阿拉斯加航空 (ALK) 2003 Q3 法說會逐字稿

At this time I would like to welcome everyone to the Alaska Air Group's third quarter earnings conference call.

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

After the speakers remarks, there will be a question and answer period.

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

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

This call, including the question and answer session, are being transmitted live via the worldwide web and will be available for playback following the call.

Thank you.

Mr. Tilden, you may begin your conference.

Thank you very much.

Hello, everybody, and thanks for joining us for our third quarter conference call.

We have a number of folks with us here today, including Bill Ayer, Chairman and CEO of Alaska Air Group and Alaska Airlines; and Jeff Pinneo, Horizon Air's CEO.

We also have Glenn Johnson, Alaska's Vice President of Finance;

George Bagley, Alaska's EVP of Operations;

Gregg Saretsky, Alaska's EVP of Marketing and Planning;

Amber Post, our Treasurer; and Rudy Schmidt, who is Horizon's VP of Finance.

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 such statements.

Please refer to our S.E.C. filings for additional information on risk factors affecting our business.

As you have seen by now, we reported net income of $40.7 million, or $1.52 per share for the third quarter, which compares to a net income last year of $12.5 million or 47 cents per share.

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

If we exclude both of these, we incurred a net loss of $14.7 million, or 55 cents per share for the first nine months of this year versus the loss of $24.4 million or 93 cents per share for the same period last year.

There is a table towards the end of our press release that 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.

We had a good quarter at the air group level with a net profit of $40.7 million.

And all things considered, we are pleased to be reporting a profit.

But as you know, we have a very seasonal business here at Alaska, and we're not yet at a point where we're producing a profit on a full year basis, especially if you exclude the government compensation that we received in the second quarter.

Alaska Airlines reported a pre-tax profit of $50.1 million, which represents an 8.6% margin, versus a pre-tax profit of $13.1 million last year.

Horizon Air reported a pre-tax profit of $19.5 million, which represents a 14.7% margin compared with a pre-tax profit of $5.9 million last year.

While these results are an improvement over last year and the best that we've seen this year, I think it's important to keep in mind the seasonality of our business.

As we pointed out in last quarter's call, Alaska Air Group sees even greater seasonality than our competitors, and this greater seasonality is due to the state of Alaska and the west coast vacation travel that peaks in the summer months.

And due to our efforts to have all aircraft available for use during the summer, by timing our heavy maintenance to fall into the off peak months.

Our RASM is enhanced due to the higher summer load factors.

And our scheduling approach lowers our CASM by producing more ASMs during the summer.

Conversely, we see upward pressure on CASM during the slower first and fourth quarters of the year.

As Brad said, at the air group level we've incurred a year to date net loss of $14.7 million this year versus a $24.4 million last year, excluding the usual items -- the unusual items he mentioned.

So, our trend is clearly positive, but it's clear that we are well short of an acceptable level of profitability.

We're uncertain at this point, but we do currently anticipate a full year loss even with the $71.4 million in government compensation that we received in the second quarter.

I thought I might share some information on how our profits developed throughout the quarter.

At the air group level we had a pre-tax profit of $28.8 million in July of this year versus $10.3 million last year of profit.

For the month of August we had a pre-tax profit of $43.9 million this year versus a profit of $22.5 million last year.

And for September we had a loss of $4.5 million this year versus a loss of $13.6 million last year.

So, again, the year-over-year trend is certainly positive, but not producing enough margin to offset the normal losses in the seasonally slower parts of the year.

For Alaska Airlines our third quarter yields were up 1.3%.

More significantly, our load factor was up by two points on capacity growth of 9.3%.

And as a result, we were able to show a 4.5% improvement in RASM for the quarter and a 13.8% increase in passenger revenue.

This 13.8% increase in passenger revenue compares to an increase of 1.1% for the industry.

So, it's nice to see that the revenue trends that we've experienced since 9/11 continue.

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

Our strongest load factor markets continue to be our trans-continental routes, which flew at an average load factor of 80.1% for the quarter, which was 7.6 points above our system average.

I'd like to take a minute to update you on the progress of our Alaska 2010 efforts.

As you recall, we unveiled a plan for Alaska Airlines that is based on us achieving the cost per available seat mile of 7.25 cents ex-fuel by 2005.

And that plan requires a $307 million reduction in our operating expenses.

There are three elements of this cost reduction effort.

The first element is the program that we started in early 2002 to strategically reduce costs by $120 million.

And we believe we'll have achieved about $80 million of that by the end of this year and the full amount by mid 2004.

And these efforts include things like shifting sales to Alaskaair.com, improving our heavy maintenance efficiencies, lowering insurance costs, and harmonizing the flying done by Alaska and Horizon to insure that we're putting the right airplanes in the right markets.

The second element of the cost management program is our effort to bring our labor costs into line with market, and to make certain changes to our employee benefit programs.

Now, while it's too early to say what the results will be in the near term, we are pleased with the initial reaction we've had from our employee groups; and their general willingness to collaborate on finding workable solutions to this part of our cost challenge.

And finally, we have $75 million of, as yet undecided, cost reduction initiatives which we're currently evaluating.

And we're now putting our efforts into identifying the specific items that we're gonna pursue, and we'll be initiating those efforts during 2004.

The outcome of this Alaska 2010 plan is a company with a competitive cost structure which enables an acceptable level of profitability on a 12-month basis.

And these profits in turn will allow us to grow without eroding cash or increasing our leverage.

As we pursue these initiatives, we have a couple of overriding themes in mind.

First, we want to continue to refine our understanding of what customers want, and what they're willing to pay for; and to align our service as much as possible with this understanding.

And second, we want to continue to pursue operational excellence.

Simply put, we think that excellent operational performance resonates with both customers and employees, and it also helps us lower our costs.

Our objective is to have all of these efforts completed by the beginning of 2005.

I also want to thank our employees for their outstanding efforts in managing cost this is quarter and really for that matter all year long .

Almost all of our major divisions once again came in under plan for the quarter; and we were able to achieve this quarter's 8 to 9% growth in both capacity and passengers with an employee base that was almost 3% below last year and 3% below plan.

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

Our operation continued to run very 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 eight months of the year was ahead of last year and we had the fewest mishandled bags in the industry in six of the first eight months of the year.

Customer satisfaction remains high, so we believe that overall we are continuing to meet or exceed our passenger's expectations for operational performance.

Looking ahead, we're projecting that our ASMs will grow this year by 7.2% and that compares to, I think, the 7.0% that we told you on the last call.

The fourth quarter growth is planned now at 8%, and that compares to 7.5% that we told you on the last quarter call.

Now, that growth is coming from the carryover of additional service that we started in 2002 and some added frequency, both in some of our newer markets as well as some modest frequency add-backs up and down the west coast.

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

And for quarters for 2004 it breaks down 9% for the first quarter, 5% for the second quarter, 3% for the third quarter and 3% for the fourth quarter.

And Brad will talk more about our fleet plans later on in the call.

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

We ended the the quarter with $749 million in cash and short-term investments, which was up $113 million from the beginning of the year.

Now, the convertible bond offering that we completed in March, and the government assistance has substantially helped with our cash position.

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

Brad?

Thanks, Bill.

As Bill said, Alaska produced a pre-tax profit of $50.1 million this year versus $13.1 million last year.

On the 9.3% ASM growth our revenues increased by 14.2%, and our expenses increased by 6.6%; demonstrating that we are generating improving profits from our growth, although as Bill says we have a lot of work left to do.

A high percentage of our ASM growth was in the trans-con and Denver markets.

This flying represented 12.1% of our capacity this year versus 5.7% last year.

Overall our passenger revenues increased by 13.8% over last year on the 9.3% increase in capacity.

Our revenues increased more than capacity primarily due to the two point improvement in load factor, but they were also helped by a 1.3% increase in yield.

Our 13.8% revenue increase compares to an industry increase of 1.1%, but I should note that our increase comes on our 9.3% capacity increase while the industry's increase comes on a 7.6% percent capacity decrease.

Looking at our market performance, we saw load factor increases across all regions during the third quarter.

Not withstanding an almost 150% increase in trans-con ASMs, load factors grew substantially year-over-year there.

In terms of yield, we've also seen strengthening in RASM across the board.

Looking forward, we see strength in our advance book load factor even given the 8% increase in planned flying for the fourth quarter.

The trans-con markets, which have formed the base for much of our recent growth, continue to have high load factors in the third quarter.

These markets have been somewhat seasonal during the startup phase, but we're hoping they'll be less seasonal going forward.

Our other revenue line item grew by 27.1% due to increased mileage plan partner revenues, as well as, increased contract maintenance revenues.

With respect to this latter item, we have a contract where we maintain two aircraft for oil companies based in Alaska.

We did a d-check on one of these aircraft during the quarter, so we did have a somewhat unusual $2.2 million increase in revenue.

However, you'll see the the offsetting expense for this revenue is in our contract services line item.

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

And we really need to thank our front line managers for this.

Our total operating cost per ASM for the third quarter fell 2.5% to 9.24 cents from the 9.48 cents we had in 2002.

And if you exclude fuel, units costs for the quarter fell by 3.9% from 8.12 cents last year to 7.81 cents per ASM this year.

This figure is a bit higher than the guidance we provided in our most recent 8-K, which was a range of 7.7 to 7.8 cents due to a true up of our costs for our defined benefit pension plans and due to the accrual of $1.1 million related to soil remediation for some underground storage tanks at several Alaska locations.

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

Starting with wages and benefits, we experienced an increase of $13.8 million or 7.5% for the third quarter.

Of this increase about $11.1 million is due to an increase in benefits and the remaining $2.7 million is due to wages.

Pension costs related to our DB plans have increased on an annual basis from $40 million last year to almost $77 million this year.

And they are responsible for $8.4 million of this quarter's increase in this line item.

Health insurance and workers' comp increased by $2.9 million.

As we said, wages by themselves increased by $2.8 million, which is about 2%.

Our FTEs were down 3.4%.

That means our average wage rate increase, which includes both scale increases and step increases, was about 5.5%.

Our fuel costs increased by about $10.9 million or 15.4% on the 9.3% ASM growth.

We were helped significantly by our fuel hedge contracts which contributed about 19.2 cents per gallon for the fuel hedged or about 6.7 cents per gallon on an overall basis.

In dollar terms our hedging program provided fuel savings of $6 million at the Alaska Airlines level and $7.1 million at the Alaska Air Group level.

For Alaska Airlines our average price per gallon, including hedges, was 89 cents for the quarter versus 82 cents last year.

Looking forward, 35% your our consumption is hedged for the fourth quarter, primarily with crude oil swaps at prices below $22 a barrel.

And I just want to give you some detail.

For the next several quarters our hedge positions are as follows: For the first quarter of '04, we're 30% hedged at $28 a barrel.

For the second quarter, 30% hedged at $27 a barrel.

For the third quarter 20% hedged at $26 a barrel.

And for the fourth quarter, 20% hedged at $25 a barrel.

For 2005 overall we're 16% hedged right now at $25 a barrel.

As we've said before, our plan is to get to a point where 50% of our consumption is hedged.

And these hedges are placed in a programmatic fashion between 12 and 24 months in advance of consumption.

Due to the fact that Alaska pays Horizon for connecting traffic, and for certain other routes that Horizon is operating for Alaska's benefit; and because these payments are charged to the commission expense line item, we like to look at commission expense at the air group level.

If you look there you'll see a 36% decrease in commission for the quarter and a 63% reduction year to date.

Aircraft maintenance costs increased by $3.6 million or 11.4% due mainly to higher engine repair costs.

We had 19 engine removals this year versus 16 last year.

And for the removals we did have, a higher proportion of the total repairs were charged to expense.

Looking forward, we are expecting maintenance costs in the fourth quarter to be about the same as this quarter at about the $36 million level.

Planning fees and other rents increased by $3.5 million, or 11.6%.

Of this amount, $2.6 million is directly attributed to landing fees, $650,000 is attributed to station rent, the remaining $250,000 is attributed to several smaller items.

Two point one million dollars of the landing fee increase is due to increased rates, while $500,000 is due to increased volume.

About half of the station rents increase is due to the operations at our new locations, while the remainder is due to increased rates.

Aircraft rent decreased $1 million or 3.1% because of lower lease rates on five 737-400's, one MD-80 and one 737-200 that we extended during 2002; and due to one MD-80 lease return.

These lower rates were partially offset by costs related to three new 737-700's that we took delivery of earlier this year.

Other operating costs decreased $4 million, or 10.4% compared to last year.

This line item includes insurance, which decreased about $4.6 million from last year, due to a credit we received as a result of clarification of our underwriter's liability related to flight 261, as well as other decreases we've seen in previous quarters.

General office supplies also decreased by $540,000 due to our people's efforts to continually reduce spending in this area.

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

We had strong sales on Alaskaair.com this quarter; with nearly 29% of our tickets sold on our own website this year versus 23% last year.

For the month of September our direct sales to customers over Alaskaair.com plus our locations exceeded 50% for the first time ever.

Additionally, 92.5% of our total tickets were issued electronically, versus 79% last year; meaning that we're getting closer and closer to the point of being a fully paperless airline.

Finally, 45% of our customers checked in via the web or via kiosk; and that's up from 45% last year.

Cost guidance, we currently project unit costs ex-fuel for the fourth quarter in the range of 8.5 to 8.6 cents.

And that should still put us in good shape to hit our full year objective of 8.35 cents per available seat mile, ex-fuel.

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

At this point I'd like to turn the call over to Jeff for a discussion of Horizon's results.

Great.

Thank you, Brad, and good day, everybody.

It was indeed a good quarter for Horizon, thanks largely to the great work our people continue to do on the cost management and service delivery fronts.

Our pre-tax earnings of $19.5 million are a significant improvement over the $5.9 million figure we posted during the same period last year.

Overall, revenues were up by 13.8% or $16.1 million on 9.9% more traffic; while our operating expenses grew by 2.1% or $2.3 million on 6.7% more capacity.

Following last quarter's unit revenue improvement of 2.9%, our third quarter RASM was up 6.7% on positive changes to both load factor-which was 1.9 points higher and yield, which improved 5.3%.

Our unit costs excluding fuel fell below the 14 cent level in two of the three months of the quarter and in total third quarter CASM ex-fuel was 14.1 cents or 5.1% lower than last year.

These positive results coming on the heels of our recent announcement of a 12-year agreement with Frontier Airlines to operates nine CRJ 700s as Frontier Jet Express give us all reason to be encouraged as we head into the fourth quarter.

As I've mentioned before, our employees continue to do an absolutely fabulous job of delivering a quality product and they're doing so with increasing efficiency.

In the recent quarter, they once again hit it out of the park.

In each of our three core promise categories with a scheduled reliability rating of 99%, on-time performance within 15 minutes at 93%, and baggage mishandlings at 2.1 claims for every thousand passengers using D.O.T. reporting standards.

In August Horizon ranked number 1 in the nation in both on-time performance and baggage handling.

As a result, our passenger inconvenience charges were nearly 12% lower than the same period last year.

Aircraft reliabilities, improved processes and great team work also resulted in improved employee productivity, which on a passenger basis was up 7.8%; an improvement trend we expect to see continue.

The 15.6% passenger revenue increase we saw for the quarter was the result of increases in both traffic and yield.

Traffic growth was driven by a combination of passenger growth, which was up 3.1%, and increased trip length stemming from more long haul flying.

Our average stage length grew 6.6% to 339 miles, thanks partly to our July -- I'm sorry -- July 1st introduction of three daily flights from Seattle and Portland to Santa Barbara and our seasonal Seattle-Palm Springs CRJ service which complemented the high season service flown by Alaska.

Our 66.5% load factor for the quarter was a solid 1.9 point improvement over last year, continuing the trend we saw in the second quarter.

August as a stand-alone period was among our top three months all time in this category and a record breaker for passenger boardings.

In terms of capacity, we grew 6.7% during the quarter, which is slightly less than the 7.5% we had projected.

For the fourth quarter we are now projecting ASMs to be 4% lower than last year as compared to our previous projection for the fourth quarter of 4.5% growth.

This change stems largely from the transition preparations necessary to begin Frontier Jet Express operations on January 1st, and in addition we're taking advantage of the lower demand period to complete manufacture specified maintenance modifications on our CRJ and Q400 fleets.

For the full year we are now projecting a 5.3% growth rate.

As I noted earlier, total operating expenses were $2.3 million higher than the same period last year.

Again, the major increases came from maintenance and aircraft rent, which together were higher by $4.9 million.

Maintenance was higher by $3 million, and the increase in this area is due to a combination of a higher number of aircraft to service, aircraft warranty expirations, and the commencement of Q400 and CRJ heavy checks in 2003 along with $700,000 to cover five unscheduled engine events on the Q400.

Aircraft rent expense was $1.9 million or 11.7% higher than last year due to a newer fleet, rental of spare engines from General Electric to support CRJ reliability, and short term rent of two Q400s from Bombardier to back up the summer schedule.

Fleet utilizations was up 6.5% for the quarter because of improved reliability, good weather and shorter turn times.

Our wages and benefits rose $.5 million dollars, or 1.3% with all of the increase coming from higher rates for unemployment tax and workers' comp and rising healthcare costs.

Wages alone were down 1.3% on 4.3% few other FTEs and 3.2% higher average wages.

We have continued to exercise good discipline prior to filling openings that occur through attrition in non-operationally sensitive positions, which has helped to drive our productivity to new highs.

Our fuel expense was 9.2% higher or $1.1 million on a 10.3% increase in price, net of fuel hedges, and 1.4% less volume.

On an ASM basis our fleet was 7.6% more fuel efficient than last year, which saved us approximately $1 million for the quarter.

Offsetting these increases are reductions in depreciation, insurance, security fees and selling expenses.

Depreciation is down by $2.2 million because we retired the F 28 fleet and are no longer adjusting for the value of those air frames and related parts.

Insurance is down by $2.4 million due to a $1 million rebate received in the third quarter for excess passenger liability reserves, lower rates for whole liability, and the elimination of third party whole war reserves.

Security charges were suspended for the quarter as part of the emergency wartime supplemental appropriations act, and that saved us nearly $1 million.

Commissions and selling expenses were $1.4 million lower than last year due to a higher percentage of internet bookings and a higher level of advertising that was used to stimulate demand in 2002.

Looking ahead, we're forecasting our CASM ex-fuel to be 17.2 cents for the fourth quarter, which compares to the 15.9 cent projection we made on the second quarter call.

The unit cost increase is related principally to our adjusted growth projection, which I noted earlier.

Given our better than planned third quarter performance in this area, for the full year we are still projecting CASM ex-fuel to be 15.9%; which is about on par with our previous full year guidance.

With the start of Frontier Jet Express operation in January, we're projecting to be back to the quarterly ASM growth rates that you've been accustomed to seeing from us.

Right now we're projecting a 12 to 13% growth rate for 2004 for the full year.

On the traffic side for the fourth quarter we're seeing strength in projected load factors for all three months, and as we've done in the past, we'll continue to update you with any changes in these projections and events that may significantly affect them as part of the Alaska Air Group 8-K.

Now let me turn it back over to Brad for a review of Alaska Air Group's balance sheet.

As Bill said, we ended the quarter with a very strong cash position, $749 million compared to $722 million at the end of the second quarter.

Our cash flows from operations for the year to date, and this includes the $71 million we received during the second quarter, were about $273 million versus $188 million for the first nine months of last year.

Proceeds from the issuance of our convertible bonds in March and the aircraft financings we've completed this year also increased our cash balance.

These increases were partially offset by cap ex of about $320 million year to date and about $56 million of debt repayment.

As you know, 2003 is a year of significant fleet activity for Alaska as we are adding 11 aircraft and retiring four for a net increase of seven units.

And that will put us at 109 aircraft at the end of the year.

Most of this activity is now behind us.

We've got one 737 700 left to deliver in November.

For 2004 we're projecting cap ex of approximately $320 million, but this figure anticipates that Horizon will take delivery of the six CRJs that they currently have on order.

As we said in earlier quarters, they are working with Bombardier to restructure this order and reduce the number of aircraft that they take in '04.

And we'll have more to say about that at some point.

Alaska will take delivery of one 737-900 in early '04 and return one MD-80.

Additionally, depending on the outcome of lease negotiations, we could end up returning additional 737 400's.

Our adjusted debt to cap ratio, adjusted for operating leases, is 78% as of September 30th; and that's one point better than the last two quarters.

Finally, I'd like to give you some information on our common stock for purposes of your EPS calculations.

During the month of October our stock price was such that we triggered a contingent conversion feature on the convertible bonds that we issued in March.

And these bonds are now convertible by holders, although they're not callable by us for three years.

If converted, this bond issue represents 5.77 million shares of common stock.

These shares will obviously not have an impact on our fourth quarter or full year earnings per share calculations, because their impact would be anti-dilutive; but we wanted to make you aware of this information nonetheless.

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

Thanks, Brad.

We've got a whole room full of people here that are very eager to answer your questions, so I'll turn it back to the operator to tee up that part of the call.

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

Please limit yourself to one question and one follow up question until all interested parties have had a chance to ask a question.

Your first question comes from Ray Neidl of Blaylock.

Congratulations, guys.

Good quarter.

Thank you, Ray.

One technical question before my follow-up, Brad, you were talking about the convertible being triggered an extra 5.77 million shares, but it has no impact, what did you say, on the fourth quarter and for the year?

Correct.

Great.

But next year it will have an impact?

Well, once the company becomes profitable, those shares would go into the denominator for purposes the EPS.

Oh, I gotcha.

It's just because you're not making money in the fourth quarter in the year.

Yeah.

Okay.

Good.

The other thing is the partnership-you just signed an additional partnership with Delta Airlines.

And I guess you have partnerships with almost everybody, American, Continental, Northwest.

I was just wondering if you could go over quickly your partnerships and how that contributes to your system and the traffic flow and revenues?

First of all, we have ongoing discussions regularly in our course of business with lots of different airline partners.

We get great benefit from these traffic flows that these carriers provide on a partnership basis.

Those discussions with Delta and other airlines continue, so there's nothing further I can provide with respect to the details of the relationship there.

What I can tell you is that we do a great amount of interchange of traffic with Northwest and Continental and American Airlines; and we view those as a bit of a unique strength for Alaska Airlines.

Because we are somewhat geographically disadvantaged, Alaska Air Group benefits perhaps disproportionately from these partnerships that allow us to connect with traffic across the country that our own network would not otherwise permit.

So, there's a utility there to frequent flyers that these partnerships bring; that is, greater for air group than it is for others in the industry.

And Delta was not part of the system before because they were so far geographically away from your system, and now they're part of the Northwest-Continental system, so is that why they've been taken in?

We don't have an agreement yet with Delta Airlines.

I thought I read that you were in discussions.

No?

I think there's speculation in the industry that there's the potential for a partnership.

But we have discussions all the time with lots of airlines, and nothing to report there yet.

Okay.

I gotcha.

Thank you.

Our next question comes from Gary Chase of Lehman Brothers.

Good morning, guys.

Hi, Gary.

I missed the beginning of your remarks, so I don't know if Don or maybe Gregg is there.

I just wanted to get any of your thoughts on sort of the network impact of that in your trans-con .

I'm just curious if you've got any kind of corporate travel managers that are, you know, more interested, or if there's anything heating up there?

Anything you could provide there would be helpful.

Yeah.

This is Gregg.

Let me try and give you some sense for how our corporate accounts have responded to both our expanding networks flown by Alaska Airlines and the partnerships that Ray Neidl referenced earlier.

On October 1st we signed a new partnership agreement with Microsoft, which is perhaps the biggest corporate account here in Seattle.

They will be moving traffic off previous preferred airlines partners to Alaska Air Group, which we view as a significant win, largely facilitated by our expanding network to the east coast and the airline partners that we have in our commercial relationships.

There is a significant amount of flow traffic between our network and points in the east, principally stemming from western Canada and the state of Alaska, but also from points fairly close to the south and to the east of us.

So, eastern Washington and the state of Oregon.

And those are new flows, which we're seeing over Seattle that didn't previously exist prior to the initiation of service to the east coast.

Gary, this is Bill.

I might just add that as we look at the trans-con routes going forward, what we're going to try to do is to better penetrate the east coast points of sale, what Gregg just mentioned from corporate accounts works on the west coast, and we know those accounts real well.

We want to do some of the same on the other side of the country, and that's going to allow us to add frequency and more utility.

We've only got one or two flights a day in these markets right now, and our plan over time is to build up that frequency, provide more utility, especially for business travelers that appreciate the frequency.

And I think the other thing relative to the economics of these routes, we're certainly pleased with the results to date, and we've seen some nice trends.

If you think back to the immediate post-9/11 period, this was a much better use of airplanes than deploying them on the west coast or potentially even parking them, which a lot of other carriers had to do.

But we think the 900, the 737 900 provides some more favorable economics compared to the 700 as we look at some of these longer routes and lower yield routes across the country, Florida, for example, has responded very well.

Orlando with the 900 in there is an airplane that contributes better than the 700 because of the economies of scale.

So, just a little insight into our strategy going forward, more frequency, and a bigger airplane.

One final effect is on our mileage plan.

If you think about Alaska's route network, we have a lot of mileage plan members that accumulate a lot of miles flying up and down the west coast.

Historically they've wanted to burn miles on our partners.

And we have mileage balancing provisions with those partners and typically we're out of balance and making cash payments to those partners.

And Alaska flying to New York and Boston and D.C. and Florida gives us redemption opportunities that's helped significantly with those balancing provisions with our partners.

Okay, and is that what you were talking about in the other revenue for Alaska Airlines?

When you said frequent flyer, you know, partnerships, are you getting some redemptions from other people on those routes?

Is that --

Yeah, that's -- the mileage plan accounting is a little bit complicated.

The other revenue line items is really miles that we sell, mainly to Bank of America through our credit card, but also hotels and all of that.

That's done terrific for years.

It's seen double-digit growth for the last several years.

Thanks very much, you guy guys.

Your next question comes from Michael Winnenberg from Merrill Lynch.

Hi.

Good morning.

I guess two questions.

When you talk about your 2010 plan, I think Bill, earlier you talked about an acceptable profit level.

And I was just curious, you know, if you could elaborate on that and what you, you know, deem acceptable, what sort of margin, or maybe it's a return on invested capital target that you're shooting for.

Sure.

We've been out, you know, talking to employees about this and describing sort of the state of the industry since deregulation and the very cyclical nature of it.

And we think something in the order of 10% pre-tax margin is where we kind of need to be.

And that allows you -- we think that allows carriers to weather downturns pretty well without having to have these dramatic shifts in capacity and effects on employment and so forth.

And if you work through the cash flows of that, you end up with maybe an 8 to 10% growth rate that becomes available to you if you have opportunities to pursue it in terms of the airplane, the capital side of it.

So, those are just some basic metrics that we're looking at.

Okay.

And then just my second question is that as you expand or grow into the Frontier partnership, every CRJ 700 that goes into that partnership is obviously a plane that is taken away from Alaska.

And I'm curious, you know, what's behind the move to link up with them?

Is that, you know, maybe less opportunities in the near term with the CRJ 700s in the Horizon system, or maybe Frontier coming to you with an offer that you couldn't refuse?

If you could comment on that, that would be great.

Yeah, Mike.

This is Jeff.

I think you're right in observing that in the short-term in order to make this transition, we're trading off some reduced flexibility for long-term broadening of opportunity.

And you might have noted that there was a difference between what was initially requested by Frontier in terms of scope of 10 airplanes and what we're initially committing being eight airplanes, that still leaves us with 12 CRJs that we're committed to on the delivery stream that are, as yet, not committed to any program.

So, as we get by the introduction of the program on this conservative basis going forward, we'll have the option to consider expanding the Frontier program against other good uses here within the Alaska Air Group network.

So, our view is that that gives us just one more avenue to consider, you know, for profitable growth.

And our arrangement with Frontier as it relates to those options is by mutual agreement.

As we get closer to it, we'll be discussing all those options and picking the best choice.

Okay.

Thank you very much.

Your next question comes from Helane Becker of Benchmark Capital.

Thanks very much, operator.

Hi, guys.

Okay.

So, just two questions.

You guys are, I think, pretty well known for high level of on-board service.

And a lot of your competitors are going to a buy on board program.

Have you looked at that or considered that?

And is that something you would look at and consider?

That's my first question.

And my second follow-up question is unrelated, and it's with respect to east coast cities.

Have you looked at additional east coast cities, you know, to add service to?

All right.

Let me start first with our buy on board.

We have had discussions with our caterer LSG Skychefs and have been watching with interest the developments in the industry with respect to that program.

At this point I would say, you know, we've learned never say never.

But at this point we believe a buy on board product for Alaska Airlines would be detrimental to our brand.

That isn't to say that we don't believe in 2004 there are some liberties we can take, and I think I referenced some of that in our last quarter's call.

And you can expect to see some change in our on board products, particularly in flights that are relatively short duration.

Long-term I think we need to watch the developments of buy on board.

There's a huge problem logistically in matching demand with supply and we've talked to some of the airlines that have experimented with that program they haven't yet seen great success.

The second question is about east coast expansion.

And I think it's fair to say that our planning group is constantly monitoring opportunities in the marketplace and it would probably be fair to say that we have a couple of opportunities that would be at the top of our list, which would include points on the east coast for potential development in 2004 or really 2005.

Great.

Thanks for your call.

Wait.

I might just add a couple of things.

This is Bill again.

On the service side of things, you know, what's really important to us is differentiation.

And that takes a variety of forms.

Not only the physical product that you put on the airplane, but we think most importantly it's that experience, the engaging customer experience between our front line employees, our flight attendants, for example.

And whatever we do with the product, we want to make sure we continue to have plenty of interaction in the cabin of the airplane.

And the personality of the company vis-a-vis our front line employees is able to shine.

So, we're not going to lose that know matter what we do with the products that we're buying.

And I just wanted to make sure that you had that.

Right.

Got it, got it.

Thank you.

Your next question comes from Jamila Letti of McAdams, Wright, Regan.

Hello.

Hi, Jamila.

I was wondering if you wanted to talk at all about the road map between where we are now and the 7.25 CASM goal in the beginning of 2005, sort of an intermediate step in 2004?

You know, as we said I think in 8-Ks and certainly in other calls, Jamila, in terms of our comparison with the analyst community -- the 7.2 is a target, an objective for the company.

But we're not offering that as guidance right now for folks with their models.

It is a very aggressive plan, it's down 14% from where I think we were in 2002.

In terms of where we see the next little bit coming together, we are putting our plan together right now for 2004.

Our hope is that we end up with a plan that has the number of 8 cents in it.

But that's not done yet.

And when it is done, we will share that with you in an 8-K or perhaps on next quarter's call.

That would exclude anything that might come from our conversation with labor.

And as you look at our 2010 plan, the $112 million request from labor amounts to about half a cent.

So, we think we'll end this year at 8.35 cents.

Next year, excluding labor, the goal would be 8 cents.

Labor could help that by another half a cent.

That would take us to 7.5 cents.

And then we have another .25 cents to squeeze out.

And that's just other cost management stuff that we would hope to identify in 2004.

Okay.

Great.

That's very helpful.

For my second question, I'm wondering with respect to the Horizon fleet when you will begin to anniversary the increased fuel efficiency of the fleet?

And then, also, I didn't hear when Jeff says what the CASM guidance was for Q4.

Could you restate the first question there?

Was it when will we realize the benefit --

When will you start to anniversary it?

As you've upgraded your fleet, it seems to have really improved quarter to quarter.

Right.

We should see that in February.

The first quarter of this year is when we retired the F-28s.

And we should see some marginal improvement from that point forward as we just introduce new 70 seaters progressively.

But the big anniversary date is the retirement of the F28s in February.

And as far as CASM for next year, I don't have that specifically.

We're looking at improvement over this year.

Certainly with the added ASMs that we're projecting in the 12 to 13% range, and then, you know, holding real hard on the fixed costs, we do anticipate marked improvement.

Okay.

But didn't you give guidance for the fourth quarter CASM?

Yeah, I did, Jamila.

We said for the fourth quarter we're looking at 17.2 cents for the quarter.

And that again is driven largely by the adjusted -- the ASM growth rate being adjusted downward relative to the transition to the Frontier program and the maintenance programs we have in.

Again, looking ahead to next year, we will be back in the saddle on the growth rate side and we should see that spring back, as well.

Horizon is going to have kind ever a funny fourth quarter with this decline in ASM.

ASMs will be down, the unit costs will be up, and it remains to be seen what will occur with revenues.

It may be that we are able to get a nice RASM pop from squeezing some of the same passenger demand onto few ASMs.

It all kind of comes out in the wash for the year because of the better than anticipated performance in third quarter on CASM.

We're still looking at 15.9 for the year.

Okay.

Great.

Thank you very much.

Your next question comes from Glenn Engel of Goldman Sachs.

Good morning and a terrific quarter.

Hi, Glenn.

A couple questions.

One, in the past you've given the business fare buckets, how they performed.

Sure.

We're seeing, I think, a continuation of the trend we've seen in the past.

If we look at the top four buckets, from a revenue standpoint those now comprise 18.4% of our revenue for the quarter.

That's down from 20.7% a year ago.

And passenger volumewise it's 10.5% of passengers versus 11.8% a year ago.

If we expand it to be the top six buckets, it's 40.6% this quarter versus 41.0% last year on revenue.

And passengers have moved down slightly from 25.2 last year to 24.9 this year.

I think what's perhaps most significant about this, though is that, you know, people ask the question: is business travel coming back, or how much is business travel off from historic levels.

And I think our belief is that it's almost hard to distinguish this.

What we know is that everybody's looking for value and everybody wants to pay the lowest fare they can pay and people are much more willing to plan ahead and stay over a Saturday to get that.

And we separately tracked some of our MVP and our MVP gold, our high tier frequent flyers.

And we know their activity didn't sag as much as the bucket mix would indicate.

And conversely, we're seeing continued activity going forward.

We're not seeing a big jump up or anything, but we know those people are out there flying on our airplanes.

But they are literally disguising themselves as leisure travelers because of the fares that they're paying.

Second, on Horizon, with the cutbacks will Frontier absorb any of these transition costs?

Yeah, the costs related to converting the program, the one-time start-up costs, are all factored into the project.

Will that revenue tied to that show up in the fourth quarter or does that show up later on?

No, the revenue -- well, Rudy, maybe you can answer that technically.

When will the revenue be realized?

The revenue won't be realized until the beginning of the next year.

And some of the expenses we'll expense in the fourth quarter, a small portion of it.

But much of the start-up expenses will be capitalized and then amortized over the full period of the deal.

So, the real cost, though, on the expenses, it's just the lack of utilization?

Right.

Yes.

We'll get a CASM improvement next year, too, because of the Frontier effort because of the way the deal is structured.

And finally, is fuel running roughly at the same level as the third quarter?

It's high right now.

I think we're at $1.01 a gallon excluding our hedges.

And the hedges are a similar-type benefits?

Yes.

For the fourth quarter very similar, maybe at that level eight or nine cents per gallon of benefit.

Your next question comes from Peter Jacobs of Ragen, MacKenzie.

Good morning, gentlemen.

Hey, Peter.

First of all, Brad or Bill, could you talk about advanced bookings, what you're seeing out there both on an absolute basis, and perhaps if you could weave in the fares that are associated with those advanced bookings.

We are seeing strengths in all regions across the board, and we're particularly pleased with the passenger bookings for the holiday travel periods.

In the third quarter our RPM was up 1.6% on a non-stage length adjusted basis.

We're flying further this year than last year because of the expansion on the trans-cons.

And I would expect that trend to hold in the fourth quarter.

As Bill said earlier, we are not seeing any significant improvement in the mix between business and leisure split, but what we are seeing is more shallow discounting in the most discounted buckets, and we're able, because of the increased demands, to squeeze a little bit and move some of that traffic out of the very bottom buckets up into some of the mid tier buckets.

Are you fairly optimistic about traffic demand staying pace with the capacity growth?

Yes.

I think we expect that through the fourth quarter our demand will actually exceed the capacity that we're gonna fly.

Okay.

Great.

Secondly, Brad, could you give us an update on fuel costs currently?

Yeah.

We are -- Peter, we're paying $1.01 per gallon at the moment for fuel.

Is that with the hedge or excluding the hedge?

That is excluding hedges.

At that price I think hedges would have a benefit of 8 or 9 cents per gallon.

Okay.

Very good.

Thank you.

Yeah.

Your next question comes from Dan McKenzie of Smith Barney.

Thank you, operator.

Good morning.

Hi, Dan.

About I believe it was October last year Horizon began experimenting with a simplified fare structure.

And I believe on the last call it was announced this this new fare structure was extended from 18 to 200 markets or so.

And I guess now that we're a year into the experiment, I'm just wondering what results you found and what have you concluded?

Maybe I'll take that for Alaska on the part of air group.

We have continued to experiment.

And you know, I guess I would hope that the crystal ball would have been more clear.

I think what we've concluded is that there's enough noise in the markets with adjustments to capacity in many of the markets that we serve that we are seeing strength in demand, which is more a function of the changes in capacity than it is changes to the price structure.

Having said that, we aren't seeing big increases in upper bucket demand.

Even coinciding with reductions in the prices in those buckets.

So, I think for the experiment to be successful, we would say if revenue at the end of the day were neutral and we eliminated or reduced the gap between the lowest price and the highest price, we'd be happy.

So, the conclusion on that is you can look forward to us continuing to expand the number of markets that we're trying.

At this point I would say we haven't seen enough benefit, but we haven't seen any downside to make that apply systemwide.

And philosophically it's consistent with our desire to try to simplify the business and to make it easier for customers.

So, to that degree we're encouraged to continue the experiments and try to insure that if we do this on a systemwide basis it's not revenue negative to any significant degree.

But we're going to continue to look at it.

What I would say is until you have significant mass in your network priced at this new pricing structure, customers aren't aware that you did anything significant.

We think the big bang really comes from moving this experiment from 200 markets to 6,000 markets.

Okay.

Thank you.

And a second question unrelated.

I'm not sure how willing you are to talk about this, but with respect to labor, any sense of the time frame for potential outcome or any kind of sense you can provide on the progress?

Nothing specific, Dan.

You know, as I said in the comments here, we're pleased with the initial reaction.

As I think everybody knows, ALPA put out a press release and they had their national economics people looking at our current performance and our business model and the plans going forward, and they saw enough there to want to sit down and talk about things.

And that's what we're in the course of right now.

So, we're encouraged that people want to talk about it.

And the watch word all along here has been collaborative.

We obviously don't have any leverage to dictate anything, and it really is gonna take people recognizing the collective benefit, long-term benefit of doing some of these things and working together on it is the key.

So, that's what we're engaged in, and we're hopeful that that will come to some benefit for everybody.

Okay.

Great.

Thanks very much.

Your next question comes from Jim Higgins of Credit Suisse First Boston.

Thanks.

Hi, guys.

Can you give us passenger trip length change in the third quarter at the Alaska Air level?

You know, without doing it exactly, Jim, I think it's up slightly in excess of 4%.

You can run that number just by dividing RPMs by -- yes, 4.4%.

Just divide RPMs by revenue passengers.

Okay, I hadn't seen the revenue passenger number.

That's the effects of trans-cons.

They're all at stage lengths in excess of 2,000 miles.

Right.

You've obviously talked about the fare bucket shifting and everything else, but I think it's fairly remarkable that your RASM is up as much as it is give than that increase.

Can you just talk a bit about that dynamic?

The big thing there, and maybe we could get Gregg to talk some more, but it's the two-point improvement in load factor.

That's probably a little bit more than three percentage points of the RASM increase.

I think it's a positive thing because it's something the company's going to need to get used to doing to present this 3% operating margin that Bill talks about.

I guess I would add that the RASM improvement there is a function of the 2 points that Brad talked on load factor and 1.6% increase in RPM yield on a non-stage length adjusted basis.

So, what we are seeing is the discounts in the lowest buckets are a little more shallow than they were same time last year, and it's more a function of getting a few bucks on the bottom than it is any kind of fundamental mixed change in the market place.

You -- I'm sorry.

Go ahead.

That's it.

Your absolute load factor level is still appreciably below the industry's.

Is that just a function of your structure, or can you move up towards the industry level?

You know, there is -- on an annual basis there is more seasonality in our network.

So, it's structural, and we'll never have the type of really high load factors that some of the carriers with international components in their networks.

There is some upside.

How much there is, you know, I think we'd like to see it move up a point.

Yeah.

We think there's certainly room there physically.

We don't run a hub and spoke system.

If you look at that listing of high to low load factor carriers, you've pretty well got the hub guys at the top.

Part of what we see here in growth is to work the process so we're able to push load factor up because there's a lot of leverage there to the bottom line.

Sure.

Great.

Thanks very much.

Sure.

Your next question comes from Peter Jacobs of Ragen, MacKenzie.

A follow-up question, gentlemen.

First, Brad or Bill, could you comment on potential route expansions on the trans-con area, Dallas, Chicago, Pittsburgh, Atlanta?

I think those are cities that have been speculated about.

Would you have any comment about that?

You know, I might just start out here and let Gregg pick it up.

But there's a lot of potential out there, Peter.

And we look at our route system both at our current cost level, and then we look at the 725 number.

And there's a lot of difference and there's a lot more opportunity for us at 725, obviously.

And so, our focus, we talked about our '04 growth plans being down around 5% with only one airplane delivery.

So, our focus right now is, you know, transforming this business model and focusing on CASM, not losing sight of revenue by any means, and the whole importance of the product side of it.

But a real good focus, a continued strong focus on CASM and getting these costs down where then we can go out and have a solidly profitable company on a 12-month basis and take advantage of a lot of these opportunities.

So, that's the overall part of it.

Separately Gregg's group does keep track of these markets and where the opportunities might be.

So, basically, Bill, the cost reduction needs to come before expansion as opposed to the expansion is not going to lead to the cost reduction?

Exactly right.

Okay.

Secondly, this is just a housekeeping question on the diluted share count.

Why wasn't the diluted share count used in the third quarter?

There is what they call a contingent conversion feature in that security that the stock had to trade -- the conversion price is $26 a share, and they had to trade above 110% of that price for 20 days out of a 30 consecutive day period.

And we hit that -- we hit that trigger during early October, but not during the third quarter.

Okay.

But on a go forward basis, it would be used on any protestable quarter?

Exactly.

As you've become accustomed to.

Okay.

Very good.

That's the end of my questions.

Thanks, Peter.

Your next followup question comes from Gary Chase of Lehman Brothers.

Bill, during your comments you had mentioned, you know, you had the cost buckets, one of which was $120 million from what you called strategic cost reductions.

And you said that the had achieved $80 million of them.

And I apologize.

It's just been kind of hard to keep track of everybody's methodology.

Should we take that to mean $80 million exists in this year's P&L, or you -- you know, you've achieved $80 million where you'll get some spillover benefit from the $80 million into next year?

Can you elaborate on that a little for us, please?

Sure.

This is Brad.

It's the former.

The way we size this thing, our unit cost ex-fuel was 8.73 cents in 2001, which was kind of the high watermark.

And the ultimate goal is 7.25 cents.

And that's roughly a penny and a half, and if you multiply that by our ASMs this year, it's the $307 million figure.

So, 8.73 in '01 to our target this year of 8.35 cents is $80 million.

So, that amount is in this year's results.

Okay.

So, next year, assuming that all goes well, we should expect an incremental $40 million plus whatever you're able to achieve on the labor front and the additional money that you'll announce apparently beginning next year, correct?

Correct.

Okay.

Thanks very much, you guys.

Yeah.

At this time there are no further questions.

Okay.

Thanks, everybody, very much.

Look forward to talking to you on the next quarter call.

Bye-bye.

This concludes today's conference call.

You may now disconnect.