluating it strongly to see if it adds something to the picture.

Certainly on the surface it appears to add an element of stability as a component of our revenue going forward in terms of the fixed fee part of it.

At the same time, there's a lot of investor capital tied up in this program and we want to make sure it generates a reasonable return.

Okay.

Are you moving a little bit away from point-to-point and more feed for Alaska and Seattle?

We're doing both, Ray.

The Santa Barbara introduction has elements of both.

It emanates from Seattle, develops the network.

At the same time, it is a great TRJ proof of concept in that it provides nonstop service where none exists into a great catchment area.

But I think our best work going forward will have elements in both.

We need to play to our strengths as Alaska Air Group, at the same time use the legs and unique capability of the equipment to everyone's benefit.

Okay, good.

Thank you very much.

Your next question comes from Gary Chase from Lehman Brothers.

Good morning, guys.

Congratulations on squeaking out a profit.

I just was curious if you had any feedback on some of the things you're doing with your fares?

I wonder if you -- I missed the beginning of the call.

I don't remember if Don Garvet's (ph) on.

I just wondered if there was any feedback there on how that stuff is going and what the implications are going forward?

Gregg Saretsky, our EVP of Marketing and Planning will answer that.

Greg?

Yeah.

I think last time on the call we said that the fare experience was very much that.

It was still in the experimental stages.

We've expanded the experiment from -- I think at the time it was 18 markets to something today which is over 200-plus markets.

You know, I guess the results are still somewhat inconclusive.

We had traffic difficulty across the industry associated with SARS and the Iraqi war in the second quarter, and there was lots of fare activity for a variety of reasons.

Sale fares really were available in almost all markets.

So we're going to continue to pursue the opportunity to simplify our fare structure.

But clearly the risk here is in deluding the higher bucket fares and not getting enough selloff into the fare structure.

The last thing we want for this thing to be is simple, but revenue negative.

So we're still searching for that elusive revenue neutral position that gives us the benefit of simplified fares and really drives the greater consumer presence.

Okay.

Should we take it, then, that it hasn't been or you just don't know revenue neutral?

I think we just don't know.

There are so many moving parts here in the second quarter with respect to what's happening with demand and the fare sale activity.

We haven't lost hope, though, in the fact that we can get to a place where it will be revenue neutral; and that's why our fare experimentation continues and that's why we've expanded it to a greater number of markets.

Okay, thanks.

Brad, just a quick clarification point.

You said maintenance in the third and fourth quarter would be 36 million.

Maybe I misheard that.

Did you mean it would look more like it did last year, which in the third quarter was 36?

But wouldn't we expect higher in the fourth?

No.

It's a very good question.

We are projecting maintenance costs of roughly $36 million in both the third and fourth quarters.

Your question is a good one.

We do have much more maintenance activity in the fourth than the third, but a lot of that -- we capitalized D checks, not C checks.

But we do capitalize Bs and 15- and 30-Ks, so a lot of that activity is capitalizeable.

That's why it doesn't hit the expense line for the fourth quarter.

And just one last one for Bill.

You know, you mentioned the fleet plan today.

You also in your prepared remarks mentioned, I think, that you wanted to have an 8% growth rate going forward.

You know, obviously, you would need to augment that.

Just wondering if you have any thoughts on sort of timing of an order and any color you can provide there would be helpful.

Yeah, Gary, it's really contingent on the progress we make on the cost front.

At 7.25, there's a lot we can be doing.

And at the current CASM, there's a lot less we can be doing.

So, you know, future growth is going to be contingent on how quickly we can get our costs down and then provide some lead time.

Obviously, you know, you can't turn on a dime here; so operationally we have to have some visibility to -- how the costs are coming down and when we're going to feel comfortable being a little more aggressive on the growth front.

And we should emphasize again this 7.25 we feel is an important target for the company, but our prediction this year is 8.35.

So there's a huge amount of ground Alaska has to cover to get down to 7.25.

As Bill said and as we've said in the 8-Ks, we would not interpret that as guidance at this points.

This is a target for the company but definitely not earnings guidance.

And so where we are, you know, as we see the costs today, is this 5% probably at best for '04.

And we think that's appropriate given everything.

So at current cost not much growth if you hit 7.25.

You'd be interested in hitting the 8% target you referenced earlier?

That's right.

Thanks, guys.

Your next question comes from Michael Leninberg from Merrill Lynch.

Good morning, guys, and a nice quarter.

I guess two questions here.

First, Bill, when you look at your utilization, and maybe you did comment on this, your utilization was down for the quarter on a year-over-year basis.

And I believe you're running a few more red eyes this year than a year ago.

What drove that?

If you could just elaborate.

George?

What drove the utilization?

Right.

We were 10-five versus 10-eight last year.

I think we had, like Brad mentioned earlier, we had a heavier check schedule and engine removal rate this year that we set aside a little more maintenance aircraft time.

Also, you know, the marketplace schedule that we put in place, we didn't use the airplanes quite as much as we thought.

There was a couple of opportunities that originally we were going to do and didn't.

And I think looking forward, we have it targeted about 11 or so, 11-one for '04 and that requires probably some reduction in turn time to achieve that.

So we're currently looking at how do we achieve that?

But increasing utilization is an important part of CASM reduction, and so we're going to be continuing efforts to achieve higher numbers going forward.

When we look into the third quarter, should we see the utilization similar to what we saw in June or on an absolute basis should it be higher?

No, it will definitely go up with third quarter -- we're forecasting right now, Mike, 11.3 hours a day versus 11.2 last year.

And then just my second question, you know, I realize, you know, you have a small international presence, so SARS is obviously less of an impact.

But then again, in the summertime you do carry a decent amount of Asian traffic, particularly the Japanese.

And I know that Japanese outbound travel, they're throwing out numbers that it's off anywhere off 40 to 50%.

And I'm wondering if you saw a little bit of that in the June quarter and if we should expect that in your seasonally strongest third quarter, especially up to the state of Alaska?

Greg?

Certainly you're correct.

We were much less impacted by SARS; but nevertheless, we are an alliance partner with Northwest Airlines, who is a big transpacific carrier, and their feed to us was down dramatically.

We see that mostly in Horizon numbers because as a percentage of their total traffic, the Northwest feed from Asia is larger than it is for Alaska Airlines.

But we also see it in our own results, principally to and from Vancouver, which was a reported by WHL as being a spot that was rather hot for SARS.

And so there were a loft U.S. tourists who decided to steer away from the pleasure of a vacation, during the second quarter, in Vancouver and we noted that in our traffic results.

Okay.

Thank you very much.

Thanks, Mike.

Your next question comes from Jamelah Leddy from McAdams Wright Ragen.

Hi.

I just wanted to quickly get back to your CASM goals.

And I understand, Brad, that you're saying it's a goal not necessarily guidance.

But if you were to get down to that 7.25 cents in '05, but keeping your previous guidance at 8.1 cents, that's such a huge decline, and I just don't see necessarily how it will just drop off all at once.

It seems to me that it logically would have to be more of a sequential basis getting from where you are now down to that 7.25.

Right.

It's a very good question.

Our previous guidance was 8.35 for this year, 8.1 for next year, and 7.85 for 2005.

And so we've just looked at the revenue environment and industry conditions and what restructuring our competitors have done, and we said it looks to us like we need to get to 7.25.

And, again, we're thinking 8.35 this year.

So we need to give you guys -- we need to come up with a target for 2004, and we haven't done that yet.

That would be a good question to ask us on next quarter's call, and it's possible we'll have something that we can furnish in the 8-Ks.

But it will be a number, obviously, in between where we are today and the 7.25 number that we're trying to get to; but I don't know.

There's a lot of stuff that has to happen for us to get to that 7.25, and we're just not confident enough yet to give you guys clarity.

Yeah, there's three pieces -- as we tried to cover earlier, there's three pieces in getting to 7.25.

There's cost initiatives that we have underway right now that are worth $120 million that we are basically feeling a good deal of confidence in, that we'll be successful with those.

We're in a conversation right now with our labor groups about changes to those costs that would amount to $112 million, and it's too early to say how that's going to turn out.

And the final piece is 74, 75 million dollars of additional cost savings that we need to find to get down to 7.25; and it's definitely too early to talk about those.

That's additional process changes, technology, automation, product changes.

We know that we need to find some way to get our costs down, but we're not -- we haven't identified it yet; and so we're not in a position to give guidance, really, on how we get down.

Okay.

Well, that helps.

And then just a couple of little things.

Contract services declined sequentially, and I thought as you entered new markets that that would be actually increasing.

Terry, do you -- if you give me a second, I'll try to pull something up.

Maybe our controller, Terry Moppin (ph) has something on that.

Yes, TSA.

George is right.

We didn't have to pay the carrier fee this quarter, for June, and that was best about 700,000 a month.

Okay.

So going forward, though, because you are entering new markets, that line item should increase slightly; is that correct?

Well, next quarter we won't have to pay the carrier fee either, so that will bring that line down, and then it would be partially offset by new contracts.

Okay.

In addition to the $71 million, we got a four-month holiday from us paying fees to the TSA or from having to collect this $2.50 security fee from our passengers.

So we got a little bet benefit on this contract services line in June and we'll get a big benefit in the third quarter.

And then the plan now is we'd be back paying those fees in the fourth quarter.

Okay.

And then the last, again, little piddly item that I have to ask about was: I think when you broke down from the Air Group down to both Alaska and Horizon Air, commissions at Alaska Air were 12.2 million but the total consolidated was 3.5 million; and I'm wondering how that could be?

Jamelah, you are very good.

Alaska Airlines pays a feed incentive to Horizon Air for markets that Horizon flies that benefits Air Group and for passengers that Horizon connects to Alaska.

So some of that cost is reflected in Alaska Airlines' commission expense, and it's eliminated when we produce the consolidated financial statements.

Okay.

Great.

Thanks so much for the details.

Jamelah, I might just add a couple of other points on the Alaska 2010 plan that I think are really important, just to re-emphasize.

One is I mentioned the requirement for the collaborative nature of this, and that means working together with all the employees to find solutions that work for everybody.

And it's really important that we maintain the employee culture here, that we maintain the service orientation; and I don't think that's necessarily been the case at the major carriers that have restructured in bankruptcy.

I think they've lost some of that.

And it's very important that we do it differently.

The other thing is Brad talks about these three sources of savings.

They as yet kind of undefined at 5 million could involve additional product changes; but we are very conscious of, first of all, the advantage we have with our product, and we certainly don't want to go save a dollar in cost to lose $2 in revenue.

So that portion is going to take some time to make sure that we do it well and don't end up moving too quickly and hurting ourselves in terms of the revenue premium that we get.

Okay.

And kind of in line with that, Bill, I think you had said a month or two ago that you were undergoing a survey to determine if -- what was important to your customers, whether it's meals at mealtime, et cetera.

Do you have results from that yet?

We do that frequently.

We do that, Greg, every six months or so?

We do an on-board survey.

And you want to just touch on the highlights?

Yeah.

Not surprisingly, there was no big "aha" in that survey result.

What we hear from customers is they love our product, and our product is mostly focused around the type of service delivered by our front line employees.

So what we need to do, as Bill just said, was ensure that as we go forward and make changes to the product that we don't lose that edge, most of which is driven by the way our front line employees interact with our customers.

So no big "ahas."

They told us that we could take some liberties with respect to some of the physical product that we provide on board.

So we're going to take another look at the type of meal service we provide.

But the bottom line is they like the type of differentiation that Alaska gives, and so we need to continue to focus on delivering a differentiated product and take some liberties with that margin of difference that currently exists between ourselves and our principal competitors.

Okay.

One last question: When you first started to do the transcontinental ropes, I was under the impression that was in order to help alleviate some of the seasonality.

And it sounds like in your prepared comments that that has turned out to be a little bit more seasonal than you expected.

Are there other things that you are planning or other markets that you're trying to target or ways to alleviate some of that seasonality?

Yeah.

Part of that is just the function of our geography.

When you operate across the northern tier, you know, the winters in the north are the winters in the north and people in the Pacific Northwest don't particularly like to holiday in the Northeast during the winter.

So we were a little bit surprised that the seasonality, in fact, is exactly the same as it is within the rest of our network.

The opportunity perhaps resides in deseasonalizing through finding more southern tier flying, and I think Florida is a good example of that.

Service to Orlando and Miami is pretty much flat year-round.

We're also -- you'll see in our fall and winter schedule, going to be providing more service to Mexico; and that, as well, is less seasonal by month than the rest of our network.

Greg, I think in a couple of those places a little more frequency will help in terms of the business leisure mix.

Which we only have one flight a day, you're pretty much carrying leisure traffic because of the schedule.

But if you can get to two or even three over time then that makes your service more appealing to the business traveler, which ought to reduce the seasonality, give you a little more strength in the wintertime.

Okay, great.

Thank you very much.

Your next question comes from Helene Becker from Benchmark Company.

Thank you very much, Operator.

Hi, everybody.

Hi, Helene.

Have you looked, Brad, on the pension of contributing Horizon's stock to the pension plan, sort of similar to the way that Northwest did with Pinnacle, one.

And two, have you considered or has the board recently considered perhaps a partial spinout of Horizon?

It's a good question, Helene.

On the pension side, we have not really considered that.

I think our goal at the end of the day is to provide good, diversified asset base to fund these liabilities; and so it probably wouldn't be our first choice in terms of funding our pension obligations.

In terms of the broader question of Horizon, we get pitched ideas on that all the time by folks.

And to date we haven't had any interest in any of that.

Horizon is very, very important, (a) to feed Alaska, and (b) just to give us this presence that we have in Seattle.

If you look at our presence in Seattle without Horizon, we're roughly 30% market share, so maybe 32. but you add Horizon into the mix and we're 47%, and so it gives us a lot of umpf.

I know that you could protect some of that with contractual arrangements and all of that, but I don't know.

We're not convinced that that's the same as having a wholly-owned subsidiary that gives you that benefit. so I don't know.

To date there hasn't been anything that's interested us on that front.

And you've seen the examples of how we're working together more than ever in terms of fleet deployment and looking at this Air Group fleet from the 37-seat dash 8s all the say through the 172-seat 900s and, again, putting the right airplane in the right market.

Horizon is just a gem, and we want to continue to work together and create more benefit for Air Group.

Okay.

Thank you.

Every day I have to say I come to work and I see your Alaska plane landing at Newark Airport at about 6:15.

Right on time.

Yeah, it's always on time.

Almost every single day I can set my clock by it.

So congratulations on a really good job here.

Perfect.

Thanks much.

Everybody's smiling, Helene.

We're thrilled to fly to New York City.

That's fun.

Your next question comes from Peter Jacobs from Ragen MacKenzie.

Good morning, gentlemen.

First of all, Brad, could you give us some preliminary cash flow from operation numbers?

I mean, I've tried to back into it given the change in the cash balance, and it looks like it could be north of a hundred million; but I just want to be sure my math is right, making some of the functions for capex and so on.

Yeah.

I think your math is right.

We have preliminarily $187 million of cash flow from ops for the first six months of the year compared to $81 million last year.

That 187, obviously, includes the 71 million in government comps.

So if you back that out, I think you get to a $116 million figure.

That's, obviously, only part of the story.

We've raised $215 million in the first six months from our convertible bond offer as well as a couple of aircraft financings; and we've had a lot of capex, as well as $42 million worth of debt repayment.

We were cash flow positive for the fix six months, but when you back out things like the debt repayment and even a maintenance level of capex that would have taken it negative.

On an adjusted basis for the second quarter, about 116 million?

Yes, correct.

Okay.

And there's two airplane deliveries in which you paid cash for, I guess, and then two that were on operating lease in the second quarter?

Is that about right?

Well, let me pull it up here.

We had three leased airplanes there was no cash involved in at all.

Then we had five other airplanes, and to date two of those five have been financed and three have not been financed.

Is that right, Amber?

That's correct.

Okay.

Then the quarter we had one delivered on operating lease and three delivered directly from Boeing.

Right.

The numbers I was given was the year-to-date.

Amber's doing it for the quarter.

Okay.

And fuel costs, can you give us any indications of where fuel, spot fuel, is right now that you're seeing out on the ramp?

Yeah.

Nowhere good.

I noticed the crude oil prices are close to $32 a barrel and we're paying 95 cents a gallon right now.

That's without the hedge, obviously.

One of the interesting things during the quarter, particularly in June I saw both at Alaska and some other airlines, is that there's a divergence between aircraft fuel as well as diesel fuel and [INAUDIBLE] motor gasoline and also where the oil was going.

Do you understand that, or do you get the same sense of that?

And are you seeing now that gap start to close, i.e., you know, as you've indicated, that you're seeing the prices go up on the ramp?

Yeah.

Your question specifically, Peter, is how aviation gas cost compares to diesel or automobile gas?

Well, it just seems to -- aviation fuel seemed to continue decline in June when spot oil and gasoline at the pumps was increasing; and I'm just kind of curious about that and if you had any insight into that dynamic?

Yeah.

We don't have any insight, is the quick answer to your question.

Jet fuel trades close to heating boil, and that's a commodity that we watch; but we don't really watch auto gas or diesel.

Okay.

And lastly, are you willing to share the revenue contribution from the transcon flights, I mean, given that the load factors were quite a bit higher than the system loads and that about 10% of your RPMs now are transcon?

How much higher is the revenue contribution?

I would suspects that it is in the 10% line.

You know, we don't have a-- I'm not sure if we're willing to share it or not, Peter.

It's something we probably need to think about.

We haven't historically done that by market.

Maybe that's something we'll think about and have a good answer for you next call.

And we haven't got the information neatly summarized.

The important thing is probably profitability, and that is information that we don't share by market; but I don't know.

Hopefully that's an acceptable answer.

We'll give some good thought to whether we're going to begin to give revenue data by market for next quarter's call.

Okay.

I was just curious.

Those are all my questions, and congratulation on a nice quarter.

Thanks, Peter.

Again I would like to remind everyone in order to ask a question, please press star then the number 1 on your telephone keypad.

We'll pause again to compile the Q&A roster.

Your next question comes from James Higgins from Credit Suisse First Boston.

Yes, hi, everyone.

Hi, Jim.

Hi, how are you?

Good.

A couple of questions related to growth, neither of which you may want to answer, but here goes.

As your capacity growth slows a little bit and you think about your route network, obviously you've been making a lot of changes over the past year, 18 months, more long haul flying, et cetera.

Do you think that as you grow capacity a little bit more slowly in 2004, will you be continuing to look for those longer haul opportunities and, therefore, maybe have to make some -- fund some of that flying from existing markets or, you know, what's your sort of generic thinking in terms of that strategy?

Maybe Greg and Jeff can talk about that.

I think we're pleased with what we're seeing in our long haul flying transcon, and the Seattle strategy is really built on continuing to do more of that.

Give than that we don't have incremental aircraft in the same numbers arriving next year, I think our strategy in deploying more capacity to transcon really reside in using Horizon to backfill some underperforming markets with bigger aircraft along the West Coast.

So it's going to be a combination of redeployment out of Alaska's fleet and some backfilling by Horizon's CRJs.

Great.

And a related question as to growth.

Do you have a sense when you talk to labor and talk to the issue of the trade-off between growth and lower all-in labor costs, is that an issue that resonates with them?

I mean, It's hard to know right now.

There have been so many changes in the industry, but is there a sense that that's an issue that resonates with them at all?

Well, Jim, let me just tell you what we've been sharing with them is sort of a business model and various rates of growth that relate to various levels of profitability and really just getting the employee group engaged in that discussion.

And we're going to know more as we talk to the labor leadership over the next couple months as to how they make that trade-off and what the thinking is.

But we've just -- our effort to date has been to just, you know, share the facts as we know them and go through cash flow models and net income models and sustainable growth models so people can really understand why, you know, this is important and when we'll see kind of how this unfolds.

Great.

Thank you very much.

There are no further questions, sir.

Are there any closing remarks?

No.

Just thanks, everybody; and we'll see you next quarter.

This concludes today's conference.

You may now disconnect.