阿拉斯加航空 (ALK) 2007 Q2 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the Alaska Air Group second quarter 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) Please note that you will be allowed one question and one follow-up question.

This call is being recorded for future playback at www.AlaskaAir.com.

Thank you.

I would now turn the conference over to Ms.

Shannon Alberts, Managing Director, Investor Relations.

Please go ahead, ma'am.

Thanks, Jody.

Hello, everyone, and thank you for joining us for Alaska Air Group's second quarter 2007 conference call.

Joining us is Bill Ayer, CFO Brad Tilden, and Horizon Air's CEO, Jeff Pinneo.

We also have with us a number of other senior management folks from Alaska and Horizon that can help answer your questions.

Our agenda includes a management overview after which we'll be happy to take questions from analysts and then from the news media.

Today's call will include forward-looking statements that may differ materially from actual results.

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

Our presentation includes non-gaap financial measures and we've provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release, which can be found on our web site at AlaskaAir.com.

As we reported earlier this morning, Alaska Air Group earned GAAP net income of $46.1 million, or $1.13 per share versus $55.5 million or $1.38 per share in the second quarter of 2006.

After adjusting for unusual items including fuel, mark-to-market adjustments that affect both 2006 and 2007, Air Group reported a net profit of $47.2 million or $1.16 per share in the second quarter 2007, compared to $60.3 million or $1.50 per share for the second quarter of 2006, and compared to a first call mean estimate of $1.25 per share.

On a year-to-date basis, again adjusting for the unusual items in each year, Air Group's net income for the first six months was $31.4 million versus $63.1 million in 2006.

Please see pages 6 through 13 of our earnings release for a reconciliation of our GAAP and adjusted results as well as additional information about expected capacity changes, unit costs, fuel hedge positions, capital expenditures, and fleet count.

Now I'll turn the call over to Bill Ayer.

Thanks, Shannon, and good morning, everybody.

This was a solid quarter for Alaska Air Group especially considering the industry challenges of higher fuel costs and a softer revenue environment, and we're also seeing increased competition in several of our markets.

Alaska Airlines adjusted pretax earnings surpassed last year's second-quarter results, and we're real pleased with this accomplishment, especially given the significant decline in our fuel hedge benefit this year, which led to much higher economic fuel costs.

Horizon posted a loss for the quarter versus a profit for last year, although a portion that loss is due to the change associated with the -- excuse me the charge associated with the removal of three Q-200s from the fleet.

A number of initiatives are underway that will help position Horizon for the future, not the least is a program to replace our 37-seat Q-200s with more efficient 76-seat Q-400s.

Despite the current challenges, we remain focused on improving our performance for the long term.

Alaska's mainline unit revenues were down from last year and were impacted somewhat by the entry of more competition into some of our markets.

Our 2010 plan is based on the assumption that competition will increase.

We're committed to maintaining our pre-eminent market position, and our people have a proven track record of successfully competing against both low cost and legacy carriers.

The growth of other carriers in our markets underscores the need to continue to improve costs and take really good care of our customers in the process.

Our proud Eskimo will be needing some sunscreen soon as we initiate our long-awaited service to Hawaii.

Honolulu is the largest market out of Seattle that we don't serve today, and the most commonly asked for by our customers.

And Kauai is a popular and growing destination not currently served on a non-stop basis from Seattle.

Our advanced bookings look great, and our ETOPS preparation is on track thanks to the hard work of many maintenance and flight operations employees.

We have a long history of differentiating our product from the competition.

Recently, our employees earned top honors for Alaska Airlines mileage plan, in the categories of best elite level program, best member communications, and best web site.

These three first-place Freddie awards voted on by frequent flyers across the nation, is a testament to the strength of the Alaska brand.

Of course our greatest point of difference is our people and they're doing a terrific job this summer of taking great care of customers, in spite of the high load factors and other operational challenges that they face day to day.

Alaska's fleet simplification is on track for completion at the end of 2008, and we're already benefiting from lower maintenance costs and increased fuel efficiency.

Alaska's CASM ex fuel was slightly better than forecast and much improved over last year's second quarter even after factoring out some one-time costs that impact the comparison.

We were pleased that the DOT recently ruled in favor of the challenge mounted by Alaska and several other airlines in connection with discriminatory and unreasonable airport rent increases at LAX, were and we're also taking a hard look at our real estate needs and where possible, reducing our space requirements.

For example, we improved our efficiency in Anchorage recently by returning four gates and 20,000 square feet to the airport.

And we believe we have similar opportunities in other parts of our system.

Some of you have asked why we're adding capacity while many other carriers are reducing their domestic capacity or at least scaling back their growth plans.

We certainly understand the economic realities of the business.

We all need higher unit revenues and lower unit costs in order to improve profitability and deliver a reasonable return to our investors.

One way to get higher RASM is to better manage the supply of seats.

Two years ago, Alaska embarked on a fleet transition plan designed to lower our operating costs and improve profitability over the long term.

And Brad and Jeff will talk in more detail about the economics of the fleet changes at Alaska and Horizon and why we think modest ASM growth is sensible.

We have a strong conviction about building long-term value at both our airlines and believe we are realistically assessing the environment and responding with appropriate goals and initiatives.

The experience of the industry over the last few years strengthens our resolve to continue making changes to improve our long-term position.

On a somber note, many of you had the pleasure of knowing Alaska Air Group's former Chairman and CEO, Bruce Kennedy.

And Bruce was killed when the small plane he was flying went down in central Washington on June 28.

He led the company as CEO from 1979 through 1991 and continued to serve on our Board until his death.

He left his mark on the company in many ways, including guiding the company profitably through the new world of deregulation, establishing the tradition of great customer service that has become our hallmark, and meeting challenges head on with honesty, discipline, and teamwork.

Bruce played a major role in building Alaska Air Group into what it is today and we're certainly going to miss him.

At this point I'll turn the call over to Brad.

Thanks, Bill.

Looking at Alaska Airlines now, excluding the unusual items, we reported record adjusted pretax income from $82.4 million for the second quarter of 2007 compared to $79.6 million for 2006.

Growth and main line revenues of $18 million and a reduction in main line operating costs other than fuel of $11 million helped compensate for the $21 million increase in our economic fuel costs.

This result represents a main line adjusted pretax margin of 11.8% for the seasonally strong second quarter, which is a touch better than 2006.

We believe these results are good, although there is always more that can be done, and we are several points from our targeted profitability level on a full-year basis.

Some of the highlights for the quarter from our perspective are, first, our economic fuel costs were up substantially as we had only $5 million of hedge benefit in 2007 versus $29.6 million in 2006.

An interesting note is that our raw fuel costs were actually down marginally from 2006, although prices have increased significantly in the last few weeks.

Second, our revenue performance was not equal to our competitors, and our unit revenues are not high enough given the very high fuel costs that we're seeing today.

Notwithstanding this, our unit revenues are considerably better than what some of us might have anticipated a couple of years ago.

Third, our unit cost performance, excluding fuel, was reasonably good, and finally, we are making great progress on our fleet transition plan and are excited about becoming a single-fleet airline just 18 months from now.

Although Alaska's main line revenues increased, our main line PRASM declined 2.7% during the quarter on a 5.2% increase in capacity.

The PRASM decline is due to a 1.6% decline in yield and a 0.8% decline in load factor.

Based on the information we've seen, our yield decline was in line with the domestic industry, and we had a load factor decline whereas many competitors saw load factor increases, many of which were related to capacity reductions.

Our RASM declines were most pronounced in Mexico where we're dealing with new competition, within the state of Alaska, where we flew more ASMs than would have been ideal due to the fact that we substituted all passenger aircraft for combi aircraft that were delayed coming out of their mod line, and Canada, where new competition put pressure on yields.

We saw some unit revenue increases in other markets, notably the transcon region.

By month, our PRASM declined 2.8% in April, 2.3% in May, and 2.8% in June.

During the quarter we saw only two broad fare increases that stuck and can point to a few failed increases and some discounting in the southern Cal and Bay Area markets.

Looking forward, we see small increases in our advanced book load factors for July, August, and September.

With respect to unit revenues, we have an opportunity to sharpen our focus, both by scheduling the right amount of capacity for a given market, at the right time, and by insuring our pricing and -- ensuring our pricing and revenue techniques are optimal.

We spent a lot of energy streamlining and simplifying our fare structure, and as a result, our customer value proposition is now much stronger than it was a couple of years ago.

We have fewer fares, our highest first-class and full wide coach fares have been brought down by as much as 60% or 70%, and are now rarely more than $500 or $600 for our longest nonstop markets.

The ratio between our highest and lowest coach fares is now 2.5 to 1 or less.

All of our published fares are now one way, and we never require an overnight stay.

Given all these changes, we believe that we now have a very strong foundation, and we should have a better ability to translate fare increases into yield increases.

We need to ensure that on a market-by-market basis, we're earning revenues that cover our costs, including increasingly high fuel costs, and earn a reasonable return on our investment.

Roughly three-fourths of our ASM increase in the 2006 to 2008 time period is the result of replacing MD-80s with 737-800s.

We're confident that replacing MD-80s with larger gate 737-800s is the right strategy for Alaska.

Simply put, one 737-800 has lower annual direct operating costs, including ownership, than one MD-80 and the 737-800 has 17 incremental seats.

The challenge for us is to determine whether to use the additional seats to reduce frequency in existing markets, while sending free aircrafts to new markets, or attempt to stimulate demand to fill the seats.

While the larger 737-800s can results in a PRASM decline, which is not our objective, even if they do, the overall economics of the transition are favorable.

As a reminder, our fleet will increase by a net of two aircraft between the end of 2006 and the end of 2008, and this includes two incremental delivery positions we've recently attained from Boeing to replace aircraft we'll likely return to lessors and two airplanes we recently brought forward from early 2009 to late 2008.

We're now projecting ASM growth of 3% to 4% in 2007, down a bit from our earlier guidance of 4% to 5%.

Turning now to costs.

Excluding fuel and fleet transition costs, main line CASM declined 7% to $0.0728.

While we're very pleased with the reduction, the second quarter of 2006 had two one-time items in wages and benefits that amounted to $6 million or about 1 percentage point of the CASM decline.

Additionally there was of a significant reduction in 2007 variable incentive pay that amounts to $5 million or about another percentage point to the CASM decline.

Excluding these two items the unit costs declined by $0.004, or 5%.

Looking to Q3, we are currently forecasting Alaska's main line CASM ex-fuel to be between $0.074 and $0.0075 on capacity growth of 2% to 3%.

The third quarter will likely be the only quarter this year where we we have flat to slightly higher unit costs, and this is due to the timing of planned maintenance costs and a quarterly dip in our ASM growth.

This CASM guidance is in line with our budget, and we're still on pace to achieve our planned full-year unit cost target of $0.075 to $0.076, consistent with our previous guidance.

With fuel costs climbing again, we're expecting our hedge portfolio to provide greater protection in the back half of the year than it did in the first half.

For the rest of 2007, we're hedged at about $59 per barrel.

If oil stays at about $75 per barrel, our hedge savings would be $22 million for the rest of the year, and that would equates to an economic fuel price per gallon of $2.28.

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

Thanks, Brad.

Good morning, everybody.

As we've seen, Horizon posted an adjusted pretax loss of $4.6 million for the second quarter.

This compares to a $10.2 million pretax profit we posted during the same period last year.

Our results are characterized by several extraordinary elements associated with our transition to larger, more efficient aircraft and simplified fleet.

Included in these are a $3.7 million in Q-200 sublease transition costs, $5.8 million in additional planned engine overhaul expenses, and an $8.5 million increase in our fuel bill, all of which I'll review in more detail in a moment.

All of this played out in a revenue environment that was characterized by solid passenger demand, but declining yields.

Transition costs aside, let me be clear.

We don't believe these results represent an acceptable level of performance, and to that end, we're actively engaged in a host of back-on-track initiatives in all division that are focused on improving profitability this year and creating momentum for additional efficiency gains in 2008 and beyond.

Our total revenues for the quarter were up 9.4% or $15.3 million over last year's second quarter, while operating expenses, including economic fuel were up 18.6% or $28.3 million.

This was on an 8% increase in ASMs, bringing our CASM, excluding fuel to $0.15, up from $0.14 in the same period last year.

Excluding the cost impact of our fleet transition expenses, our CASM excluding fuel was $0.1465, up 4.4% from last year's second quarter.

As I noted, the second quarter was highlighted by the continued implementation of our plan to replace our 37-seat Q-200 fleet with 76-seat Q-400s.

During the quarter, we took delivery of six new Q-400s with the remaining 2 deliveries of our current order of 13 occurring by the end of the summer.

As planned, we delivered three additional subleased Q-200s to Commute Air in the period, bringing the total we've sent their way to 5.

With each new Q-400 delivery, we add a highly efficient aircraft that has more than double the seating capacity, yet trip costs that are just 30% higher than the Q-200s, and with respect to fuel, they are 38% more efficient on a seat-mile basis.

The Q-400 is also allowing us to introduce new game-changing pricing structures in many of our short haul markets.

With simplified structures and reduced fares at every level, we've been able to use the increased capacity of the Q-400 to stimulate incremental local traffic, and at the same time, accommodate the increasingly strong demand for flow passengers across the AAG network, All in a way that's revenue positive.

Central to the plan is the lowering of walk-up fares in our short haul markets by 40%-plus on average.

The impact of which will be to stimulate demand at yield levels that are higher than our current market averages.

While RASM will decline somewhat with the added capacity, the cost efficiency of the Q-400 will produce even lower CASM levels, improving margin as a result.

When combined with the features of our much-acclaimed Horizon passenger experience, these new fare structures will greatly enhance the value proposition of flying over driving for many of our customers.

The initial reads from our test markets have been very encouraging.

And our plan is to continue rolling out the new structures in several phases between July, 2007, and January, 2008.

Mostly in conjunction with added Q-400 capacity.

In addition to our fleet events, we also formally applied to serve Loreto, Mexico, and we refined our previously announced plan for new nonstop service to California from Spokane and Boise.

We also recently announced added service from Santa Rosa, with a third daily round trip to Los Angeles, and new service to Portland beginning in October.

Another exciting event during the quarter was the opening of a reengineered gate facility in Portland designed to enhance the value of the Horizon shuttle experience for our valued Portland to Seattle customers.

Among the many features of this separately branded service are efficiently designed boarding and deplaning flows, laptop work stations, and complimentary wi-fi provided by the Portland airport.

Taking a closer look at revenues, our 9.4% increase was supported by an 8% capacity increase stemming from Q-400 deliveries and the first-quarter redeployment of two CRJ-700s from Frontier to our native network.

During the second quarter, capacity in our brand flying and in Alaska capacity purchase flying increased 16.6% and 25.1% respectively.

Revenues from our Frontier Jet Express flying were down nearly 25% on a capacity reduction of 30.4%.

This line of business now accounts for 5.6% of our total revenue, and about 15% of our total capacity.

Due to the low RASM nature of the Jet Express flying, relative to our other product lines, the reallocation of capacity back to our native network has positively impacted system RASM, which was up 1.3% for the quarter.

In light of our product mix changes, I'll focus on the revenue performance of our brand flying where we had a 7.6% increase in revenue on a 16.6% increase in capacity.

Traffic grew 15.5%, resulting in a load factor decline of less than a point, despite the sizable capacity growth.

However, our traffic performance came somewhat at the expense of yield, which was down 7.4%.

We are seeing signs of very strong demand through the summer, with record forecasted load factors but expect that strength to be tempered somewhat by continued softness in yields.

Our system operating expenses including economic fuel were up 18%, or $28.3 million, with $5.8 million this variance linked to the planned increases in engine overhaul activity that I've briefed you on before.

This continues to build in maintenance activity that began in 2006 and that is expected to peak this year before receding in 2008 and beyond.

In the second quarter, we completed 18 overhauls, compared to 10 in the same period last year.

We also recorded $3.7 million in expenses related to transitioning out of our Q-200 fleet, and expect to record similar charges in Q3 and Q4.

Turning to our operations, our scheduled reliability was 98.9% for the quarter, while flights arriving within 15 minutes of schedule came in at 86.5%.

During this period, we consistently placed among the top two or three of all airlines that report to the DOT, including the Hawaiian carriers.

Our people accomplished the while dealing with double-digit traffic growth and along the way, they established a new record for productivity of 160 passengers per FTE, a full 7.6% increase over the prior year.

I can't thank them enough for their initiative, tenacity, and solid teamwork.

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

Thanks, Jeff.

Air Group ended the quarter with $988 million in cash and short-term investments, down $26 million from our balance at the end of 2006.

We generated about $255 million of operating cash flow in the first six months of 2007, and had proceeds from new financings of approximately $200 million.

Both of which were offset by net capital spending of $420 million, and debt repayments of $62 million.

Almost all of the capital spending here in the first half of the year was related to aircraft and advanced deposits, all on support of our MD-80 phaseout of Alaska and our effort to simplify Horizon's fleet.

We've taken delivery of seven 737-800s and 11 Q-400s so far this year, and expect to receive seven 737-800 and twi Q-400s in the last half of the year.

We contributed $17.5 million to our defined benefit pension plans in the quarter bringing our year-to-date to $35 million, and our total contribution since 9/11 to $365 million.

At December 31, 2006, our plans were approximately 80% funded using the projected benefit obligation measure of the liabilities which is the most conservative accounting measure.

At this point I'll turn the call back to Shannon.

Thanks, Brad.

We're happy to address questions from analysts at this time.

Jody, would you please go ahead and assemble the roster?

Yes, ma'am.

At this time, we will open now the question-and-answer session to the analysts only.

(OPERATOR INSTRUCTIONS).

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Ray Neidl with Calyon Securities.

Yes, just looking at your RASM, we talked about RASM pressure regarding Mexico.

I think most of your new competition is with Delta with R jets.

I'm wondering how much of an effect that will have long term.

You have a superior product with a bigger airplane than an R jet on a lot of those routes.

Then in Alaska, I think you said you also had RASM pressure because you were adding more capacity.

That's -- that should be something that's more under your control.

I'm wondering what you're going to be doing about that in the future.

Thanks, Ray.

This is Brad.

Maybe first of all let's talk about Mexico.

We do have significant increases in competition in a lot of our Mexico markets out of LAX.

And as you know, a lot of this competition is in the form of 50-seat jets that are operated by Express Jet on behalf of Delta.

Our belief is that we've been in those markets for a long time.

Those markets have done well, and I guess we believe that we have the right asset.

We're in most of those markets with large gate 737s.

So we have a low-cost airplane that we think is going to prevail over the longer run in those markets against the 50-seat CRJ.

If Alaska Regional, if we just go to that for a minute, you're right, that is completely within our control.

Our capacity -- we have these five aircraft that have been going through these mod lines with Pemco in Dothan, Alabama.

And they were delayed coming out of the mod lines.

We had 144 airplanes instead of these 72-seat airplanes.

And our capacity in the markets was up 11% for the second quarter, which is a more normal mindset might be flat or up 1% or 2%.

Those airplanes are now here and on line, and we expect that to correct itself in the third quarter.

Okay.

And also, now that you bring up Express Jet, they're doing some independent flying out west in your territory.

What if any effect have you seen that on your markets?

Are there airplanes taking customers from you Or are customers all on those airplanes?

Ray this, is Jeff I'll start, maybe Brad will want to chime in here.

Generally the added service they put into the markets goes against service that we had within the network.

And that was impacted somewhat.

We've taken additional steps to address that more directly with added service from Spokane and Boise to southern California.

First -- the first wave of that was July 1.

And then July 22 was the second with service into San Diego beginning that day, so there's no question that this competition will spread demand across more capacity.

And we're seeing some of that at the same time.

We've got good strength in our network, and certainly good, strong customer loyalty with mileage plan and everything else in place.

Brad?

Yes.

I might just note that outside of Mexico, the -- the capacity increases are not huge.

There are a number of frequencies, but in terms of ASM increases, they're not huge.

We are seeing -- but we are seeing some impact, and we're seeing it both on the -- I guess on the passenger side and on the yield side.

Okay.

Great.

Thank you very much.

Okay.

Your next question comes from Robert Barry with Goldman Sachs.

Hi, everybody.

Good morning, Robert.

Of the 3% to 4% ASM growth you see this year, how much of that is just related to the upgauging?

It is virtually all related to the upgauging this year, Robert.

I'll just see if I can pull some figures out.

I think we end this year with -- we started the year with 114 airplanes, and I believe ween the year with 116 aircraft, is that right, Jay?

We ended the year with 116 aircraft.

That's an increase of two net airplanes really comes at the back end of the year.

So it's virtually all related to the upgauge of -- of MD-80s to 738s.

And looking into '08 aside from what you might do ex the upgauging, what do you think that upgauging related pressure would be in the mix of ASM growth?

If we go back to whether we announced the MD-80 plans, which was I guess early 2005, we thought that we would have about 15% capacity growth over the three-year period from 2006 to 2008.

And it was roughly 5% a year.

And as I remember, there was a net of -- net growth of airplanes of four aircraft.

But net which would have been 4% capacity growth.

And then the balance of the -- of the 15%, 11% would be due to the upgauging.

So I think that's kind of a -- a pretty good general mindset.

Having said that, we are doing the planning for 2008 now, and we're looking at exactly what our plan will look like for next year.

I'm sorry.

Just to be clear, in '06 to '08, the 15%, some of it was just organic growth, and 11% of it was the upgauging?

I think you said 4% was unit and 11% was upgauging.

Okay.

And did I hear you correctly when you were talking about pricing, you said that there's been a couple of fare hikes, a couple of failed ones.

But it sounds like there's been enough sale activity that it's essentially offsetting most or all of the price hikes, is that correct?

I think that is fair to say.

As we look at the second quarter, Robert, we did get some fare increases through a couple of small ones that Southwest led.

But if you look, the decline in average fares due to inventory was greater than the increase in fares due to fare increases.

And is that consistent across your network, or is it more of a West Coast phenomenon?

You know, I'm not sure that I have the data in front of new address that question.

Yes.

Okay.

Then one last thing to clarify.

I think you mentioned fuel cost of $2.28, assuming $75 oil with your hedges.

Was that for the third quarter, or is that for the back half?

That's the back half.

Okay.

Do you know what it is by quarter?

Yes.

Just give us a second.

We can pull that up.

The hedge positions for Q3 and Q4 were roughly the same.

So it's certainly fair to assume that it would be the average, and there wouldn't be volatility between the two.

That's exactly right.

It's basically the same for the third and fourth quarters.

Okay.

Great.

Thank you.

Thanks, Robert.

Your next question comes from Mike Linenberg with Merrill Lynch.

Hi, good morning, everyone.

This is Lily on behalf of Michael.

Hi, Lily.

Hi.

The first question, sort of piggybacking on a Ray's question of capacity increases.

As you look out to Q3 and perhaps to Q4, are you seeing a moderation of capacity of competitive capacity increases in your markets, or do you see the trend sort of being somewhat like what you saw in Q2?

I think generally, Lily it is somewhat like what we saw in Q2.

As you looked at Q3, you saw some little changes both on the plus side and the minus side.

It's fair to say it's generally like what we saw in Q2.

All right.

At least the good news is you don't see a huge hike going forward.

Yes.

Okay.

And my second question is for Jeff at Horizon.

Jeff, the Q-400s that's coming in is certainly a very exciting airplane.

I'm just looking at sort of how many of these guys are coming in.

Do you have any plans of perhaps doing something with that aircraft out of the Alaska's Horizon network?

Perhaps teaming up with another network carrier?

I understand you got constraint given your relationship with Alaska, but maybe there's something interesting sort of projects that you could do on the side.

What are your thoughts on that?

Well, that's a good question, Lilly.

And I think the right way to think about that is from the standpoint of inside-out priorities.

Our first responsibility with the tool is to improve the quality of revenue and the efficiency of what we're doing today.

So all the initial deployments are replacing Q-200s, or filling selected gaps within the network framework.

And then from there, we believe there's a number of brand flying, point-to-point opportunities that are really well suited to the Q-400 that have only begun down the road.

Santa Rosa being our most recent example.

Really fits the capability of the airplane.

The nature of the market is such that it -- it benefits greatly from the added service it brings, and it does it very cost efficiently, and contributively.

So I think that we would explore more of that as a second priority.

To the extent that a -- a partnership or a contract flying opportunity came along that met our three criteria of being financially contributive, operationally sustainable and culturally additive, we would certainly consider it.

But it falls number three on the list.

I see.

Thank you very much.

Your next question comes from Jamie Baker with JPMorgan.

Good morning, everybody.

Good morning.

Brad, back to your clarification on fuel, a couple questions ago, do you have an economic estimate rather than simply a GAAP estimate by quarter and by entity?

Jamie, it's Jay Schaefer.

Hey, Jay.

So for the remaining half of 2007, if you assume $75, it's 228.

Between Q3 and Q4, I wouldn't expect there to be a big difference between them.

Okay, okay.

That's helpful.

Brad, you talked earlier in your prepared remarks about all the changes that have taken place within your fare structure and you know how that should help RASM.

I might normally have taken this to mean you were sort of guiding a little up in terms of RASM expectations.

Haven't most of these changes already taken place?

I'm just having a little difficulty interpreting basically why you were making those comments.

I think, Jamie, we -- we do provide guidance on the cost side.

We don't provide guidance on the revenue side.

We kind of talk about what we know about.

I think looking out, I think the point we're making is that we felt like there was a -- basically a problem with the fare structure for the industry, and I think you're well aware of that.

And, it led to our competitiveness and our ability to grow over the long run and give our customers something they want.

And the effort, I think, over the last two, three, four years was on making a lot of though changes, bringing down the Ys, getting rid of the overnight stay, changing the gap between the high and the low and so forth.

The point that we're trying to make is that we feel with all those changes behind us, we do have a great value proposition for customers.

A very, very good value proposition.

And now we have fuel that in the last few weeks has gone from $60 a barrel to $75.

And to make ends meet you would need about a 5% in unit revenues.

And what -- we don't want to guide because we don't know what the third quarter is going to look like.

But our objective would be to recover some of that fuel cost increase through the revenue line.

Okay.

Well, that clarity does help and answers my question.

And lastly, just, in terms of fixing Horizon, you point out getting rid of some of the Q-200s.

Would you be able to hazard a guess as to what second-quarter results at Horizon might have looked like had the fleet been optimized?

You seem to readily admit that second-quarter losses at that unit are rather unusual.

Yes.

We can -- as far as the extraordinary elements, Jamie, the things you look at right away are first of all the transition costs related to the commuter sublease, taking a $4 million hit each quarter, every quarter as long as that continues.

So that's a starting point.

Then we're at a bubble point in our engine overhaul activity on CRJ's, extraordinary amount of activity related to that.

And that's worth about $8 million to $9 million.

Okay.

So you're up to $13 million right there.

On that adjustment.

From there, there's a whole lot of complexity associated with the ins and outs of aircraft.

The winding down of our Frontier Jet Express program, jets coming back.

Going out, Q-400s in, and you can imagine the training activity and the bubble related to that.

So there are some costs in that bucket that we don't expect to see going forward.

Just on -- on one point, note, this maintenance bubble that is receding next year, we think will shift to about $20 million to $22 million to the positive next year alone.

So we're going to be glad to see that behind us.

Plus we're going to have a much higher concentration of new airplanes on warranty and expect our maintenance costs to come down considerably.

Excellent.

Okay.

Thank you very much for that.

Big help.

Appreciate it.

Your next question comes from Gary Chase with Lehman Brothers.

Good morning, everybody.

Hi.

Guys, just wanted to ask a couple of questions on, just go back to this concept of upgauging.

And I wondered if you could give us any flavor for how much of the RASM pressure you think you're experiencing as just purely from that additional gauge.

And how much is competitive impact.

Is there any way for us to think about that?

Hey, Gary.

It's -- it's a good question.

I -- I guess I would say I think the bigger drivers of our RASM performance during the quarter were the two or three things that we mentioned.

It was the activity that we had in Mexico, the activity in -- in inter-Alaska, and -- and that type of thing.

So I think it was the bigger driver is probably the competitive activity.

And in terms of the influence of the 738s, that's -- we can look market by market, and we do see some markets where we put capacity in and it did put pressure on PRASM.

I think as a secondary driver.

Having said that we are moving into a meeting as soon as we finish the call to look at our schedule for the fourth quarter, to look into next year and to make sure we have the market by market where we put bigger gauge equipment in so we have the right number of seats in the market.

Probably not an entirely satisfactory answer but I think net-net the bigger driver in the second quarter was competition but I do think there's an opportunity under gauge to get the right number of seats in the market.

Okay.

Two quick questions related to that.

The economics of fleet replacement, is the upgauging behaving as you thought it would, in terms of incremental revenue generation?

Are you getting the economic benefit out of fleet replacement that you thought you were going to get all in?

I -- I guess the -- on the cost side, it's certainly true.

The way we kind of would like to think of this is that we had 23 long-term MD-80s before that produced a certain amount of revenue.

And that revenue, the objective was to capture that revenue with 18 737-800s.

Then we look and say what's been our experience as we -- we begin to pull out MD-80s and replace them with 738s?

If anything, we were planning on $1 million-plus of fuel savings for airplane and given where fuel is we've achieved more than that.

We can -- we looked in terms of maintenance costs, we looked at the last five years of the MD-80s compared to the 20-year average for a 738, and we were budgeting $1.5 million of savings there.

And the truth is that new airplanes are better than that because you get this honeymoon.

So we're actually getting -- we're enjoying the honeymoon on the 738s, and the ownership cost is a little touch higher on the 738s, but it's been completely within expectation.

I think relative to the business case, I think thing are tracking fine.

But having said that, I do think there's an opportunity to go in and look market by market and make sure it's working.

So they are in line even on the revenue side with what you thought you'd see?

I mean the cost side we know.

But can you make, can you give us a sense of whether the economics on the revenue line make it an all-in --

Yes.

I guess the way we like to answer the question, Gary, is I think there's an opportunity.

I don't know the scale of the opportunity, but I do think there's an opportunity to go in and make some tweaks to the schedule, to make sure that we haven't added seats inadvertently to a market and I think we can pick RASM up a little bit.

I don't want to really raise expectations.

There's some level of opportunity there, though.

And lastly, just a cursory glance at the schedule gives -- shows a bit more competitive capacity add in Alaska markets as we move into the third quarter.

Is that accurate?

And, is there a different way that we ought to be looking at what these competitive pressures are and how they'll affect you?

Yes.

Lilly asked that question.

And there are notably there are.

Southwest was going to add four Seattle-Denver flights.

So that is an increase.

But there are some decreases, as well.

If you look at American, they're going to pull back a Dallas flight.

Southwest is pulling back a Reno flight.

Airways is pulling back a Vegas flight.

And United is pulling back a Denver and a Chicago flight.

And a Portland-Denver flight.

So there's -- there's -- there is activity on both side of the equation there.

Thanks, guys.

Yep.

Your next question comes from Peter Jacobs with Ragen MacKenzie.

Hi, good morning, gentlemen.

First question is the old standby, Brad.

What are you seeing in spot fuel prices out there right now?

We thought you might ask.

This is Jay Schaefer.

The spot market as you know moves around tremendously.

But just as of two days ago, the noneconomic or the raw price is $2.38 a gallon.

And with our hedge savings it would be about $2.24.

Great.

Secondly, there is more a philosophical question, perhaps Bill and Brad.

And I'm curious if there has been any discussions either amongst management or with the Board, about the matching fares with -- with some -- with competitors as opposed to actually maybe trying to get back to differentiating Alaska a little bit more from the customer experience standpoint.

Maybe adding back some more meals and amenities and things like that that have obviously been reduced over the past several years and needed to be to be more competitive.

But have perhaps has Alaska gone too far?

I guess lets me just leave it at that.

I'm wondering what your viewpoints are on that subject.

Yes.

Peter, there is Bill.

It's an ongoing and active discussion and always has been about what -- where is the customer value proposition, what's the relationship between product and price.

And what are the people -- what's their interest, what are they willing to pay for, what do they care about, what differentiates us.

That does change over time.

And I think one of the benefits hopefully that we have, being a little bits of a smaller carrier compared some of the others is we can be closer to our customers.

So we do a lot of things to talk to our frequent flyers, our MVP Gold members, and talk about -- they tell us about their travel experience not only on Alaska but on other carriers.

What do they see and what would they be willing to pay for that we don't currently offer.

I think it's an ongoing thing.

It's an evolving thing.

And there may be a point where the industry has gone too far, and people are willing to pay a little more for something different.

Well, it would seem to me with the load factors, particularly that I have experienced on some of my more recent flights, and don't take this the wrong way, but it's becoming more of a cattle car feel, namely because of the number of people on board, but also the lack of the amenities.

I'm wondering from my standpoint, maybe a willingness to pay an extra $10 or $20 on the flight to have a little bit better of an experience.

Then you have to obviously balance that with the lower load factors, so on and so forth.

But I'm just wondering if we've got to that point or that discussion is -- is starting to become more active within the company.

We know that we need a revenue premium in any given market against an LCC because we don't have the cost structure, and never will have the cost structure of some of these other careers.

And that revenue premium comes about both through selling higher buckets, higher fares at a given bucket level, and a higher load factor.

That's how we have in the past anyway received a -- you know, achieved a revenue premium.

I guess when we talk about this whole thing, we start with the most fundamental thing that's of importance to our customers, and that's, on time, hassle free, get your bag at the other end.

And we continue to have challenges, with just reliability, on-time performance, baggage delivery.

And what customers tell us is, we get that right, then everything else we do in terms of the differentiation and a lot of that is just through people -- it's our flight attendants recognizing frequent flyers by name.

And the experience that people have with our people becomes really, really important.

But we continue to be very much focused on the operation and improving reliability and on-time performance.

And we're still not where we want to be that score.

Okay.

Thanks.

Your next question comes from Frank Boroch with Bear Stearns.

Good morning, everyone.

Hi, Frank.

Brad, you mentioned you're looking at your '08 planning, you know, as we speak.

And I'm curious with the upgauging next year, what is sort of your initial pass at unit cost ex-fuel leading you to believe.

This year was over -- basically over $0.01 shaved off of prior year's CASM- ex-fuel at Alaska Air.

How much more do you think is -- can come from the upgauging?

Yes.

You know what, we are doing the planning now, Frank, and we're -- I guess we're not providing guidance yet on that.

But it might be fair to say that we all -- all along we have said, hey, the world is changing.

We have to get both of these companies ready for a new competitive reality.

Our objective with Alaska is to get to CASM-ex fuel at $0.0725, and we've said over the last probably year now that we believe to be competitive we need to get our costs below $0.07.

So we have -- I think we've come down probably $0.013 or something like that, if you go back to 2001.

And it's been almost -- it's been regular progress every year.

I mean, if we put those plans together, I think a lot of us in this room would have an objective of seeing equal or better gain in 2007 than we've seen over the last few years.

But that -- that's probably what we're comfortable sharing.

We should get through the rest of the planning process, and then share with you exactly what the plan is.

Okay.

And my last question, as you look at the balance sheet where it sits today, about $1 billion in cash, roughly 30% of sales and you look at the market cap right now as basically equal to the current cash on hand, at what point or does there come a point where you say, this -- this is very attractive to us.

Maybe we should purchase some of the stock ourselves.

How do you look at that?

Frank, I'm going to give it to Jay Schaefer, our Treasurer, to handle that.

It is a good question.

If you look at the conservative nature of how the company has managed its balance sheet historically, it has served us well.

Post 9/11, we were able to do a lot of things that other airlines couldn't because of their weaker balance sheets, expanding east, and putting on fuel hedges and whatnot.

So we do tell -- it's a good question and it's one we talk about internally.

It's not something we would mention publicly until we knew what we were ready to say.

Having said that, we have some religion in the conservative balance sheet.

It helps us with an unfunded pension plan of about $200 million.

It helps us think about competitive incursions into the markets.

It certainly gives us some comfort as we continue to put on fuel hedges that if fuel were to go to 80 or 90 or, God forbid, 100, that we would have balance sheet to deal with that.

So we try and think about all of these uses of cash as we come up with how to structure the balance sheet.

And that is one of the things that gets talked about.

Great.

Thank you.

Your next question is coming from Daniel Mckenzie with Credit Suisse .

Hi, good morning.

Hi.

Just circling back to the competitive capacity question, and, at the risk of kicking a dead horse here, as you think about the opportunities side of the network, where you see the competitive capacity coming, how would you rank the other network opportunities that are out there?

In other words, is there someplace else where you could, other markets where you could put the aircraft that might be, say more RASM accretive?

And then I guess tied to that is a follow-up.

I'm just wondering, at what point would Alaska be considered -- would Alaska consider parking perhaps an aircraft or not parking but selling an aircraft or -- or downsizing fleet, as we've seen some of the other legacy carriers do like United, U.S.

Airways, at finding better profitability through shrinking.

Good questions, Dan.

As you look at some of our markets, were have 12, 13, 18, 20 flights a day, you do look and say, hey, maybe there's limited amount of revenue in this market.

Maybe we're bringing the profitability of each flight down by putting additional flights into the market.

So you look at things such as what are we going to do this fall out of Portland.

We're going to launch flights from Portland to both Boston and Orlando.

We know that's entirely new revenue to the network.

So -- I guess I would just say that we -- as we look at the schedule, there's -- there's a responsibility to put the right amount of capacity into the market relative to what you think the demand is.

And this so-called Seattle or Northwest strategy that we've had over the last several years of finding new cities outside of the network, we think has worked really well.

I think you can expect to see us continue to do that to the extent it makes sense.

The question of parking aircraft, I think you know that we've on the Alaska side, got a lot invested in this MD-80 transition plan.

It was a three area program between 2006 and 2008.

We worked with Boeing on it.

We've got all these delivery positions kind of lined up.

And truthfully, we've exercised options over this entire period.

So we're more or less done.

And we've also done a deal to sell the MD-80s with sale leasebacks that have fixed dates.

Having said that, if you got -- I mean, there is kind of a structure set up, and even the MD-80 returns have been optimized for us to get the most value of those aircraft prior to the next major airframe overhaul or engine check.

Having said that, if you felt like, hey, you really don't have a place to fly an airplane that can cover its costs or there's nothing to prevent you from putting an airplane down one or two months prior to a return, that's something we haven't looked at yet.

Okay.

Great.

Thanks a lot.

Dan, this is Bill.

I think you know that we have a very strong conviction about the need for the relationship between profitability and growth.

So as we look beyond the MD-80 transition, growth becomes less certain.

And it's really contingent on our ability to perform and provide a ROIC and on the investment on new airplanes.

We're going to be pretty strict about that and we're going to hold ourselves accountable and the Board is holding us accountable to make sure that we're investing money wisely for investors.

That's right.

Okay.

Good.

Thanks again.

Dan.

I would now like it turn the conference back over to Ms.

Alberts.

Hi, thanks, Jody.

You know, the next portion we're going to take questions from our journalists and Caroline Warren, our Managing Director of Corporate Communications, is going to host that portion of the call.

Jody would you please remind our callers the procedure for asking questions?

Yes, ma'am.

Again, we will now open the question-and-answer session to the reporters only.

(OPERATOR INSTRUCTIONS).

Ms.

Alberts, there are no questions at this time.

Okay.

Thanks, everybody, for joining us.

We look forward to talking to you again next quarter.

Thanks.

Take care.

Thank you.

This concludes today's conference call.

You may now disconnect.