阿拉斯加航空 (ALK) 2004 Q3 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Alaska Air Group third quarter 2004 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.

During the Q&A session today, participants will be allowed to ask 1 question and 1 follow-up question.

As a reminder, today's conference call is being recorded and will be available for playback on the investor relations site at alaska-air.com.

Thank you.

Mr. Tilden, you may begin your conference.

Thank you, Cynthia and good morning, everyone.

Thank you for joining us for our third quarter 2004 conference call.

Before we get started, I would like to introduce a number of folks here with us today, including our Chairman and CEO, Bill Ayer;

Horizon Air CEO, Jeff Pinneo;

EVP Operations, George Bagley;

EVP Marketing and Planning, Gregg Saretsky;

Treasurer, Glenn Johnson;

Controller, Brandon Peterson; and Horizon Air VP Finance, Rudy Schmidt.

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

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

In addition, to the extent this call includes non-GAAP financial measures, a reconciliation of the differences between the GAAP and non-GAAP measures appears in our press release that can be accessed through our website at alaska-air.com.

As you've seen by now, Alaska Air Group reported net income of 79.2 million for the quarter, or $2.94 per share, compared to net income of 40.7 million or $1.52 per share in 2003.

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

First, this quarter's results include a special charge related to the restructuring initiatives we announced in late August and early September, that amounted to 27.5 million before tax, 15.8 million after tax, or 59 cents per share.

Second, like last quarter, this quarter's results include mark to market fuel hedging gains which reflect the increase in the value of the Company's hedge portfolio during the quarter.

These amounted to 57.2 million before tax, 32.8 million after tax, or $1.22 per share.

These amounts are net of the gains realized on contracts which settled during the quarter.

Finally, this quarter's results include the recovery of certain disputed Mexico navigation fees, which were originally paid in 2002 and 2003, that amounted to 11 million before tax, 6.3 million after tax, or 23 cents per share.

Excluding these items, our net income was 55.9 million, or $2.08 per share, in the third quarter versus 40.7 million, or $1.52 per share in 2003.

For the 9 months ended September 30th, Air Group's net income was 34.8 million, or $1.29 per share, compared to 29.6 million or $1.11 per share in 2003.

If you exclude the unusual items we just mentioned, as well as those recorded in the first and second quarters of 2003 and 2004, our net income was 24.7 million or 92 cents per share for the first 9 months of this year, compared to a loss of 14.7 million or 55 cents per share in 2003.

There is a table attached to our earnings release that will help you reconcile these figures to our GAAP results.

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

Thanks, Brad, and good morning.

Again, excluding the unusual items, Alaska Air Group had net income of $55.9 million or $2.08 per share, compared with net income of $40.7 million, or $1.52 per share in 2003.

We are pleased with our profit improvement over last year's third quarter and with the progress we are making on restructuring initiatives.

At Alaska Airlines, unit revenues were up 3.7 percent, while unit costs excluding fuel and unusual items were down 6 percent from last year.

This is the biggest year-over-year reduction in unit costs we have seen since we started our cost reduction program following 9/11, and we are now confident that we will realize our full year unit cost, ex-fuel, objective of 8 cents for 2004.

Those of you that follow us, know that we have a very seasonal business.

Perhaps the most seasonal of any of the major airlines, given our flying in the state of Alaska, where revenues essentially double in the summer months.

Alaska's third quarter profitability is really driven by our results in July and August.

In fact, we often lose money in September, and this year was no different after factoring out the unusual items.

So, while we are encouraged by the profit we reported for the third quarter, we are very much aware that we still have a substantial amount of work ahead of us to produce a reasonable level of full year profits.

Given the losses we produced in the first 6 months of the year, and our expected loss in the fourth quarter, we currently believe that we will produce results for the full year that are essentially break even, or perhaps a small loss, excluding the unusual items.

We talked on these calls about our Vision for 2010, which is our plan to get the Company to produce an appropriate level of profits, on a consistent basis.

Our target is an average 10 percent pre-tax profit margin over the business cycle.

We believe that this level of profitability will provide secure careers and retirements for our employees, excellent value for our customers, and reasonable returns to our shareholders.

A central component of our 2010 strategy is our plan to reduce costs to a competitive level.

Our goal at this stage, is to get our unit costs, excluding fuel, down to 7.25 cents on a full year basis.

We are aware of the significant cost reductions our competitors are realizing, and it is possible that 7.25 cents may not ultimately be low enough, but that is the target that we've set for ourselves.

We have now had 9 consecutive quarters of year-over-year reductions in unit costs, and we've achieved productivity improvements in 10 of the last 11 quarters.

We have increased the momentum and we have a real sense of urgency as we pursue our transformation initiatives to achieve our goal of 7.25 cents for next year.

Let me briefly review some of the new initiatives that we are pursuing to achieve the remaining portion of our goal, which in dollar terms amounts to about $170 million.

We announced a management reorganization in late August, and on September 9th we announced the closure of our Oakland maintenance base, as well as the contracting out of our Fleet Service and Ground Support Equipment Maintenance functions.

In total, these moves will result in a reduction of our head count of 900 positions, or around 8 percent.

As you know, we have taken pride in the fact that we haven't had any broad-based layoffs since 9/11, and in fact there have been none in the last 12 or 13 years.

However, we reached the conclusion that it was essential that we take these difficult actions to secure the future of Alaska Airlines and Horizon Air for our more than 13,000 remaining employees.

We expect the savings from these job-related initiatives to be approximately $35 million per year.

We continue to pursue the restructuring of Alaska Airlines labor agreements so that they are in line with market.

We are now, or soon will be, in negotiations with all of Alaska's labor groups.

Our objectives as we restructure these agreements are to 1) achieve market labor costs, 2) achieve productivity that is on par with the profitable airlines, and 3) achieve market-based employee benefit costs.

Based on these 3 objectives, in the spring of 2003 we targeted $112 million per year of labor savings.

As a result of increases in our wage rates since that time, combined with labor cost decreases achieved by our competitors, we believe that our wages and benefits are now above market by more than the original $112 million, and the market is still moving.

On last quarter's call, we announced we were adding a row of seats to our 737-400 and 737-700 aircraft.

When complete, these added seats will represent a 2.3 percent increase in ASMs, and we believe these changes will result in a unit cost reduction of almost two-tenths of a cent, which translates into roughly $40 million in cost savings.

We are hard at work with our process reengineering efforts using lean manufacturing principles, and we continue to make good progress on our supply chain management initiatives.

In the next few days, we expect to finalize a long-term power-by-the-hour engine maintenance agreement for our 737-400 fleet.

With this agreement, we will have achieved total supply chain savings of $30 million annually, and we believe additional supply chain initiatives will produce additional savings of $20 million by the end of 2005.

Our belief is that these projects, together with the cost management discipline that we have been pursuing since the beginning of 2002, will help us achieve unit costs, ex-fuel, of 7.25 cents next year.

Now we are not yet at the point where we want to offer the 7.25 cent figure as formal guidance, but I will say that we are as convinced as ever that we need to get our costs down to at least the 7.25 cent level, and we are working very hard to get there.

Turning to Horizon, we reported a pretax profit of 17.5 million for the quarter versus $19.5 million last year, excluding the mark to market fuel hedging gains.

The contract flying arrangement with Frontier Airlines has been good for Horizon, as it has produced stable and positive results.

You might recall that Horizon funded the Frontier operation by shifting capacity from its native system, and that has had a very positive impact on load factors.

Over the past 12 months, we produced load factor increases in the range of 5 to 8 points due to high load factors on our Frontier flying, as well as significant increases in the load factor within the native network.

At the Air Group level, we continue to have a reasonable level of liquidity, although as you know, we have borrowed significantly to maintain this position over the last several years.

Our philosophy has been to maintain a relatively conservative balance sheet to protect our business from unforeseen events, and to use the balance sheet strategically to restructure our business.

The severance program we are offering departing employees is an example of using a portion of this liquidity to restructure our Company.

We've managed our liquidity wisely up to this point, and we are committed to doing so in the future.

Regarding fuel, we are faced with unprecedented costs along with the rest of the industry, and our fuel hedging program has provided some protection for us.

As fuel prices have increased, we have realized cash receipts since we started hedging in July of 2002, of $66 million from settled hedge contracts, and the value of our contracts that we will settle in future quarters is approximately $120 million.

Roughly half of our consumption over the next 4 quarters is hedged at about $30 per barrel, and I believe that is the second best hedge position in the industry.

The credit for our overall progress goes to our employees.

I'm gratified by their level of understanding of the challenges that we face, and I continue to be very impressed with their professionalism and their dedication and their focus on the operation and on our customers through these difficult times.

At this point I would like to turn the call back to Brad, who will take you through Alaska's P&L.

Thanks, Bill.

Alaska Airlines reported a pretax profit of 106.3 million in the third quarter versus a profit of 50.1 million last year.

Excluding the unusual items we mentioned at the outset of the call, we produced a pretax profit of 72.5 million this year versus 50.1 million last year.

Alaska's revenues increased 9.6 percent on a 5.6 percent increase in capacity, and a 3.7 percent increase in unit revenues.

Our unit revenue was the result of strong load factors, which were up 3.5 points year-over-year, partially offset by a 2.2 percent decline in yield.

Load factors were up year-over-year in all of our regions.

As we look at our revenues for the quarter, 2 things stand out.

First, we outperformed the industry in terms of both yield and load factor by a significant margin.

But second, like the rest of the industry, our trends weakened during the quarter, and the fourth quarter currently looks some what soft.

Looking first at our performance versus the industry, our 3.7 percent increase in unit operating revenues, or our 2.6 percent increase in unit passenger revenues, compares to a decrease for the U.S. domestic industry of 4.5 percent.

So we have a favorable gap versus the industry of more than 7 points.

Our yields were down 2.2 percent for the quarter, while the industry's yields were down 6.8 percent, and our load factor was up 3.5 points for the quarter, while the industry load factor was up 1.9 points.

But as I mentioned, our yields and our unit passenger revenue trends weakened as the quarter progressed.

In July our unit revenues were up 8.8 percent, in August they were up 2.3 percent, and in September they were down about half a percent.

As we look forward to the fourth quarter, our load factor for the current month of October looks like it is on about the same pace of year-over-year improvement as we saw in the third quarter.

However, our advanced bookings for November and December are flat or down slightly from where we stood at this point last year.

This is on top of yield that we currently believe will be below the prior year levels.

It's difficult to forecast revenues, but given what we see today, we believe we will have year-over-year decline -- we believe we will have a year-over-year decline in unit revenues in the fourth quarter.

On the cost side, operating expenses increased by 64 million or 12 percent.

Excluding fuel, the restructuring charge, and the Mexico navigation fee recovery, our operating expenses actually decreased for the quarter by 2.7 million.

As Bill mentioned, excluding the unusual items and fuel, our unit costs were down 6 percent year-over-year, which is the best performance we've seen since 9/11.

Our cost performance for July and August was very good, as we had unit costs excluding fuel of approximately 7 cents.

However, as we stated before, our business is very seasonal in terms of both revenue and costs, and by September our unit costs, ex-fuel and unusual items, had increased back to over 8.1 cents per ASM.

This just helps us put the results of the summer months into perspective, and let's us see what we need to do to get back to a meaningful level of profitability on a full year basis.

As we stated last quarter, effective April 1st, we lost the ability to defer recognition of unrealized gains and losses on our fuel hedge contracts, until the period in which the hedged fuel is consumed.

We lost hedge accounting because the correlation between crude oil, which is the commodity we use to hedge, and west coast jet fuel, fell below required thresholds.

Because market prices rose significantly this quarter, the value of our open hedge contracts increased substantially.

As a result of our inability to apply hedge accounting, the mark to market gains associated with this increase in value are being recorded currently in nonoperating income, despite the fact that actual consumption will take place in future periods.

We are providing information on mark to market gains and losses, as well as calculations of our economic and raw fuel costs per gallon in 8-Ks and other communications.

We have also provided a table with this information as an attachment to the press release.

In those tables you will see that we realized gains on settled hedge contracts totaling 12 million at Alaska, and 1.7 million at Horizon during this quarter.

And as we previously noted, we had an additional 57.2 million at the Air Group level of unrealized gains related to contracts which settle in future periods.

Our hedge positions for the future are as follows.These are annual numbers.

If you would like the quarterly details, they are available in our 8-Ks, or we can provide them during the Q&A.

For the fourth quarter of this year, 50 percent of our consumption is hedged at $30.39 per barrel.

For 2005, 50 percent of our consumption is hedged at a price of 29.84 per barrel.

For 2006, 25 percent our our consumption is hedged at about $35 a barrel.

And for 2007, 4 percent of our consumption is hedged at about $36 per barrel.

With crude oil prices at $55 a barrel, these hedges will obviously provide good protection for the Company in the quarters ahead.

This is another example of us using our relatively strong balance sheet to improve the Company's strategic position.

Turning now to other items in our P&L.

As we mentioned, the restructuring charge totaled 27.5 million for the quarter.

This includes severance and other benefits that will be paid as a result of the elimination of jobs.

We expect to record an additional amount of approximately 25 million in the fourth quarter, which also relates to these changes.

From a cash flow perspective, we expect the majority of the severance to be paid out in the early part of 2005.

Wages and benefits increased by 8.6 million or 4 percent for the quarter.

Of this amount, about 7.1 million is due to higher wages, and the remaining 1.5 million is due to higher benefit costs.

Approximately half the wage increase is due to a 4 percent rate increase for our pilots that took effect on May 1st.

Overall, our FTEs increased about 1 percent, on a 5.6 percent increase in capacity, and 7.2 percent increase in passengers.

So we saw another healthy increase in productivity this quarter.

As Bill said, that means we've had year-over-year improvements in productivity in 10 of the last 11 quarters.

Contracted services declined by 2.7 million or 13 percent.

During the quarter we recorded 8.6 million on this line item of the income statement, in connection with the recovery of the disputed Mexico navigation fees paid in 2002 and 2003.

Excluding this item, contracted services would have been up, due to businesses we have contracted out since last year.Landing fees and other rentals increased 4 million or 12 percent due to higher rates, primarily at Sea-Tac, Portland, and Los Angeles, as well as a 2 percent increase in departures.

We continue to work with our airports to find better ways to manage our joint costs and capital needs.

Aircraft maintenance costs decreased by 8.1 million, or 23 percent due to fewer engine overhauls and a change in the mix of heavy versus light airframe checks.

For the remainder of the year, we anticipate this line item will be somewhat higher than in 2003, as outsourcing of all base maintenance work takes effect.

The savings from contracting out will come through in the wages and benefits line item.

Looking ahead to 2005, we plan to change the way we account for engine and airframe overhauls at both Alaska and Horizon.

Starting January 1st, we intend to charge the cost of these overhauls directly to expense, as opposed to our current practice of capitalizing and amortizing them.

We are working with our auditors now to finalize the change.

As we make the change, we will write off the unamortized portion of previously capitalized overhauls as a cumulative effect of an accounting change.

We'll provide information about this in our year end call, and SEC filings.

We anticipate ending the year with ASM growth of about 7 percent, which is up slightly from prior forecasts.

For the fourth quarter, we expect growth of about 5 percent.

As far as our fleet is concerned, we've committed to take 3 737-800s in 2005, and those will be configured with 160 seats, and winglets.

And we intend to take 3 more 737-800s in 2006.

We currently expect our CASM, ex-fuel and the restructuring charge for the fourth quarter -- sorry, we currently expect our CASM, ex-fuel and also excluding the restructuring charge, to be approximately 7.9 cents for the fourth quarter.

This is down from the 8.1 cent guidance we provided last quarter, due to higher ASMs and the savings from our recent restructuring initiatives.

Achieving this number would result in full year CASM ex-fuel of about 7.9 cents, which is a bit lower than our full year goal of 8 cents.

Bill talked about the work we have underway to achieve next year's target of 7.25 cents.

I would like to emphasize that at this stage, that figure is a goal, and not a forecast or guidance.

We anticipate being able to provide some details regarding our 2005, and in particular our planned unit cost, during our fourth quarter call.

At this point, I would like to turn the call over to Jeff to take you through Horizon's results.

Great.

Thanks, Brad, and good day, everybody.

As you've seen by now, Horizon reported a $24.4 million pretax profit for the third quarter.

Our results include the $6.9 million mark to market hedging gained, mentioned earlier by Bill.

Excluding this item, our pretax income would have been $17.5 million in the quarter as compared to $19.5 million in 2003.

For the quarter, our operating revenues grew 5 percent on 18.4 percent more ASMs as compared to 2003.

This was 1.4 points higher than the guidance we earlier provided to you.

The increase stems from traffic growth on our native network, and the impact of our contract line for Frontier Airlines, which now accounts for 23 percent of total capacity.

I'm comment further on revenues associated with the Horizon native network in a few moments.

Our total operating expenses increased $9.6 million or 8.5 percent with spiking fuel costs a primary driver.

Excluding fuel, they increased 4.9 percent.

On a unit basis both RASM and CASM ex-fuel were 11.4 percent lower when compared to last year.

For the first time, unit costs excluding fuel, fell below 13 cents to 12.57 cents, due principally to the effect of the Frontier contract, a 6.1 percent increase in aircraft utilization, and favorable adjustments to property tax and medical claims reserves.

In prior calls, we pointed out that because we are in our first year of the Frontier Jet Express contract, there will be unusual year-over-year variances.

The structure of the agreement, which allows for a pass through of a number of significant expenses, combined with the longer haul nature of the flying, results in lower unit revenues and costs.

On our native network, Horizon's load factor was 71.7 percent or 5.2 points higher than in 2003, all on 9 percent fewer ASMs.

Dating back to October 2003, we've set record native network load factors in 11 of 12 months, with August's 73.8 percent, our new all-time high.

Yield for the quarter was slightly lower than last year by 2.2 percent, on our native network, and when combined with load factor and the reduction in capacity, revenue for this line of business was lower by $5.8 million.

However, when excluding passenger fees and fees paid to us by Alaska and other partners for connecting traffic, yield was actually 3.6 percent higher than the prior year.

This increase reflects modest improvements in our regional economies and the shifting of capacity from underperforming markets to the Frontier product, and to more productive schedule harmonization missions with Alaska.

Let me also point out that in conjunction with Alaska, we continue to extend our common sense fares to more cities in the quarter, as we work toward 100 percent coverage on October 15th.

To date, we have been encouraged by results and the response of our customers.

Turning to the other side the ledger, our operating expenses excluding fuel, were up by $4.9 million, due largely to increased maintenance, aircraft depreciation, and airport charges.

Wages and benefits would have been higher by nearly $2 million had we not reduced our accrual for medical costs to reflect the downward trend in claims activity.

Our maintenance expenses were up by $2.7 million or 37.5 percent, because of a 13 percent increase in block hours flown, fewer aircraft covered by warranty, and high (indiscernible) costs from the Q400 fleet, which are driven principally by higher parts costs.

Depreciation expense was up by nearly $700,000 or 25.9 percent, due to the purchase of three Q400s this year, which we chose not to structure as operating leases.

If addition, we increased our reserves for parts related to our retired F28 fleet.

At the present time, we are actively marketing 8 F28-4000s.

Our current net book value for the fleet is $2.8 million, including inventory.

Our airport charges increased by just under $1 million or 6.8 percent as a result of rate increases in our major hubs, stemming largely from capital improvement, debt service, and security costs.

These increases are spread across 4 percent fewer flights, reflecting the shift of capacity to Frontier Jet Express.

Security screening charges, which were suspended last year as part of the Emergency Wartime Supplemental Appropriations Act were nearly $1 million higher.

Through all the challenges of record load factors and terminal construction projects in several key cities, including Seattle, our people did an absolutely remarkable job of delivering excellent experiences for our customers.

On our native network, 98.8 percent of our flights operated just as scheduled, and 87.7 percent of our flights departed within 15 minutes of their scheduled times.

On a year-to-date basis, we remained ahead of our internal targets and continued to be in the top tier of airlines nationwide.

At Frontier Jet Express, our performance also improved over the second quarter and remained well ahead of the standards set in our agreement.

We also pay very close attention to baggage handling, another of our core promises to customers.

By comparison to last year, baggage-related inconvenience charges were lower on 2.3 percent more passengers on our native network.

Our customers continue to tell us we are on the right track with things that matter to them, with the most recent indication being Horizon's ranking among the top 5 airlines in the nation in 2 key categories by over 2,000 business travelers polled by Conde Nast Traveler Magazine.

Finally, our work on process improvement continues as our productivity as measured by passengers per full time employee, rose 6.6 percent over last year, coming in at 145 passengers per FTE.

The number excludes Frontier passengers, and Horizon's staff dedicated to this operation.

Our guidance for fourth quarter ASM growth is 24 percent which is unchanged from the last call.

And for the full year, we're projecting a little over 20 percent growth.

Unit costs ex-fuel for the third quarter were nearly a cent lower than on our last call projection, due to lower than projected maintenance expenses, an unplanned insurance claim settlement, and a reduction in reserves for property taxes and medical plans.

For the fourth quarter, we are projecting 14.4 cents as compared to 14.5 cents on the last call, and for the full year, we are now projecting 13.8 cents as compared to 14.5 cents on the last call.

Now, I would like to turn the call back to Brad.

Thanks, Jeff.

We ended the quarter with $879 million in cash and marketable securities compared to 812 million at the end of 2003.

For the year-to-date cash flows from from operations were roughly 280 million including a $43 million refund of 2002 taxes.

We also received 94 million from aircraft finances completed during the period.

Capital expenditures were approximately 120 million and we paid down the total $150 million on our line of credit, and $43 million on the other long-term debt.

At this stage, we have financed all of the 737-700s and 900s we have taken delivery of in the last 5 years.

Air Group has no further deliveries scheduled for 2004.

Our debt to capitalization ratio adjusted for operating leases, is 77 percent as of September 30th, the same level as at the end of 2003.

At this point, I will turn the call back to Bill for some final remarks.

In closing, I'd like to reiterate that we are committed to doing whatever is necessary to insure the survival and viability of our Company.

While the pain experienced by all airlines, including Alaska and Horizon, is truly unprecedented, we believe that this pain is a necessary part of restructuring for the long-term.

As we go about this transformation at Alaska Air Group, rather than doing just enough so that we can survive today, our goal is to position our Company to be one of undisputed leaders in the airline industry of the future.

Reporting a profit in the third quarter strengthens our beliefs that we are on the right track.

Still, much hard work remains to transform our Company from one that is profitable in a seasonably strong quarter, into one that is consistently profitable year in and year out.

At this point we are available to address any questions that you might have.

(OPERATOR INSTRUCTIONS) Ray Neidl, Calyon Securities.

Good quarter, guys.

It's too bad you can't keep that up for the next couple quarters, you would be in real good shape.

Just a couple of quick oversight things.

Maintenance base, you announced the closing of it, cost savings there.

And you went over all the -- your cost reduction targets.

But when are we going to really see the big kick in from the savings that you are estimating from the closing of the Oakland maintenance base?

Will that be next quarter, this quarter, next summer?

We think that you will see that right away, Ray.

We project savings from the closure of maintenance of $15 million a year.

We think that's a somewhat conservative number.

We actually forecast savings of $5 million related to that change in the fourth quarter of 2004.

Okay.

Great.

The follow-up question is, this is kind of minor, but it might apply to you.

There has been somebody out there trying to sell some new product called "weather hedges for airlines" kind of modeled along fuel hedges.

You're the type of airline that probably could really use a product like that.

Have you looked into that or is it feasible, or is it something you are just not interested in?

Ray, to be honest, this is the first we heard of weather hedges, but it might be something we would have more interest in.

I know that lots of airlines got hit really hard by the hurricanes in the southeast this quarter.

Helane Becker, Benchmark Brokerage.

So this has to do with labor.

I know what you said about negotiating with all of your labor groups, and I think you mentioned $112 million was the '03 target.

And now you need to sort of rethink that.

Can you just go through the timing, I think you have a May of '05 kind of deadline, with your pilots anyway, and what your new target might be?

Maybe I can start.

Helane, this is Bill.

The basic structure is that we are in formal section 6 negotiations with ALFA right now, and we are hopeful that we will reach an agreement.

If we don't, we do have this binding interest arbitration provision in the contract, which stipulates that I think we negotiate until December 15th, and then if we can't reach agreement, as I say, we are hopeful -- very hopeful that we can.

But if we can't, then that would go to an arbitrator who would make a decision that would be effective in May.

May 1st, of 2005.

And the arbitration standard is, generally speaking, with respect to market.

And it's a little more complicated than that, but that is basically what the language has.

As I say -- Brad can talk more about this, the numbers here in a minute, but the -- we are really happy that we have this arbitration provision.

Not that we necessarily want to use it, but we think it creates the right kind of atmosphere for both parties to come to the table with serious proposals, because there is a deadline.

And as you know, that is generally not the case under the Railway Labor Act, there is generally no deadline to these things.

And the negotiations go on and on and on, and everybody gets frustrated.

So, we think this is a good structure to have, if we need it.

And Helane, on the numbers side, as you know, our goal with labor as with the rest of our business, is to basically be in line with the market.

We originally set this target of 112 million in the spring of 2003, based on our rates at that time, and based on our view of the market at that time.

And since then, our rates have gone up, and the market has in for the most part, gone down.

We believe that in the spring of 2003 that it was 112 million, and our all up sense, with the pilot piece is obviously an important piece of this, our all up sense that our pilots were about 82 million of that $112 million figure.

It was 54 million in outright wage rates, 17 million in productivity, and another 11 million in benefits on those amounts.

As we look at the market today, and we do believe the market is moving as we speak, our view is that overall we are above market by about $125 million, and roughly $100 million of that would relate to the pilot group.

Okay.

And then, just quickly on the follow-up.

So Bill, if I hear you correctly, you're negotiating with the idea of getting an agreement within the next 2 months.

That's correct.

Okay.

Thank you very much for your help, and that was a nice quarter.

Gary Chase, Lehman Brothers.

Just a quick clean up question.

I hate to make your head hurt, Brad, I know you must be sick of this.

But the economic cost of fuel, when you said you have 57 million of mark to market gains that you wanted to -- that, you know, you excluded from the quarter in deriving the 55.9 million in income?

Yes.

Did that include the hedge gains that you realized this quarter?

Yes.

Okay.

The 57 million --

That was a net figure.

So the gross figure mark to market gains would have been 68 million or something like that.

Okay.

We realized 13 million related to contracts that settled this quarter.

So the net amount that we think should be excluded from this quarter's earnings is 55 million.

Okay.

Apologies for that.

No, no problem at all.

It is a very complicated subject and we spend a lot of time on it.

Just out of curiosity, has the correlation improved?

I mean, is there any chance that you will go back to hedge accounting, or is that something that is reviewed on an annual basis?

Yeah, Gary, this is Glenn.

It has improved slightly, but we are not back in hedge accounting yet.

We're looking at both the accounting side of that, and the commodities we use, Gary.

We would like to again, requalify for hedge accounting.

We know this is very confusing for everybody.

Now, to more fun stuff.

Bill or Brad, could you maybe explain the rationale that you use to determine sort of what, you know, everybody has got a different definition of what the market is.

Can you just kind of give us a rough sketch of how you are viewing your competition?

And I mean, am I to take it from the commentary that the cost targets are based on some competitive set that, you know, you've determined you need to be at input cost parity with, and can you elaborate on sort of what that competitive set is?

You know, sure, we would be happy to talk to it.

How we historically viewed this, and it's a supergood question, because there are a number of ways you can look at this.

We are the ninth largest airline.

You might say that we should have the ninth highest labor cost, you might say we should have a simple average of major airlines, you might say something else.

Going back 18 months we said, how about we look at the 8 -- look at a simple average of the 8 airlines that are larger than Alaska, and 4 other airlines that are smaller, but are still very significant in size, 4 that have basically half a billion in revenues or more.

And that's ATA, Air Tran, Frontier, and Jet Blue.

And so historically, we've looked at this notion of 8 plus 4 in terms of wage rate as the definition of market.

And whether that is exactly what we use going forward maybe remains to be the subject of conversations we have with our labor groups.

But that's certainly one way of looking at it.

With respect to productivity, our sense is that we need to be competitive with the growing and profitable airlines, so that is kind of our mindset around that.

And we've talked about benefits.

We think where the market is headed with respect to pensions, is away from defined benefit plans and towards defined contribution plans.

And in our mind, Gary, that's generous defined (ph) contribution plans.

And we'll talk with our labor groups about ways to transition, but we would like to move towards defined contribution plans.

And on health insurance, we believe the market is a reasonable allocation of those costs between the employer and employee, and we've suggested that we think a market allocation for all employers, not just airlines is roughly 80/20. 80 percent of the costs are borne by the employer, and 20 percent by the employee.

But I do want to emphasize, there is active conversation with all of our unions, and they may have slightly different perspectives on some of this.

Okay.

Thanks very much, that is helpful.

Just I guess one last question for Gregg.

Any -- I thought, Brad, you might have mentioned in your comments there wasn't much distinction across the network.

Anything worth talking about in terms of performance, say Alaska vis-a-vis west coast, et cetera, et cetera.

You know, there really isn't much disparity in our results across the various regions within our network.

With one exception, that's the transcon.

They continue to be punitively low yields on the transcon.

For the quarter, the third quarter our unit revenue declined 6 percent year-over-year, and that decline sort of started in July with year-over-year improvements in unit revenues and ended up in September with the decline of over 12 percent in unit revenues in transcon.

I think, while those are pretty big declines, they are comparable to what we are hearing other airlines report for the same quarter.

Michael Linenberg, Merrill Lynch.

This is Lilly on behalf of Mike.

I just have a quick clean up question with regard to the closing of the maintenance base.

Is all that pretty much done?

Like, are you guys like completely cleaned out of that already or is there still some more work, or any issues outstanding on that front?

Yes, this is George.

We are completely out of any activity down there and have been for some time, and checks are now being done outside the Company.

We have a little clean up to do of whether we keep or dispose of the hangar, and some other items.

But like Brad said, the effect of that financially will be felt in the fourth quarter.

I see.

Thank you very much.

And you know, this wasn't that huge of an operational change.

We were doing 60 percent or so of our checks outside to begin with.

We just had 2 lines in Oakland.

So it's really transferring the existing in-house maintenance in Oakland to the existing vendors that we have doing the outside checks.

Jamie Baker, J.P.

Morgan Chase.

A question on Horizon.

Given all the noise with Frontier, does it stand to reason that your fourth quarter year-on-year RSAM decline would be similar or greater than the rate that we saw in the third quarter?

Well, there's no question their caught up -- this is Jeff, Jamie -- in the turmoil that everybody else is in.

And in forecasting our results for Frontier, as you recall, the arrangement works on a base margin plus incentives for our own operational performance, as well as for Frontier's financial performance.

And you know in our forecasting a year ago we had presumed, you know, a certain -- a certain level, at least of seasonal profitability, that so far hasn't materialized.

So, we are just being conservative in our forecast going forward.

Again, the base level still makes sense for us.

And, you know, we are just continuing to focus on both the operational excellence part of it, as well as our own cost components, which really preserve the margin.

Just to clarify, Jim, you know, this is fixed fee flying.

It is not prorated.

Exactly.

Which is why I was just hoping to get a little more clarity than that, in sort of how to incorporate that against the other seasonal change that your historic results might lead us to believe.

But that -- that is okay.

We will come up with something.

We always do.

And just to make absolutely sure, Brad, I would hate to make a mistake here, but the $1.74 fuel guidance, that is for the unhedged portion.

That's not your all in estimate for Q4?

Absolutely correct, Jamie.

Jamie, just to follow up on the RSAM, we do obviously, you know this, but just for others on the call, we do give actual RASM information at the months close.

So there is a lot of uncertainty in about fourth quarter, but we will let folks know those numbers as we see them in our 8-Ks.

Okay, look forward to it.

Thanks everybody.

Good quarter.

Jamelah Leddy, McAdams Wright Ragen.

I just have a question about potential future expansion plan, and particularly in light of your comments about lower yields in the transcon markets, I'm wondering what your thoughts are about the opportunity for a future domestic expansion?

Gregg?

You know, we have regularly a list of 1 or 2 city pairs that are on our list for potential expansion markets, and as we look forward to 2005, we have our usual 1 or 2 that might be on there.

A lot of our growth on the transcon has been funded by redeployment out of our historic network along the west coast.

As we have seen those markets shrink, there is an opportunity to gain new incremental revenues in our network by that east/west flying.

You know, transcons have been low for a long time, and I think the reality is there needs to be some overall reduction in capacity.

We are hearing good things from United and from American Airlines talking about reductions in their networks which will help, I think overall, the position in transcon markets.

The reality for Alaska Airlines is, we have 1 or 2 flights in any one of those markets.

And so for us, a reduction in capacity means an exit from the market, and so we're going to stay the course.

And Jamelah, the general topic of growth, I think you know, our focus right now is on our business model here, and transforming our cost structure.

And it doesn't make sense to grow an unprofitable airline.

So I think we're taking this in the right order.

Which is to get the costs in line, maintain revenues, do all the hard work that we can do on revenues, and we've done pretty well on that.

And only then, once we are profitable and we've kind of reached the 7.25 number if that's where we need to be, and we are generating adequate profits, then we will talk about some growth.

I think it is important that we keep the focus here on the cost restructuring.

Absolutely.

And just one more question as far as any changes in the competitive environment.

Every now and then we hear rumors of others entering the west coast market.

Have you seen anything that would lead you to believe that this is more imminent than just a potential event in the future?

We are hearing the same rumors that you are about Virgin America's interest in flying on the west coast.

We are watching that closely.

We can't confirm anything in that regard.

We've also watched with interest some of the capacity changes that United is making on the west coast.

I don't believe that for Alaska, they would be material.

The amount is something on the order of 120 flights a month between the Pacific Northwest and southern California, against our 4,000 flights a month.

So, it's a pretty insignificant change for us, in total.

Okay.

Thank you very much.

Nice quarter.

James Higgins, Credit Suisse First Boston.

Question on the comment on softness of fourth quarter advance bookings.

Is there a chance that this is related to the fare restructuring?

In other words, you're moving into a quarter when your business travel is going to be a higher proportion of total.

Therefore you might actually be seeing bookings move in closer?

That is a possibility, and that is certainly what we are hoping for.

We have seen is that the peaks have been getting peakier, and the valleys have been getting deeper all through 2004.

But I will say that our advances are keeping pace with the increasing capacity that we're flying.

Brad said, you know, 5 percent more capacity in the fourth quarter, and advances were up about 5 percent, so we are more or less flat, but the trend that we see is a bit disturbing.

We're seeing more strength in October and less strength in November and December.

Some of that might be related to elections, and people's decisions to stay home in the early part of the month of November.

And then, to your point with, you know, big reductions in our walk up fares, there could be more demand that comes closer to the day of departure.

You know, our top 4 buckets, we're seeing 23 percent of our revenue coming in the top 4 buckets, which is up nicely from 19 percent last year.

That is a nice increase.

And then secondly, where do you stand with the AMFA dispute over the maintenance outsourcing?

It is going through the grievance process right now.

I don't actually have a date for resolution of it.

I guess we think it is December now.

Peter Jacobs, Ragen MacKenzie.

First question relates to the cost reduction goals that you have set for 2005.

The 2.225.

And acknowledging that that is a goal, I would suspect that that means you want to be at that run rate by the end of the year, or is that a goal for the entire year?

It is a really good question, Peter.

We want to get to that structural level of cost in 2005 and we are still working on our 2005 plan.

A big piece of what we need at this stage, is reduction in our wages and benefits, and it is quite possible that some of those reductions aren't in effect for the full year.

The pilot piece, as you know that arbitration -- those rates, if we ended up going through arbitration, would take effect May 1st.

So they'd only be in effect for two-thirds of the year.

I think that's what we can say about it for now.

On our year end call, we will be prepared to provide more guidance on what exactly our plan is for 2005.

Just 2 other things.

One, could you just remind me on the number of pilots that you have currently.

And number two, as a follow-up to Jim's question, when we look at the load factor guidance for November and December, perhaps maybe being a little bit softer than -- are there regions that you are seeing stronger traffic growth vis-a-vis where you have your capacity growth, and weaker regions that you could comment on for that November and December prebooking time period?

Peter, I'll do the first half, and give it to Gregg for the second half.

We currently have 1,460 pilots, and I will turn it to Gregg to talk about the December load.

It is pretty much the same across all regions.

Again, a little bit more softness in the transcon.

But that is also the reason it has the greatest year-over-year increase in capacity.

For the next 90 days, our capacity in transcon is up 40 percent year-over-year, and bookings are tracking just slightly below that.

( inaudible )

Nope.

Glenn Engel, Goldman Sachs.

Good morning, and congratulations.

Just specific ones first.

One, your other revenue was up significantly in the quarter.

Is there anything unusual there?

I'd ask our Controller, Brandon Peterson to take that one.

That is really just due to better performance of our affinity card, it's the mileage plan revenue.

Gregg, do you want to add anything to that?

That is the majority of it.

I think both cash receipts are up, and then travel on our OA partners, where we do recognize profit, on that revenue as our members travel on our OA partners.

So both of those activities are up.

On the share count side I'm not seeing the impact of the convert.

Right.

The convert?

This is Brandon.

That -- are you talking about the?

5.8 million.

The 5.8 million shares?

Yes.

That will come in in the fourth quarter of the accounting -- the accounting that everybody has talked about passes.

It'll be effective for our fourth quarter.

We have a 2 issues there, Glenn.

We have a contingent conversion feature so the shares are not convertible until we get above 28.60 per share, and that may change, accounting rules may change to change that.

And then the second, with this if converted method, we have to actually demonstrate that they are dilutive.

The interest -- when you add the interest on the converts to the numerator, and you add the shares to the denominator, and I believe with our year-end forecast right now, they would be anti-dilutive, in any event.

True.

Somewhat as straightforward as fuel hedge.

Talk about the Internet penetration kiosks, how you are doing there.

Our web bookings for the quarter were 31 percent, up from 29 last year, same quarter.

Year-to-date, we're at 30, up from 27.

So we're seeing a nice trend.

Self-service, both on the kiosk and on our website is tracking at about 50 percent.

And you're alaskair.com of the Internet?

Those are the figures I gave you.

And the online agencies will add about another 10 points.

Okay.

And Glen, we have some programming initiatives underway to kind of round out alaska-air.com website capability or functionality.

And we think that will continue to drive passengers to the website as the preferred distribution channel.

David Strine, Bear Stearns.

Pension contributions for '05.

Do you have a projection yet?

David, we don't have an exact number yet.

But I will tell you our mindset around that is to basically contribute what we think our run rate is, in terms of the increase in liability, and that was roughly $50 million in 2004.

And our estimate is that it would be similar to that next year.

And CapEx in '05?

You know, 2 things on that.

Our current forecast is a little over 300 million, maybe 320 or 330 million.

If we do do this change in accounting policy, so that we charge overhaul directly to expense, that would go down by $100 million, because airframe and engine overhauls would be expensed, not capitalized.

And then, Bill, a broader question which relates to responses you made earlier.

When you are thinking about the -- the labor costs and looking at the set of comps that you have, the 8 larger airlines and the 4 smaller airlines.

Is it the assumption for the 8 larger airlines, that they will continue to have defined benefit plans?

Or is the assumption that they may be moving away from that in the near term?

I think we clearly see a shift in that and you see that underway with carriers that have had the opportunity to do that.

Moving more to, you know, DC plans.

And that is where -- as Brad said, that is where we think we need to go.

It's hard to imagine growing the Company and having that kind of liability hanging out there in this environment.

So when you -- I mean you mentioned earlier that you were going to -- this is something you are dealing with in the next few months.

I know it is hard to hit a moving target, but we may not have progression on costs at other airlines, just within the next few months.

So how do you -- how are you going to address that?

Well, we are continuing to negotiate and, over those issues, and the mark to market decision will come through arbitration next spring and --

If we can't agree in negotiations.

If we can't agree.

So we have taken -- I mean, there is 2 separate looks at the market.

One would be by an arbitrator, which if there is language spelling out how he should look at the situation, and then there is just the negotiations that we are having with our pilots between now and then.

And we are still talking around what is a reasonable look at the market.

All right.

I think the important thing, David, there is the perspective about the long run.

The market is always changing.

It is maybe a little bit more active now than it is in other time periods, but if we did not get a negotiated agreement and ended up getting an arbitrated agreement, that would be a 2 year deal.

And so that there would be another negotiation following that.

So, I think our big objective here is long-term to move towards market agreements.

Got it.

Ray Neidl, Calyon Securities

Yes, Brad, you're throwing out a lot of numbers there.

I might have missed this.

But did you give us guidance for both Alaska and Horizon for ASM growth for next year, particularly the first quarter.

No.

We did not.

I think on the Alaska side, there are some things moving around.

But I think in terms of a mindset, a number of around 2 percent would be safe.

And we will true that up on the fourth quarter call and we'll give you our thoughts about how that will be spread by quarter.

Jeff, it's going to be higher at Horizon?

Double-digits?

Low double-digits?

Yeah.

With the carry over growth and 1 planned delivery next year, we're looking at about 12 percent.

Now, at Alaska Airlines, Brad, that ASM growth, that is down quite a bit from what you had been seeing earlier in the year.

Is that correct?

I don't believe so.

I think we have been saying 6.5 or 7 percent for this year.

And we are basically, at Alaska, we have -- our basic plan is we have three 800s coming in '05, and three coming in '06.

But those are largely replacing 737-400s which are going to back bill 737-200s which we are taking out of service.

So, we're kind of in a holding pattern with respect to growth.

As Bill said, the big drive now is on ensuring the Company's profitability and we look forward to growing more aggressively once we are confident about our profit.

Well, once you get to that right cost structure then, you feel that you can probably step up your growth to 7, 8, 9 percent.

There is enough opportunities?

Depending on profitability.

Ray, that would be the idea, you bet.

The other thing affecting next year's growth a little bit, is the benefit from these added seats on the 737s.

We'll get a couple points of ASM growth out of that.

Peter Jacobs, Ragen MacKenzie.

One follow-up question relating to the wage reductions that you might be seeking from the pilots.

If I do the math correctly here, it basically comes to about $68,000 on an annual basis.

And, you know, that is something big for the pilots to swallow, who, you know, I would estimate on average probably make about $180,000 per year.

Granted some of the reduction will come from productivity improvement, but could you put color around on your optimism that this thing will probably need to go through the binding arbitration process, because I think on these kind of magnitudes, which would be about a 35 percent decrease in annual salary, that is tough for somebody to sign up for.

You know, that math, Peter, is I guess I would say that is yours, not ours.

It doesn't sound like it is totally unreasonable.

But, I think that is the scale of reductions that have been seen at other carriers.

I think the number that we've talked about is something that would bring us in line with the market.

I think to say it is all in terms of W2 type income, is not the right way to look at it, because some of it is benefits and clearly some of it is productivity.

So the hope would be the W2 income doesn't go like that.

In terms of our optimism about arbitration, I mean, we are best leaving that stuff with the pilots, but it is in both parties interest to try to get a negotiated deal if we can.

We know the contract language will work a lot better for us.

We feel like we have a better chance of getting real productivity improvement if it is negotiated.

That is certainly what we are trying to do.

But I don't think it is appropriate for us to talk about chances of getting a negotiated deal versus an arbitrated outcome.

Okay, that's fair enough.

And then just a follow-up on that.

If it does go to binding arbitration, and then it's revisited 2 years in the future, I think that's what you said, does that then get revisited through the arbitration process, or through a normal Railroad Act type negotiation?

It would be normal section 6 negotiations at that stage.

Unless we agreed separately to binding arbitration again.

Okay.

So this is basically a one-shot deal then?

Yes.

Yes.

We have had the provision for a long time now, Peter.

And to the extent that it works for both sides, it is something that could be continued.

Well, a lot of airlines would not be looking at bankruptcy right now if they had a provision like this.

I think you are right.

At this time there are no further questions.

Mr. Tilden, are there any closing remarks?

No.

I think that does it.

We appreciate your participation and look forward to chatting with you next quarter.

Thanks, everybody.

Thank you for participating in today's Alaska Air Group third quarter 2004 earnings conference.

You may now disconnect.