阿拉斯加航空 (ALK) 2005 Q3 法說會逐字稿

Good afternoon.

My name is Mary Ann and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Alaska Air Group third 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. [OPERATOR INSTRUCTIONS] As a reminder, today's conference is being recorded and broadcast over the web.

At this time I would like to turn the call over to Shannon Alberts, Managing Director of Investor Relations for Alaska Airlines.

Please go ahead, ma'am.

Thanks, Mary Ann.

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

Joining us today are Air Group Chairman and CEO, Bill Ayer, Horizon Air's CEO, Jeff Pinneo, Alaska's Executive Vice President Finance, Brad Tilden, Executive Vice President Operations, George Bagley, Executive VP Marketing and Planning, Greg Seretsky, Air Group Controller, Brandon Pederson and Horizon Air Vice President Finance, Rudy Schmidt.

I will begin by reminding everyone that this call includes forward-looking statements and our actual results may differ materially from those statements.

Please refer to our SEC filings for additional information on risk factors that could affect our business.

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

As we reported earlier today, Alaska Air Group posted net income of $90.2 million for the quarter or $2.71 per share on a diluted basis compared to net income of 74 million or $2.29 per share in 2004.

There are three items that affect the comparison of 2005 to 2004.

Those includes deal heads mark-to-market gains, refunds of Mexico navigation fees and restructuring items.

We detailed the effect of each of these in a table that was included with the press release.

After adjusting for these items Air Group reported net income of 71.5 million, or $2.16 per share in the third quarter 2005, compared to net income of 50.7 million or $1.58 per share in 2004.

On a year-to-date basis Air Group adjusted net profit was $54.4 million, compared to 19.5 million in 2004.

As you know our business is seasonal and even in the best years the majority of our profit comes from in second and third quarters.

It's difficult to predict, but at this point we expect to be about breakeven for the fourth quarter.

Looking at our operating companies and again adjusting for the items we noted, Alaska Airlines posted a pretax profit for the quarter of 106 million, compared to a pretax profit of 64.1 million in 2004.

On the same basis Horizon had a quarterly pretax profit of 14.4 million compared to a pretax profit of 17.5 million in 2004.

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

At this point I will turn the call over to Bill Ayer.

Thanks, Shannon, and good morning, everyone, or good afternoon, I guess, depending on your geography.

I will start with a brief overview of the quarter.

Brad and Jeff will take you through some of the details of the Alaska and Horizon P&Ls, and Brad will finish up with a review of Air Group's balance sheet.

And then we will be happy to address your questions.

Last quarter we talked about the operational challenges Alaska Airlines was experiencing as a result of some restructuring activities that occurred just as our load factors was ramping up to record levels for the summer.

We found ourselves operating far below our standards for reliability and on time performance, so we decided to reduce the schedule to take some pressure off the operation.

I'm pleased to report that during September just under 80% of our flights operated on time and we completed 99% of our scheduled flights.

And our performance has continued to improve during October and we are now meeting our goals and tracking ahead of last year.

I want to thank our employees for their hard work in taking care of our customers and helping us get back on course.

Many changed their summer plans in order to make a difference and we appreciate their efforts.

I also want to thank our frequent fliers for their loyalty and patience while we work through our challenges.

We know our service fell short of their expectations during the summer and we are grateful that they stuck with us.

Like many carriers Alaska had record load factors for the period, up 3 points year-over-year and by month our load factor was up 2.8 points in July, 2.7 points in August, and 3.8 points in September.

Increases were particularly significant in the Southern California bay area, mountain and Transcon regions, with each of these posting gains of more than 4 points for the quarter.

Horizon also posted record load factors up 2.6 points for the quarter.

Alaska's yield increased 7.5% during the quarter.

This is the second quarter in a row that we've seen yields improve as fares across the industry have risen in response to fuel costs.

Our yields were strong each month of the quarter, increasing 7% in July, 8% in August and almost 9% in September.

This suggests that passengers continue to prefer our product in spite of the summers operational difficulties.

While the East Coast has seen greater fare declines in the past several years than the West Coast, fares on the West Coast are still among the lowest in the country.

Horizon experienced a slight yield decline, down 1.1% for the quarter, due to increased stage length.

Turning to costs, unit costs were up year-over-year as a result of our decreased ASMs.

Our performance in October reflects continued operational improvement and we expect to return to our originally planned level of ASMs by November.

As with every airline, raw fuel costs at Alaska and Horizon increased dramatically this quarter.

Air Group's unhedged fuel cost was $208 million for the quarter, a sizeable jump from 152 million in 2004 and 102 million in 2003.

We benefited from our settled fuel hedges to the tune of about $44 million.

We've saved a total of 180 million since 2002 as a result of our hedging program and our hedge portfolio for future purchases was worth about $212 million at quarter end.

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

The fair increases we've seen this year are an encouraging sign but it's obvious that additional fair increases are necessary if jet fuel stays at current levels.

Alaska's expenses for the quarter reflect more than $15 million in savings as a result of the new pilot contract that became effective May 1st.

This combined with a year-over-year decrease of more than 1,000 FTEs across the company, resulted in a wage and benefit expense reduction for the quarter of more than 30 million.

Our employees have made some difficult adjustments and I want to acknowledge their sacrifice.

As a result of these changes and the more than 150 million in annual savings from other initiatives completed over the past two years, our business today is much more viable and we now have a platform for growth.

You may have seen our recent announcement that Alaska's mechanics ratified a new four-year contract that resulted in a wage increase.

Our mechanics' wages had fallen below market and we've adjusted them in keeping with our stated philosophy to pay competitive market rates for all work groups.

Horizon also recently reached a tentative agreement with its mechanics on a three-year deal.

Let me talk a minute about our view of the future.

If anything, the pace of change in our industry is accelerated.

With the recent bankruptcies of Northwest and Delta it would be easy to conclude that costs are the only thing that matters.

Make no mistake, costs are important.

However, we believe this is a business that's about customers and our success will depend on understanding and delivering what our customers value.

In order to make good on our promise to provide value, we must have low cost combined with the right amount of product differentiation.

Our CASM ex-fuel goal is $0.0725 but given the changes by our competitors since we announced this goal and the high level of jet fuel prices it is likely that we will need to have even lower costs.

As evidence that we are on the right track with regard to what our customers value, we were honored that Alaska Airlines was recently named the best domestic airline in he nation for premium service in Condé Nast Annual Business Travel Survey.

Horizon also earned kudos among the single class carriers.

A recent order for 35 Boeing 737-800 aircraft, plus 65 options and purchase rights, provides the opportunity for significant growth, yet also gives us the flexibility to manage that growth as the economics dictate.

We are excited about these airplanes because they are fuel efficient, have low maintenance cost, and with 157 seats will help us continue to reduce unit costs.

The 800s are a good fit for the payload and range characteristics of our markets.

We anticipate using our new 800s to grow in three ways -- To provide more frequency; to connect existing cities in different ways; and to serve new cities from Seattle and other major gateways.

We took delivery of three 800s this year and in 2006 we have firm orders for ten and hope to take delivery of two more during the year.

With four retirements, that give us a net growth of eight airplanes for '06.

In 2007 our current intention is to increase the fleet by another eight aircraft net of retirements.

We are also enthused about Horizons announcement to acquire additional Q400 aircraft.

This airplane is well suited to Horizon's markets and the fleet additions will help position Horizon or future growth.

Jeff will talk more about this in a minute.

At the Air Group level we expect to post a modest profit for the full year, which is a big improvement over the past four years and should make us one of only a few profitable airlines this year.

Our current expectation is that our full year pretax margin will be in the range of 3% to 4%, which is obviously not adequate over the long-term.

Let me close by saying that our business needs to work for all of our constituents, employees, customers and shareholders, or ultimately it won't work for any of them.

I'm confident that as we execute our plan, we will emerge as a company that provides excellent job and retirement security for our employees, great value to our customers, and solid returns to our shareholders.

Now I would like to turn the call over to Brad to take you through the Alaska Airlines P&L.

Brad.

Thanks, Bill.

As you've seen, excluding the three notable items detailed in our press release, Alaska Airlines reported a pretax profit of 106 million this year versus a profit of 64 million last year, an improvement of 42 million or 65%.

At a high level the improvement in our profitability can be explained by 57 million improvement in revenues, a 20 million increase in our fuel cost net of hedges, and a 5 million decrease in costs other than fuel.

On a year-to-date basis, and again excluding unusual items, Alaska reported a pretax profit of 85 million in 2005, compared to a pretax profit of 25 million in 2004.

Despite capacity decline of 3.2%, as Bill mentioned, passenger revenues increased 8% on the heels of a 7.5% increase in yields and strong load factors.

These combined to push RASM up 12% for the quarter.

Our RASM got progressively better during the quarter finishing with September up over 14%.

From our review of the ATA industry data, it looks like our PRASM outperformed the industry by a little over three points in both July and August.

I should point out here that the delivered decreasing capacity for much of the quarter made our RASM a bit higher than it might otherwise have been.

We saw increases in pricing throughout our system, most notably in the Transcon and Southern California regions.

At this date Alaska has led or participated in ten fare increases.

These increases are obviously being driven by the very high cost of fuel.

Looking forward most of our markets are showing a slight improvement in bookings over last year.

Additionally, based on what we are seeing now, we expect positive yield comps in the next few months, although we do not expect the increases to be quite as significant as what we saw during the third quarter.

As a result, our current expectation is that we will see year-over-year increases in RASM in the fourth quarter but not to the extent we saw in the third quarter.

Our total economic fuel expense was 141 million for the quarter, which is up by about 20 million from last year.

Bill talked a bit about our fuel hedges.

One thing he didn't mention is that we have had supply contracts in place since early in the second quarter that fix the refining spread for about a third of our consumption.

These agreements saved us approximately $6 million during the quarter.

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 just below $50 per barrel.

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

Given the current price we haven't placed any hedges in the last five months, although we continue to monitor fuel prices and the actions of our competitors.

Operating expenses, excluding fuel on the three notable items, were down 3.4 million, or just under 1% compared to 2004, on the decline in capacity.

Also excluding these items our CASM was $0.0753 compared to $0.0735 last year.

We estimate that the capacity pull down resulted in an increase in our unit cost of between $0.004 and $0.005.

Looking at some of our operating expense line items this quarter, wages and benefits were down 33 million or 16% compared to 2004.

More than 15 million of this decline is the result of lower pilot wages under the new pilot contract and another 10 million results from the decline in FTEs, mostly on the Seattle ramp and in Oakland maintenance.

We have also seen corresponding reductions in related costs such as pension, medical, Workers' Comp and payroll taxes.

Our productivity was up 14.9% for the quarter, giving us 13 consecutive quarters of productivity improvement.

We expect smaller year-over-year decreases in wages and benefits going forward as we begin to anniversary some of the structural changes we made last fall.

We estimate they will decline approximately 8 million or 4% in the fourth quarter.

Contracted services increased 10 million compared to the third quarter of 2004, but this line item includes refunds of Mexico navigation fees in both years.

Excluding these refunds contracted services increased 7 million or 28%.

This represents amounts paid to vendors for ramp service, aircraft cleaning and ground equipment maintenance, as we subcontracted much of that work in the last year.

Aircraft maintenance increased 16 million or 60% compared to the third quarter of 2004.

We've talked in the past about the difficulty of year-over-year comparisons following our change in accounting and the power by the hour deal on our Boeing 737-400 engines.

However, sorting through this a bit, we estimate that roughly 6 million of the increase can be attributed to costs associated with work done by contractors which, unlike wages paid to our own employees, is included in this line.

Another 6 million can be attributed to a larger number of air frame maintenance events and additional money we spent on cabin improvements aimed at increasing both reliability and customer satisfaction.

The remaining difference year-over-year can be attributed to the new accounting policy and the power by the hour agreement.

We expect maintenance costs to be approximately 9 million higher in the fourth quarter of 2005 compared to 2004.

We expect that fourth quarter capacity will be up about 2%, resulting in flat ASM growth for the year.

As Bill said, we expect to take delivery of 12 airplanes in 2006 and retire four, for net growth of eight aircraft.

In terms of ASMs this would amount to something in the range of 4% to 5% growth.

By quarter we expect our ASM growth to be 2% to 3% in the first quarter, 4% to 5% in the second quarter, 5% to 6% in the third quarter, and 7% to 8% in the fourth quarter.

We are currently forecasting our fourth quarter unit costs, ex-fuel, to be approximately $0.078 per available seat mile.

This forecast includes the impact of the new agreement with our mechanics and their signing bonus.

For the full year we expect to finish with a unit cost, ex-fuel, of approximately $0.08 per ASM.

There is no doubt that we were hurt by the operational issues that we faced for much of the summer.

That combined with our capacity pull back had a significant negative impact on our unit cost.

The restored flying, improved operation performance, and new airplanes should help our unit costs improve in 2006.

We are going to work very hard to put together a 2006 budget that gets us to $0.0725.

And as Bill said, we believe that our cost will ultimately need to go lower than that and we are working now to make that happen.

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

Thanks, Brad.

Hello, everybody.

Thanks to an outstanding effort by our front-line teams and the support of our loyal customers, Horizon was able to post a solid performance during the third quarter, despite the dual pressures of record fuel prices and unprecedented summer operating challenges.

After adjusting for the mark-to-market fuel hedge gains, we produced a $14.4 million pretax profit for the quarter, compared to 17.5 million during the same period last year.

Were it not for the 24% increase and the economic price per gallon, we would have posted a 6.4% improvement in adjusted pretax profit.

Our traffic grew 13.6% on 9.8% more capacity, resulting in a load factor increase of 2.6 points to a record 75% for the quarter.

Passenger revenue increased 12% over last year, while operating expenses, excluding fuel, increased 11%.

This translated into a modest improvement in RASM and 1.3% increase in CASM ex-fuel.

In just a moment I will break down our expense changes in more detail.

Our Frontier Jet Express program has continued to perform quite well and now accounts for about 22% of our system capacity and 9% of our total passenger revenue.

As in the first two quarters of the year, our team exceeded both our on time and scheduled reliability targets, which triggered our contractual operational bonuses and we are currently on pace to finish the year on the same note.

On our native network, which is composed of Horizon's own brand flying and our Alaska network development flying, our load factor was 75.7% or 4 points higher than in 2004 on an 11% increase in ASMs.

We were fortunate to set records for load factor and passengers boarded in all three months of the quarter, partly due to year-over-year realignments of capacity in addition to the effects of increased harmonization flying within the Alaska Air Group network.

By substituting CRJ 700s for Alaska's aircraft in certain low density strategically important markets, we have been able to preserve or enhance schedules and frequency patterns while substantially lowering operating costs and, in several cases, increasing market revenues.

All while freeing Alaska's aircraft to pursue more productive missions.

The net effect on market profitability has been very dramatic in every case where such action has been taken.

Harmonization flying now represents about 34% of our system capacity, up from 25% last year.

We were also glad to see considerable improvement in average ticket prices on the native network.

Due to an 8% increase in passenger trip length, native network yield declined by 3.8%.

Now this was offset by a 3.9 point improvement in load factor which left our native network RASM virtually unchanged year-over-year.

Turning to expenses, our operating expenses for the quarter, excluding fuel, were up $11.6 million or 11%, with wages and benefits and maintenance comprising 63% of the increase.

Wages and benefits were higher by $5.6 million or 14% on a 2% increase in FTE.

The increase is due principally to a new planned time off, or PTO program, that we introduced in the third quarter, a favorable adjustment to group medical accruals recorded in 2004, and increases in wages and FTE.

We are confident that the new PTO program will improve both our operations and our overall cost efficiencies, while giving our employees more flexibility and discretion to tend to personal matters.

Our maintenance expenses were up $2 million or 20%, stemming primarily from cycle driven events onQ400 engines and propellers and accelerated inspection intervals on Q400 engines.

This is the first major propeller service that we have encountered for the Q400s.

A portion of the maintenance increase is attributable to an enhanced reliability campaign on the CRJ.

Landing fees and rent increased $1.2 million or 11% due to rate increases in several of our cities, as well as increased flying to new airports.

Contracted services also increased by 22% as a result of our expanded harmonization program with Alaska.

And last, fuel costs, net of our settled fuel hedges, were up 31% or $5.3 million on just 5.4% more gallons consumed.

Through it all we have not lost sight of the need to stay focused on overall cost reductions and the process and productivity improvements that lead to them.

On our native network we realized a 7% improvement in employee productivity and a 4% improvement in aircraft utilization over the same period last year.

In fact, if not for the January, 2004, ice storm, we would have seen improvements on both of these items in each of the last 13 quarters.

Continuing on the operations front, our scheduled reliability for the quarter was 98.4% and our on time performance was 82.8%.

While our on time numbers came in below our set standard, we still placed within the top three carriers in the country in two of the three months.

With the pressures of the summer just past, summer's 86.1% showing marked a significant improvement and a return to our more normal and traditional standard.

I really can't say enough about the job all our employees did this summer to serve our customers and support each other through seemingly endless operational challenges.

Their skill, heart and outright tenacity resulted in Horizon being once again recognized by Condé Nast Traveler's business traveller readers as the top regional airline for domestic single class service.

My sincere thanks and congratulations goes out to all of them.

Yesterday we were pleased to announce a restructuring and amendment of our order book with Bombardier that will provide an optimal fleet mix to address our near-term challenges and opportunities.

It calls for Horizon to take an additional 12 Q400 74 seat turboprops from Bombardier, seven of which will be converted to CRJ700 orders and five of which will be incremental orders.

Delivery of our new Q400s is scheduled to begin in late 2006 and continue at one or two aircraft a month through the first half of 2007.

We will also take delivery of our one remaining CRJ 700 order in the spring of 2006.

The addition of these aircraft will allow us to shore up our presence in our traditional markets, pursue new market opportunities as they arise, lower our operating costs CASM, and substantially increase the average fuel efficiency of our fleet, all in a platform that has become well accepted by customers throughout our service area.

Turning to the capacity front, we are forecasting a 9% increase for the year, which is lightly lower than the 10% guidance we gave on the last call.

For the fourth quarter we are projecting an 8% increase compared to the 10% given on the last call.

The decline in our ASM projections is principally related to the loss of 1-8 that was struck by another carrier's taxing aircraft while parking in Portland.

The aircraft is likely to be out of service for another four months.

For the fourth quarter we are estimating CASM ex-fuel at $00.138 which is slightly higher than our previous guidance and is due primarily to lower capacity than forecast.

This takes the full year number to $0.134 as compared to the $0.132 guidance on our last call.

Now let me turn the call back over to Brad, who will take you through the Alaska Air Group balance sheet.

Thanks, Jeff.

We ended the quarter with 746 million in cash and marketable securities, compared to 874 million at the end of 2004.

The 128 million reduction in cash is the net result of cash flows from operations of 183 million off set by capital expenditures of approximately 308 million, including purchase deposits made in conjunction with our recently announced order for 737-800s and the purchase of two 737s earlier this year.

Factoring in Horizon's new Q400 deal, we expect capital expenditures to be roughly 140 million for the rest of 2005, bringing the 2005 total to 450 million.

And we now expect 2006 CapEx to be 430 million.

We are getting well ahead of the financing on these airplanes and, in fact, closed on a $172 million purchase deposit facility yesterday with three European banks and we've secured financing commitments for eight of the 12 Alaska deliveries in 2006.

Our adjusted debt to cap ratio was 76% as of September 30th, down from 79% at the end of the second quarter.

At this point we would like to open the call up to your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Ray Neidl of Calyon Securities .

You threw out a lot of information.

Did you say that fourth quarter was going to be breakeven and did you give the ASM growth at Horizon for 2006?

We'll let Jeff do the ASM growth for Horizon for 2006.

The fourth quarter I think we said is that our crystal ball is pretty murky, but our current expectation is for breakeven results at the [everet] level.

Hi, Ray, this is Jeff.

With the order we announced yesterday, we are looking at about 6.75% growth for next year.

Great.

And did -- just a general question is my follow up.

In the third quarter, Alaska Air had very nice operating margins, double-digit, Horizon looks like they were improving, looks like it was around almost 6%.

Going forward Horizon, what is your goals, what is your satisfaction for an operating margin at that division?

I think both companies are aligned about what constitutes reasonable returns as exceeding the cost of capital and a long-term goal of 10% return on revenues is what we are shooting for, Ray.

We have got a multi-year plan to get there.

We think what we announced yesterday is a good step forward in improving the efficiency of our delivery as well as improving our revenue capabilities with the increased capacity.

Okay, great.

Thank you.

Your next question comes from Mike Linenberg of Merrill Lynch.

Good morning.

I know earlier, Bill, when you were going through some of the comments and highlighting some of the accomplishments, I think you made the comment about the platform for growth was in place.

I just -- where are we with respect to the various labor contracts?

I know the mechanics are done, the pilots are done.

You did -- as you indicated that 7.25 is maybe -- that now is no longer the -- maybe that's where you want to be in 2006, but it has to probably go lower 2007 giving energy costs, et cetera.

Can you just -- I realize it seems like I'm throwing out a few questions here in one, I apologize but I'm just trying to get a sense of where you are in labor and what sort of role and maybe whether it's labor or other cost areas that you see '06, '07, et cetera.

Right.

Yes, where we are with labor, Mike, is we are still bargaining with really three groups, two fall under the IAM, our customer service and reservation agents and we are in mediation with them, we have some mediation dates in November.

And the ramp, the other IAM group, and we have some mediation scheduled for December.

And then the flight attendants, which you might recall we had a tentative agreement that was defeated, we are back talking to them, I think, at the end of November, also.

So we are just very optimistic that we are going to get these things done.

They have got to work for everybody, obviously.

But I would tell you that the economics, the bulk of the labor savings in terms of the marketplace in getting to market, has been done with the deals -- the bulk of it has already been accomplished through the deals that we have in place.

And these remaining deals, there is some economics but there is also work rules and some things like that that we just think are going to allow us to have a more productive company.

But the bulk of the dollar savings, I think, you've seen it already.

And again philosophically, what we are going to try to do is be at market and then what we say is once we've reached the market levels with respect to wages and work rules and benefits, then the cost savings that we need to make need to come from other places.

This is not a situation where we want to go back and back to labor.

That doesn't seem fair to us.

And there's just all kinds of things that we've already done in terms of process improvements and there's a bunch more that we have scheduled.

What we always said with this transformation plan is we have got to get the business model repaired, we have got to start seeing some profits and then some growth can actual be beneficial in terms of putting further downward pressure on unit costs and generating further profits.

But we didn't want to get into a growth mode before we had the bulk of the cost savings behind us.

But there is certainly more to be done and 7.25 will not be low enough.

Brand, do you want to add to that?

Mike, just as we are looking maybe beyond -- 2006 and beyond in terms of non-labor things we can do to reduce cost.

Some of the things that we are looking at are maintenance as an area.

I think if you were to benchmark us against other airlines with similar fleet ages, I think you might see that there's an opportunity in the maintenance area.

And that is something that won't come quick, but with our new labor agreement behind us we can maybe put all of our energies on process improvement in the maintenance area.

We think there's a lot of opportunity in our airport processes.

We have roughly 1000 folks in Res and another 2000 in the airports.

We want to continually improve those processes.

You know that the whole notion of lean principals is something that we are really beginning to get very interested in and we think it has got a lot of promise for the company.

The 737-800s have 157 seats.

Our average airplane today has 135 seats.

So they have got substantial unit costs efficiencies and we are looking forward to growing with them.

Complexity throughout our system we are focused on eliminating.

And finally there is an exercise we are starting right now, kind of a clean sheet aircraft scheduling exercise that's going to take into account the efficiency, better -- better account, I should say, the efficiency of crews, the use of hotels, where the airplanes are RONing at night, turn times and all that sort of stuff.

We are taking a fresh look at that entire process and we are going to look to try to pull costs out of that.

We are optimistic that there are lots of things we can do to improve our competitiveness without us having to go back to labor right away.

And I guess the other thing, Mike, as you've seen from this quarter, is revenue plays a huge role in this as well.

And it hasn't gotten quite as much air time as it deserves here but we have got a really good revenue management group here that's working very hard on how do we squeeze an extra $1.00 or $2.00 out of trips and what is the U.S. [disity] of demand look like and where are we along the demand curve.

And continue to work the revenue side of the business just as hard as the cost side.

One other on the cost that, Brad, you listed a good amount of information and I appreciate that.

I guess just specifically turning toward airports and Sea-Tac in particular.

I mean, obviously, with Southwest wanting to go to King County.

That got a lot of air play and that may have helped your cause there, you being the largest operator out of C-tech.

Is that something where maybe going forward we could see some savings there given -- from Southwest's view it's the most expensive airport in their system?

Yes, Mike, this is Bill.

I think there is opportunity at Sea-Tac and we are going to be spending time over the coming weeks and months to fully understand the costs at Sea-Tac and what ideas, working together, having the airlines and the Port work together to look for further opportunities.

It's a big area, it's very important to us, obviously, given our size at Sea-Tac and it's something we are going to get on with the Port.

In terms of modeling, Mike, if you go back a couple years ago Sea-Tac costs were $5 a passenger, maybe that's four, five years ago now, and at one point we were modeling $23 or $24 a passenger by 2009.

It would be a very impressive feat to get costs to actually go down, but I think Sea-Tac has already reduced their projection for 2000 -- the latter part of this decade from $23 or $24 down to $14.

And what we would hope to do is slow the rate of increase in that.

And I think the whole Boeing field exercise was really helpful in that.

Well then very good.

I'm glad, it sounds like it turned out in your favor.

Nice quarter.

Your next question comes from Jamie Baker of JP Morgan.

Good morning, everybody.

Brad, I didn't realize the mechanics signing bonus was going to be included in the CASM guidance.

I thought that was a one-timer.

Refresh my memory, that's $1,000 ahead and around 700 heads?

Exactly right, Jamie, roughly $700,000.

I can do the math there.

Secondly, this notion of a potential turboprop renaissance, it's an interesting one to me.

I think that Horizon's conversion of 70 seat RJs is the first example at the industry level.

Can you just give us a little bit more color as to the relative economics of the two planes, particularly at what JetCarol price the RJs stop making sense or make less sense and the Q400 really steps up.

Hi, Jamie, this is Jeff.

We've had a few years now of operating experience with both aircraft types and what we've learned is that the fuel efficiency in particular of the Q400, the overall operating cost efficiency is significantly greater than the RJ on stage lengths under let's say 800 or 900 miles.

There is a crossover point out there where they start to look a lot more alike.

But since we have so many needs and opportunities in that sweet spot of stage length, it really makes for a better mix with what we've just done than to have more RJs coming down the pike.

Our opportunities and needs really are close to home.

We have got a number of markets that we've been serving and building for a quarter century now that are under served with -8 capacity, very high-frequency levels and high density.

By introducing the Q400 into those markets and exercising a re-marketing partnership clause in this deal that will engage Bombardier in the re-marketing of some of these -8s, we are able to introduce a better level of service, a more efficient level of service in a lot of our existing markets.

I would say it's less about a statement on the RJ as it is a statement on the -8 itself and the need to improve our efficiencies in those markets.

Having said that, we built enough flexibility into this to be able to respond to some new market opportunities that are particularly well suited to the Q400, both in terms of their stage length and in terms of their -- just the capabilities of the airplane being able to get into places that others can't.

We still, by the way, also have RJ options, 17 of them, that gives us some flexibility to respond in that direction should opportunities arise.

Jamie, this is Bill.

Jeff, you have found zero avoidance, customer avoidance of turboprops.

When you fly the airplane side by side with the RJ, it's just a great customer experience.

Gives you lots of flexibility.

It really is.

It's super fast on stage lengths of 300 to 400 miles.

There's no decrement in block time, very comfortable, very quiet.

We've added -- as you know we've gone up to 74 seats and have detected no bumps in the road at all in terms of customer perception of the comfort and the level of service.

So that's improved even further the economics of the airplane over the 70 seat RJ.

And I'm sure that has nothing to do with the complementary glass of Pinot.

That's excellent feedback, the color I was looking for.

Thank you so much.

Thanks, Jamie.

Your next question comes from David Strine of Bear Stearns.

Thanks, good morning.

Hi, David.

RASM growth is pretty good in the quarter.

I just want to get a feel for how the momentum feels there, particularly on the West Coast moving into the fourth quarter.

Let's have Greg Seretsky give him that.

Good morning, David.

Our RASM growth in the third quarter was pretty much equally split between load factor improvement and RPM yield improvement.

As we look out into the fourth quarter we continue to see advances tracking at roughly the same modest growth as our capacity.

But we don't see load factor improvements of 3 to 4 points that we saw earlier in the year.

So, part of the RASM gain that we saw in third quarter will decline because load factors aren't as strong in the fourth quarter as they were in the third quarter.

And as Brad said, partly facilitated by our capacity pull down.

We do expect the RPM yields to continue to be strong.

And so I guess my guidance would be -- .

But not strong enough to compensate for the load.

No, our RASM growth will still be positive.

It won't be in the 12% to 15% range.

My guess is it will be maybe close to half of that.

The RPM yield side will continue and the load factor's side of the improvement will be somewhat flat.

Brad, reverting back to the question about 4Q CASM guidance, anything else in there aside from the new mechanic contract that's driving that change?

There are some accruals for incentives, profit sharing, a program we have called operational performance awards where our employees can make up to $100 a month for customer satisfaction and on time goals.

There are some anticipated costs there that would also affect the number a bit.

And other than that there is nothing else that's driving it?

You know, there's nothing else I have right now, David.

It's -- I think our guidance is -- it's up maybe a touch from our last guidance for the fourth quarter but that's the detail I have right now.

Okay.

And tax rate, do you expect that to be pretty consistent going forward?

Yes.

With what it was in this quarter?

With the year-to-date rate for the first three quarters of the year, we do.

That's good.

Thanks a lot.

Your next question comes from Jamelah Leddy of McAdams Wright Ragan.

When you spoke about improvements in load factors you mentioned a couple of different regions including Transcon, Southern California.

I'm wondering if you can talk about some areas where load factors were a little bit below the average or below your expectations?

There were two areas in our network that had declines year-over-year in load factor.

One is the Canada region, where we had new entry by competitors, and the other is in Mexico, and we had the same phenomena there with new capacity from competitors.

Thank you.

My other question is with respect to Horizon, I'm wondering if you could talk a little bit about the agreement with Frontier, if that's meeting your expectations and if you are continuing to look for other similar type agreements.

Yes, Jamelah, this is Jeff.

We are very pleased with the agreement thus far.

We are just about to cross the two-year mark in the experience and along the way we've learned a lot and we've affirmed what we thought going in, is that we are pretty good at this in terms of being able to operate well, deliver on our promises to Frontier.

We've met or exceeded our operational hurdles and bonus targets in each of the quarters that we've operated.

So that's a good sign.

And we think that's a good calling card for other potential work that might be out there.

Of course, the marketplace is volatile for contract flying and continues to change with prospective partners in varying degrees of impairment.

And so we are pretty happy right now with the balance that we have in our program in terms of the mix between native network and contract flying.

It gives us a lot more flexibility to respond to changing circumstances.

But that said, we keep the channels of communication open, not only with Frontier which is the first priority in terms of any changes or growth they would like to see in the program, but others as well and evaluate those things as they come to us.

For the next year or two, of course, with what we've just announced a lot of our focus will be right close to home.

We are going to work to really shore up and provide high levels of service in our traditional markets and maybe selectively be on the hunt for a few new opportunities.

But that said, if something comes along that looks attractive we will certainly be responsive to it.

Great.

Thank you very much.

Thanks, Jamelah.

Your next question comes from Glenn Engel of Goldman Sachs.

-- or afternoon, whatever I am.

A couple questions.

One, I thought profit sharing was about 10% of profits, yet I don't really see it showing up anywhere.

You know, it's -- we made a change to that program for this year, Glen, where it went to 5% of profits.

And we added in this other program that can pay up to $1,200 a year if operational and customer satisfaction goals are met.

With that change, profit sharing is now 5% of profits -- the pool is 5% of profits.

And we booked $2.1 million year-to-date for that.

It's not on a line item but that's the amount.

So you are no longer splitting that out?

That would be a number in the fourth quarter wouldn't have a big catch up for that?

No, there wouldn't be a big catch up for that.

There would be the fourth quarter portion of that, but it certainly wouldn't be a big adjustment.

There was a big increase in rental and landing fees in the third quarter?

If I took out the one-time gains of about 20% at Alaska, why would that be?

What one time gain for landing fees?

Navigation, I'm assuming that's showing up under landing fees and other rentals.

It's actually not, Glenn, that's in contract services.

But I think landing fees and other rentals were still up 8% and that is a line item that we've had trouble with for several years now and we are trying to get a lot more active in terms of working with our airports to get those costs down in the years ahead.

If I looked at a goal of $0.0725 and 5% capacity growth, I would actually need to lower your non-fuel costs by $100 million while growing 5%.

I just don't know how you get there.

What are the big areas where I will actually see reduction in '06 versus '05?

To get to seven -- I guess, first of all, Glen, I think our current run rate, despite the third quarter number and the fourth quarter number, we think our current annual run rate is somewhere in the neighborhood of $0.075 per ASM.

We were really hurt in the third quarter of this year by the lack of ASM production.

So if you take this year, which we said we think will end at $0.08 or something like that, and adjust for new airplanes coming into the fleet and better ASM production next year, we think our run rates $0.075 or something like that.

And then it's the areas that we talked about that are going to get us from there down to the $0.0725.

Okay.

Thank you.

Your next question comes from Gary Chase of Lehman Brothers.

Good morning, guys.

Hey, just a couple quick questions.

I'm going to apologize in advance.

I missed, I believe, every bit of your prepared remarks so I apologize but just a couple quick things.

Brad, I thought I heard you say something about breakeven in the fourth quarter.

Was that a comment around net income or pretax or -- ?

Pretax income.

Well, I guess same thing if you are breakeven.

Wanted to ask you as well, you guys had said, and it's not the first time you said it, that this 7.25 was something you were going to work hard to produce in '06 and that given the industry environment and particularly fuel, that it may need to go lower.

What kind of flexibility do you have to reduce the size of your current fleet as some of the new aircraft come in if you don't hit those goals?

I mean, you've consistently said you don't want to build the growth on the wrong platform and so on and so forth.

So, do you have the flexibility to do that in the years ahead if you are not satisfied with the cost position that you achieve?

We've got a lot of flexibility, Gary.

I think -- first of all our 737-200s, we are planning on phasing out positively.

So there's eight of those airplanes that will leave in the next couple of years.

Then our 737-400s and 700s, we have roughly four lease returns a year.

So airplanes would be scheduled to go back between now and 2009 or 2010.

So those give us a little bit more flexibility.

And then on top of that we have 18 owned MD-80s, that if we needed to reduce capacity even further, those would be candidates for sale.

We've got a lot of flexibility and we are quite comfortable with that and it's a great part of the Boeing deal is not only the firm orders and the timing of them with respect to lease expiration, but also the options and the purchase right airplanes.

But I would say that our mindset is about growth.

We see opportunities, Greg's group sees a lot of marketing opportunities out there to grow and we think with the continued cost efforts here we do have the right platform.

But we are not going to defy gravity here and try to grow an unprofitable business, which is where we would have been a year or two ago.

Right, understood.

Just a couple other quick ones, Greg.

Lot of capacity moving around, kind of atypical but in this day and age moving in the right direction from an industry perspective, how do you view what we are seeing in the most recent schedule of filings?

How do you think that impacts Alaska, a little, a lot, not at all?

I mean clearly it's going to be helpful taking capacity out of the domestic entity but is there any way to get some color around how helpful it might be for you?

Yes, Gary, I think if you are referring specific to reductions announced by Delta and Northwest, we have almost know overlap with them so their capacity reductions really don't help us.

But you might hypothesize that a capacity reduction in other markets in the country might cause competitors' capacity to move to fill that void and that might moderate what we would have seen otherwise in competitive incursions in our geography.

But I would say the impact that we expect from those capacity reductions on Alaska Air Group is very small.

You haven't seen anything yet shifting around that suggests to you there is response to those changes that will benefit you or harm you or anything of that nature, right?

Not really other than the new U.S.

Mexico bilateral which has created a third designation in each country.

We are seeing a lot of interest on the part of our domestic competitors in Mexico.

So to the extent that we are the largest carrier off the West Coast to Mexico, there is a potential down side for us there in some of those markets.

And just curious as well, Jeff, when you were talking about, I think it was opportunities for the turbos, you mentioned an 800 mile stage length.

Did I hear that right?

Yes, thanks.

What I was referring to with that was sort of the crossover point or the beginning of the crossover point between the CRJ 700 the Q400 in terms of its economics.

It's actually closer to about 900 to 950.

But the sweet spot for the Q400 is really in the 300 to 500 mile range.

Right, because you'd take a pretty good size decrement on block time out at that stage, I assume.

Yes, the grade is pretty quick.

Okay, thanks very much.

Appreciate it, guys.

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

Hi, good morning.

Had a question, it's kind of a follow-up to the other question about scheduled shifts.

It seems that there's a trend among the legacy carriers to move more of their operations to international flying.

I think United said that.

I think Delta and even America have said that.

Is there anything with respect to those trends that could be positive for you or negative for you?

Nothing that's been disclosed already in terms of their intentions in the markets that they are going to serve.

I think what you are seeing is domestic capacity withdrawals that have been announced by some of those carriers have been met with international expansions of sort of equivalent type.

So most of that is coming out of long haul Transcon markets, the best we can see.

And we are not a player in the Transcon except from Seattle and there hasn't been any big reduction capacity in the Transcon from the Seattle market.

So when you talk about, I guess Bill, particularly, you mentioned a number of times on the recent conference calls about growth.

And you're positioning yourself for growth.

Can you elaborate a little bit more on what that might look like?

Is it more Transcon, is it more flying from other cities or mini hubs?

I'm trying to get a better feel for the kind of the hub -- what the growth is going to look like, what you're trying to accomplish.

We'll let Greg answer that, Bob.

We sort of have three different types of growth that we envision.

One is an increasing frequency in existing markets and we pulled down a fair bit of capacity this summer.

It is certainly an opportunity to go back and replace what we would have flown had we not it pulled down.

Two is to connect the dots differently.

We have got a lot of cities that we serve but don't necessarily serve between those two cities on a nonstop basis.

So eliminating some of the connecting traffic and putting on nonstops.

And the last, I would say, is growing our presence where we have point of origin strength, specifically in places like Seattle and Anchorage and Los Angeles.

One thing to keep in mind, Bob, is the Transcon flights are more than twice our average stage length.

One new round trip to a Transcon market is an airplane and it's roughly 1% growth for us.

So it begins to consume airplanes pretty quickly.

And the last question I have has to do with profitability at $65 a barrel oil.

I know you talked about your fuel hedges but I'm trying to get a better sense of if fuel prices stay at these levels sort of indefinitely, and I know nobody can predict fuel prices, but do you feel that you can remain profitable or achieve your margin goals at these levels of fuel prices?

Bob, this is Bill, maybe I will start on that.

Near-term with our hedge position we bought some time, basically, and we understand that hedges go away and then everybody is equal on fuel prices.

What has to happen across the industry if fuel stays high is that fares have to go up.

There is just no two ways about it, you have got to get more revenue.

And then I think one of the questions for the whole industry is at significantly higher ticket prices, what does the demand picture look like and then how much excess capacity is there?

And this is a broader industry question really, but it's something that we are interested in understanding and understanding our individual markets with respect to demand curves.

Demand the elasticity and various price points, what does demand look like in business versus leisure and all that.

So it's something we are going to spend more time understanding.

But as of right now, as we said with the aircraft order, our mind set continues to be to take advantage of some of these growth opportunities.

And as Greg mentioned, really continue to build our position in places like Seattle and the Pacific Northwest, where additional destinations and additional frequency really increase the utility of Alaska Airlines for our customers.

And the experience this summer, I will tell you, with the operational issues that we had, we all ended up talking to a lot of our frequent fliers and we have a lot of very loyal people because of the utility of our network, especially from a place like Seattle.

So that's encouraging for us and we continue to build that and then look at some other gateways maybe along the way where we can do the same thing and that's part of the whole value equation for our customers.

Great.

Thank you.

Your next question comes from Jamie Baker of JP Morgan.

Just a quick follow-up.

Every several months Richard Branson is being quoted as saying that we will hear about Virgin America in the next several weeks, kind of a repetition process.

I'm wondering if you are hearing anything around the industry, in particularly as you speak with folks at SFO?

Nothing.

Okay.

Continuing rumors.

We are hearing the same things you folks are hearing, nothing definitive.

Thanks for taking the follow-up.

Your next question comes from David Strine of Bear Stearns.

Thanks.

Brad, a quick follow-up on Glenn's question.

I just want to make sure I have this right.

For the Alaska entity CASM ex-fuel in 2006 you are saying you're on a run rate for $0.075 without any new initiatives.

Is that correct?

Correct.

Okay.

That's it.

Thank you.

David, you asked about fourth quarter costs.

I was going to jump in and give you a little bit of detail.

A couple of our line items in the fourth quarter that are going up a little bit higher than you might expect.

I think we mentioned, but maintenance costs for the fourth quarter we are expecting to go up by about $8 or $9 million and landing fees, if I can find it here, landing fees up by $5 million, 13%.

Those are a couple of the lines that might have higher increases than you would be expecting.

Thanks a lot.

At this time there are no further questions.

Ms. Alberts, I'll turn it back to you for closing remarks.

We don't have any closing remarks.

We thank everybody for taking part today and wish you a good day.

See you next quarter.

Thanks.

Thank you.

This concludes today's Alaska Air Group third quarter 2005 earnings release conference call.

You may now disconnect.