阿拉斯加航空 (ALK) 2004 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the Alaska Air Group second quarter 2004 earnings conference call.

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

Please limit yourself to one question and one follow-up question.

As a reminder, today's conference is being recorded and will be available for rebroadcast.

Thank you.

I would now like to turn the conference over to Brad Tilden.

Please go ahead, sir.

Thank you very much, Amanda.

Hello, everyone and thank you for joinings us for our second quarter 2004 conference call.

Before we get started I would like to introduce a number of folks here with us today including Chairman and CEO Bill Ayer, Horizon Air CEO Jeff Pinneo, EVP Operations George Bagley, EVP Marketing and Planning, Gregg Sartesky [PHONETIC], VP Finance Glenn Johnson, Controller Branden Peterson, Treasurer Amber Post and Rudi Schmidt.

As our usual practice I will begin by reminding everyone that this call may include forward-looking statements and our actual results may differ materially from such statements.

Please refer to our SEC filings for additional information on risk factors affecting our business.

In addition, to the extent this presentation includes any non-GAAP financial measures, the most directly comparable GAAP measures, and a reconciliation of the differences between the GAAP and non-GAAP measures appear in our press release and can be accessed through our Web site at alaska air.com.

As you've seen by now, Alaska Air Group reported a net loss of 1.7 million for the quarter, or 6 cents per share, compared to a net income of 45.2 million or $1.70 per share in 2003.

This are 3 items that significantly affect the comparison of 2004 to 2003.

Last year's results included the receipt of 71.4 million in government compensation which translated to 44.3 million after tax, or $1.66 per share.

This year's results were affected by two items.

First, an impairment charge which relates primarily to the accelerated retirement of our Boeing 737-200 Com B [PHONETIC] aircraft, which amounted to 37.2 million before tax, 24.7 million after tax, or 92 cents per share.

And second, a credit related to our fuel hedging program of 22.3 million before tax, 14.8 million after tax, or 55 cents per share.

Because of the gap between West Coast jet fuel prices and crude oil has widened in the last three months, the correlation between the two of these has fallen below required thresholds, and we're now required to mark our hedges to market, and record the entire unrealized gain or loss, including the portion which relates to future quarters, in nonoperating income.

So if we exclude all of these items, our net income would have been $8.2 million in 2004, versus $900,000 in 2003, and our earnings per share would have been 31 cents this year, compared to 4 cents in 2003.

Our air group operating revenues were 698.7 million which is up 14.4% from the same period in 2003, on 8.2% capacity growth at Alaska, and 25.1% capacity growth at Horizon, while our operating expenses excluding the impairment charge were 682.1 million which is up 11.8%.

At this point, I would like to turn the call over to Bill Ayer.

Thanks, Brad.

Good morning, everyone and thanks for joining us.

While we're pleased to report a profit, we still have a lot of work to do to reach a satisfactory level of profitability.

A level of profitability that will provide our shareholders a reasonable return on their investment, reduce our vulnerability to the ups and downs of this industry, and enable us to grow on a sustained basis.

On previous calls we've talked about our plan for restructuring the business, and as we look at our situation today, we believe -- we believe that by year end we will be about halfway to our unit cost goal of 7.25 cents, ex fuel.

We've had a great many successes that's are helping to improve our competitiveness and I can't begin to tell you how appreciative I am of our people for their hard work and conceiving and executing these initiatives.

But I would be remiss if I didn't tell you that there is a substantial amount of work ahead of us to reach the 7.25 cent level.

We are keenly aware of the steps being taken by the rest of the industry achieve lower costs and we intend to quickenn the pace of our own efforts.

If you exlude fuel and the 737-200 impairment charge, and, by the way, any subsequent reference we make here to CASM X [PHONETIC] fuel also includes the impairment charge, Alaska had unit costs of 7.98 cents for the quarter, down 4.1% from last year.

This marks the 8th consecutive quarter in which we've hit our target for a year over year reduction in CASM X fuel.

As you know, wages and benefits are the most significant cost for all Americans including Alaska, and for that reason we were happy to see that our productivity increased by 7.1% during the quarter to 134 passengers per FTE per month.

This is the second quarter record for us -- a second quarter record for us and it means that we've now had year over year productivity gains in 9 of the last 10 quarters and we're on pace to reach record levels for the full year in 2004.

We're working hard on executing our plan to achieve CASM X fuel of 8.0 cents this year, and we're putting our plan together now for 2005.

Given our expected capacity in 2005, we need an incremental cost reduction of $169 million and I don't need to tell that you this is a substantial amount of money given our size.

We're going to continue examining our business and operating model and we're looking at all possibilities to streamline and improve our operation.

As we do this, we'll continue to be guided by our twin objectives of running an excellent operation and providing great value to our customers, which to us means to continuing to differentiate in ways that matter to our customers.

I thought it might be helpful to take you through the some of the initiatives that we have under way that will lead us to our goal.

Our companywide supply chain management effort is on target to achieve annualized savings of $30 million by the end of this year, and we're currently developing our 2005 supply chain plan.

We've identified a number of major -- a number of commodity groups that we're working on, and depending on the commodity, we're pursuing various procurement strategies.

Another ongoing effort is the application of lean, or rapid process improvement principles.

Last quarter I mentioned that by using lean principles, we were able to shorten our aircraft turn times which generated enough surplus airplane time for two new daily round trips between Seattle and Chicago.

We're using lean principles to reduce the quality and many other processes as well including our call handling in our red centers, passenger processing at our Seattle ticket counter, and many other areas.

While we're just learning in this area, we are excited about the potential that these tools promise.

Wages and benefits accounted for 38% of our total operating costs last year, and we're targeting about one-third of our cost reductions in this area.

Our objective is to pay our employees competitive wages and benefits.

We think this philosophy is fair to our employees, and will help ensure the company's competitiveness, and therefore the security of our employees' careers and pensions.

We're currently in negotiations with our pilots, as well as most of our other work groups.

If we are unable to reach a negotiated agreement with our pilots, a third party arbitrator will set pay rates and a number of other work rules to market, as it is defined in the contract by May 1 of 2005.

As you all know, the market has changed significantly in the last 3 years.

And it will likely change further in the next year as pay scales and work rules of the major airlines and the low cost carriers converge.

What we don't want to offer specific guidance, we are optimistic we will reach market-based agreements with our work groups over the next several quarters.

As Brad mentioned earlier, we recorded a special charge this quarter related to the accelerated retirement of our fleet of nine 737-200 Com B aircraft.

We plan to retire this fleet by mid 2007.

We also announced our plan to replace these aircraft with five existing 737-400 aircraft, which we plan to modify to carry cargo, and will handle the rest of that Com B [INAUDIBLE] with existing all passenger 737-400s.

Four of the 5 modified aircraft will be converted into combination passenger-cargo airplanes with 70 seats and 4 cargo pallet positions, and 1 will be converted to an all cargo airplane.

While the 737-200s have served Alaska very well over the last 23 years, they have high maintenance costs, high fuel costs, and they don't have a lot of operational commonality with the rest of our 737 fleet.

This change will simplify our operation, significantly improve our schedule reliability, in the small Alaska markets, and lower our unit costs.

In addition it will increase our cargo capacity in Alaska, and this move underscores our commitment to the important markets in the state of Alaska.

We plan to acquire three incremental Boeing 737-800s to backfill the 5 737-400s that will be converted, and we expect to take delivery of 1 of these in 2005, which will bring us to a total of 3 new airplanes, all 800s in 2005 and then 2 in 2006.

All of the 737-800s will be configured with 160 seats, 16 in first class, and 144 in the main cabin.

This means that in addition to the good range in payload characteristics of that airplane, this aircraft for us will have relatively low direct operating costs per seat mile.

As we announced late yesterday, we also plan to reconfigure the seats on our existing 737-400s to increase capacity by 6 seats.

This will increase our system capacity by 240 seats, or about 1.7%.

The reconfiguration of the 400 fleet will begin this fall and completion is expected by mid-November.

We're also going to change to leather seats on all of Alaska's 737 aircraft; our passengers have a clear preference for leather seat covers.

They're easier to clean and because they last longer than than fabric covers we believe they will be lower in cost over the long run.

While we're on the subject of seats, Verizon is also adding an additional row of seats to its Q400 airplanes, so those airplanes will have 74 seats beginning in the fourth quarter.

We continue to evaluate the optimum fleet plan for 2006 and beyond with an eye toward committing to further growth; however, our immediate focus is achieving a cost structure that is fully competitive.

So those are some of our plans for the future and I thought I might briefly share with you some of our recent successes.

We were delighted that for the second year in a row our mileage plan won the Freddy award for the best mileage program in the industry.

And Travel and Leisure Magazine readers recently named Alaska Airlines the best airline among the majors in the domestic category-- again, this year.

And while we pursue our restructuring initiatives, it is essential that we not lose site of the reason we're doing all of this, and that is to offer our customers better value in air travel.

We're gratifyed that our employees continue to find ways to deliver award winning service during these changes.

I might also make a couple of comments about our new simplified fare structure.

As you know, we substantially reduced walk-up fares.

We've eliminated the Friday/Saturday night stay requirement, established a maximum of 6 structural fares in any market with logical gaps between the fares, and we reduced the gap between the highest and lowest fares, from a multiple as high as 10 to 1 in some markets, down to more typically today 3 to 1.

As you might imagine, these changes have been well received by our passengers and our employees who sell them.

On capacity growth of 8.2%, and a 2.5% increase in average stay length, we reported a yield increase for the quarter of 1.2%.

In Horizon, we fully implemented contract flying for Frontier, as Frontier Jet Express, where we earn a predictable profit for each departure.

We now have 9 CRJs dedicated to Frontier, which for the quarter accounted for approximately 22.5% of Horizon's capacity.

We also continue to harmonize flying between Alaska and Horizon, with goal of optimizing air group profitability by putting the right aircraft in the right market.

And Jeff will get into the details of Horizon's performance in a few minutes.

At this point, I would like to turn the call back over to Brad to discuss some of Alaska's P&L adds.

Thanks, Bill.

As you've seen, Alaska reported a pre-tax lot of 2.8 million in the second quarter versus a pre-tax profit of 59.6 million last year.

Excluding the unusual items we mentioned at the outset, we've produced a pre-tax profit of 14.4 million this year, versus a profit of 6.8 million last year.

So we are showing some improvement year over year as a result of the relatively stable revenue environment, and continued progress on our transformation initiatives.

Both of these are offset by significantly higher fuel expense.

On 8.2% ASM growth, our operating revenues increased 13.1%, and our operating costs, excluding the impairment charge, increase 11.3%.

As has been the case in recent quarters, the majority of our ASM growth continues to be in the transcon and mountain regions.

This flying represented 16% of our capacity in the second quarter of '04, compared with just 10% during last year's quarter.

On the capacity increase, we produced an increase in passenger revenue of 12.9%.

The difference between between the capacity growth and the revenue growth is due to a two-point increase in the load factor and the 1.2% increase in yield.

Our passenger revenue increase of 12.9% compares with an industry increase of 7.8%, on fairly similar capacity increases for Alaska and the industry.

Load factors increased to nearly all of our major markets except the transcon and mountain regions, where they were off slightly is due to the large capacity increases.

As we look forward, our advanced bookings for the summer look reasonably strong.

We are gratified by the success we've seen increasing load factors on top of the significant capacity growth.

At the same time, we see some upside for Alaska Airlines as our load factors have room to move up by at least a couple points before they reach industry averages.

On the cost side, our operating expenses increased by 94 million or 18.6%, excluding fuel and the impairment charge, our operating costs increased by 16.6 million, or 3.8%.

At the beginning of the call, we mentioned that effective at the beginning of the second quarter, we lost hedge accounting, or in other words, the ability to defer recognition of any unrealized gain or loss on our fuel hedge contracts, until the hedge fuel is consumed.

We lost this accounting because the correlation between crude oil, the commodity we've historically used to hedge, and West Coast jet fuel, fell below required thresholds.

The implications of this going forward are twofold.

First, we will have more volatile earnings as we mark our entire hedge portfolio to market each quarter, and report the gain or loss in other nonoperating income or expense.

And second, to an increasing extent, the benefits of our fuel hedge program will not be reflected in fuel expense.

The way we think about this is as follows: We had unrealized gains on our balance sheet of 26.5 million dollars at March 31, '04, and that is the extent of the amount that will ultimately be reflected in fuel expense.

As we move forward, to the extent that we are consuming that fuel, we will -- that -- that 26.5 million will roll out in the fuel expense, but any subsequent gain or loss in the portfolio, including those positions or new positions, will be reflected in other nonoperating income.

To help use our financial statements we will start to provide information on market-to-market gains or losses, as well as calculations of our economic fuel cost per gallon and raw fuel cost per gallon in our 8-Ks and other communications.

We provided a table as an attachment to our press release that we will hope will help you sort the information out for this quarter.

While we're taking a gain or loss this quarter because the backdrop of rising fuel prices, the new accounting does make it more difficult to work with our financial statements.

While we still believe in the merits of our fuel hedging program, and while the basic economics of our hedges are unchanged, we are evaluating the program and in particular, the hedge commodities we use to determine if cost effective changes can be made to improve our correlation in the future.

We recognize that this may be confusing, if any of you have questions on the subject, further questions on the subject, we will be happy to address them during the Q&A portion.

Before we move on to another area, I might quickly mention that our hedge positions going forward are as follows.

The third quarter of this year, we're 40% hedged at 29.30 per barrel.

The fourth quarter, we are 50% hedged at $30.39 per barrel. 2005, we're 48% hedged at 29.20 per barrel.

And for 2006, we're 15% hedged at 31.24 per barrel.

With crude oil prices above $40 a barrel these will obviously provide good protection for the company in the quarters ahead.

Looking at some of Alaska's other line items this quarter, wages and benefits increased by 11.7 million or 6.1%. 7.5 million of this is due to an increase in wages, primarily wage rates, and 4.3 million is due to an increase in benefit costs.

Health care and pension costs continue to grow, but a at a slower pace than last year, increasing by 1.5 million each this quarter.

Of the overall wage increase, approximately half relates to a 4% contractual increase for our pilots, that took effect May 1.

Contract services increased 9.7 million, or 49%, the vast majority of which is due to new contract relationships for service to Dutch Harbor, Alaska and for a mail contract for service of flying mail to and within the state of Alaska.

We're still planning on about 6.5% ASM growth for 2004, which breaks down to 5% growth in the third quarter and 4% growth in the fourth quarter, and I think all of that is unchanged from what we shared last call.

Going forward, our guidance for CASM X fuel is as follows: For the third quarter we're estimating 7.6 cents, and last quarter we were estimating 7.5 cents.

And for the fourth quarter, we are estimating 8.1 cents, and last quarter, I think we had estimated 8.0 cents.

These numbers would result in full-year CASM X fuel of 8.08 cents, which is 8 bits above our target of 8.0 cents.

Approximately 2 basis points of the difference is due to the southeast Alaska mail contract, which was not in our plan at the beginning of the year.

This added flying generates expenses but no ASMs because the subcontractor does the flying.

The remaining 6 basis points of CASM over target is equivalent to approximately $13 million and we're hard at work on bringing that down.

We also want to note that as part of our overall long term cost reduction efforts, we're contemplating some business changes which may have short term negative CASM impacts, but significant long term economic benefits.

An example would be entering into a maintenance agreement, where we pay for overall repairs based on hourly usage rather than paying for each event as it occurs.

If we were to consummate agreements like that this significantly impact our finances, we would update you on our monthly 8-K filings.

As you know, our CASM goal for 2005 is 7.25 cents so by the end of this year we hope to be roughly halfway toward that goal.

While we're very encouraged by the success we've had to date, as Bill said we're fully focused on doing the things we need to do now to position us for success in the years ahead.

I will turn the call over to Jeff.

Thank you, Brad and good day, everybody.

As you've seen by now, Horizon achieved a $4.7 million pre-tax profit for the quarter, excluding a small F28 impairment charge, and $2.7 million market-to-market fuel hedging gain, as referenced by Brad, our pre-tax profit would have been $2.4 million, still a significant improvement over the $2.9 million loss we had last year, or that we would have had during the same period last year, had it not been for the nearly $19 million of government compensation we received.

For the quarter, our revenues were up 12.6%, and our operating expenses were higher by 7.4%, all on a 25.1% increase in capacity.

Traffic increased nearly 34% for the period, leading to a record second quarter load factor of 67.5%.

In June, for the first time in our history, we carried more than a half a million passengers in a single month.

On a unit basis, our RASM fell 9.9% but our CASM X fuel and X impairment declined more sharply by 17.2%, to a 13.4 cent level, nearly 3 cents lower than last year, and slightly better than the guidance we provided in our last 8-K.

Now, as you absorb these numbers, keep in mind that our first year of Frontier Jet Express service is a key driver of the significant year over year variances you're seeing.

Our agreement is typical of other fee-based arrangements, in that it relieves us of exposure to certain expenses such as fuel, station labor, and airport charges, while providing a guaranteed base margin plus incentives.

The structure of the agreement, coupled with the longer haul nature of the contract flying, results in increases in capacity that outpace the growth of revenue and expense, leading to unit costs and unit revenues that are considerably lower than our own native networks.

For the second quarter, our Frontier Jet Express product line accounted for 22.5% of our total capacity, as Bill mentioned, up 16% from the first quarter.

It also accounted for 24.7% of our traffic, and 9.6% of our total passenger revenue.

By the end of May, we were operating at our mature commitment level of 9 CRJs and so for the rest of the year, Jet Express will account for 23% of our total capacity.

On our native network, our load factor was 2.4 points higher, on 3% fewer ASMs than in 2003.

Yield was also higher, by nearly 2%.

Together, they accounted for a passenger revenue increase of 2.6%, which builds on our 4.5% increase in the first quarter.

Several factors are contributing to the improvement in yield, including a lower level of fair sale activity this year as compared to last, when we were trying to stimulate traffic following the Iraq war.

In addition, trip length is lower by 3% because we reallocated some of our longer haul CRJ aircraft to Jet Express, and I should note that in this quarter we extended our common sense fare simplification program to all flying to and from Montana.

We are now applying this approach in 80 % of our network, all without any material unit revenue dilution.

Turning to expenses, total operating costs increased by 7.4%, driven primarily by fuel, which was up an astonishingly 39.1% over last year, on 6.9% less usage, and a 52% increase in the average cost per gallon, net of all currently settled fuel hedges.

In fact, [INAUDIBLE], let me take you through the detail on a couple of the more significant expense categories.

First, wages and benefits were higher by 1% or $400,000 on a 2.2% increase in FTEs, an increase of 4% in the average wage, and a 2.4% decrease in employment taxes and benefit costs.

The reduction in benefit costs is due to a lower level of medical claim activity, and a slight increase in employee contribution.

Maintenance expenses were up $2.1 million or 28.8%, due to an increase in block hours, less aircrafts covered by warranty, and a higher number of heavy check and engine overhauls on the Q200 fleet.

On the product front, our people did a fabulous job of caring for our customers with excellent reliability and on time performance.

For the quarter, we recorded a 99% schedule reliability rating on our native network, which was shietly better than last year, and a 91.8% rating for flights departing within 15 minutes of schedule.

That's on time performance.

In both case, we remained well above our own internal targets and in the top tier of carriers nationwide.

Separately our Frontier Jet Express team also did an exceptional job in these areas.

Another core promise category that we watch very closely is baggage handling, and in this one our people continued to perform at industry leading levels, having ranked either number 1 or number 2 in the country in every month except January, the month of the great Northwest ice storm.

By maintaining a high level of performance we've continued to reduce passenger inconvenience charges, which on a unit basis were 18.7% lower than last year.

All of this is not been lost on our customers, as reflected in our just having been named Travel and Leisure Magazine's prestigious "Best in the World" list of top 10 domestic airlines.

In our first showing, Horizon Air placed seventh in the nation and that's something we're very proud of.

We continue to maybe good headway on process improvement with employee productivity as measured by passengers per FTE, which was up 19.2% over last year to 143 passengers per FTE.

While a portion of this improvement is due to the nature of the Jet Express and our arrangement with them, within our own system, productivity was 8% higher than the prior year, thanks to constant attention to cost control, process improvements, and prior investments in technology.

Our capacity growth of 25.1% was 1.1 points higher than the guidance we provided on the last call, due to higher-than-expected utilization of our Frontier Jet Express CRJ 700s.

Our guideance now for the next two quarters is as follows: In the third quarter, we are looking at 17% increase in capacity, unchanged from the last call.

As of the fourth quarter, 24%, which compares to 26% on the last call.

For the full year, we are still projecting a 20% increase in ASMs.

Looking ahead, we continue to project CASM X fuel for the year to be 14.1 cents.

However, we are increasing our estimates for the next two quarters based on a lower level of flying at Frontier, that will be partially offset by the addition of the Q 400 #18 to our fleet, which just joined us here about 10 days ago.

By quarter, we are forecasting CASM X fuel, including Frontier Jet Express, to be 13.5 cents for the third quarter, and that compares to 13.3 cents on the last call, and 14.5 cents for the fourth quarter, which compares to 14 cents on the last call.

I will now turn the call back to Brad for discussion about the Alaska Air Group balance sheet.

Thanks Jeff.

We ended the quarter with $865 million in cash and marketable securities compared to $812 million at the end of 2003.

Some of the activity-- this reflects a receipt of $43 million in 2002 tax refund, the receipt of 94 million from aircraft financings, cash flows from operations of 186 million, a pay down of $110 million on our line of credit, and cap ex of 84 million.

At this stage, we have now financed all of the 737-700s and 900s we've taken delivery of in the last five years.

For the full year, we're projecting capital expenditures of approximately $235 million, which is low by historical standards.

Air Group has no further aircraft deliveries scheduled for 2004.

Our adjusted debt to cap ratio adjusted for operating leases is 79% as of June 30, and that's 2% higher than at the end of 2003.

At this point, I would turn the call back to Bill for some closing comments.

Thanks, Brad.

I would just like to close by reiterating our conviction to succeed in this marketplace.

This company has a long history of outperforming the industry, and we intend to keep that record intact.

You all know our goals.

We made good progress in consistently managing our costs down and improving our overall competitiveness.

We build a preferred brand because of our outstanding employees.

But the cost gap between where we stand today, and where we need to be, is still substantial.

Our people are fully engaged in this transformation.

And we're committed to doing the necessary things to ensure our long-term future.

At this point, we would like to open the call up for your questions and we have a number of folks here to help address them.

Your first question is from Gary Chase with Lehman Brothers.

Brad, I'm going to go ahead and apologize in advance for this one, but could you walk us back through the hedging change?

It sounded like you had 26.5 million in accrued gains on the balance sheet at the beginning of the quarter -- or the end of the first quarter, and you were going to prorate those with consumption through the remainder of the year.

But then the rest of your consumption will float with the market and you will book further hedge gains in other nonop?

Is that --

I will ask our controller Branden Peterson to jump in, but basically what happens is all of the hedge activity through March 31, 2004 still qualifies for hedge accounting.

So we had $26.5 million on the balance sheet, and that -- the gains or losses on that is deferred, and as that fuel that was hedged rolls through, and that will happen over the next two year, that 26.5 million will be reflected in fuel expense as it has been historically.

Anything that happens subsequent to March 31 of '04, any change in gain or loss -- change in value of those contracts, or any new contracts we put on, all of that activity will be reflected in other nonoperating income or expense.

Did that help, Gary?

Yeah, it does.

It was a little confusing because I wasn't sure if your existing contracts would be mark-to-market that way.

But --

It is only the change -- they're all mark-to-market.

But the change in value from March 31 of '04 goes to other nonoperating income.

Okay.

Thanks.

Sorry for making you walk through that again.

Bill --

My pleasure.

He needs the practice.

Hey, Bill, you mentioned, you know, having an eye towards growth.

I forgot the exact language you used.

You know, I think in the same sentence, you know, you noted that part and parcel to that was making sure that you had the right cost structure in place.

Can you comment on whether or not, you know, in other words, is growth contingent on, that and is that part of the discussions that you're now having with your employee groups?

I think, you know, from an economic perspective, growth needs to be contingent on that.

You can't grow a company that is not profitable.

And you know, you can work through all the numbers and the cash flow and the debt levels and all of that, and basically, you know, you need profitability to fund growth and that is true of any business in America.

So we have, I think, our priorities right here.

We have really good growth opportunities, down the road.

And we want to get to those as soon as we can, but we're disciplining ourselves to recognize the brutal facts of this business model, and fix that first, and then engage in the growth.

So it is a matter of focus and priority.

And I'm very confident that we are going to achieve these cost goals and once we do that we will be back in the growth business.

Okay.

And sorry, we got chopped off at the beginning of the call-- I don't know if Gregg is in the room but I just wanted to get the -- have you walk through the rationale for the additional fee, you know, continue to just take us through what the thinking is there, and --

Sure.

A couple of things.

Our objective here was to try and find a way -- with the low fares and our common sense fare restructuring, we're seeing a lot more demand in the in all of the buckets.

And we are operating at record high load factors for Alaska Airlines.

There is an opportunity for us to satisfy more of the demand that is coming our way, by adding more seats, while at the same time being careful not to deteriorate the customer experience, and so we're accomplishing the addition of seats on our 400 fleet, 737- 400 fleet, by removing closets at the back of the aircraft.

So we're making a trade-off here in exchanging real estate that wasn't generating revenue for real estate that will now generate revenue, without deteriorating the customer experience.

We think that is a good tradeoff.

And we're looking at the rest of the fleet to see if there are similar opportunities, and initial observations really are that there may be a similiar opportunity on our 737 fleet but we haven't seen the same opportunity across the entire fleet.

Okay.

So no change to pitch or anything of that nature, and no reduction in your first class cabin?

No reduction in the first class cabin.

And you know, the pitch changes dependent on row.

You know, and some case, the rows will go -- some rows will gain an inch of pitch, and some rows will lose an inch of pitch.

And there will be slightly more rows with one-inch less pitch.

You know, the way the aircraft is built there are fixed points with emergency exits over the wing so your play is limited by the fixed point of the wing.

Okay.

That's all I have.

Thanks a lot, guys.

Thanks, Gary.

Your next question is from Jim Higgins with Credit Suisse First Boston.

Yes, hi.

Gary actually got my major question, but it looks like Frontier has eliminated I believe Denver- Ontario, California service and I was just wondering does that say anything about the nature of the relationship?

Are there any implications there?

Or is it just a one-off?

Yeah, this is Jeff, Jim.

I think what we're seeing is, you know, just the growing maturity of the relationship here.

They're learning about the proper allocation of RJs and airbuses and Boeings, they're still working through the absorption of airbuses and the retirement of Boeings as well so they're in flux an awful lot.

And I think our sense is that, you know, there is some experimentation going on and they're taking action based on the early learnings here; they've announced RJ service beginning in October to Little Rock, for example, so there is some reallocation of capacity in search of things that work well.

Second, separate issue, do you have any data to share on -- this is related to the changes in the fare structure, on perhaps what -- I don't know how you want to look at it, proportion of revenues that are coming from your new top tier buckets as opposed to the amount that came from the former buckets?

Just trying to get a sense of what -- of how this new fare structure is affecting your aggregate mix.

Obviously, the year over year comps are really difficult-- [INAUDIBLE]

Sure.

Because of the simplification we've gone from an average of 12 buckets in most markets to an average of six.

So as we look at the percent that comes from the upper buckets, it is actually quite different year over year.

What I can tell you is in general, we're seeing a migration to the mid and upper buckets from the lowest buckets, so the percentage of traffic in our very lowest bucket is down year over year and conversely we're seeing a higher percentage of traffic in our upper buckets year over year.

And specifically if I look at the top four buckets which may have historically been defined as business demand, we are seeing an increase of 3 points of traffic in the upper 4 buckets to 40% year over year from 37.

But what I can also tell you is that we are seeing revenue in those buckets down about 1 point so I will remind that you the math works that way because we dropped our walkup fares in most markets by up to 30%.

So [INAUDIBLE] As Brad announced, our RPM yield for the quarter was up 1.2 points for the quarter, and so I think my comments -- our last conference, [INAUDIBLE] we consider this a success if we go up to revenue [INAUDIBLE] and that's about where we are.

Okay.

Great.

Thank you very much.

Your next question is from Helene Becker with the Benchmark Company.

Thank you very much operator.

Hi, gentlemen.

Good morning.

Could you just talk a little bit about the balance sheet in terms of principal repayments, for the rest of this year, and then could you just remind us if your pension contributions now are all caught up, and where you stand with that?

Helene, this is Brad I might ask Amber [INAUDIBLE] to help me with that.

Okay.

Hi, Helene.

We will have our pension contributions completed by September.

Everything that we plan to contribute this year, which is approximately 49 million, and we're doing that [INAUDIBLE] over the year.

As far as debt repayment, our credit facility expires this year, and we anticipate having that fully paid down by the end of the year.

We have an additional 40 million remaining on that amount.

And as far as other debt payments, approximately 48 million for this year.

Yeah, our basic debt repayments are about 50 million a year.

Right, Amber?

Correct.

It was considerably high this year with the termination of the credit facility, but we paid down $110 million of that already.

Okay.

And then Brad, what did you say cap ex was year to date?

We are -- it is -- I think 84 million year to date.

We're expecting 235 million for the full year.

Right.

Okay.

And then I thought I heard you say that bookings for July and August looked okay, but did you say something about September?

Yeah, maybe I will jump in, Helene.

We are seeing very strong demand across the summer including the month of September but remind everybody that September has been very much price motivated by aggressive fare sales which were launched already two weeks ago.

So we're sort of holding our breath on revenue for September.

I think we share the concern that's been voiced across the industry that there is a lot of increased demand year over year chasing traffic, which is price motivated.

Okay.

Thank you.

Your next question is from Peter Jacobs with Reagan MacKenzie.

Hi, good morning, gentlemen.

I guess the first question would be what row of seat does I want to book to get that extra inch?

Anything before the window exit.

And just along those lines, with the reduction of those seats, with an inch of pitch, where would that put you relative to your competitors for those customers that will lose out on that?

You know, our average across the fleet is 32 inches in pitch, and our average will continue to be 32.

But where we lose an inch was rows will shrink to 31 and where we're gaining an inch most of those rows go to 33.

How you would put that in Southwest and United, your main competitors across up and down the West Coast.

You know it's really variable across the [INAUDIBLE] types; what I can tell you on the 737-700s for example, our pitch is 32 and 33 inches, and Continental is at 31.

Okay.

And our rows on that same aircraft type will shrink to 31, will be competitive in those few rows that shrink to 31 with Continental and we'll still have a more generous pitch in other rows.

Secondly Brad, can you give us an update on what you're currently paying for fuel, please?

$1.34 is the raw price and I think systemwide the hedges are worth 8 or 9 cents a gallon.

Ok, so, If I recall, you had been up north of $1.40 not too long ago so that is actually a little bit of an improvement.

Yeah, this whole West Coast [INAUDIBLE] thing has been a huge issue for us.

It was as wide as 29 cents in May and it's come in considerably, so, while crude oil prices are still very high, our end of plane costs have come down a bit from the [INAUDIBLE].

I think it is roughly 10 cents.

Where would you put that spread at right now? ("I think it is roughly 10 cents") Okay.

And when we look at -- let's see here, price competition on the -- on the West Coast, how severe do you see that being right now for the late summer time period?

I would say that fare levels are about where they were last year for the fall at this point in time.

So it is just a question of what percentage of the capacity is going to be available for lower bucket demand.

It's not that the prices themselves have fallen dramatically from where they were a year ago, but our sense is that there is a great ever percentage of total inventory flying with the lower bucket availability so the mix will be deteriorating.

Okay.

And lastly, just a personal experience, I recently booked flights to both Dallas and Minneapolis, and I was pretty much floored by the prices that American can get for a Seattle to Dallas flight, and Northwest, which basically owns the market between Seattle and Minneapolis, and I can recognize those are your partners, but it would seem to me, those would be pretty ripe markets for somebody hike you to move into, and offer, you know, more reasonable fares.

What would -- What would be your comments on that and what are the obstacles for entering service there?

You know, if we see an opportunity there is nothing preventing us from going after it.

We partner with Continental.

We fly to Newark.

They were already in the market from Seattle to Newark.

We are in Chicago now.

American, our partner, is in Chicago.

So over time, those opportunities, as we see those opportunities, you know, we feel free to pursue them.

We haven't got any plans right now for Dallas and Minneapolis service.

Okay.

Thanks.

And that's all my questions for now.

Peter, I might just add one thing on the seat question, a scenario we are very sensitive to and seating comfort is important to customers.

Our surveys of our customers rate us very, very highly on seat comfort, and so, you know, we want to maintain that rating but we do have -- we do enjoy a nice gap among our customers over competitors on this.

That is something that I see a very much of a value proposition that Alaska has as a customer of the airline, and it is something that I would be concerned that you would lose that appeal because that is an appeal of flying Alaska.

Right and we think we can maintain that even with this change.

Okay.

Great.

Peter, I might just jump in we really appreciate your comments on the fare structure and the value that Alaska offers.

We talked a lot about that.

That is the central theme to the plan for the future of the company-- is to offer that really compelling value to our passengers, and to keep that part of the value equation and we think that really helps our growth prospects going forward, so we appreciate your observation there.

Your next question is from Ray Neidl with Blaylock & Partners.

I was just wondering if you guys did go into Minneapolis or Detroit, that would be a good way of alienating Northwest as your partner I guess.

Yeah, we didn't alienate Continental when we went to Newark, so I think, you know, as long as each partner continues to bring value to the partnership, those things are manageable.

Okay.

Is Delta doing to be a partner pretty soon?

I don't know.

Okay.

Hey, Brad, you gave the fuel hedges, you went through that really quick I didn't get them all, but it sounded like you had some pretty cheap hedges in there at a big percentage.

I'm just wondering late in the game how did you get -- how did you do so well?

Well, our strategy is to buy a little farther out.

We buy starting 24 months in conception, 24 months in advance of conception and we try to get to our desired position with 50% 12 months in advance of consumption, so you are buying on the flatter part of the curve and let me just find those figures.

Against it was 29, and 30 dollars in the third and fourth quarter of this year; 29 dollars for next year and that is for 48% of our consumption and $3 1 a barrel in 2006 for 15% of our consumption.

We are going to provide a little bit more detail on our next 8-K, and you will kind of see the next 4 or 5 quarters are 50% hedged and then we are going to go -- you will see it going down 10% per quarter, so we are down to 40, 30, 20, 10 in the successive quarters.

Very good hedges.

Congratulations on that.

The last question is, I know you can't talk about what you're doing with your labor unions and trying to get your costs down in detail, but in the case of Delta, they're telling me outside of the pouch group, they can get a lot of cost cuting to automating a lot of jobs, Delta claims that, you know, they're one of the leaders of automation and I know Alaska is as well.

Is that part of the game plan to get your costs down is to start automating a lot of the ground handling jobs?

Well, Ray, this is Bill.

Automation, use of technology, has been a central part of our plan from way back.

And the intent of it, the reason to automate is not to replace jobs directly, it is to do these tasks more efficiently, so for a customer, you know, for the customers and for ourselves, and deploy our people in their highest value endeavors.

And so you look back at what we've done with the kiosks at the airports, for example, and we really led the industry on that whole initiative, the self service check-in, and what we were able to do is to grow the airline and redeploy people, you know, and not eliminate jobs in the process.

And that would always be our intent with technology.

Sometimes it is a little bit lumpy that way, but what you want to be able to do is roll out technology and hopefully if you've got the right cost structure, take advantage of growth opportunities and so your growth into the future is more efficient in terms of people.

That's our intent.

And we're continuing to work the airport of the future, we just opened a brand new terminal in Anchorage, and with all of the -- you know, the limitation for us has been most recently has not been the technology, it has been the geography of the airports, it has been the infrastructure, the physical buildings, and with this terminal in Anchorage we were able to get involved in the very early phases of planning of that so we actually built the physical space to accommodate our technology and it makes it very, very efficient-- very seamless for the customer and more efficient in terms of our operation and we look forward to doing more of that and continuing to maintain a leadership role in the industry in terms of this whole airport processing-- making it easier for customer, making it easier for our employees.

We ought to do an atlas trip up there to see a new terminal before Labor Day, though.

Good idea.

Hey, one last thing.

It is not a big part of your system, but are you involved with the transcon price wars at all?

I don't know how you can fly transcon and not be.

What we saw in the second quarter was 5% reduction year over year in our transcon RASM, and half of that drop was driven really by a drop in load factor, which was a function of our 75% increase in capacity on the transcon.

And the other half was due to a slightly lower ticket price, part of which was, you know, a change in the mix, 130% increase in the ASMs to Florida year over year, and those Florida yields have a lower average yield than the transcon business market.

A bit of a long answer to say absolutely we're in the same transcon mess as the rest of the industry are, fares are very low and they are not strengthening.

We have 900s on a lot of those routes now, so overall we have a 75% increase in capacity, and a 5% reduction in CASM which is a lot less than some of our other competitors have talked about.

Great, thanks a lot.

Your final question is from Susan Donofrio with Fulcrum Global Parters.

Hi, everyone.

Two questions for you-- one is on the labor side.

I'm just trying to think of, you know, you're trying to get a market-based agreement, and you know, the market is, you know, clearly moving, as well.

I'm just wondering, if when you get an agreement, and the market moves; there any type of trigger that would reopen a agreement?

Or when it it is done, it is done?

Well pretty much when it's done, it is done, although it would certainly be interesting in talking about the other idea.

And generally speaking of labor, history is a good guide here and over time economic forces drive to you market, and that's been the case throughout history and our industry and we've got examples moving up and examples moving down.

And the market today, we think is becoming reasonably clear, and it is likely to become even clearer over the coming months.

And we're just looking forward to getting back to the market rates because as I said earlier, that's our philosophy.

We think that allows us to attract and retain really good people.

It allows the company full competitiveness on the cost side.

And it is the natural order of things anyway.

And I'm sure we're going to get there.

Great.

My other question is, if you look at the news, it looks like the headlines are increasing with respect to another potential attack on aircraft.

And I'm just wondering your thoughts as to whether you think that passengers are becoming immune from the headline noise, you know, with respect to bookings, or are you seeing any impact on bookings?

I don't think we've seen anything that we can trace back to passenger nervousness about flying.

I haven't sensed anything or heard anything.

Greg?

No, and I look at our forward bookings, and the demand is as strong as ever, so--

I think what is important, and I think the TSA is doing an increasingly better job of managing the staffing, to -- for the peak, at least where we fly.

That is not true all the way across the country, I understand but in our bigger airports, they've been quite responsive.

We give them, you know, daily forecast, of demand, by hour, even, and so they've been getting better at staffing, and when I talk to frequent fliers, it is not the fear part of it, is the how can I plan, I'm a business traveler I need to be somewhere on time I don't want to spend two hours at the airport, and you know, when 90% of the time it works really well and 10% of the time you end up missing your flight, that tends to make people nervous about the whole prospect.

So the consistency on TSA processing is really important.

Horizon has had a lot of success with this guarantee on the shuttle market because that is particularly sensitive for the short haul business markets, and Jeff you paid out very few on that because the processing has been good and the express lanes and so forth that we have.

So generally we've been I think reasonably pleased with TSA's performance out here.

Great.

Thank you very much.

I do apologize, your final question will be from Michael Linenberg with Merrill Lynch.

Yeah, hi, I guess just two quick questions.

Bill, were you talking about the pilot agreement.

And I think in May of '05, there is -- you would run into, or there is a part of it that has an arbitration clause or where it would go to arbitration.

Do you have that feature in any of your other labor agreements?

I don't believe we do.

Yeah, we had -- some in other areas over time but we don't at this point.

Pilots is the only one.

Okay.

Then just I guess a follow-up to some of the comments made by Greg.

You talked about the transcons, and you know, how they perform, can you just give us some color on some of your other major markets, you know, how things evolved over the quarter?

What they were versus a year ago?

It was actually pretty flat across most of the markets.

You know, we saw strength, big increases in Canada, and Mexico and Canada obviously driven mostly by the reduction in the-- or the strengthening of the Canadian dollar, so we had a foreign exchange benefit to all of the tickets we sold in Canada, so we saw very nice increases in ticket price out of Canada.

Strong demand in Mexico.

That's largely a function of there being less fare sale activity year over year.

And then pretty much flat across the board for every other region.

No big increases, no big reductions.

Greg, does -- you know, some of the new service that's being announced by West Jet, where I know they're going to be flying out of Calgary and Vancouver, I think there are some markets where they will overlap with either you or Horizon along the West Coast; that -- obviously it is something you're watching closely, but is that something where you could start seeing some pressure on those fares?

I think we do expect that.

Certainly they've launched with some very, very aggressive introductory pricing.

Which is maybe 50% lower than what we've seen.

But that is for a very limited window.

It is about a 30-day offer.

And then they've matched our prices beyond that.

So at least at this point it looks like they are not trying to make it on a price play.

They are going to try and draw traffic through the strength of their brand.

And their point of sale in Canada.

Okay.

Thank you very much.

You have a follow-up question from Peter Jacobs with Reagan MacKenzie.

One last question, gentlemen, please.

Brad or Bill, could you just review some of the highlights of how the arbitration agreement works?

If I recall, it is a combination of some of the major hub and spokes, as well as some low cost carriers, and if you could mention kind of what basket of airlines that you would compare the pilot wage rates with, but also, I believe in the past, you've mentioned that you thought that the pilots' total wages would need to come down about, I think it was 15% to get to what you would consider market.

Does that still stand?

A couple of things.

The first part, there are two different benchmarks in the arbitration agreement.

One for wage rates, and one for work rules and I think the wage rate, the language is something like wage rates to be determined with reference to 8 major airlines plus significant competitors, or something like that.

And then in addition to that, each side can bring up to five other items before the arbitrator, and I think that -- by an average of major airlines, George? --

Yeah.

So that is kind of the benchmark that we use.

In terms of what the number that we would expect, I think what -- as we said in the [INAUDIBLE]-- we don't want to offer specific guidance on our expectation with that.

I think our observation might be is that the market has come down since we've last shared information about this, and our expectation is that it might come down further in the next 12 months.

Okay.

Thanks.

And good luck on reaching an agreement.

I think that would be received positively.

Yup.

You're right, Peter, thanks.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers.

Mr. Tilden, are there any closing remarks?

No, ma'am, thank.

Thank you for your participation and see you next quarter.

That concludes today's conference call.