阿拉斯加航空 (ALK) 2005 Q2 法說會逐字稿

Good morning, my name is Lisa and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the second quarter 2005 earnings release 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 one on your telephone keypad.

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

Ladies and gentlemen, as a reminder, today's conference is being recorded and can be accessed at www.alaskaair.com.

Thank you.

I would now like to turn the call over to Ms. Shannon Alberts, Managing Director of Investor Relations.

Please go ahead.

Thank you, Lisa.

Hi, everyone, and thank you for joining us for our second quarter 2005 conference call.

Joining us today are Chairman and CEO Bill Ayer, Horizon Air CEO Jeff Pinneo, Alaska EVP Finance Brad Tilden, EVP Marketing and Planning Greg Seretsky, Controller Brandon Pedersen, VP Finance and Treasurer Glenn Johnson and Horizon Air VP Finance, Rudy Schmidt.

I'll 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 that could affect our business.

In addition to the extensive presentation includes any non-GAAP financial measures, the most directly comparable GAAP measures and a reconciliation of the differences between GAAP and non-GAAP measures appear in our press release which can be accessed through our website at www.alaskaair.com.

As you've seen by now, Alaska Air Group reported net income of 17.4 million for the quarter and $0.56 per share.

This is compared to a net loss of 1.7 million or $0.06 per share in 2004.

There are a few items that significantly affect the comparison of 2005 to 2004.

This quarter's results include a 9.2 million after tax restructuring charge related to the contracting out of our Seattle ramp operations, while 2004 included a 24.7 million after tax impairment charge related to the planned retirement of our Boeing 737-200 Combi aircraft.

This quarter's results also includes a 1.9 million after tax mark-to-market gain on our portfolio of fuel hedge contracts that settle in future periods.

This is compared to a gain of 14.8 million after tax in 2004.

After adjusting for these items, Air Group reported net income of 24.7 million or $0.74 per share in the second quarter of 2005 compared to net income of 8.2 million or $0.31 per share in 2004.

Looking at our operating companies and again adjusting for the unusual items, Alaska Airlines posted a pretax profit of 34.2 million compared to a pretax profit of 14.4 million in 2004.

And on that same basis, Horizon had a pretax profit of 10.7 million compared to a pretax profit of 2.4 million in 2004.

Most of you know that our business is very seasonal with the second and third quarters typically our strongest.

Although we were profitable for the second quarter on a year-to-date basis and after adjusting for unusual items, Air Group reported a net loss of 17 million compared to a net loss of 33.2 million in the first half of 2004.

Please refer to the tables on pages eight through ten of our press release for a reconciliation of the GAAP and adjusted amounts.

At this point, I'll turn the call over to Bill Ayer.

Thanks, Sharon, and good morning, everyone.

For today's call, I plan to provide a brief overview of the quarter and then Brad and Jeff will take you through some of the details of Alaska's and Horizon's P&Ls and Brad will finish up with a review of Air Group's balance sheet.

Then we'll turn to your questions.

Let me start with the difficult news of our operation at Alaska Airlines.

Many of you have seen the press coverage of Alaska's poor operational performance this summer.

Our on time performance and reliability significantly deteriorated in May when several changes took effect at the same time that our schedule was expanding and loads were building to record levels.

While we anticipated that there would be some challenges, we were not prepared for the combined effect of changes across our Company.

The result has been operational performance that is well below our goal and it falls short of what our customers have come to expect.

We are committed to improving our performance in order to deliver on our promise to customers and relieve stress on employees.

I'll talk more about the impact on our employees in a few minutes.

As you'll see when the June DOT rankings come out, our operation got even worse in June with a disappointing 96.7% completion rate and on-time performance of about 50%.

To take some of the pressure off the operation, in mid-June we reduced the summer schedule by eight round trips per day or 3.5% of planned summer ASMs.

With this summer reduction -- schedule reduction combined with other efforts, we've been able to improve on-time performance running at better than 60% month to date so far in July with reliability of over 99%.

But we obviously have a lot of work to do.

As you might imagine, we're getting a lot of letters from customers concerning reliability.

And along with other senior managers, I'm personally calling some of our most loyal customers who are rightfully concerned about our recent operational problems.

For the most part, they've been giving us the benefit of the doubt and are remaining loyal because they like our people and enjoy the service we provide.

But the goodwill we've built won't last forever in the face of ongoing operational problems.

It is no surprise that if we don't get back to delivering on our promise to customers, Alaska's reputation will be tarnished and our customers will go elsewhere.

We simply cannot and will not let that happen.

Turning to revenues, we have better news.

As with other carriers, we're seeing higher load factors and ticket prices.

Alaska's load factors was up 5 points over second quarter of 2004 and passenger revenue was up 7.9%.

RASM was up 8.4% for the quarter compared to the prior year, driven by the increase in load factor, a 2.5% increase in yields and the schedule related capacity reductions.

Our temporary decrease in ASMs makes our RASM a bit higher for the quarter than it would otherwise be.

Our load factor increases were strong all quarter, up 5 points in April, 6.7 points in May and 3.4 points in June.

Our passenger unit revenue was up 9.7% for the quarter, well ahead of the industry gain of 3.9%.

Now looking at costs, we're satisfied with our absolute dollar performance for non-fuel costs during the quarter, but we were hurt by the lack of ASM production which caused a break in our string of 11 consecutive quarters of year-over-year CASM ex-fuel improvement.

We're big believers in the fact that a good operation and low cost go hand in hand and we're confident that we will continue with our good cost momentum once we get our operation back to normal.

Like every airline, our raw fuel costs increased this quarter, fortunately the hedges we have in place provided some protection.

During the second quarter, Air Group recorded $28.2 million of realized gains from settled hedges compared to 8.6 million in 2004.

So the hedge savings were approximately two-thirds of our adjusted pretax results.

At current fuel prices, the industry just doesn't work in its present state.

We want to be known as the value leader in our markets but the gap between current fares and the high cost of fuel remains a concern to us.

While our hedge position is relatively good, it provides only temporary price protection.

We're encouraged by the fare increases we've seen in the last few months and the results of our revenue management efforts.

And we believe that more of the same is possible.

Let me talk a little bit about our view of the future.

With a competitive cost structure and strong customer preference for our product and brand, we're well positioned for growth.

Our recent order for 35 Boeing 737-800 aircraft, plus options and purchase rights for up to another 65, gives us the perfect aircraft and flexibility for that growth.

The 737-800 is fuel efficient, has low maintenance costs and has range and payload characteristics that fit our markets well.

Growing with these 157 seat aircraft will put downward pressure on our unit costs.

We anticipate using our new aircraft to grow in three ways -- to provide more frequency, to connect some existing cities together and to serve new cities from Seattle and other major gateways.

However, this order gives us the ability to regulate our growth if we find that we can't grow profitably.

But as I said, our strong preference is to grow.

Now let me get back to our employees.

As a result of the difficulty changes we've undergone this year, our people are naturally worried about their futures, their families, and their quality of life.

As I listen to employees around the system, many express anxiety that there could be more large scale outsourcing.

We have now made the bulk of the structural changes that we believe are necessary to achieve a competitive cost structure and are confident that in time we will reach collaborative agreements on our remaining labor contracts.

This means that, although we can't guarantee lifetime employment, we have no plans for additional significant outsourcing.

As we've acknowledged before, our employees represent our only true source of differentiation and competitive advantage.

As a result of the operational problems we've experienced lately, many of our employees, who had planned to spend time with their family and friends this summer, are instead putting in long hours taking care of our customers.

We owe it to them to get the problems fixed.

As a management team, we did not anticipate that so many of these changes would take place in such close succession, which has led to a negative impact on our operation and our people and for that, I apologize.

I am grateful for the efforts and patience of our employees through this process.

We could not undergo this transition -- transformation successfully without their extraordinary efforts.

I don't take that for granted and to each of them, I would just like to say thank you.

Now I'd like to turn it over to Brad to take you through the Alaska Airlines P&L.

Thanks, Bill.

As you've seen, excluding the unusual items, Alaska Airlines reported a pretax profit of 34.2 million this year, versus a profit of 14.4 million last year, that's an improvement of $19.8 million.

In summary our revenues for the quarter were up by 38.7 million.

Our fuel costs, net of hedges, were up by 20.8 million and other expenses were basically even with last year.

Despite the capacity decline of 1.6%, passenger revenues increased 7.9% on the heels of strong load factors and a 2.5% increase in yields.

As Bill said, our load factor for the quarter was 77.9% compared to 72.8% in 2004.

We're currently showing advanced bookings that are outpacing last year for the remainder of the summer, although at this stage the load factor gains do not appear as significant as what we've experienced recently.

The yield increase reverses a trend in yield declines that we've seen the last three quarters and is driven by industry fair increases that have occurred in the last few months.

In April, yields were flat.

In May, they were up 2% and in June yields increased by a strong 5.6%.

Based on what we're seeing now, we expect positive yield comps in the next few months.

During the first half of 2005, and in particular in the last two or three months, Alaska has led or participated in seven separate fare increases.

Our customers tell us that low fares are important and we're absolutely committed to offering our customers the best value.

But as Bill said, it's important to balance this with our need to recover a significant portion of the very high fuel costs we're experiencing.

Other revenue declined 3.4 million or 9.8% compared to 2004.

This decline is due to the termination of contract maintenance work that we were doing for third parties in the second quarter of 2004.

The second quarter of '04 was unusually high and included 5.9 million of maintenance revenue compared to zero this year.

The decline in maintenance revenue was offset by increases in Milous(ph) plan and other revenues.

On the cost side, our operating expenses ex fuel and the unusual items were flat compared to 2004 on a 1.6% decline in capacity.

I'll talk more about the significant changes in non-fuel operating costs in a moment, but we'll first focus on the two unusual items in our P&L.

As most of you know we include mark-to-market gains and losses on our fuel hedge portfolio in our GAAP results.

However, we also look at the economic price of jet fuel, giving ourselves credit for gains and losses on hedge contracts that settled during the period and excluding mark-to-market gains and losses on hedge contracts that settle in future periods.

On an economic basis, our cost per gallon was $1.51 this quarter compared to $1.23 in 2004, resulting in economic fuel expense that was 20.8 million higher this year.

The 2005 cost reflects a gain related to fuel hedging contracts which settled during the second quarter of 24.5 million for Alaska Airlines.

Looking forward, 50% of our remaining 2005 consumption is hedged at approximately $30 per barrel, 42% of 2006 is hedged at just below $40 per barrel. 20% of 2007 is hedged at $45 per barrel and 7% of 2008 is hedged at 49.50 per barrel.

The majority of these contracts are caps or call option,s meaning that we would benefit from any decline in fuel prices even on the hedged portion of our consumption.

As a result of our decision to contract out our Seattle ramp operations, we recorded a restructuring charge of 14.7 million before taxes or 9.2 million after tax.

We offered our ramp service agents a severance package similar to that offered to other displaced employees in the second half of last year.

Severance package includes two weeks of pay for each year of service, an additional cost bonus based on years of service, free medical coverage for a year, and free non-revenue travel benefits for a time period which is based on the employee's tenure.

We believe that this package is more generous than that offered by any other carrier.

Over the past twelve months our charges for the VSI program have totaled $68 million.

Looking at some of Alaska's other line items this quarter, wages and benefits decreased 21.7 million or 11% compared to 2004.

Wages declined 12% due to two months of reduced pilot wage rates and the subcontracting decisions announced this spring and last fall, as well as a reduction in management headcount.

Benefit costs declined 9% compared to 2004, mainly due to lower pension expense and a favorable adjustment to our vacation liability stemming from the new pilot contract.

We expect a greater year-over-year decline in wages in the third quarter as we see the full quarter effect of some of these changes with the increased tapering down as we get into the fourth quarter and begin to anniversary some of the structural changes we made last fall.

We estimate the wages and benefits will decline approximately 34 million or 16% in the third quarter and 19 million or 10% in the fourth quarter, both compared to the same quarter in the prior year.

Aircraft maintenance increased 9.5 million or 23% compared to the second quarter of 2004.

The increase is a result of four factors.

First, we have a relatively new power-by-the-hour agreement whereby we expense our 737-400 engine maintenance on a flat hour basis regardless of when the work is actually performed.

Second, all of our heavy maintenance work is now conducted by third parties and the costs are now included in maintenance expense, instead of being divided between maintenance and wages.

Third, we had more airframe work and full engine overhauls in 2005 and fourth, at the beginning of the year, we began expensing all overhaul work instead of capitalizing and amortizing those costs.

As we said last quarter, we'll struggle with the comps for the rest of the year, but we believe the operational changes we made will improve our productivity and efficiency over the long run and the accounting change we made will improve the transparency of our results and our ability to manage the business.

We expect that maintenance expense will be up 16 million and 6 million in the third and fourth quarters respectively, as a result of the factors above and our decision to move the timing of some maintenance activities up from 2006.

Contracted services increased 2.2 million or 8% compared to the second quarter of 2004.

The increase represents amounts paid to ground service, fleet service and GSE maintenance vendors.

Landing fees and rents increased by 5.2 million or 15% despite a 6% decrease in the number of departures.

This increase was due mainly to increased rental costs primarily in Seattle, Portland and Los Angeles.

We expect landing fees and rents to be up 10 to 15% in the third and fourth quarters compared to 2004.

As we've shared on many other calls, we're concerned with the rise in airport costs, especially in Seattle where, with Horizon, we represent just under 50% of the departures.

Over the last year or two the Port of Seattle has taken steps to significantly lower their projection of future costs but we believe further reductions are needed and we're working with the Port on these.

You may have heard that one of our competitors is looking at Boeing Field as an alternative airport in Seattle as a way to control airport costs.

If you have questions about this, and in particular our reaction to it, we'd be happy to address those in the Q&A portion of the call.

The reductions in our summer and fall capacity will translate into ASMs that we believe will be about even with 2004.

We expect that third quarter capacity will be down 3.5% and I think on last quarter's call we thought we shared with you that we forecasted that it would be up 2%.

And our current estimate is that fourth quarter capacity will be up about 1% year-over-year, which is the same as we shared on last quarter's call.

The capacity changes are significantly affecting our unit cost projections.

As we pull down the schedule, we eliminate some variable costs.

However, because a high proportion of our costs are fixed in the short run, close in schedule reductions clearly don't result in equivalent cost reductions.

Adjusting for the new capacity figures and assuming the tentative agreement with our mechanics, which represents a cost increase, ratifies, we expect that our unit costs ex fuel for the next two quarters will be approximately 7.4 cents per ASM for each quarter.

Our estimate is that the schedule reduction will increase our third quarter unit cost estimate by about four-tenths of $0.01.

We're currently forecasting our full year unit costs, ex fuel and restructuring charges, to be in the range of 7.8 to 7.9 cents per ASM.

As we said last quarter, we still believe that 7.25 cents, or perhaps something lower, needs to be our goal.

However fixing our current performance issues to better serve our customers and resolving our labor issues needs to be our main focus in the near term.

We know that getting our customers where they need to go on time and with their bags is a core promise that we need to do a better job of delivering on and we're working hard to get this right.

We're thankful that our customers have shown incredible loyalty through our struggles.

While our operations are going to be the immediate focus, we haven't lost sight of the need to manage our costs.

Getting our reliability up and restoring the flying we reduced will be a big driver in helping us regain cost momentum.

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

Great, thanks, Brad, and good day, everybody.

Adjusting for the unusual items that Shannon referred to, Horizon posted a pretax profit of $10.7 million, which is a significant improvement over the $2.4 million figure we posted in the same quarter last year.

For the second quarter, our revenues were up 12.8%, outpacing the increase in operating expenses which were higher by 7.7%, all on a 7.2% increase in capacity.

Our traffic was up 15.9% for the period, leading to go a record second quarter load factor of 73%, a level that is 5.5 points higher than the same period last year.

In fact, we've achieved record load factors now for 13 consecutive months.

On a unit basis, our RASM increased 5.2% to 16.6 cents, while our CASM ex fuel declined 4.9% to 12.8 cents, reflecting a 12.3% improvement in native network productivity and a 1.4% improvement in our craft utilization.

Turning to our Frontier Jet Express operation, you might recall that we reached our mature capacity level of 9 CRJ700s in June of 2004.

The good work of our Denver team continues to be a point of pride as they once again exceeded all operational performance targets, resulting in contractual performance bonuses each month of the period.

For the quarter, our Frontier product line accounted for approximately 22% of our total capacity and traffic and 9% of our total passenger revenue which is comparable to last year's mix.

On our native network our load factor of 7.4 points higher -- I'm sorry -- our load factor was 7.4 points higher on 8.2% more ASMs and 20.5% more RPMs than in 2004.

Yield was down 5% primarily due to the 7.3% increase in passenger trip length versus a year ago, but average ticket prices were up as we were able to match a series of industry fare increases.

Together, this accounted for a 14.4% increase in native network passenger revenue.

On the expense side, our non-fuel operating costs increased by 2.1% on a 7.2% increase in ASMs.

Fuel costs, after hedges, increased almost $5 million or 31.4%.

Our intaplane(ph) costs per gallon net of hedged benefits was $1.59 this year compared to $1.28 in 2004, up 24% while our consumption increased 5.7%.

Like many other airlines, we have gone to extraordinary lengths to refine our fuel management practices to help mitigate these unprecedented increases.

There are a few other notable expense differences for the quarter that I'd like to mention.

First, wages and benefits were higher by 5.4% or $2.2 million due to a 3.7% increase in average wage and a 2.1% decrease in employment taxes and benefit costs.

The reduction in benefit costs is primarily due to lower Workers' Comp expense based on favorable claims activity.

We also paid close to $400,000 in operational performance rewards to our employees for exceptional performance during the quarter.

Maintenance expenses were down $1.3 million or 13.8%, primarily due to the timing of events.

Along with Alaska, effective January 1st, we changed our accounting for overhauls to the direct expense methods.

Aircraft rents were down $1.5 million or 7.9% since we converted two aircraft to long-term financing in June of 2004.

Airport charges were up 13.6% on 0.5% decline in native network departures, a shift that was driven primarily by significant rate increases in several of our key airports.

Other expenses declined by 10.3% due to reductions in aircraft liability insurance and property taxes and a gain on the sale of one of the retired F 28s.

On the products front, our people have done a remarkable job of rising to the challenges of heavy loads, unseasonable weather and other operational pressures.

Our 98.9% scheduled reliability rating on the native network was nearly identical to last year in spite of these factors.

Our on time performance in baggage handling slipped a bit relative to last year due partly to our higher than forecast loads and the need to deliberately hold for connecting passengers and baggage.

Through it all, we continue to see improvements in our native network productivity with a 12.3% improvement in passengers for FTE over the same quarter last year.

This is a strong testament to both the people and the systems we rely on every day to serve our customers.

Our efforts this quarter have been somewhat impacted by the operational challenges at Alaska that Bill has referred to, but improvements are being made and we're confident that Horizon's performance will soon return to industry leading levels.

Looking ahead we are projecting a 10% increase in capacity for the year which is driven by a combination of utilization improvements, an additional four seats on our 19 2-400s and the delivery of one CRJ-700 in April of this year.

This figure is slightly lower than the one we provided on our last cal, which was affected by a calculation error.

By quarter, our ASM growth is projected to be 10% in the third quarter, which is compared to the 15% guidance on the last call, 10% in the fourth quarter, compared to 13% guidance on the last call, our CASM ex fuel is projected to be 13.2 cents for the year.

By quarter, the breakout is as follows -- Q3 12.2 cents compared to the $0.12 guidance we gave you before and on Q4 13.6 cents which is compared to the 12.8 cent guidance on the previous call.

Now I'll turn the call back to Brad for a discussion on the Air Group balance sheet.

Brad.

Thanks,Jeff.

We ended the quarter with 726 million in cash and marketable securities compared to 874 million at the end of 2004.

The $148 million reduction in cash is the net result of cash flows from operations of $102 million offset by capital expenditures of approximately 250 million, and this includes $100 million in conjunction with our recently announced orders for 35, 737-800s.

Alaska took delivery of its third 737-800 on July 1st and that represents the last delivery for Air Group in 2005.

We expect capital expenditures to be roughly 100 million for the rest of 2005 and $430 million during 2006, as we begin to take delivery of airplanes from Boeing under our new agreement.

Our adjusted debt to capitalization ratio, adjusted for operating leases, was 79% as of June 30th, down slightly from 80% at the end of the first quarter.

At this point, we'd like to open the call up for your questions.

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

Your first question comes from Ray Neidl with Calyon Securities.

Yes, Brad, you're talking about that we could ask questions on the high landing costs at Seattle.

And could you just elaborate on that a little bit more?

What are they now and what do you expects them to be?

I understand they could like go as much as triple as where they are now and what are you doing with the Seattle Airport Authority to try and control that?

Ray, maybe I'll start with some of the numbers and Bill might have a comment on the big picture where we're headed.

We are -- this year, we expect to pay about $56 million to the Port of Seattle for our costs.

That's about $10.50 a passenger.

That's up -- maybe that's double from where we were a few years ago.

If you go back and look at the Port's projections, a lot of what's happening is there are a number of capital projects that are coming online now and basically getting factored into the rate base and rates were expected to hit their peak in 2009.

I think at one stage the Port believed that the cost per enplaned passenger might be as high as $25.00.

They're down substantially now, I think their estimate is $14.48 for the average airline at SeaTac and our rate would be a little bit better than that because I think we utilized space a little bit more terms per gate and so forth than the average airline.

So that's some big picture numbers.

Bill, do you have anything?

I might just add, Ray, that obviously airport costs are a big deal and all carriers need to find ways to over time to reduce costs or at least stem the increase.

In terms of the Seattle Boeing Field situation, a little bit of the background on that is that there's been a long-term planning effort in Puget Sound, in the Seattle area, that determined that the airport, you know, the center for commercial airline activity would be SeaTac and what ensued then was a major investment program of $4 billion plus of infrastructure and the third runway and things like that.

So we feel like the carriers made a commitment to SeaTac and our approach would be to work with the Port of Seattle to look at future projects and to work -- and find ways, collaborative way to bring down costs over time.

And I think it's fair to say also that a lot of the costs that were incurred now come from decisions that were made in the late 90s when the airline industry was in a whole different financial position.

So part of this is the long lead time on capital projects and decisions that were made in a whole different environment.

As far as Boeing Field goes, you know, we don't believe that's a good idea.

We think the best approach is to work with the Port and continue to take advantage of the infrastructure developments and find ways to reduce costs.

But I would say that if Boeing Field's -- if Boeing Field turns out to be viable for a carrier, then we're going to have to be there as well.

We don't have any choice.

We can't have a competitor with a significant cost advantage at a different airport serving the same market.

So if somebody else goes there, we're going to be there too with about the same scale of operation.

But if you have to split your operations, though, won't that increase your cost of doing business in Seattle and make your hub less efficient at the current airport?

We have to be careful which flights in which markets, because you're right, we do a fair bit of connecting with ourselves and with Horizon and with others.

But certainly there's a lot of traffic that is simply interested in point to point service and that would be the traffic that could benefit from a Boeing Field operation.

And overall, if done correctly, overall we would end up, I guess, with lower costs, if you believe that we can't work with the Port to get our costs down in Seattle, which is long-term what we believe can happen.

Okay.

And secondly, the flight attendants recently rejected a contract that, I guess, their union had approved.

Can you give us an update on where we're going to go from here and maybe a total status of all the other unions?

I know the pilots are in the bag now but the other unions, where do you stand with concessionary contracts?

Let me have Greg Seretsky start on the flight attendants.

Yes, good morning, Ray.

Good morning.

We are in discussions right now with both the NNB to get the mediator back on the property and to re-engage in discussions with the AFA.

There's a certain protocol that the union needs to follow with respect to surveying the membership to find out what exactly they didn't like in the tentative agreement and to collect, I guess, the survey that membership on whether or not they would support a strike if and when it comes to that.

But we're a long, long way away from any of that kind of activity and we don't have, yet, dates to get back together.

I would say at the earliest, it would be sometime late this fall.

And, Ray, with respect to the other groups, we have a tentative agreement that's being voted on currently with AMFA, with our mechanics, and that vote should be completed, I think, by the middle part of next week.

And then we do have a mediator we're working with on the two IAM contracts, the customer service and reservation folks, as well as the ramp, because we still have an amendable contract with ramp.

Even though we did that outsourcing in Seattle, we still have to find a way to reach an agreement with them.

We want to do that as soon as we can.

And that's our intent and we believe that collaborative deals are always the best and we want to move as quickly as we can to get there.

Okay, great.

And Brad, just to verify some numbers you were throwing out there real quickly, your unit costs, ex fuel, for 2005 is going to be 7.8 to 7.9 with a goal of 7.25.

And then you threw out a 7.4 cent unit cost.

What was that, was that for the quarter?

Correct, Ray, for the third and fourth quarter, our current estimate is 7.4 cents.

Great.

Thank you, guys.

Yes.

Your next question comes from Jamie Baker with J.P.

Morgan Chase.

Yes, good morning, everybody.

Good morning.

Brad, you know, at first glance, the worse in CASM guidance seems to be largely a function of the scheduled pull down, but I'm wondering how much cushion you've also built in there for irregular operations.

You must have some assumption in the CASM guide as to when the operation starts getting back on track.

Can I inquire as to what those assumptions are?

Yes, sure, we can talk about that a little bit, Jamie.

We do try to provide conservative guidance to the street, particularly with respect to costs.

We put numbers out there that we hope to hit or meet and this is a time of significant restructure in our industry and we're trying as hard as we can to get our costs down.

We absolutely believe that we need to get down to at least 7.25.

This is a temporary set back for all the reasons we talked about.

We felt like we needed to pull the ASMs out of the schedule and I think we've given you a pretty conservative cost estimates, what I hope turn out to be conservative cost estimates for the third and fourth quarter and for the full year.

In terms of how much cushion is in there, I think I'd prefer, Jamie, just to say that we try to provide conservative guidance and hopefully those are numbers that we can do well with respect to.

Well, let me try to go about it a slightly different way, then, Brad.

All right.

Presumably, and, Bill, chime in if you care to, but presumably the operation you're running today is not the operation that you want to run going forward.

And presumably your business plan incorporates some assumption as to, you know, whether it's this week, next week, next month, that things begin to smooth out and both as an analyst and I suppose as a passenger, just any guidance you can give us as to your conservative assumption as to, you know, when we'll see your operating metrics return at least close to historical norms, I think would be appreciated by all on the call.

Yeah, I mean, we did a couple things, Jamie.

We did say that we think our third quarter costs are being pushed up by four-tenths of $0.01 by the reduction in ASMs alone.

So that's one data point in terms of how much we're being affected by the schedule reduction.

And then by the fourth quarter, we're hoping to regain momentum and get something back close to normal, but that's something that we need to wait and see to some extent.

Yes, I think we're encouraged by the most recent trend.

You know, the schedule reduction that we made really took full effect July 1st, and so we've been particularly interested to watch the trend since July 1st.

And we're really where we want to be in terms of reliability, as I said, better than 99%.

It's the on time number that needs work, obviously, and I think what we've said is we want to track this trend line.

We don't want to go back and have the problem again.

So we're not going to put heat back on the operation until we're confident we can operate an on-time reliable Company and at this point, I mean, the customer's always important here, but our employees are getting worn out.

They are busting their pick every day out there with one full flight after another and for them, as much or more than customers, we need to get this thing back on track and get it stabilized before we start talking about increasing the capacity out there.

Okay.

Will do.

Thanks for the color everybody.

Your next question comes from Mike Linenberg with Merrill Lynch

Yes, hi.

I guess going back to labor, and I know that the pilot deal is done, but, you know, it went to arbitration and I know there was some issues with that, and then they came back with, I guess, a second deal that maybe was endorsed by ALPA.

And then it was turned down, overwhelmingly, and I'm just -- I'm curious, you know, if there's any insight that you can give to us on that?

I mean, is it morale, is it something where ALPA, the leadership, is out of sync with the rank and file?

Is it just the difficult operating environment that we're seeing out there?

What happened there?

That's a great question, Mike and it's real disappointing to us as well.

ALPA came to us after the arbitration and said, would there be an opportunity to rebalance this?

Because if you recall, the arbitrator basically put all of the cost savings into wages.

And didn't make any call about any of the other areas like pension or any of the productivity areas.

And we said, sure.

We would be happy to go back and rebalance it and move the money around a bit.

And that's what came with the TA and it was a small group of people that met over a relatively few numbers of days to craft what we believed would be acceptable to all the pilots.

And that was kind of the pretense going in, as that obviously what we were trying to accomplish.

And then what happened was -- you saw the results.

I think it starts with a lot of our pilots just being totally shocked by the wage arbitration decision.

And people just not thinking that was really in the realm of possibility.

Although, when you look at what's happened with the marketplace, it very much is.

And compared to what our kind of historical position has been relative to the industry.

So, that just got people, you know, pretty upset.

And while we moved from, you know, down to 20% pay cut for both captains and first officers in the tentative agreement, that was still viewed as more than was needed, I guess.

So, it's very unfortunate, but, you know, we do have a current contract and that's what we're operating under today.

Okay.

And then my second question, I know there is this increasing talk about Boeing Field and, you know, if SouthWest does something there, you have to be there, you know, given that that market is your bread and butter.

But at the end of the day, you know, it's not a big facility.

I mean, what are we looking at like in size and scope?

Is this a hundred seat -- excuse me -- a 100 flight a day operation or is this something like 10 to 20 flights?

Are even the facilities there that would be availability to build any operation of scope within the next five or ten years?

What's really there and what's the potential?

It's quite limited, from our understanding, on facility space.

There really isn't a terminal that would be adequate and operations would require new construction.

Beyond that, I think we don't know much more.

There's been no firm proposal by anybody to operate there at this point, but if there is, then we're going to get very interested in understanding what our kind of equal access looks like, because we think that's a requirement given it's a federally funded airport, and we're going to be there needing to match whatever competitive offering there is.

And you're right about Seattle being our home and we need to protect it and if somebody goes and does that and gets a significant cost advantage, we're going to have to be there as well.

Okay.

Very good, thank you.

Your next question comes from Gary Chase with Lehman Brothers.

Good morning, guys

Hi, Gary.

Just a quick question for Brad and I apologize, there's a lot of things going on today.

You may have stated this in your prepared remarks but you mentioned the schedule reduction as something that you're doing to address these operational problems that you keep mentioning.

Has there also been -- have there been other things that factor into the 0.4 cent CASM impact you were been talking about, like increased block time and other things that we should be aware of that you hope to unwind over time?

Or is it just strictly you pulled the capacity out of the schedule and that's what affected the CASM performance?

Gary, I think far and away the biggest factor is the reduction in ASMs.

It is also true that, you know, we started with unit costs of 8.73 and the low hanging fruit is what you get first so it does get harder as you get lower and lower down the spectrum.

But I think far and away the biggest thing affecting that four-tenths of a $0.01 increase in guidance was the reduced number of ASMs.

I think we continue to be -- I'm not sure if we've really made the point yet, but we think that we are largely at the point when we get the deals done that we need to get done with our labor groups, we're going to be largely at the point where our wage rates are at market and our benefit structures are competitive and we're going to kind of have done what we need to do with employees.

But there's going to be a lot of opportunity left with our business model just to continue to refine it and true it up and make our business model and our offering completely in sync with what our customers want and are willing to pay for.

Glenn Johnson's in the room, he leads lean initiatives for Alaska and we have many, many initiatives that are all around basically increasing quality, increasing reliability and in the process decreasing costs.

We've had a lot of success with that to date and we're very bullish on it in the future.

So, on a long-winded answer, I think for third quarter the ASMs are the big deal but there's lots to be done over the years ahead and we're optimistic about hitting our objectives.

Okay, well, actually, that's a good segue into my next question, which is -- and I can't remember if it was Brad or Bill, but you'd said you've gotten enough done with employees where you think your costs have reached a place where you're competitive and that's what spurs the growth, et cetera, et cetera.

Can you give us some sense of how you determine what you need to do in order to be competitive?

You know, clearly, your biggest low fare competitor, you know, quite aside from airport costs, unless our numbers are badly off, still has some pretty sizeable cost advantages relative to even after adjusted for this.

What revenue premium do you think you can sustain?

What's the thinking behind the idea that you have achieved a competitive cost structure or that you've done enough to get where you need to be?

There's probably a lot of ways of looking at that.

I mean, first of all, in terms of looking at employees themselves, I mean, we look at the market and we look at how our pay structures and our work rules and our benefits compare to the market.

And what we've said time and time again is we want to be in the range of market and we think with something close to the deals that we've been pushing towards, we're going to be in the range and we're going to be largely there.

In terms of the rest of the cost structure, it's not -- we absolutely need to be at a point where the revenue premium we earn is equal to the cost disadvantage that we have. 725, as you know, is a number that we've talked a lot about.

As you look at 725, and we certainly do look at that and compare it against our competitors.

We stage-link adjusted it to compare it to specific competitors.

That's got a lot in it.

It's got small markets in the state of Alaska where it is far more expensive to fly but where the revenue premium is a lot higher.

And then it's got markets up and down the West Coast where we're up against Southwest.

It obviously requires a revenue premium when you've got a higher CASM and we have been successful in achieving revenue premiums both in terms of load factor and ticket price in most of these core markets up and down the West Coast.

And I think, you know, where we are right now is -- what we're saying to employees is once we get in the range of market with respect to pay and benefits and work rules, then that's where we stop.

We don't go ask for more and if we need to continue to lower our CASM, we need to go back and look at all the non-labor opportunities that we have to do that.

So philosophically, we're grounded in this concept of market pay of benefits.

I think that's an important point that we want to be sure to be communicating to our folks.

But 7.25, as you know, is our kind of target here and we're not there yet, so we need to continue to work on that.

We think getting the schedule back on track, getting the operation back will help a lot in moving back and getting momentum going, cost momentum going in the right direction.

And then there's going to be other things beyond that that we're going to need to do.

We're very encouraged by this whole what we call zoom, this whole lean approach where we engage front line employees to look at their work processes, they know them best, and find ways to eliminate waste and improve efficiency and reduce cost and improve quality.

And we've got a bunch of those things going and we're in the process of ramping up that whole effort to include a lot more things in every area of the Company.

So it's safe to say then on routes where you directly compete, i.e., you know, non-Alaska, you feel that your costs are much closer to parity with the competitive set?

We're closer, Gary.

We still have work to do.

One thing at the risk of making a long answer even longer, we did an exercise for our board recently where we did kind of breakdown our cost competitiveness against the low-cost carriers and we said where Alaska isn't completely on par with an LTC, what are the sources of the variance?

And we sad is it our employee pay and benefit structure?

Is it our employee demographics?

Is it aircraft ownership costs?

Is it our product, first class seat assignment, meals and so forth, or is it just the way we do business which these lean principles that we talk about, are our way of getting at that.

And I guess what encourages us a little bit is that on the employee stuff, we are largely there.

If we can get the deals that have kind of been -- as they've currently been configured done, we're largely there.

On the employee demographics, we are certainly not at the same point as a JetBlue or a Southwest, but we are at place that growth would help us.

This new deal we have with Boeing for airplanes is terrific and the 737-800 is certainly going to help us with our unit cost to drive those costs down.

The product, that's maybe getting specifically at your question, there are lots of ways that we can make investments in a differentiated product.

And that's easy we just need to test those investments and make sure that we're getting an adequate premium.

And the final thing is, this is a 73-year-old business, we have some inefficiency that we need to get out of the business.

So anyway that was a model that was useful for us and useful for the board and a couple of those boxes we feel really good about.

A couple of those boxes we have further work to do, but we do feel like we're in a position where a lot of what's in front of us is in our control.

We -- there's no reason that we shouldn't be really successful with this transformation effort.

And the growth component of it, as we've said all along, is once we get visibility to a competitive cost structure, which is what we have right now, it's not that we're there yet, but we have visibility to it, then we start putting the wheels in motion to start thinking about growing and the airplane order, of course, is the first step.

Thanks, guys.

I really appreciate all the color.

Your next question comes from Helane Becker with Benchmark.

Thank you very much, operator.

Hi everybody.

Hi, Helane.

I'm sorry, Brad, I missed this number.

You said possible spending for '06 is what?

430 million.

Got it.

And in terms of the new aircraft from Boeing, how -- what's the financing?

Will you be in the market to do, you know, double ETCs or is Boeing financing this plane?

Can you just talk a little bit about that?

Sure, Helane.

You know, Glenn Johnson, our Treasurer, is in the room.

I might slide the mic down and ask him to talk a little bit about how we plan to finance the 800s.

Hi, Helane.

Hi.

We have not made any specific plans as far as the order that's coming.

I think we have a broad range of things available to us, including paying for some airplanes with internally generated cash and then more traditional debt financing and potentially even accessing the double ETC market that you mentioned.

And there's always the opportunity to go out into the equity market at the appropriate time also.

Okay.

I think that last part wasn't something I was expecting to hear.

All right.

Thank you.

Now, Brad, getting to the current quarter, can you just talk about (bad audio).

I'm sorry, Helane.

I know you were moving that microphone.

What was your question on?

It was in the current quarter, could you just talk about the trends for traffic in July and August?

I thought you said something positive about forward bookings, but I don't remember, embarrassingly so.

I'll have Greg Seretsky answer that question on future (inaudible).

We're seeing continued strength on our advanced bookings through the third quarter.

Although, admittedly, when you're operating at a 80% load factor, it's hard to gain load factor increments year-over-year than when you were operating in earlier quarters at 65 and 70% load factors.

So we're anticipating a trend of something on the order of two to three points of load factor improvement year-over-year in each of the next couple of months.

Okay, great.

Thank you very much.

Your next question comes from Glenn Engel with Goldman Sachs.

Good morning.

Question first on labor.

Not only was it the pilots, but now the flight attendants also appear to have rejected the agreements.

What makes the union leadership seemingly so out of touch with the members and what can you do to get yourself more in touch with what the members feel?

Well, I'm not sure I'd characterize the leadership that way, Glenn.

I think -- I know in the case of the flight attendants, they worked really hard and they believed that this was really a fair deal given the environment that we're in and we spent a couple of years with them getting here.

So they're quite disappointed as well.

But your second question is what we all need to be doing all the time is being in touch with our front line people that are doing the heavy lifting out here and how are they feeling and what is it they'd like to see in a contract given the reality of what we're dealing with and the changes we're trying to make in our business model for the long-term.

And this whole thing is intended to provide long-term security for our employees.

But it is frustrating, you know, that we haven't been able to make progress and achieve the things that we think are in their long-term interests and really a good alignment with customers and ultimately with shareholders.

Even if -- even before the recent capacity cuts, you weren't looking at that much capacity growth in the year and so it just seems surprising to have so little capacity growth lead to such a big drop-off in service.

How much of this is just your people not performing as well as they could and how much of it is that you've got -- somehow you've cut costs too far?

Well, it's a good question.

I think, you know, it's natural -- first of all, as we said earlier, it's all these changes coming at the same time and it's management leading -- trying to lead change here and we didn't anticipate that all these things would coincide at the beginning of the summer schedule.

Maybe we're perennial optimists here, I guess you have to be in this industry, but we figured that the pilots -- we would be able to get a deal with ALPA back in December.

We didn't necessarily think that was going to go to arbitration.

We had changes with fleet service.

We had changes, earlier changes, with the heavy maintenance in Oakland, which required some retraining of people.

We had the arbitration decision on May 1st and, as I described earlier, a very negative reaction to that.

And then the Seattle ramp change that happened in the middle of May.

So we ended up with a whole bunch of things happening at once and at the same time we're ramping up the schedule and we're ramping up demand and the result has been an operation that is just not acceptable for employees or for customers.

And we've had to take the action that, certainly short-term, harms the financial performance of the Company.

There's no two ways about it, but we think long-term it's exactly the right thing to do and we're looking forward to seeing the trends reverse and we'll get back with some ASM growth.

The other thing I might say in answer to your first question about, you know, employees.

You think about what we're trying to do here, we don't have the financial distress of other people.

It's evident to employees.

We talk about, you know, the trend, the $200 million in losses over the last five years is not a trend that's sustainable.

But we don't have the near-term issues that a lot of other carriers have had that have had to make big cuts with employees.

Now we're not asking for the same level of reductions, either, but there's something about the visibility of where we are to the front line people and we have not communicated to the degree we need to about, you know, the long-term benefits of change.

And what we need to do and what happens if we don't and we're continuing to work that, but I think to a degree, these PA rejections are a bit of evidence of that.

You mentioned that some of the maintenance costs in '06 have moved up to '05, does that mean we would expect '06 maintenance costs to be lower than '05 levels?

Yeah, Glenn.

There's one check in particular on a very old airplane that's $4 million that moved from '06 into '05 and '06 will be lower by that amount for sure.

Thank you.

Your next question comes from Robert Toomey with EK Riley Advisors.

Hi, good morning.

I'm on a cell phone with a low battery in case it cuts out.

So I'm wondering if -- yes, it just gave me a signal.

Can you talk a little bit about your fuel hedging strategies at $60 a barrel oil?

You know, you give us the information on the fuel hedge prices, you know, the fuel hedge information going forward, but how do you use your -- do you feel your hedging will be as effective as it's been in the past with oil prices at this level?

You know, Bob, we might send this one down to Glenn Johnson as well.

Hi, Bob.

We obviously are at record high fuel prices here and we've looked at the forward curve.

You know what?

One of the tenets of our fuel hedging program in the past was that the forward curve was lower than the current spot price and what we've experienced lately is that it's a high and flat -- relatively flat curve and so there's relatively little opportunity as we look out in terms of placing future hedges right now.

So, we're in kind of an evaluation phase around our hedging program right now, but we're certainly pleased with the hedges that we already have placed and I think Brad gave you the statistics earlier in terms of the levels and the strike prices that we have for the next three years.

But do you see yourself being able to take it -- you know, gain advantage from hedging if oil prices --

I think we lost Bob.

Yes, I think he was asking about a long-term competitive advantage from hedging and maybe just to reiterate, our goal with hedging all along was to reduce volatility.

And so when you have the big extreme spikes in fuel our costs don't go up as much but our belief is that as costs go down, being hedgers, we will pay more, so we do believe that fuel hedges provide temporary price protection and not a long-term cost advantage or a long-term source of profit.

Lisa, we have time for probably one more question, if there is another question.

Okay, sir, your next question comes from David Strine with Bear Stern.

Thanks for fitting me in at the last.

Couple quick questions.

First on maintenance, Brad, you mentioned a couple numbers for increases in the third and fourth quarter, 60 and 13 million.

What proportion of that is due to the change in the accounting from not capitalizing it and what is due to the switch to the power-by-the-hour?

Do you know offhand?

Yeah, I'm just going back to look at those figures.

Basically, there is a lot of stuff going on there, David, and one of the things is that previously, whenever we did an engine overhaul, we looked at that engine overhaul and we actually charged some of the overhaul to expense and some to capital and we haven't gone through and done that in 2005 with the new policy.

So we don't -- we're not in a great position to answer that question.

I think we can say that we thought the change in accounting at the beginning of the year was -- we thought the effect of that timing was going to increase our costs by 5 to $10 million.

So that much is change in accounting and the rest of the stuff is either timing or stuff happening with our operation.

Okay.

So it's not possible to isolate the amount that's coming just from the switch to power-by-the-hour itself or -- ?

Right.

Okay.

For this year, it's not.

Long term, we think that --

Negative this year.

It's cost additive this year, is that what you mean, Brandon?

So power-by-the-hour is cost additive this year.

Long-term I think we were forecasting savings of $15 million a year, something like that.

Okay.

And last question, Bill, and I know probably everybody in the room is feeling this, that there's a seemingly a morale and perhaps a cultural challenge that you guys are now facing as you're transitioning the Company to a lower cost entity.

And I'm just wondering, and I think you alluded to this a bit in response to some earlier questions, just trying to get a handle on are there anything in particular you can say that you're doing that is going to try and address directly the morale issue or the cultural issue and, obviously, people respond best and probably most to money itself, but aside from that, and aside from perhaps trying to improve the communication, is there anything in particular that you can point to that you have in mind or you're starting to do to try and fix that issue?

Yeah, in fact Glenn Johnson is here.

What we've done -- I think, David, the best thing we can do is get the operation back and when you think about the life of a customer service agent, for example, what they want most, at least right now, is an on-time airline.

Because when it's not, their troubles and their problems just magnify.

So we've got a full court press on returning the operation to, you know, reliable on-time state and I've asked Glenn Johnson actually to head up a task force, a special assignment here, to just look at all of the opportunities to do that.

I might have him just talk a little bit about where he is on that.

Sure.

As Bill said, we need to get the operation back on track and one of the very first things to that extent is to get a few of our key stations staffed to handle the type of operation that we have right now.

And obviously being off track requires a little bit more staff than we had originally anticipated.

So that's an immediate first step that we're taking.

Then second, back to this issue of our processes and procedures.

With all these changes that we've implemented, we think there's a need to go back and look at the new processes, procedures and subcontractors that we've put in place and make sure that all the connections between systems and different working groups are working correctly.

And so there's a great deal of effort that we need to do around that as soon as we get this immediate problem resolved.

And then probably the longest term and most important is re-connecting emotionally with our employees and getting back to the trust and respect and pride that we all have in the business.

And I think we're all committed to that immediate step, the interim step and the long-term objective.

And you know to that end, Glenn, as I said earlier in our comments at the beginning, we know that the only true source of differentiation, the only sustainable competitive advantage that we'll ever have is our people.

We have great people.

We have people that want this Company to be successful and because of that, we have a ton of optimism that we're going to get through this and we're going to move on into a real bright future.

Thanks, best of luck in the next quarter.

Right.

Thanks, David.

All right.

Thanks for participate.

I guess that's our last call and we'll talk to you next quarter, everybody.

Thanks very much.

This concludes today's second quarter 2005 earnings release conference call.

You may now disconnect.