阿拉斯加航空 (ALK) 2006 Q2 法說會逐字稿

Good morning.

My name is Kelly, and I will be your conference operator today.

At this time I would like to welcome everyone to the Alaska Air Group second quarter 2006 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 session. [Operator instructions]

The company has requested that you limit your questions to one and one follow-up.

Today's conference is being recorded for future playback www.alaskaair.com.

Thank you Shannon Alberts you may begin.

Okay.

Thanks Kelly.

Hi, everyone and thank you for joining us for Alaska Air Group's second quarter 2006 conference call.

Speaking today will be chairman and CEO Bill Ayer, CFO, Brad Tilden, and Horizon Air CEO, Jeff Pinneo.

Also here to answer your questions are Alaska executive vice president marketing and Planning Gregg Saretsky, executive vice president operations, Kevin Finan, Senior Vice President Customer service Glenn Johnson, Horizon Air vice president Finance Rudi Schmidt, Air Group Controller Brandon Pedersen, Treasurer Jay Schaefer, and Alaska's managing director of Corporate communications, Caroline Boren.

Our agenda for today includes a management overview after which we will answer questions from analysts.

Following that we have set aside time to address questions from the news media.

This call does include forward looking statements and these statements may differ materially from our actual results.

Additional information on risk factors that could affect our business can be found in our periodic SEC filings.

To the extent our presentation includes non-GAAP financial measures, we have provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release, which can be found on our website at alaskaair.com.

As we reported earlier this morning Alaska Air Group reported GAAP net income of $55.5 million, or $1.38 per share in the second quarter of 2006 versus net income of 17.4 million or $0.56 per share in 2005.

There are several notable items that affect the year-over-year comparison including a restructuring charge this year associated with the early out payments to over 100 flight attendants and a special charge last year related to the ramp subcontracting work.

Both quarters include mark to market adjustments associated with our fuel hedge portfolio.

Rather than go through all the details now, I would like to refer you to the reconciliation on page 10 of our earnings release.

After adjusting for these items, Air Group reported a net profit of $60.3 million, or $1.50 per share for the second quarter 2006, compared to a net profit of $24.7 million, or $0.78 per share in 2005 and a first call consensus of $1.29 per share.

On a year-to-date basis and after adjusting for the unusual items in both quarters for each year, Air Group's net income for the first six months was $63.1 million, versus a net loss of $17 million during the first six months of 2005.

Now it is my pleasure to turn the call over to Bill Ayer.

Thanks Shannon and good morning everybody.

We're extremely pleased with these results which represent a record second quarter adjusted net profits.

And coupled with our strong first quarter performance and a favorable revenue environment, the year-to-date result is a strong indication that our plan is working.

And because of the seasonality of our business, we expect the third quarter to be even stronger than the second.

It is gratifying to see everyone's hard work paying off and I want to congratulate and thank the employees at Alaska and Horizon on this excellent performance.

We're now entering the fourth year of the Alaska 2010 long-term transformation plan.

And while we're taking full advantage of the current industry revenue environment we believe that sustained profitability will be achieved through continually improving the value of our product to further process improvement, higher productivity and improved efficiency.

We have a number of initiatives in work that will help us continue our progress.

Alaska Airlines posted a 9.6% passenger RASM increase during the quarter while Horizon system wide passenger RASM increased 10.4%.

Alaska's passenger unit revenue increase was largely the result of a 7.6% improvement in yields, making five consecutive quarters of year-over-year yield improvement.

Our average revenue per passenger has increased to approximately $160, up $14 from last year and up $25 from the second quarter of 2002.

Horizon's yield was up over 5% for the quarter.

And although our unit revenue gains weren't as strong as the industries, over the last few years fares on the west coast did not fall as much as those on the east coast and our markets have not had the capacity of reductions we've seen in other parts of the country.

Alaska RASM improvement came on of a 5% increase in ASMs versus an ASM decrease of about 5.5% for the rest of the industry.

During the 2002 to 2006 period oil prices increased threefold, from $25 a barrel to $73 a barrel today.

And our unhedged annual fuel expense grew from $314 million to more than $900 million.

So while we are fortunate to be able to recoup much of that increase in the current fare environment, we also recognize that we can’t bank on continued fare increases to sustain our profitability over the long term.

Alaska reported a non fuel CASM of $0.0792 compared to $0.0809 last year essentially in line with our most recent guidance and down 2.1% year-over-year.

This quarters cost performance was driven in large part by the excellent work of our maintenance and engineering organization in setting and achieving some aggressive goals for efficiency and reliability.

Brad and Jeff will provide more detail as they take you through their P&L's in a minute.

One increased expense that we're actually very proud of is the accrual for our various employee gain sharing plans, including the $10.6 million booked this quarter, we have accrued approximately $19 million to date in anticipation of 2006 payments for employees at Alaska and Horizon based on a strong first half performance.

This is consistent with our philosophy of paying market based wages to our employees and sharing meaningfully in the upside in the form of incentive pay.

Employees are also the beneficiaries of our improving balance sheet.

We have contributed $72 million to our pension funds this year meeting our internal funding goal for 2006 earlier than planned.

We ended the quarter with over $1.1 billion in cash and investments.

Our solid balance sheet combined with progress on unit costs lays a solid foundation for future growth by giving us access to capital on improved terms as well as the option of paying cash for some of the airplanes that we have on order.

I would like to share an example of how we're leveraging our strong balance sheet to the benefit of our customers.

Yesterday Alaska Air Group's board of directors approved spending $18 million for the renovation of the Sea-Tac check-in area, modeled after the innovative airport of the future design that we pioneered up in Anchorage and that has worked so well for our customers there.

This major remodel will improve our passengers and employees experience by streamlining the check-in process and eliminating the traditional ticket counter.

From a CASM perspective, productivity and efficiency will also increase allowing us to grow our presence at Sea-Tac without adding additional airport real estate.

This remodel is part of the $1.9 billion in capital expenditures that we planned for the next three years and we look forward to sharing more details about the design and what this will mean for customers over the next couple of months.

Our customers will also benefit from additional Mexico routes that we have recently announced, so beginning this fall Alaska Airlines will offer seasonal nonstop service from Portland to Los Cabos and Puerto Vallarta, and from Seattle and San Francisco to Cancun and year-round service from Los Angeles to a new destination La Paz.

While modest in terms of additional ASMs these routes expand our service offering along the west coast.

We're also improving service to our cargo customers.

We completed the modification of a 737-400 freighter in June and our four additional 737-400 combi aircraft are scheduled modification through 2007, replacing our 737-200 combis.

We expect our first modified 737-400 combi aircraft to enter service later this year.

Turning back to our people Alaska's customer service reservations and ramp employees ratified new four year contracts last week.

This means that Alaska and Horizon are now current with all of our labor agreements and that at Alaska we have achieved new contracts with each of our labor groups that reflect the market realities of the industry.

You'll recall that Alaska's current two-year pilot agreement is the result of an arbitration and we're looking forward to starting the negotiation process on a long term agreement late this fall.

We also just began Section 6 negotiations with Horizon's pilots whose contract becomes amendable in September.

Alaska and Horizon employees are doing a great job serving record numbers of customers this summer.

Alaska's load factor increased again this quarter, this time by 1.4 points to just under 80%.

And Horizon achieved an impressive 3.6 point load factor gain for the quarter.

Our people also get credit for the substantial improvement in Alaska's operating performance compared to last summer.

On-time performance for June was up 23 points to 72.9%, putting us in the top half of the industry.

And while there is still work to do, these numbers are a testament to the collective efforts of our people.

I'm very grateful to employees at both companies for continuing to make our customers a priority as we work through the many changes needed to achieve our goals.

And finally I want to note that Horizon will mark its 25th anniversary in September.

And congratulations to all the people at Horizon whose creativity, spunk and determination have built a great airline over the past quarter of a century.

And I was fortunate that I was able to spend 13 years of my Air Group career over at Horizon and I couldn't be more proud of Horizon's accomplishments.

With that I will turn the call over to Brad.

Thanks, Bill.

Looking at Alaska Airlines now, excluding the unusual items we reported pretax income of $79.6 million for the second quarter of 2006 compared to pretax income of $34.2 million in 2005.

This equates to a pretax margin of 11.2% in 2006 versus 5.5% in 2005.

On a 5% increase in capacity, our revenues increased $94.1 million or 15%, our non fuel operating expenses, excluding special charges, increased by 13.5 million or 3%.

And our economic fuel cost increased by $40.2 million, or 31%.

Digging into our revenues our RASM increase for the quarter was 9.5% and we seemed to gain a bit of momentum as the quarter progressed.

In fact June was the strongest month of the quarter increasing 10.9% compared to increases of 8.8% and 8.6% in April and May, respectively.

The RASM increase that were driven by 7.6% increase in yields and a 1.4 point improvement in our load factor.

We've participated in 5 fare increases in our major West Coast markets this year and as a result we saw yield increases in all of our major regions with these being relatively more significant in Canada, the Bay area, and the long haul Alaska markets.

Advance bookings look reasonably good for the third quarter, while July looks about flat, our bookings for August and September are currently up by about two and three points respectively.

Turning to fuel our economic fuel expense net of hedges was a 196 million for the quarter at the Air Group level which is up by 45 million from last year.

We again benefited from our hedge program with subtle hedges lowering our economic fuel expense by 34 million for Air Group and by 30 million for Alaska airlines.

To see a reconciliation between raw, economic, and GAAP fuel costs, please refer to the tables on pages 8 and 9 of our earnings release.

If fuel were to finish the year at $75 per barrel we estimate that our hedges would lower Air Group’s fuel cost by 54 million for the balance of the year, bringing the annual benefit of our hedging program to about 120 million.

In addition to these crude oil hedges we also have physical purchase arrangements in place which effectively fix our refining spread for 43% of planned consumption for the balance of 2006.

These arrangements saved us $4 million in the first half of 2006.

Looking forward 46% of our third quarter consumption is hedged at $43 per barrel and 35% of our fourth quarter consumption is hedged at $46 per barrel.

For 2007, 20% is hedged at approximately $45 per barrel and for 2008, 7% is hedged to just below $50 per barrel.

The majority of these hedges are call options which means that we would benefit from any decline in fuel prices.

During the second quarter we made no changes to our hedge positions.

As you know we significantly slowed down our hedging activity in mid 2005 based on a sense of fuel markets at the time and the lack of hedging by our competitors.

Given the volatility we're seeing today and given the renewed hedging actions of some other airlines, we are planning to resume our hedging program this quarter.

Our people delivered the cost performance that we expected achieving CASM X fuel $7.92 per ASM for the quarter, a 2.1% decline from 2005.

Looking at some of the specific line items from our P&L, wages and benefits were up $6.8 million, or 3.8% compared to 2005, these costs include among other things a signing bonus paid to our flight attendants and a true up of our retiree medical accrual.

We expect that wages and benefits will increase roughly 6.7% and 5% in the third and fourth quarters, respectively, now that our major structural wage changes have passed their one-year anniversary.

These are on FTE increases of 5.4% and 4.1% respectively.

Our productivity was up 2.7% for the quarter to 158 passengers per FTE giving us 16 consecutive quarters of productivity improvement.

We had 82.7 employees per aircraft compared to 83.9 in the first quarter of 2005, or in the second quarter of '05.

Bill mentioned the great performance by our M&E folks.

For the rest of the year we expect our maintenance costs will be slightly down year-over-year in the range of $1 million to $3 million per quarter.

Selling expenses grew 6 million or 18% over 2005, the change resulted from an increase in our accrual for our mileage plan awards as well as higher revenue related costs such as credit-card and codeshare fees.

Finally at the Air Group level our tax provision was once again favorably impacted by a $2.9 million adjustment to a tax contingency accrual which works out to be about 7%, which works out to be about $0.07 per share.

This brings the year-to-date adjustment to 5.5 million.

We do not expect any further tax related adjustments this year.

We're still anticipating ASM growth of about 5% for the year, this ASM growth is a result of 12 new, 737-800s four of which we have received so far this year.

And these are offset by the retirement of four MD-80s and four 737-200s.

We expect ASM growth of about 6% for the third and fourth quarters.

Our current expectations are that unit costs will be down marginally in the third quarter to $00.074, and down between 4% and 5% in the fourth quarter to $0.075 or $0.076.

We're feeling some pressure on cost because of the higher incentive pay, higher wages, and the revenue related costs I mentioned.

We're now forecasting our full year unit costs to be in the neighborhood of $0.077 per ASM.

While this is a substantial improvement over the $0.0801 we reported in 2005 it is higher than we would like to be.

We still have $0.0765 as our internal goal for the year and we're working hard to get there.

At this point I will turn the call over to Jeff to walk you through Horizon's results.

Thank you Brad and good morning everybody.

For the second quarter, we're pleased to report a $10.2 million adjusted pretax earning figure, this compares to a $10.7 million adjusted profit in 2005 and was realized despite a 25% increase in fuel expense over last year and a very heavy planned engine overhaul schedule that added over $4 million in maintenance expense for the quarter.

This increase in engine overhaul activity which we previously briefed you on is forecast to add about $30 million in expense this year over last a burden that puts a bit of a drag on our efforts to grow earnings in proportion to our revenues this year.

That said, we're tracking ahead of our plan and anticipate that the smoothing of these scheduled events in future years will result in less volatility.

As at Alaska, passenger demand has remained very strong through the period with new records for load factor and traffic set in each month of the quarter.

This has allowed us to continue to participate in industry fare increases launched to cover rising fuel costs resulting in a 17% upsurge in passenger revenues on 6.5% more passengers.

Continuing our trend for several quarters, Horizon's record second quarter load factor of 76.6% combined with a 5.3% increase in yield to drive our system RASM up 9%.

Focusing on our native network, a 9.8% increase in yield combined with a 2.7 [point] increase in load factor to produce a RASM gain of 12.3%.

In this line of business our average fare of nearly $99 represents a 12% increase over last year, aided in part by a 2% gain in average passenger trip length.

RASM was slightly lower at Frontier JetExpress as a result of the fixed fee arrangement.

The share of revenues that our product lines account are nearly the same as in the second quarter of 2005.

Our Frontier JetExpress operation represented 24% of our total ASMs up slightly from 22% in the second quarter of 2005 due to higher utilization and good weather.

On the expense side our operating costs excluding fuel were up $18 million or 14% for the quarter with maintenance and wages and benefits accounting for the lion’s share of the increase.

On a unit basis our CASM X fuel was up 9.8% over last year to $0.14 reflecting the anticipated surge of engine overhaul activity.

Adjusting for this, the remaining elements of our CASM X fuel metrics are on improving trends in line with improvements in employee productivity and asset utilization.

I noted that our maintenance cost increase this period were both sizable and forecasted.

In addition to increased engine overhaul activity, we also conducted more sea checks than last year and incurred some extraordinary costs associated with getting our two Q400s that we acquired from Hainan Air ready for service.

Wages and benefits and variable pay were up $6.4 million or 15% on a 3.4% increase in FTEs and a 4.2% increase in average wage.

The variable pay component, some of which is based on achieving certain operational performance targets, increased $1.9 million year-over-year.

In fact, the operational performance reward for the second quarter is the largest payout we have made to date, a testament to the incredible efforts being put forth by our people to keep our planes on time and our customers satisfied.

Most of the remaining variants is attributable to increases in selling expenses, property taxes, and contracted services resulting from our increased flying.

Our focus on further reducing unit costs to ensure our competitiveness will remain high, with aggressive CASM targets remaining at the center of our profit improvement plans going forward.

Turning to our operations, I'm proud to report that our team continues to do an outstanding job and my hat is off to them all.

Our aircraft utilization was up 3.5%, employee productivity was up 2.3%, on-time performance was up about a point, and we were the only regional airline to place among the top 10 airlines in the country in Travel and Leisure magazine’s recent reader survey.

On the fleet side, we have begun to take delivery of the 15 Q400s we announced that we would be acquiring last fall.

The first two from Hainan Airlines in China arrived during the first quarter.

One is currently in service and the other will go into service soon.

The 13 remaining are new aircraft and we expect to begin taking delivery from Bombardier beginning late this year through August 2007.

As part of this deal, we had announced our intention to remarket several of our Q200s in order to facilitate the efficient addition of needed capacity in several of our native network markets.

We're pleased to announce that we have a tentative agreement with CommutAir to sublease 16 of our Q200s for their use in their capacity purchase agreement with Continental.

Operating as Continental connection out of Cleveland.

The Q200 delivery stream extends from January 2007 to early 2008.

Many of you already know that this is Horizon's 25th anniversary and we're doing a lot to celebrate the extraordinary accomplishments of our people over that time.

On June 21, with over 1000 employees and family members present, we unveiled a special 25th anniversary livery, which adorns one of the two Q400s that we purchased from Hainan Airlines earlier this year.

You can see downloadable photo of the anniversary livery in the newsroom section of horizonair.com or in the skies above the great Northwest.

Now for a quick look ahead to the rest of the year, we anticipate ASMs to increase about 7% for the year compared to the 6% guidance that we previously reported.

This breaks down to 5% increase for the third quarter and a 6% increase for the fourth quarter, versus previous guidance of 4% and 5% respectively.

CASM X Fuel is projected to be 14.2 cents for the year compared to our previous guidance of 14 cents.

This increase is related to preparation for new aircraft deliveries next year and rescheduling of some planned heavy maintenance work from early 2007 into 2006.

By quarter we are projecting CASM X Fuel at 13.9 cents for the third quarter up from 13.7 cents reported on last call, and 14.7 cents for the fourth quarter up from 14.4 cents reported on the last call.

I'll now turn the call over to Brad who will take you through the Air Group balance sheet.

Thanks Jeff.

We ended the quarter with our balance sheet in very good shape.

We had just over 1.1 billion in cash and short-term investments which is equal to 34% of revenues, and this compares to $983 million at the end of 2005.

The increase over the last six months is the result of strong cash flows from operations of $245 million, and proceeds from new debt of $187 million, both of which were offset by capital spending of roughly 300 million.

The new debt is the result of financing three 737-800s and one CRJ-700.

We currently expect our capital expenditures to be $630 million in 2006, $680 million in 2007, and settling down to approximately 500 million per year after that.

Our debt to capitalization ratio, adjusted for operating leases is 69% as of June 30, an improvement from 73% at the end of 2005.

This ratio was favorably impacted by the forced conversion of our senior convertible notes in April.

As we look at the third quarter there were two other items that we would like to mention that we also included in this mornings 8-K.

First, in conjunction with our plan to retire our MD-80 fleet, we expect to finalize an agreement in the next few weeks to buy out five of our nine long-term aircraft leases.

This transaction will likely result in a charge of approximately $65 million before tax, or $40 million after-tax.

When we announced the retirement of our MD-80s earlier this year, we shared with you that we expected to book additional charges on our leased aircraft as we enter deals to either buy out the leases or sublease or park the aircraft.

This charge is in line with the estimates that we provided then.

We still have four long-term MD-80 leases and we will have an incremental special charge for these when we determine their ultimate disposition.

Second as Bill mentioned we have two new agreements with the IAM for contracts covering our customer service, reservations, accounting, and ramp groups.

As part of these contracts we agree to offer senior employees a voluntary severance package.

It is very difficult to predict the number of people who may accept this offer, but if 25% were to accept, we would have a third quarter charge of approximately $20 million before tax or $13 million after-tax.

In the 8-K we also mentioned the possible dash 8 sublease that Jeff talked about we’ll provide more information on this when the deal is finalized.

At this point I will turn the call back to Shannon.

Thanks, Brad.

At this time we would love to take any questions you might have.

Just to remind everyone the first Q&A session will be for analysts and we set aside some time for your questions.

[Operator instructions]

Your first question comes from Ray Neidl, Calyon Securities.

Yes, good morning.

First thing is in the regional sector, the recent Continental deal with Republic, does that preclude Horizon from getting any turboprop business with Continental?

Ray, this is Jeff.

As you know that RFP process was public, and as the sole Q-400 operator in North America we were invited to participate, which we did.

From what Continental told us, they have made a preliminary decision to move ahead with the 44 jets with Republic, have not ruled out turboprop activity going forward, you know, it was a productive exchange.

We built a good, you know, basis for relationship and conversation going forward so we plan to keep those channels open.

Okay.

And the other major question is there's probably going to be, hopefully there is going to be pension reform legislation this week before Congress goes into recess.

Does Alaska Air Group have a dog in that race?

Do you care one way or another what happens?

You know Ray this is Bill maybe I will start and then Jay Schaefer can talk a little more about the legislation.

You know, I think everybody knows our basic view of pensions and DB plans is that they represent an obligation between the company and its employees.

And so, our plan has always been to fund our pensions and to make good on those commitments.

And going forward we think that both employees and companies within the company will be better served with 401K plans and that's in fact where we have in place for all of our new hire employees now under these contracts with the exception of pilots and that will be a topic obviously with ALPA as we sit down here late this year.

But, Jay, maybe on the legislation, do you want to just cover that and our position?

Sure.

Regarding the broader legislation it requires all plan sponsors to become fully funded at an accelerated rate.

As Bill mentioned we have been funding our pension plans regularly every year so I don't know that we are particularly concerned with the legislation.

There is some airline specific relief that may or may not be included and if it is included it isn’t clear to us yet whether we would want to take advantage of it while it might allow us some longer amortization's for our unfunded amount, it might have some penalties associated without which we would not want to incur.

So, I think right now, we are keeping an eye on it and we will let you know when we have a view of where it ends up and how we would want to participate, if at all.

And Ray, I think you know this is less of an issue for Alaska than for the other legacy airlines our unfunded ABO was 224 million at December of 2005, and our unfunded PBO was $308 million.

So, its less of an issue from the respect of our balance sheet that it would be for other legacy airlines.

Great.

Thank you very much.

Your next question is from Helane Becker, Benchmark Company.

Thank you very much.

Operator, hi everybody.

Hi Helane.

Just a couple of things, one I did not get who you had the tentative agreement with to sublease those aircraft?

That's CommutAir, Helane.

They operate out of Plattsburgh, New York.

They are current Continental connection supplier and they will continue that arrangement with these dash 8s out of Cleveland.

Okay.

So, when we are looking at the income statement, where will the revenue, will that be a deduction to aircraft rent expense?

How will that show up, you know the revenue from that?

I think the sublease revenue for those aircraft will fall down in the non-operating section as well as the lease expense on those aircraft.

Once those go out of the fleet.

What did you just say about the fleet?

Once those aircraft go out of the fleet over to CommutAir that both the revenue and expense associated with those aircraft will be down on the non-operating section of the P&L.

Okay.

Got you.

And then, just on the second-half delivery schedule for the other aircraft that are coming in.

Maybe Brad, can you just kind of summarize the [quarters] those are coming?

Yes Helane.

We have, for the 800s we have two of those coming in the third quarter and six of those are coming in the fourth quarter.

And are they already financed?

We have commitments to finance those.

Okay.

Thanks very much.

Thank you very much.

Your next question is from Michael Linenberg, Merrill Lynch.

Good morning.

I guess just first question to Jeff.

You know you highlighted Horizon’s ASMs up 7% this year.

With potentially 16 airplanes going out to CommutAir and you're bringing in a bunch of 400s, I mean how should we think about ASMs at Horizon on a system basis in 2007?

Well, we're forecasting growth, of course, the pace of incoming aircraft is front loaded early part of the year Mike and we anticipate deploying those in existing markets as well as a couple of growth markets.

The pacing of the outflow is much more evenly spread into early 2007.

So, right now we're looking at about a 10% ASM figure for - a growth figure for next year.

Okay.

And then, if I could ask just that same question, and you may have said this, I apologize, 2007 ASM growth?

Brad or Bill?

For Alaska we're thinking in the neighborhood of 5% to 6% Michael.

Okay, 5% to 6%.

And then, just my, I guess my second question, and I don't know if Gregg is in the room.

Yes, yes.

Sort of more of a competitive question.

You guys really were the trailblazers between you know, markets like L.A. and Cancun and you know, and San Diego [Cabo] and now it looks like Delta and United want to fly from L.A., Cancun.

You know United I think is already flying it.

You have Frontier starting to come and you know, moving into some of these markets off of California down to Mexico, like I think San Diego, Cabo, I mean anything like you are seeing or you know with bookings and you know, maybe are these markets becoming crowded as a result of the relaxation of the US/Mexico bilateral?

Yes.

There’s certainly been a flurry of activity as a result of the liberalization of the air service agreement.

There are a lot of filing for new services by Delta that have not yet been published as a schedule, so we are not sure if those filings will actually materialize into real ASMs.

But, we are watching that.

Certainly additional capacity to Cancun has been put into the GDSs for sale.

But you know, Mexico is a leisure destination and what we have seen in the past is these markets are highly elastic.

So, I would expect that notwithstanding big increases in capacity coming this winter that we will see probably some price reduction being offset by increases in volume and we have just had a stellar year in Mexico and expect that would continue.

Okay, good.

All right, that's my questions.

Thank you.

The next question is from David Strine, Bear Stearns.

Thanks good morning.

Hi David.

Brad you mentioned that you're going to take a charge due to some lease buyouts.

Like to know what's happening in the leasing market that is driving the decisions to buy out the leases?

You know, these are MD-80's David that we took in the early and mid 90's, its kind of high prices and then went on to put financing on them.

And so, candidly the lease rates we’re paying on those aircraft are considerably above market, and those are leases that terminate between 2010 and 2013.

So, when we made the decision, you know, if you're going to operate the leases in your fleet, the right accounting is to just go through and book those lease charges as you move forward, when we made the decision to retire the MD-80 fleet early we kind of confronted the fact that we are going to have to do something with these aircraft that have these above market lease rates.

And so, I think in March when we announced this decision, we said there was going to be pretax charge of 130 million to 150 million for the owned planes and a similar charge for the leased airplanes as we either buyout the leases or park or sublease the aircraft.

So, anyway that's a little bit of the history what we are - with this announcement we are dealing with, five of the nine aircraft that are under long-term leases and I guess we have announced a charge of 65 million pretax or about 40 million after-tax.

Did that help?

Yes.

Thank you.

And so, a broader question, more strategic about the way you're thinking about the business and then if you size adjust your you know, the amount of cash you have on the balance sheet now, and you know look at the growth plans for the business, I am wondering what -- how you’re perceiving the best use of cash to provide total returns for shareholders.

And you know is a dividend something that you think may make sense at some point?

It's a great question, David.

I think you know, this is a very conservative company with a conservative board of directors.

And as you looked at everything this industry was going through after 9/11, we have a very consciously managed ourselves to have a very strong cash position.

And that even carries through to the financing commitments and so forth.

So, if you look at us today we have $1.1 billion in cash.

We think a very strong cash position is appropriate giving capital spending of $600 million plus for the next couple of years we have a $2 billion fleet campaign over the next three years, we do have under funded pension plans, we have this MD-80 charge I just mentioned is a cash charge, that's not a non-cash charge and then there is four other airplanes that we’ll have to deal with at some point.

So, we do have significant financial commitments.

I think, this is a conversation that would need to be held with the board of directors but the idea of a dividend or something like that, you know one, two, three, four years down the road, once we are further along with our transformation and beginning to produce regular strong financial results is a probably an appropriate question that should be dealt within that time.

And then Dave, I might just add, this is Bill I might just add that we're just really glad you know that we have had this conservative approach that the board has led us in that direction in terms of equity, you know, and on the balance sheet cash.

And this continues to be very volatile and uncertain industry.

And you know, we’re just real pleased with the cash position.

So it is a high quality problem, but it's a problem but, you know, we see that we couldn't be happier to be where we are with the balance sheet given the status of the industry.

Okay.

I appreciative that perspective and then last question?

With respect to unit revenue growth performance moving out into the third quarter, what is your sense on how things are shaping up?

David, this is Gregg.

We sort of are looking at the unit revenue growth performance that is on par with what we have seen in Q2.

I would say at this point, 7% to 8 percent is what we're looking at in Q3.

Okay.

Thank you very much.

Your next question is from Peter Jacobs, Wells Fargo.

Good morning gentlemen.

Good morning.

Great.

So I got just a quick simple one this morning.

Brad could you just give us the current fuel prices that you are seeing?

About $2.20 per gallon unhedged.

Okay.

Thank you and that's it.

Peter, this is Shannon.

Just wanted to let you know that we have put on our web site at alaskaair.com, under our newsroom, our market share and distribution of [CASI] by region and we’ll update that quarterly and so that will be a convenient place for all of you.

That is terrific, I appreciate you doing that.

For others on the Call.

That's a question Peter’s asked about and we are glad to say we have got a good answer for him right now that works with Reg-FD.

Your next question is from Robert Toomey, Riley Investments.

Hi good morning.

Good morning.

Brad I think you mention earlier that some of the airlines are starting to move back more proactively in fuel hedging.

Can you explain what you see going on there and you did mention that you would start to do that again as well.

You know given the environment we are in with very high oil prices, what would be your -- , can you talk about your strategy at all there?

Sure, Bob I might start and then ask Jay Schaefer, our Treasurer to kind of jump in with some specifics of our strategy.

You know, we got into this fuel hedging several years ago as a risk management program and our sense at the time was that you know, like any risk management program would probably have a modest cost over time.

And of course what has happened is fuel prices have gone up from low 20s per barrels to 75 and we have reported a lot of hedging gains in the last two or three years.

As we look at fuel today we said, hey it's at $75 per barrel but there is a lot of uncertainty.

There's a talk in some camps about oil going higher by 10 or 20 or even $30 a barrel.

And so, in conversations with some of our investors and with the board of directors and the finance group of our board, we decided that it does make sense it is prudent to resume our hedging activities with that risk management mindset and the idea is to spend some money now to avoid the harm that would happen to our business if fuel went up by a significant amount.

So, that is the thinking, I think it is in you know, what competitors do is important because the positions of our competitors might affect how quickly they want to pass on fuel price changes to the form of higher fares.

So, we have seen competitors put on incremental hedges in the last few months.

So, that's some of our thinking.

Jay, can you talk about what type of instrument we would use and what are targets would be and when we would try to get there and so forth?

Sure.

You know, our toolkit has all the regular kinds of securities but I will say that our preference historically has been towards caps.

It offers us a fairly inexpensive way if you look at it as a percentage of our overall fuel budget to protect against spikes going up.

But we benefit from any reductions in oil prices.

And we have typically layered them on in roughly 5% strips going out, maybe three years.

We have not yet begun to add any new hedges on, but if we did I think it would look very similar to what you've seen us do in the past.

Okay, thank you.

And one other question I had was I guess it would be for Jeff relating to the Q-400s and the Q-200s.

I guess you sort of answered it with your response earlier to ASM growth for '07.

But, I am trying to get a better understanding of, can you explain what the Q-400 does for you?

And I guess I'm trying to get at., do you, are you anticipating significant growth over the next few years?

And is that why you're making this transition?

Thanks.

That's a great question.

We have come to know the Q-400 for about three or four years now as a highly efficient delivery vehicle for ASMs that has become quite preferred by our customers.

So, on both camps, it does good things for us.

And as we look at our needs, they start very close in, they start with most, a number of native network markets that we have being serving for 25 years, we're working real hard with dash 8s, but coming up short on the kind of capacity we need to provide good service patterns and good value pricing in the market.

So, by introducing the Q-400 into those patterns, Seattle-Portland is a great example, Seattle-Pasco, places like that, we dramatically improve the CASM efficiency of our service, at the same time the customer appeal of it as we become more vulnerable to substitutes in those short haul markets.

So, it starts there, and then when you look at the range performance of the airplanes, it gives us a way to efficiently reach out and connect more dots within the Alaska Air Group network in the West, this next week we will be introducing Service from central Oregon, Redmond/Bend to Los Angeles, with a connection north to Seattle as well.

It will be our longest Q-400 route, about two hours and thirty minutes, but just shy of what we have edged up to in other parts of the network as well with no – not only no customer resistance, but quite good customer acceptance.

So, and then you look at the operating costs of the Q-400 with 74 seats, we are going up to 76 seats.

It becomes a very central player in our initiatives to bring our CASMs, our unit costs down to more competitive levels within our peer groups.

So, I think on all fronts we feel very good about it.

Of course, as being the launch customer for any fleet type, you have a very close partnership with the manufacturer and working through you know the maturing of the airplanes, and we are doing that real well with Bombardier and Pratt & Whitney.

Great, thanks.

And one other question I might ask.

Is your CASM goal X fuel still $7 -- 7.25 cents for Alaska Air lines?

Yes, Bob, that is still our stated goal I think we said on the last two or three calls that we do have a belief that the ultimate number is going to need to start with a six, we will need to get below 7.25.

But in terms of public goals 7.25 is still what we are working with.

And then Bob, this is Bill, I might just add that we have got you know, daily get togethers with the officer group to talk about initiatives and we have got a lot of things in the work right now, and a lot of things that we are thinking about for the future to keep driving this down.

But, its all about efficiency and productivity and the right tools and using technology and how do we serve the customers, provide the product that they want and are willing to pay for it and do it in an efficient manner as possible.

And we just - we have got a lot of effort engaged in this to continue our progress in the future.

Great, thank you very much.

[Operator instructions].

Kelly, we have time for about one more question before we turn to the media portion of the call.

Thank you.

Your final question is from Kevin Crissey, UBS.

Hi guys, I just want to get a sense for, you know, whether you have a sense actually for how close we might be towards peak yields.

And to the extent that you are seeing elasticity you know, load factor exchanged for fares and your willingness to do that?

Kevin maybe I will take it, this is Gregg.

I would say for the most part we have not experienced resistance to the price increases that we have taken this year and remembering that fares in our region are still a bargain in real terms.

What I would say though is that there have been pockets where we may be seeing some initial resistance, mostly on short haul markets where there has been some load factor trade-off, and those have been in markets where we have actually seen the biggest RPM yield increases.

So, if your question is should we expect future fare increases, I would say we would not rule those out.

But at some point there's a limit to how much the market you know, will accept and we may be seeing at least in a minority of markets some early indication of that.

Do you attribute that at all to any change in the economy and basically, you know, we are looking at and seeing a lot of you know questionable reports coming out now that say you know, UPS today, and numbers seeing a softening economy, I would guess that that's not already factored into this as much as it is just pure price.

But, to what extent do you expect the economy to have more of a affect on that?

Well clearly the strength of the economy will be a huge factor going forward, we are not seeing today, we don't believe that anything we are seeing today with respect to price resistance has been a factor of a weakening economy.

But, we need to keep an eye on it.

Thank you.

Okay we're ready for the media portion of the call, and I'm going to turn the call over to Alaska's Managing Director of Corporate Communications, Caroline Boren.

Good morning, I know we have several journalists participating today and I want to welcome all of you.

Thank you for joining us on this very busy day of earnings announcements.

Kelly, would you please remind callers what they need to do to ask answers and then we can begin.

[Operators Instructions].

Your first question is from Nick Eaton, Seattle P. I.

Hi everyone good morning.

I believe Jeff, you mentioned that Horizon is planning to do heavy maintenance on some of its planes, I was wondering if you could maybe expand on what sort of maintenance you’re planning?

These are just scheduled maintenance activities, Nick, that are hour and cycle driven.

And because we took new aircraft Q-400s and CRJs all, all in a kind of a rapid pace upfront, they're all kind of hitting their deadlines.

So these are just scheduled forecasted events that are part of our maintenance program.

And it’s [closely] timing, I would say last year was extraordinarily light on the schedule, this year is extraordinarily heavy.

This next year is extraordinarily heavy as well – sorry, this current year.

So you have a little bit of volatility just in the timing of it and the expense impact accordingly.

Okay.

And then how is the company reacting to the safety standard changes that it has been doing recently with Menzies Aviation?

Has that affected the balance sheet?

Glenn?

Sure, Nick.

The, just a [right up front] I guess that Menzies has really made substantial progress since last year in terms of their service delivery to us and therefore to our customers.

As Bill mentioned the 23 point improvement in on-time performance for the month of June and 15 points for the quarter.

There -- we have experienced the expected reduction in our expenses with regard to the transition from our own ramp employees to Menzies Aviation but no balance sheet impact, specifically.

Thank you.

[Operator Instructions].

You have a question from Elizabeth Gillespie, Associated Press.

Hi, this is a question for Brad about fuel hedging.

How soon do you anticipate to begin putting hedge positions on again and the antici -- what kind of price are you anticipating as it is, you know, since oil is trading at you know, $74, $75 a barrel.

Are you thinking that you're going to have to be hedging up at $80 plus?

Hi Liz, I think I might ask Jay Schaefer our Treasurer to address that as well.

In terms of the timing, we will begin layering out some hedges this quarter.

In terms of the expected price, you know, we really consider these fuel hedged products to be a risk management tool to take volatility out of our business plan.

So, when we layer on the hedges, we don't particularly worry about the price at which we're buying it, we simply say we need protection for consumption of oil.

And you know, the fact that we have been very successful with them in the past is great news, but we don't use that as a benchmark for should we take future volatility out of our business plan.

So, you're right, fuel prices are very high right now, and we still think it is the right thing to do to remove that risk out of our plan.

Yes, but, I mean you could get to the benchmark if you are putting out hedges in the $80 of a barrel range, if you had a spot price of $73 or forward price $75 or $77, but you bought an out of the money hedge and paid the call premium you would be into the 80s I would think.

Yes, that's right.

And with that instrument if the price came down we still get the benefit of the reduction.

Right, we would.

We very much think of it as an insurance program.

Okay.

Thank you.

[Operator Instructions].

At this time there are no further question.

Okay, I think we will wrap it up and thanks everybody for joining us today, and we look forward to talking with you next quarter.

Good bye.

This concludes today's Alaska Air Group's second quarter 2006 earnings release conference call.

You may now disconnect.