阿拉斯加航空 (ALK) 2009 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

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

At this time, I would like to welcome everyone to the Alaska Air Group second quarter 2009 earnings conference.

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).

At this time, it is my pleasure to turn the conference over to Managing Director of Investor Relations, Shannon Alberts.

Please go ahead.

Thanks, Lori.

Hello, everyone, and thank you for joining us for Alaska Air Group's second quarter 2009 conference call.

During this call today, Alaska Air Group Chairman and CEO Bill Ayer will provide a Company overview.

CFO Glenn Johnson will talk about Air Group's financial position, and Alaska President Brad Tilden and Horizon Air President and CEO Jeff Pinneo will comment on the financial and operational performance and future initiatives of Alaska and Horizon.

Other members of the senior management team are also present to help answer your questions.

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 available on our website.

Our presentation includes some non-GAAP financial measures and we have provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release.

This morning, Alaska Air Group reported a second quarter GAAP profit of $29.1 million.

Excluding the impact of mark-to-market adjustments related to our fuel hedge portfolio and the charge associated with Alaska's new pilot contract, Air Group reported an adjusted net profit of $26.5 million, or $0.72 per share.

This compares to a First Call mean estimate of $0.53 per share and to last year's adjusted loss of $14.1 million, or $0.39 per share.

Again, excluding unusual items, Air Group reported a year to date profit of $1.1 million, or $0.03 per share compared to a loss of $51.8 million, or $1.42 per share for the first half of 2008.

Additional information about expected capacity changes, unit costs, fuel hedge positions, capital expenditures, and fleet count, can be found in our investor update included in our Form 8-K and available on our website at Alaska Air.com.

With that, I'll turn the call over to Bill Ayer.

Thanks, Shannon.

And good morning, everyone.

We're all hearing concerns about the economy and oil prices.

While these have a significant effect on our profits, they are largely beyond our control.

Our approach is to focus on what we can control and I want to give you an update on some of the things that we've been doing to transform our Company.

While our execution hasn't been perfect, as we look back, the direction of change has been right.

Importantly, we're improving our capabilities, both in understanding the profit drivers of our business and in how to make changes across the organization.

And we're optimistic about the future because we're seeing clear signs that what we're doing is working.

I'm going to take a couple of minutes to talk about five changes that are having a positive impact.

There are many more, both big and small, but these items were particularly important to this quarter's results.

First, we've adjusted our network in an effort to improve unit revenues.

In addition to reducing overall capacity, we're better matching aircraft size and scheduled frequency to demand, including substituting some Horizon airplanes in several West Coast markets.

We're also bringing new revenue into the network by redeploying capacity to new markets such as Hawaii and Minneapolis, with Austin, Atlanta, and Houston coming soon.

As testament to the effectiveness of these efforts, Alaska's second quarter passenger RASM was down only 5.9% and Horizon brand PRASM was flat and that's versus a negative 14.5% for the domestic industry.

Second, we've made difficult changes involving people in order to right size our operation in the face of lower demand.

Since last June, we've reduced the number of Air Group employees by nearly 1500, or about 11%.

As a result, we've been able to maintain productivity in spite of a decline of 1.5 million passengers, or 12% year to date.

We wish we would never have to layoff people, but it is necessary, given the dramatically lower passenger volumes.

And we look forward to the day that we can grow and bring many of these folks back.

Fortunately, the vast majority voluntarily opted to take advantage of the several leave and early out programs we made available.

Third, we're focusing on ancillary revenue.

We began charging a first bag fee on July 7, while we've now joined most of the industry with this fee, we implemented a 25-minute baggage delivery guarantee, which is unique in the industry.

In addition, our people put a lot of thought and effort into assuring the change went smoothly and thanks to them, the process is working very well and the early results are on track to meet our goal of $70 million annually.

Fourth, we've made two important changes to our mileage plan.

As we announced in a recent investor update, we renewed our affinity card agreement with Bank of America.

The revised agreements that better economics that we estimate will result in $30 million of incremental annual revenue through a higher rate per-mile and other enhancements.

This comes on top of the changes we made last fall to increase the number of miles required for reward travel, while still keeping our rewards structure competitive.

And last, but not least, we decided a few years ago that moving each airline to a single fleet type would serve us well over the long-term.

And now that we're operating in the most fuel efficient airplanes in their class, we're reaping the benefits.

For example, in the second quarter, Alaska's fleet generated 76 ASMs per gallon of fuel, a 12% improvement over the second quarter of 2007, and that means lower emissions, too.

Through all of this, we've been very careful to preserve cash, which is not only provided a margin of safety against economic uncertainties, but has made it possible to buy back shares at opportune times over the past two years.

These share repurchases are indicative of our long-term commitment to shareholders.

Finally, I want to thank everyone at Alaska and Horizon for running safe operations and for the terrific improvements they have made in reliability and on-time performance.

Because of their hard work, Alaska earned the number one ranking in customer service for the second year in a row by JD Power and Associates.

And that's well deserved recognition for an outstanding team.

Now I'll turn the call over to Glenn.

Thanks, Bill.

Good morning, everybody.

Air Group, as Shannon said, reported a second quarter 2009 adjusted net profit of $26.5 million versus the $14.1 million loss in 2008, so nearly a $41 million improvement.

That states fuel on an economic basis excluding mark-to-market adjustments on our hedges that settle in the future, which is our usual practice, and it also exclude itself the transition charge associated with the new pilot contract at Alaska Airlines.

There are three major drivers of the improvement.

First, consolidated revenues declined by 9.3%, and that's even after taking into account our renegotiated affinity card deal that was retroactive back to January 1 of this year, which added about $15 million to revenue, substantially all of which is in the other revenue line.

And I would also point out that we have no first bag fee revenue impact in this quarter, since the first bag fee starts in -- started in July, actually July 7.

Second major driver was consolidated nonfuel operating costs, excluding the normal items, were about flat.

And as I mentioned in quarter one, we're disappointed with that, given the significant capacity reductions, but it's not unexpected for the reasons that we outlined on last quarter's call.

And on the nonfuel operating costs, we also saw a significant increase in variable pay costs, nearly $14 million across Air Group.

We are concerned about unit costs at both companies.

They do need to come down and both subsidiaries will maintain their focus on absolute and unit cost reductions and on productivity improvements as we begin planning and budgeting for 2010.

Ultimately, though, the biggest driver of the year-over-year improvement was dramatic decline in fuel expense.

We paid $235 million less to suppliers for raw fuel this year versus the same quarter last year.

On an economic basis, which is the basis for adjusted results, we saw a 50% decline in economic fuel costs.

Our economic fuel costs include roughly $10 million in net hedge costs, or about $0.11 a gallon for hedges that settled during the period.

By contrast, last year we had net hedge benefit of $56 million, which reduced our cost per gallon by about $0.54.

We're maintaining our strategy of using caps almost exclusively to manage the volatility in fuel and we continue to think about our hedge program as insurance, so we would expect a modest incremental premium cost over time.

We've talked on each call recently about our focus on return on invested capital.

We remain committed to our long-term goal of achieving a 10% return on invested capital for our investors and updating our investors on our results each quarter.

For the 12 months ended June 30, Air Group generated an adjusted return on invested capital of just over 5% on our $3.4 billion base of capital.

To put that in perspective, we need about $14 per passenger to reach our 10% ROIC goal.

It's encouraging that our ROIC is positive and trending in the right direction and we do have efforts under way across both subsidiaries to close the gap through a combination of incremental revenue sources and expense reductions.

Turning to the balance sheet, we closed the quarter with cash and short-term investments of just over $1.1 billion, which was about the same as at year end and that puts our cash at 32% of revenues for the last 12 months.

We believe this remains the strongest position among the majors, and I would note that we also have our undrawn $185 million line of credit in terms of liquidity.

Our adjusted debt to cap ratio was 80%, a slight improvement over the year end results.

In terms of cash flows, in the first half of 2009, we generated approximately $130 million of operating cash flow compared to just $100 million last year.

In addition, we realized proceeds from financings of $393 million.

As we told you, we closed on the sale leaseback financing for six 737-800s in the first quarter, we debt financed four 737-800s and we debt financed two Q400s on the Horizon side.

We'll close one more 800 debt financing today and one in fourth quarter.

Those cash inflows are offset by share repurchases.

Following the board's approval on June 11, we resumed our share repurchase program and as of June 30, we had repurchased 700,000 shares for $11.8 million.

Through Tuesday of this week, we've paid a total of $23 million for about 1.3 million shares.

So that's an average price of $18.50 per share.

Our shares outstanding have declined from 40.4 million shares two years ago to 35.1 million today, as a result of this ongoing share repurchase program.

We also incurred CapEx in the first half of the year of $309 million and we repaid debt of $167 million since January 1.

From a liquidity standpoint, we're in the process of renewing our line of credit, the $185 million line, which expires in March 2010.

We have selected Citibank and Bank of America as coleads.

And I would say that despite the state of the credit markets, we're optimistic about our ability to renew the facility.

Now let me turn to our fleet plans and CapEx.

We've reached agreements for new delivery schedules with both Boeing and Bombardier.

We appreciate the partnership.

When you look at our fleet plan from now through 2012, note that there's not a lot of activity.

On the Alaska side, Alaska ended the quarter with 116 aircraft, while we had hoped to sell four 737-700s this year, it's looking unlikely that we'll be able to reach acceptable terms on those.

On the Horizon side, under the new agreement with Bombardier, which we reached in June, we'll take three Q400s this year and then no airplanes in 2010 or 2011, and then four in 2012 and four in 2013.

We do expect to sell or park three offsetting aircraft this year as the four -- I'm sorry, the Q400s are delivered.

Long-term, the objective is still an all-Q400 fleet at Horizon.

But given the market conditions, we expect to use the mixed fleet of Q400s and CRJs for the foreseeable future.

For revised delivery schedule allows us to push out associated capital spending for both companies.

So looking into the future, and on a very preliminary basis, we estimate 2010 and 2011 aircraft CapEx to total approximately $230 million for the two-year period, which is considerably lower than the $600 million or more that we've averaged over the last three years.

Our total CapEx is somewhat dependent on what happens with non-aircraft spending.

In particular, what investments we make in the funding mechanisms for moves and improvements at both Los Angeles and Seattle.

We should be able to pay down debt with the incremental cash generated as a result of this lower CapEx over the next few years and reduce our leverage.

Finally, I wanted to quickly remind you where we are at with our pensions.

At year end, our pension assets had declined to about $650 million and our unfunded obligation had grown to about $450 million, resulting in a large year-over-year increase in our pension expense.

At quarter end, our assets were valued at about $680 million and it's likely that we'll have to make a contribution of about $50 million in 2010.

Now I'll turn over the call to Brad and ask him to provide color on the individual subsidiary performance and outlook.

Thanks, Glenn, and good morning, everyone.

For the quarter, Alaska Airlines reported an adjusted pretax profit of $44.9 million compared to a loss of $15.6 million in 2008.

This represents a pre-tax margin of 6% compared to a negative margin of 2% in 2008.

And these results exclude the $35.8 million pretax charge associated with our new four-year pilot agreement.

Might also note that because the new mileage plan agreement with us signed June 1st -- or signed in June, but effective as of January 1st, the second quarter includes $7.5 million of revenue that's related to the first quarter.

The big news for the quarter, though, was winning the JD Power and Associates award for the second year in a row.

What makes this award so special is that Alaska and Horizon together make up only 3.5% of the domestic industry and were concentrated on the West Coast.

This award is a tribute to all of our people who work hard every day to deliver a great experience for our customers.

And it's very gratifying to see this sort of national recognition for their efforts.

Part of our success comes from the fact that operationally, we've been running on all cylinders.

Our employees have delivered fabulous on time and baggage performance numbers recently and these are the results of hard work by many people over a number of years.

Alaska led the major network airlines in online arrivals in April and again in May and we're hopeful that our 84.5% figure in June will also lead the pack.

Turning back to financial results, Alaska's main line passenger revenue was down $80 million, or 12% for the quarter.

The decline was the result of a 6% reduction in capacity and the 6% decrease in passenger unit revenues.

Passenger RASM declined by 2% in April, 7% in May, and 8% in June, and the shift in the timing of Easter positively effected April.

The actions we took to pair frequencies in weak markets and redeploy that capacity in a host of new cities helped us deal with the weak economy and significantly outperformed the industry during the quarter.

Looking forward, our July advance book load factor is up 4.5 points.

August is up a point.

And September is down a half a point.

The booking curve has shortened considerably in the last couple of months, but notwithstanding this, we are concerned about demand for the fall.

We expect to fly about 5.5 billion ASMs in the fourth quarter, which is 1% less than the prior year and 11% less than this summer.

Compared to summer levels, we expect our employee count to decrease by about 500 people, or 6% this fall.

Most of these reductions have been anticipated for sometime, but that doesn't make them any easier.

We like growing a lot better than shrinking and we wish that we didn't ever have to reduce our staffing levels.

However, we do believe that keeping staffing levels in sync with our flying is necessary in this environment.

We did have some very good news on the people front during the quarter.

We couldn't be more pleased to have ratified new agreements with our pilots and flight attendants and a tentative agreement with our technicians.

Getting these behind us gives us a unique opportunity to work together, focus on customers and competitors, and increase the gap between us and the rest of the industry.

If the technicians ratify their agreement, we'll have only one work group that does not participate in our performance-based pay plan.

So there is obviously an opportunity here to get everyone aligned around some common goals, goals that will make the company stronger and more successful if achieved.

With respect to costs, our CASM X-fuel for the quarter was $0.0822, up nearly 10% on the 6% decline in capacity.

As we look to the rest of 2009, we are still forecasting full year CASM X-fuel of $0.081 on a 6% decline in capacity, and third quarter CASM of between $0.078 and $0.079 on a 5% decline in capacity.

Those of you who followed us for a while know that we're not at all comfortable with costs above $0.08.

We understand the need to get our costs below $0.08 next year and we're hard at work on this.

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

Thank you, Brad.

And good day, everybody.

Horizon posted an adjusted pretax loss of $300,000 for the quarter, a $7.4 million improvement over 2008's second quarter, marking our fourth consecutive quarter over quarter improvement.

These results include a $5.2 million charge related to our six remaining Q200s to reflect current market valuations.

While we're pleased with our improved performance in this challenging environment, we remain concerned about the outlook on demand and volatility of fuel costs, as well as our overall cost structure.

Breaking it down, our second quarter revenues decreased 16.4%, or $31 million, on a 12% decline in both traffic and capacity.

System yield was down 5%, pushing system RASM down 4.7%.

By line of business, our brand flying revenue and capacity were both down a little over 14%.

Brand RASM was flat, which was a great accomplishment in this environment.

For capacity purchase flying, revenue declined 19.3%, a result of lower fuel cost reimbursements and a 13.2% decrease in departures over last year's second quarter.

On the expense side, our unit costs excluding fuel and transition charges increased 3.5% on the 12% capacity decline.

Maintenance costs were down 22.6% due to fewer aircraft, less planned events, and ongoing benefits from several process and vendor cost improvements.

We've made great strides in scaling our operating model to new capacity and traffic levels, trimming more than 480 employees, or 12.8% over last year's second quarter.

This outpaced the 11.4% decline in passenger boarding, resulting in a 1.5% improvement in passengers per FTE.

Lastly, our fuel expense was down nearly $30 million, or 51%.

While our folks can be rightly proud of the gains their hard work has produced, we still have much to do to achieve our cost goals.

Our unit costs and maintenance and flight operations continue to be high relative to our peers, as do airport costs in several key cities.

The temporary suspension of our fleet transition will allow us to bring even more resource and focus to these and other critical areas that impact our P&L.

On the demand front, our advanced book load factors for brand markets are up about 3.5 points, down 1.5 points, and down three points for July, August, and September respectively.

As at Alaska, summer load factors have been building much closer in.

However, it's not at all clear that these late booking curves will continue into the fall.

Accordingly, we are taking a conservative posture with respect to capacity and will be ready to respond to any further changes in demand should they emerge.

Working with Alaska, we continue to be very disciplined with asset deployments, ensuring the right mix of aircraft are assigned at the right frequencies and times in each market.

This partnership is squarely centered on maximizing AAG profitability while protecting strategically important markets and positioning us to capitalize on opportunities as they emerge.

Our people deserve tremendous credit once again for working together to produce an 88.8% DOT on-time rating for the quarter, up a full point from last year.

This ranked us ahead of all mainland-based DOT reporting carriers in both April and May.

Looking ahead, we project our third quarter CASM X-fuel and transition charges to come in between $0.144 and $0.145, up 6 to 7% from 2008's third quarter on an expected capacity decline of 10%.

For the full year 2009, we're forecasting CASM X-fuel to be 5 to 6% higher than 2008 with capacity down 9%.

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

So lots of hard work at both airlines over many years.

And we're starting to see some favorable trends.

But the crystal ball is as cloudy as ever and we have to stay focused on controlling what we can and continue to make changes to strengthen the company and improve our results.

With that, back to Shannon.

Thanks, Bill.

At this time, we would like to invite questions from analysts.

Lori, would you please assemble the roster for us.

Absolutely.

(Operator Instructions).

Today's first quarter question comes from William Greene with Morgan Stanley.

Yes, hi.

I'm wondering if we could talk about the buyback, maybe some color here.

Should we think of it as a one-time opportunistic one, or will you increase it, or what do you say to the board level at this point?

Hi, Bill.

It's Jay.

The buyback is just a continuation of the program that we started in '07.

We took a pause in '08 as fuel ran up and we kind of think about this as three constituents, customers, employees, and shareholders, and on the shareholder front, I think a buyback is just a great way to talk about our confidence in the company.

You looked at the valuations, our stock was down in the $15 range when the board made the decision to do the buyback.

And, you kind of want to get into a nice virtuous cycle where this is something that we would like to do frequently, but it's dependent upon our strong liquidity position and our continuing profitability.

So given that the liquidity outlook is pretty solid at this point, at least you've got pretty good liquidity level, are you -- as you look forward and eventually things start to improve, are you willing to hold less liquidity, or is this about the level you are comfortable no matter what the economic environment?

Bill, this is Glenn.

Good morning.

We ran the liquidity up, the cash position up, as we looked at the high fuel prices and uncertainty.

As Bill mentioned in his closing comments, the crystal ball is still cloudy.

There's certainly a time when we will get comfortable with the outlook and want to bring that liquidity level back down.

But at this point, we're comfortable with the higher level of cash, just given the uncertainty.

And last question on the liquidity again, you mentioned the credit card agreement added I think $30 million in revenue.

What was the liquidity implication?

I didn't catch that.

Good morning, Bill.

This is Brandon.

So it's $30 million annually in terms of revenue, $15 million of which we recorded in the first half of the year.

And on the cash side, we'll get in about $25 million of extra cash related to that deal and that actually came in July.

Okay.

Thanks for the help.

Okay.

Our next question comes from Jamie Baker with JPMorgan.

Hey, thanks.

Bill, question on demand and the network.

Given the seasonality of your network, revenue I guess tends to roll off a little bit more than the industry norm from summer to winter.

So holding the economy constant, I would actually think the roll off could be steeper this year, just given the potential for H1N1 to resurface in the winter.

On the other hand, you got the Hawaiian routes ramping up.

Any thoughts on how the overall seasonality of the network might be different this year versus last?

And again, once we smooth for economic devastation in the first half of the year?

Yes, Jamie, this is Bill.

I can start and Steve Jarvis, VP of Marketing can give you a little more color.

Great.

I think the overriding comment is uncertainty.

We have been working a lot of years to deseasonalize this network with Mexico service in the winter and Hawaii and some of these other leisure destinations, but we're still very seasonal and we know that business travel is way down and maybe Steve can talk about it.

We've got sales people out there making calls on big corporate accounts and they are down a lot.

So it just comes back to this, where are we, is there a recovery, when are we going to see it and we're going to error on the side of being conservative in terms of network capacity.

Jamie, this is Steve.

Bill's right.

We are concerned in being conservative in relation to the business travel side of the equation, so you're right, as summer rolls off, we do get concerned.

We're out there competing for a larger share of a shrinking pie.

Talking to our corporations like other carriers, corporate travel is way, way down and there's two things that are really effecting that.

One is there are companies, big companies in our backyard that are shrinking or being acquired.

And then secondly, corporate travel managers are clamping down on policy, so there are fewer folks traveling and they are traveling on lower fare.

So corporate travel is way down.

We're doing what we can to backfill that with leisure, but we share your concern as the summer rolls off.

Well, and that's one of the concerns that I have is, as downturn drags on business travelers may actually become sort of accustomed to having dinner at home, that sort of thing.

Second question, you may have heard some of my questions on other conference calls this season.

I'm kind of preoccupied with this idea of distressed asset sales this winter.

We've already begun to see Republic doing interesting things at Frontier and Midwest.

Your balance sheet is second to none.

Is this the downturn that, Alaska makes a big break away from the western corridor?

Boy, I guess time will tell.

We have been opportunistic in terms of our expansion of our new route selection and this goes way back to post 9/11, where we develop the Seattle strategy, as we called it, which was to be more significant to folks that are based in the Pacific northwest in terms of our route structure.

And it worked.

And it's working.

And we're going to continue doing more of that with the Houston and Atlanta and so forth, and Hawaii markets seem to be working pretty well.

So as we look at our near-term growth, our near-term opportunities with markets, and we're going to be down on capacity, but as we look at rearranging the network, we're going to continue to look for those sorts of opportunities because they have to happen beneficial.

Good deal.

That's a big help.

Thanks a lot, guys.

Okay.

Our next question today comes from Mike Linenberg with Bank of America.

Please go ahead.

Oh, hi.

Good morning, Mike.

Two questions.

Back on the pension piece, I want to make sure I heard it correctly, that it doesn't seem that there will be any sort of cash contribution to the pension plan this year, but there could be a $50 million cash contribution in 2010; is that right?

So there's no required contribution this year, Mike, but we are following our normal practice of covering service costs.

Depending on where the assets come out and where the underlying interest rate is that we have to discount the liabilities at, we could have a required contribution in the neighborhood of $50 million next year.

And that would be about the same as the service cost contribution that we've been making kind of historically.

Okay.

So this year, and that was sort of part 2.

The question is that this year we should anticipate about a $50 million expense, pension expense that runs through the P&L.

Actually the pension expense is about double that, about $90 million, if I recall the number correctly, Brandon.

And that's because of the impact of the reduction in the assets last year and so from an accounting perspective, we have to take that reduction in the assets over about a 12-year period.

So we basically doubled the accounting expense.

But the cash contribution is $50 million this year.

Okay, okay.

And then just my second question, in the past, in some of your presentations, you've sort of delineated capacity changes in your markets versus what we've been seeing around the country.

And at least up until, the, call it the middle part of 2009, you know, it looked like that there was a lot more capacity growth in Alaska's markets.

And some of that I think was just the function of new entrant competition.

As we look out into the second half of '09 and we start incorporating maybe some bigger cuts by the likes of Southwest and maybe Virgin America isn't taking any more airplanes, how do those numbers look now?

Can you give us an update, and maybe are they shifting where, maybe you're in a better, capacity situation as we move to the latter part of the year?

Yes, Mike, this is Brad.

And I think you are right.

When capacity started coming down a year or so ago, I think the West Coast was slower to see reductions because of virgin and maybe Southwest was slower to pull down on the West Coast.

We don't have exact figures with us for the fall, but I think if you just look kind of market by market, you do see our significant competitors with like reductions of one frequency in a lot of our city pairs, so I think we are going to see a bit more reduction by our competitors in the fall than we've seen over the last little bit.

Okay.

Very good.

Thanks, guys.

We'll go next to Gary Chase with Barclays Capital.

Good morning, guys.

This is Dave Fenton.

Question on the demand side.

I would say almost universally, if not universally, we've heard commentary out of companies during earnings the last four weeks or so, there's been some uptick in demand off horrible baseline.

Just curious to get some color there and if you guys at the margin, if you're seeing any improvement in trends.

Yes, Dave, we have Andrew Harrison, our VP of planning with us.

We'll ask Andrew to address your question.

Yes, good morning.

We're seeing much of the same as you're hearing from other carriers.

We're seeing somewhat of a stabilization of demand during the summer on a unit revenues.

But again, looking into the fall and winter, in '08, our unit revenues increased over 4% and in Q4 of '08, they increased over 8%.

So we have some pretty tough comps coming our way as we head into the back end of the year.

Right.

Right.

And some of that stabilization, how does that break down between business and leisure?

Have you noticed anything different between the two groups?

Basically as Steve mentioned earlier, we've just seen basically the consistent, breakdown in the business travel.

I think just in general across many of our regions, we're seeing somewhat consistent strength in those yields and I think a big part of that is getting our capacity right, by pulling down capacities in the weaker regions and putting more up into the state of Alaska when the industry pulled down a fair bit of capacity.

Okay, and then looking at your capacity guidance for the quarter and then obviously for the year, you should be down, particularly on the main line side.

In the fourth quarter, as I sort of carry that through, through 2010, kind of feels like you should be down a couple percent in capacity.

Is that -- I mean is that a fair assumption?

Or do you think you could see a little bit of that capacity come back next year?

Dave, this is Brad.

We are still working on 2010.

But our basic mindset right now is about flat capacity in 2010 compared to 2009.

Okay.

And you mentioned you don't like to see an eight handle on CASM.

Do you think it's conceivable to sort of, be on flat capacity to be close to 7 -- high $0.07, low $0.08 CASM, or do you think the two things are incompatible.

Hi, Dave.

This is Glenn.

We're absolutely committed to getting that back down and as I mentioned in my comments we have got a number of efforts under way on the expense side in particular to drive the CASM down.

Certainly there's head winds against that in terms of inflationary pressures and so forth, but we've got a lot of levers we can pull in terms of cost reductions, space at airports, to name a few to bring the CASM down next year.

Okay, great.

And one last quick one, just what's the spot assumption underlying the fuel guidance?

This is Jay.

So kind of just assume a $64-barrel of oil, at about $0.25 a gallon, about 190 at the pump and then sort of you gross up for some hedging premium costs, maybe 206 a gallon for third quarter.

Okay.

All right, great.

Appreciate the color, guys.

Thanks, Dave.

We'll go next to Peter Jacobs with Reegan McKenzie.

Hi, good morning, everybody.

Good morning, Peter.

A couple questions.

First, on the balance sheet and how you think about your leverage there, granted, your balance sheet is in a lot better shape than many of your competitors, but at an 80% all-in capitalized operating lease leverage ratio of 80%, it's still about 10 to 15 percentage points higher than I guess I'm accustomed or would think about over the past 5 or 10 years that you've been carrying.

So I'm wondering, one of the opportunities here might be to use some of that cash that you have to perhaps take out any higher costs, interest cost issues that might be out there.

Is that an opportunity that you're looking at, or are you still satisfied with where you are with the balance sheet right now?

Great question, Peter.

This is Glenn.

So first, I would say philosophically, just like we don't want to see a CASM that starts with an 8, we certainly don't want to see a leverage that starts with an 8 over the longer-term and so we do need to drive that down.

Right now the balance is between ensuring we have cash to weather whatever storms might be ahead of us as an industry, and as Bill mentioned, the crystal ball is cloudy.

We certainly do have the capability to pay down some debt, some higher priced debt, and we continue to evaluate that, but that option is always open to us.

And, the other thing is that now with the deferral of the airplane orders, we've got seven airplanes coming in on the Horizon side next year, with seven going away.

So no net increase in airplanes, but you could think about that.

We haven't made any final decisions yet, but you could think about that as having been prefinance with this year's debt deals that we did, so we'll be able to drive down the leverage by paying off debt next year and not taking any incremental debt.

I'm sorry.

That's seven Alaska airplanes and then we've got the three Horizon Q400s the end of this year.

And just to be clear, Glenn, with the CapEx comments that you made earlier of $230 million per year, that was in each year for 2010 and 2011.

Did I understand that right?

No, I'm sorry.

That's actually the total for the two years.

It's $180 million in 2010 and $50 million in 2011, on a very preliminary basis.

And that's gross CapEx?

That's aircraft CapEx.

Aircraft CapEx.

With the deferral of the airplanes.

Now I have just a general comment on your markets, and Brad, could you give us some color on some of the markets that are performing very well for you right now and some of which might be challenging either because of the business is slow or that you're seeing a considerable competition out there?

Yes, and I think the big, the main comment we would make, Peter, is the RASM decline was 6% for the quarter make, Peter, is the RASM decline was 6% for the quarter and it was fairly well balanced throughout our network and I think we really have to recognize the planning by our network folks.

As you probably know, we made pretty significant capacity reductions in southern Cal, the Bay Area, Arizona, Nevada, and if you look, with the demand was also way up in those markets.

So if you look at the RASM performance in those markets, it was down kind of in line with the system reduction of 6%.

Lot of those airplanes were redeployed into new places like Hawaii -- so forth, and again RASM in those regions was generally in line.

So there weren't big outlier in terms of reasons with real big RASM increases or real big RASM declines.

Okay, and lastly, I have a little quirky question for you.

And that is, I'm just wondering about the thought process in discontinuing the red eye flights to Orlando and Miami.

And I think those were discontinued maybe about six or nine months ago, but it would seem to me that farce aircraft utilization being able to fly in, turn the aircraft in an hour and fly it back is pretty good from an operating cost standpoint as opposed to still flying two flights a day to those markets, but parking flying two flights a day to those markets, but parking an airplane overnight.

So what's the thought process around that?

Hi, this is Andrew.

As you may recall back into the summer when fuel was starting to go through the roof, those red eye flights were just not worth flying given the cost of those flights.

And we've done some analysis and being able to look back at results going back a little bit and on the whole we find that we get a much better in this environment revenue premium by flying those during the daytimes.

So right now, I mean you'll see Boston, Miami, Orlando, Dallas/Fort Worth.

Anchorage is really the only place right now we're doing the red eyes.

You'll see coming shortly, we had a red eye (inaudible) coming down to a daytime.

Right now in this environment, we think our best move here is to have good strong flying during the day and make sure we have still good connections with doing that.

You still have the red eye to Boston, don't you?

No.

I don't believe so.

And we should see better average ticket prices, better yields on the daytime flights and that's what we're hoping to see in this lower demand time.

The other thing, Peter, this is Bill, I might just add, I mentioned one of the things that gives us optimism about the future is the capability of our team here and the things that we are learning and just getting really good at.

I don't think it's possible to overstate the importance of getting capacity right, especially during the time like this.

And I think that same lesson is being learned by the industry.

But it's just very powerful.

When you get capacity right, you see dramatic improvement in bottom line in these markets.

Okay, thanks.

That's all I have.

We'll go next to Helane Becker with Jesup & Lamont.

Thanks very much, operator.

Hi, everybody.

Hi, Helane.

Just a couple things.

Can you say, or did you say the impact of H1N1 virus was on the numbers in the quarter?

And two, can you say what your capacity is now in Mexico and Hawaii, because I think you made lots of shifts, to -- maybe someone in those plants were shifted again.

Yes, hi.

This is Andrew.

Really, the H1N1, hit us pretty hard in May and I think if you look at main line results, our load factor year-over-year was down a point and that was we believe solely due to the H1N1.

I think our revenue is probably down about $10 million, but what we have done, some in June, but really starting earnestly this month, we've pulled down Mexico about 38% and we've redeployed that into Hawaii and some of the other new markets.

Where we sit today, we're still working on the winter schedule, but we think that you'll probably see our Mexico service come back after year-over-year full steam levels in the peak winter season.

And I think looking at the full, which really was damaged, the bookings were damaged both in the summer and the fall by the H1N1, I think in hindsight, we're feeling pretty good about our decision to reduce capacity right now in Mexico and redeploy it and I think net-net, we're probably better off with that.

Okay, thank you.

And then on, on that $15 million in revenue that I guess was in other related to the affinity credit card, so how do we think about that?

Do we take that out, or is that a number that's -- how should I think about that in terms of modeling?

Yes, Helane, this is Brandon.

How are you this morning?

The $15 million, I don't think you should take that out.

I think you should think of that as ongoing.

I think Glenn said it was $15 million in the first half.

Bill made the comment that it was $30 million annually.

So roughly $15 million times two is the $30 million.

We, we see that as being an ongoing thing.

Okay, but it was all in the second quarter, or was it because it was signed just recently, right?

And then when we go forward for modeling, it's $7.5 million per quarter.

That's what I'm trying to get at.

Yes, that's exactly the way to think about it.

It was retroactive back to January 1st, but we signed it in late June.

So there was essentially a pickup of all the activity that occurred in the first quarter at the old rate per mile that we took into the June results.

So going forward, I think of that in terms of about $7.5 million in the third and fourth.

Okay, and is then there an offset liability, there should be no costs associated with that, but it's a balance sheet item as well, right?

Actually, no, not in this case, because what we do is when we sell a mile to the bank, we do two things with the proceeds.

We take most of the proceeds and we defer it in the form of, or defer it because we owe -- excuse me.

We owe the customer a free light.

Well, the value of that flight doesn't change.

So to the extent that we sell that mile for more than we were previously, all of that incremental drops to the bottom line.

Yes, I saw that.

Thank you very much.

I appreciate your help.

You're welcome.

We'll take our next question from Michael Derchin with FSN Equity Capital.

Hi, everyone.

Couple questions.

One related to your pilot contract.

Part of it, as I recall, had, it seemed like a phaseout of the defined benefits over time.

How does that work actually?

Michael, it's Brad talking.

There's maybe a couple of big provisions there.

One, any new hire pilot that the company has will go directly into a defined contribution plan.

So that -- on the Alaska Airlines side, what that means is any new hire in any group will be covered by defined contribution plan, not a defined benefit plan.

Then existing pilots have a choice, basically staying with the current setup, which is largely a DB plan there is some DC element or they can go to a more balanced setup with equally weighted between DB and BC or they can quit taking credit service under the DB plan and have all of their retirement benefits funded through a DC, so they have got a choice.

And that seems to be not being expert in that area, quite a meaningful change over the long-term.

We think it's really, really important.

These -- I mean as we've talked now, we've got, what, $400 million plus of unfunded liability.

And so trying to get out of the defined benefit plans, we felt was critical for the long-term future of the company.

And we're really, really pleased to be there.

I think what we have will be a good retirement program for our employees as well.

That's great.

Lot of the other -- your counterparts are thinking about bankruptcy as a way out and be able to do it as on ongoing exercise, getting cooperation from your employees understanding significance, I thought was very impressive.

We never liked that bankruptcy option.

No, I don't like that one either.

The other thing I wanted to compliment you on is the transparency that you guys provide in your IR.

It's really very, very good.

One of the things you give is some insight on the advanced book load factor for the coming three months and I notice that there was a fairly positive change in the most recent that you issued today versus a month ago.

Are you also getting some pricing traction with the strength in bookings in July and August?

This is Andrew.

Actually first, for Peter Jacobs, my apologize.

You can tell the internal back and forth, but we still do have a red eye in Boston.

My sincere apologies and hopefully -- are still good.

As it relates to the uptick, couple of things.

Basically industry-wide and airline-wide, there was a price increase of about $5 one way in the structured fare, and that seems to be sticking right now.

Having said that, Southwest had a fairly significant prefall sale and so some of the fare actions at the style fare level that have occurred recently is starting to stimulate some of the bookings for the fall, but again, they are not associated with much higher ticket prices at this point.

Got it.

Thanks very much.

We have time for one more question, if there's one there, and then Alaska's Managing Director of Corporate Communications, Caroline Boren will conduct the media portion of the call.

Thank you.

We will take a follow-up with William Greene from Morgan Stanley.

Hi.

One quick question on the bag fee.

Have you seen any share shift relating to putting it in versus Southwest?

Or is it too early?

I think it would be way too early to see anything like that, but I would -- what Bill did say and I think what we would reiterate is it's gone very smoothly, the implementation.

It hasn't been perfect, but it's been very, very smoothly and we did see immediate pops to revenue as soon as we implemented it.

And we're not hearing anything from customers about concerns people known, kind of known in the industry, that's our perception, that it's sort of an expected thing across the industry.

Okay.

Thanks for your help.

At this time, we welcome questions from journalists participating in today's call.

Lori, would you please remind our callers of the procedure for asking questions.

(Operator Instructions).

We'll take our first question from Amy [Huswan] with the [Orgonion]

Hello, Amy.

Hi, Caroline.

I heard a couple of numbers coming out regarding the staffing reductions.

I heard 1500.

I heard another 500 coming up this fall.

Yes, Amy, if you look at our second quarter results for both companies, Alaska and Horizon, we have 1500 fewer people than we had 12 months ago.

And as we look at the fall, we think -- it's important to know that we have a seasonal reduction every fall, but this fall we think our decline from summer to fall will be about 500 people on the Alaska Airlines side.

And that doesn't include Horizon.

That's simply--

Right.

Okay, great.

And Horizon, much more of the work is front loaded.

We do anticipate seasonal reductions relative to capacity reductions and a few other modest trends at this point.

And Amy, that was Brad Tilden speaking to the Alaska side and Jeff Pinneo on the Horizon numbers.

Okay, great.

And that, I'm sorry, is a what percentage reduction and how does it relate to capacity reduction?

So on the Alaska side, it's 500 on the base of 8800 or 9900 employees.

And so we could run the math on that.

I think it's about 6%.

And then the capacity, again, our fall capacity -- there's two numbers.

But the fall will be 1% lower than last year, but 11% lower than the summer.

So I think the important thing to think of is the level of flying is down 11%.

The employee count will be down about 6%.

Got it.

And on the Horizon side, Amy, year-over-year for the quarter, we were down 488 -- a little over 408 employees, nearly 13%, 12.8% and that correlated to the 12% capacity decline.

And Amy, a bit of the discrepancy between that and the BTS numbers that you've also looked at relates to how they calculate part-time employees.

So they basically round that up to any part-time employee is a 50% employee, whereas we take into account the exact number of hours for part-time employees.

Okay, great.

Thank you so much.

We'll go next to Megan Coon with Flight International.

Good morning.

Hello, Megan.

I wanted to find out the amount of the testing that you did for the road 44 trial.

Hi, Megan.

This is Steve.

It's still a little early to tell with the price elasticity is on that.

We've tested different stage lengths and different prices and I can tell you that certainly when we were flying it for free, we had much higher update than at all, we were seeing upwards of 30% of the aircraft using it when it was free and we've been all over the map since.

We need to stick with it, probably need to get another aircraft or two in the air, certainly would like to get an 800 in the air that can fly Transcon so we can look at pricing for longer haul markets.

Right now it's really hard to tell what the curve looks like.

It's kind of all over the place.

It will probably be different in terms of uptake between handheld and PCs.

But other than that, we're still testing.

And in terms of, with the regulatory issues with 44, has that caused Alaska to look into any other options 44, has that caused Alaska to look into any other options for internet connectivity?

Well, we think we're going to be able to come through that and certainly continuing to work with our partner 44, we definitely need to have Wi-Fi on board our airplanes, if the industry is heading that way, especially the domestic industry.

And we think we have the right solution for us in our network because of the over-water needs we have and the state of Alaska, Mexico and Canada.

We think we're with the right partner, but whatever happens, we need to have Wi-Fi on board the airplanes, so we're going to continue to look at the industry.

Okay, great.

Thank you.

We'll take our next question from Tom Vance with KUOW Radio.

Hello, Tom.

Hello.

I have a quick question about parked airplanes.

Does Alaska or Horizon have airplanes parked in the desert Southwest?

And if so, are there prospects to put them back into -- you mentioned ramping up to Mexico or possibly selling.

This is Glenn Johnson, the CFO.

We have four MD-80s that are parked that are scheduled to go back to lessor at some point in the future and those are not on our operating plan at this point.

Other than that, we don't have airplanes parked in the desert on any kind of long-term program.

We have three aircraft, the ones that we'll deliver to Horizon later this year that are temporarily stored, anticipating delivery in the fall of this year.

Other than that, when we talked about parked airplanes at this point, it's really a reflection of just a little bit lower utilization per day.

So we're using the airplanes about an hour or less a day on the Alaska Airlines side than we were a year ago, which results in the equivalent of about 10 airplanes reduction.

And then we actually have six Q200s, the smaller turboprop on the Horizon Air side, that are stored in Portland right now in anticipation of moving those out in the near term.

But again, Tom, just to clarify for the MD-80s and the Q200s, those were part of a planned transition to an all-737 fleet and an all Q400 fleet that we announced a couple of years ago, so it's not a response to--

I'm thinking more the classic picture of the, yes, of the desert and all the airplanes that aren't needed anymore, just sitting there.

We have no intent to fly either the MD-80s or the Q200s.

Understand.

Thank you very much.

Thanks, Tom.

At this time, we have no further questions.

Great.

Terrific.

Thanks, everybody, for your participation, and we look forward to talking with you next quarter.

Take care.

Thank you very much, ladies and gentlemen, for joining Alaska Air Group conference call.

This concludes your conference.

You may now disconnect.