阿拉斯加航空 (ALK) 2010 Q2 法說會逐字稿

Good morning.

I will be your conference operator today.

I would like to welcome everyone to the Alaska Air Group second quarter 2010 earnings conference call.

Today's call is being recorded, and will be accessible for future playbacks at www.AlaskaAir.com.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question and answer session for analysts and journalists.

(Operator Instructions).

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

Thank you.

I would now like to turn the call over to Alaska Air Group's Managing Director of Investor Relations, Shannon Alberts.

Thanks, Melissa.

Hello, everyone, and thank you for joining us for Alaska Air Group's second quarter 2010 earnings call.

Today Alaska Air Group CEO Bill Ayer will provide a Company overview, CFO Brandon Pedersen will talk about Air Group's financial position, and the Presidents of our two operating subsidiaries, Brad Tilden, and Glenn Johnson, 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 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 net profit of $58.6 million.

Excluding the impact of mark-to-market adjustments in connection with our fuel hedge portfolio, and CRJ transition costs at Horizon, Air Group reported an adjusted net profit of $84 million or $2.29 per share.

This compares to a First Call mean estimate of $2.12 per share and to last year's adjusted net profit of $26.5 million or $0.72 per share.

Again excluding unusual items, Air Group reported a year-to-date profit of $97.1 million or $2.65 per share compared to a $1.1 million or $0.03 per share for the first half of 2009.

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

With that I will turn the call over to Bill Ayer.

Thanks, Shannon, and good morning, everyone before.

Before we get into the quarter's results, I want to talk about the leadership changes that we recently announced.

After eight years at Horizon's helm and more than 28 years in various positions it the both Alaska and Horizon, Jeff Pinneo has retired as Horizon's President and CEO.

Glenn Johnson, who formerly served as Alaska Air Group's Chief Financial Officer, has replaced Jeff as President of Horizon.

Backfilling Glenn's role is Brandon Pedersen, who many of you already know through his roles in Finance and Investor Relations.

Jeff took the CEO job at Horizon just a few months following 9/11 and helped them navigate through some of the industry's most challenging years.

He led the Company as it made substantial improvements in operational performance and customer satisfaction.

Speaking for all of us here, let me say how grateful I am for all that Jeff has accomplished and the legacy he helped build overall of these years.

Glenn Johnson spent twelve of his 28 years at Air Group overseeing Finance and then Customer Service at Horizon.

That background, combined with his most recent roles running Alaska's Operations and Finance Organizations gives Glenn the experience and perspective to continue the transformation of Horizon.

Glenn will talk about those plans in a moment.

Finally, Brandon Pedersen was elected CFO, replacing Glenn.

Brandon joined us in 2003 and is well prepared to take on this expanded role.

Like Glenn and Brad before him, Brandon is committed to the same conservative financial principles that have differentiated us for many years, and to achieving an acceptable long-term return for investors.

I have the utmost confidence in Glenn and Brandon, and the fact that we can make this type of leadership change from within our own ranks is a result of the focus we placed on developing people over the years.

It is truly an honor for me to work with so many talented and dedicated leader at both companies.

This quarter's results represent Alaska Air Group's best adjusted quarterly profit in our history.

Our results were driven by higher load factors, improved pricing, bag fee revenues, and good cost control, partially offset by higher fuel costs.

For the third year in a row, JD Power & Associates ranked Alaska's airline's highest in customer satisfaction among traditional network carriers in North America.

Brad will talk more about this in a minute, but I want to express my thanks to all employees for consistently providing the kind of customer service that has earned this recognition.

Last week, Alaska Airlines was named number one among legacy airlines worldwide in Aviation Week's annual "Top Performing Airline Study".

Their report notes the benefits of being smaller and more nimble and highlight some of the things that we have been working on for some time, such as taking a long-term view of the business, focusing on a few key areas, and executing well.

Aviation Week's recognition is a tribute to our entire team including our supervisors, managers, and other leaders in Seattle and throughout our system.

Our ability to set aggressive goals and make the changes required to achieve them are core to our success and we will continue to build those capabilities.

While we are well aware of the risks in this industry, we are optimistic about our future.

We're seeing the results of the virtuous cycle among employees, customers and investors that we talked about when we laid out our Alaska 2010 vision back in 2003.

We have an engaged, hard working employee group that is providing an outstanding travel experience for our customers, and this quarter's record financial performance gives us confidence that together we can achieve even more.

With that, I will turn the call over to Brandon.

Thanks, Bill, and good morning, everyone.

It is a pleasure to be speaking with you today in my new capacity.

As Shannon said, Air Group reported an adjusted net profit of $84 million for the quarter, compared to a $26.5 million net profit last year, an improvement of more than $55 million after tax and $91 million on a pretax basis.

Our results translate to a 13.8% consolidated pretax margin and a 12 month return of 8.3% on a $3.5 billion base of invested capital.

Depending on how the year shakes out, and I will be quick to say that this is not earnings guidance, we may very well hit our goal of a 10% return on invested capital.

We're proud of the progress we have made towards that goal.

It is the result of the hard work and commitment of many dedicated employees, and we are enthused about the results.

At the same time, I want to reiterate that Air Group's goal as a 10% return over the business cycle, which means that in good years we'll need to generate 12 or 13% returns to offset weaker returns or weaker years, excuse me, in the cycle.

The $91 million improvement in our pretax result was mainly due to a $133 million or nearly 16% increase in revenues, offset by a $50 million increase in our economic fuel costs.

First bag fee revenue which was new in the third quarter of last year accounted for more than $25 million of the revenue improvement.

We originally estimated that the first bag fee would generate $70 million of incremental revenue annually, but in the year since it began, we have collected $98 million.

Ancillary revenue per passenger, which includes bag fees, and is an important metric for this year's PBP incentive payout, totaled $11.13 per passenger for the first half of the year.

Speaking of incentive pay, we have accrued nearly $40 million year-to-date or half of our expected $80 million annual expense.

Last quarter, Glenn told you we were tracking to $72 million, so we have seen a bit of an increase that has negatively impacted costs.

However, because we have six months of financial results in the book and have better visibility to the operational and cost metrics, significant upward adjustments that would impact our cost guidance are not likely at this point unless we're able to reach agreements to add Horizon's pilots and mechanics and Alaska's Customer Service agents to the PBP program.

The $50 million increase in our economic fuel costs was mainly due to the higher average cost of oil this year.

On a raw, or unhedged basis, however, our fuel costs increased $64 million, or 40%, which serves as a reminder of the impact that volatile crude oil prices can have.

Despite the recent price stability, this reinforces our conviction that our hedge strategy of using all caps to hedge 50% of our planned consumption is the right one.

Turning to the Air Group balance sheet, we closed the quarter with cash and short-term investments totaling just under $1.3 billion.

That puts our cash at 35% of trailing twelve months revenues which remains among the strongest in the industry.

We generated $334 million of operating cash flow during the first half of the year, up from $123 million last year, on the higher profit and much stronger advanced ticket sales.

Our free cash flow potential for this year is significant, given the improving financial results, $230 million of expected depreciation addback, and the lowest amount of CapEx since 2004.

Cash generated from operations was offset by $108 million of capital spending, $27 million in share repurchases, and $131 million of debt repayment, including $55 million of prepayments.

We talked before about our desire to bring our cash balance down to 25 to 30% of revenues, and our intent to prepay $200 million of long-term debt by the end of 2011.

In light of the potential for more free cash flow than we had anticipated, we're planning to have a conversation with our Board about various alternatives for getting to our target.

During the quarter, we completed the $50 million share repurchase program that was authorized last year, and in June, our board approved a new $50 million repurchase program, reinforcing our ongoing commitment to provide a return to investors.

We now expect 2010 capital spending to be $210 million, slightly higher than the $203 million that we originally planned.

We recently exercised options for two Boeing 737-800 airplanes to be delivered in 2012, so with the firm orders currently on the books, we should have 114-737s through 2011 which is one less than we had at the end of 2009 and two fewer than we have today, and growth of four units in 2012.

While it is too early to give guidance for 2011, we can say that annualizing our current schedule would result in ASM growth of approximately 3 to 4% at Alaska next year and the new aircraft in 2012 would represent about an equivalent amount of growth.

Glenn's comments today will focus almost exclusively on his vision for Horizon, so I want to take a moment to acknowledge Horizon's results for the quarter.

On an adjusted basis, Horizon posted a profit of $8.2 million, their best second quarter since 2006.

Those results exclude a $3.4 million pretax charge related to one CRJ that we subleased to another carrier.

We're planning to dispose of an additional four RJ's during the third quarter and expect to record a charge in the $7 to $9 million range.

As we accelerate our transition to an all Q400 fleet we will likely incur additional costs in coming quarters including costs related to CRJ disposal, furloughs, and other expenses.

We'll keep you updated as we know more.

Now over to Brad.

Thanks, Brandon, and good morning, everyone.

As Bill said, this was a great quarter for Alaska Airlines, and we received some important external recognition for activities that have been under way for six or seven years now.

We received a JD Power award for the third year in a row, and the margin between us and the number two carrier was the largest it has been in the three years.

The top performing airline award from Aviation Week is great recognition for leaders throughout the Company that are working so hard to position us to compete successfully in this new environment.

For those of you that don't follow this award closely, we are honored to have taken over the top spot from Singapore Airlines, who ranked highest for the last five years.

We cannot be more proud of our people and those at Horizon Air who help us serve our common customers every day for these accomplishments.

For the quarter, Alaska Airlines reported a record adjusted pretax profit of $128.1 million compared to a profit of $44.9 million in 2009.

This represents a pretax margin of 14.7% compared to 6% last year.

Alaska's main line passenger revenue increased by just over $100 million this quarter, or about 17%, due to a passenger unit revenue increase of 11.6% and 4.4% more capacity.

The passenger RASM increase was a function of a 4 point improvement in load factor and a 6% improvement in yield, and the increase in yield is due to both bag fees and ticket prices.

Looking at the individual months, passenger RASM increased by 11% in April, by 13% in May, and by 11% in June, and our PRASM increase compares with increases for the domestic industry of 10%, 14%, and 18% for those same three months.

You may recall that we out performed the industry by 9 points in the second quarter of 2009, so we are extremely pleased to have kept pace as well as we did this quarter, especially given the fact that we added a lot of low RASM flying in long stage length markets like Hawaii.

In fact, if you compare our passenger unit revenue for the second quarter of 2010 to the second quarter of 2008, we were up 6%, whereas the industry was down 2%, so we out paced the industry by 8 percentage points over this time period.

The above and beyond efforts of our people on the front line and operations and Customer Service positions and in network planning, revenue management, and marketing are all reflected in these numbers.

Nearly every one of our regions posted unit revenue increases, and we saw particular strength in the Southern California, Bay Area, and Mexico regions, where our scheduled pulldowns have been most pronounced over the last couple of years.

As we continue to refine our network, we are launching a number of new markets in the next few months.

In the third quarter we inaugurating service to St.

Louis from Seattle, and we're starting service between LAX and San Jose and between Portland and Honolulu.

In the fourth quarter we start service between San Diego and Maui, and we'll also add Portland-Kona and San Diego-Puerto Vallarta service.

And in March of 2011, we'll start service between Lihue on the island of Kauai and both Oakland and San Jose.

Network changes like these have helped to diversify our revenue base and reduce the seasonality of our business.

Importantly, our fleet and invested capital do not change as a result of this new flying, and we expect Alaska's main lane ASM growth to be 7% for the third quarter, 9% for the fourth quarter, and 5% for the full year which is within the range of our previous guidance.

Horizon's full year capacity is expected to be down 1 to 2%, which will result in a consolidated capacity increase of 4% for the year.

Alaska's total departures will increase by less than 1% for the year, and will remain 10% lower than 2008.

Alaska's July advanced book load factor is up 3 points, August is up a point, and September is up half a point.

Yield trends are positive, and we're continuing to see business demand return as evidenced by an increase in revenues in the middle fare classes and in the first class cabin.

Effective June 16th we made some small changes to our fee structure which included increasing the first bag fee from $15 to $20 and tightening our bag service guarantee from 25 to 20 minutes.

We estimate that these will produce about $30 million in incremental annual revenue.

Turning to costs, we ended the quarter with CASM ex fuel of $0.0779, down about 5% year-over-year on a capacity increase of 4.4%, and in line with our initial second quarter guidance in spite of higher than expected incentive pay accruals.

For the rest of 2010, we are still forecasting full year CASM ex fuel of between $0.079 and $0.08 which represents a decrease of about 4% from 2009.

We're making very good progress on the productivity and over head initiatives we talked about over the last couple of quarters.

Each of our operating divisions has aggressive targets, and our leaders are doing a great job executing against these plans.

At this point I will turn the call over to Glenn.

Thanks, Brad.

Good morning, everyone.

I am pleased to be joining you in my new role as President of Horizon Air.

Because our results and guidance are already outlined in this morning's 8-K, I am going to forego the usual overview and spend a few minutes talking about my vision for Horizon.

Horizon has many strengths, including our safety record, our reliability in on time performance, our customer satisfaction and loyalty and our outstanding highly committed employees.

The one area where Horizon hasn't delivered acceptable results is profitability.

While we're making progress as this quarter's results indicate, we believe we can and must deliver a 10% return on invested capital at Horizon, matching the goal for Alaska Airlines and Alaska Air Group.

For the twelve months ended June 30th, Horizon's rate was 5.1%, and although we have considerable work to do, I am confident we can achieve the target.

To continue closing the gap, and to accelerate the pace of the improvements, Horizon's leadership team is evaluating our current business model and determining the changes that will be necessary to make Horizon successfully financial for the long-term.

Let me just remind you of the number of efforts that we already have under way.

First, we're focused on completing the transition to an all Q400 fleet.

Our plan calls for us to replace our remaining 13 CRJs with eight Q400s, which will leave us with a fleet of 48 Q400s.

When we finish that transition, we will have reduced our invested capital by approximately $100 million between aircraft and inventory, thus saving about $9 million per year in expense.

As we transition to the single fleet type, we're working closely with Bombardier to improve the Q-400's reliability, and we're considering the addition of several new line maintenance stations to better support the expanded Q400 flying.

Second, we're committed to achieving market level maintenance and pilot costs.

We solicited bids from a number of US vendors for heavy maintenance work, and confirmed this is a significant savings opportunity.

We're now engaged with the IBT, which represents our mechanics, to determine whether we can realize the same level of savings within our current framework.

If not, we'll transition this work to a highly experienced US based vendor, always of course with robust industry leading standards and oversight to ensure the highest level of safety.

For many years Alaska Air Group has used vendors to perform most heavy and other specialized maintenance with excellent results.

On the pilot side, we recently announced an agreement in principle with the IBT on a new contract.

The Company and union are continuing to work together to translate that agreement in principle into a tentative agreement, which will then be voted upon by the pilot group.

Third, we're looking at all areas where Horizon and Alaska have similar functions to identify duplication.

We have had good success in transitioning several back office functions into what we call "shared services".

While remaining two legal entities with two operating certificates, we are actively evaluating which operational areas we can also consolidate.

Finally, we're considering a change in the mix of capacity purchase agreement or CPA versus brand flying that Horizon does.

As you know, Horizon has a hybrid model, where about 45% of our ASMs are sold to Alaska Airlines, in an industry-standard CPA deal, and about 55% is brand flying, where we bear the revenue risk, and the passengers connect to Alaska we earn a pro rate of the joint fare.

Over the last decade or so, an increasing portion of Horizon's flying has been dedicated to Alaska, and our aircraft have been well suited for complementing or substituting for Alaska on certain routes.

That flying, coupled with our past and possible future expansion into geographical areas that are not traditional Horizon locales such as California, Arizona and Mexico, is causing us to take a fresh look at the costs versus benefits of maintaining the Horizon brand from an external perspective.

We anticipate reviewing our evaluation of the Horizon business model with our Board during the third quarter.

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

Thanks, Glenn, and let me just once again congratulate the employees at both airlines on a great second quarter.

With that, we're ready for questions.

(Operator Instructions).

Your first question comes from Bill Greene of Morgan Stanley.

Good morning.

You have got some very impressive margins, and the way I sort of kind of think about this, is that margins like that can often attract competition, so how do you think about what you should do going forward?

How do you get them even better than almost at peak, and how do you make sure you're not sort of subject to increasing inroads from competitors as they look at your margins and say we need some?

Hey, Bill, this is Brad.

It is a great question.

I will tell you we're spending some time right now on our I think many of the analysts are familiar with we have the strategic plan which we call our 2010 plan and we're working right now on the extension of that strategic plan, and an important part of that is a conversation about our market position, and one of the things that we're thinking about is what do we do over the next two or three or four or five years to ensure that we're positioning ourselves as the airline that offers the best value or really good value on the West Coast of the United States, great value to all of our customers, and I guess I might -- the high level answer to your question, is I think that principle is the principle that's going to help ensure that we have an answer to the LCCs that may be attracted to our markets that have these good margins.

And so what are some of the things that would be considered?

I am not sure I quite understand what you would do.

To continue to enhance the margin?

Yes.

I guess I would say and this is just my thinking, but on the revenue side we need to -- I think we're flying at 86% load factor in the month of July month to date.

There is probably some opportunity to continue to push the load factor up a little bit.

We do have a mindset about the fare, that there probably are limits to how high this fare can go where we're still in a position where we can tell our customers that we are offering them great value, so load factors are a opportunity.

Fare is maybe some opportunity.

Then part of the story of Alaska Airlines and Horizon Airlines over the last decade is every year looking for ways to make our businesses more efficient so that we can offer these low fares and still provide great returns for our investors.

This is Bill.

I might add that at the end of the day, it is really the customer that decides success and margins and all of those things, and so one of the advantages that we have been talking about for some time is the fact that we are smaller and more nimble, and I think we demonstrated that with all the market changes and network changes we have made, and being more in touch with customers, so we have lots of opportunities, and take advantage of those opportunities to talk to our customers, survey them, respond to their needs, and I think we can move a little bit faster than some of the bigger carriers.

Maybe we can understand a little better what customers care about, and as Brad says, really addressing this customer value notion, and working to improve, continually improve the value that customers perceive when they fly on Alaska or Horizon.

Okay.

You also, Brandon, you mentioned uses of cash.

What sort of, aside from I guess the obvious, is there anything else that would be on the table?

I guess buybacks, dividends, or reinvestment, but you mentioned you were looking through that.

How do you think about that?

Is there any color you can add?

Yes.

I think you hit them.

It is first of all a high quality problem to have, and as I mentioned, we'll be talking with our Board about this over the next quarter or so.

I think you named the things that would be likely.

You have continuing with repurchase.

You have repayment of long-term debt.

You have investing in other opportunities.

There is lots of things out there, and we'll be talking about each of those.

As you know, we have talked about our plan to prepay $200 million over the next two years or so or year-and-a-half, I guess, from this point on.

That will reduce negative carry, having lower debt is good for shareholders, and it is all about thinking about things that we can do with that cash that are good for our shareholders over the long-term.

All right.

Thanks for the time.

Your next question comes from Hunter Keay of Stifel Nicolaus.

Thanks.

Good morning.

Hi, Hunter.

I am not sure if you guys saw awhile back about a month or two ago but Hawaiian Airlines actually cut its PRASM guidance.

Is there a read-through here?

I know you compete in slightly different markets, but are you causing that weakness for them?

Do you think you are taking share from them or are you actually seeing a little bit of weakness yourself?

How are you guys reading that?

Hunter, this is Brad.

I am not sure we can comment on Hawaiian, but I would say that our Hawaii business has been very, very good.

We are ramping up.

We're going to be at I think 108 flights this winter, a week, 15.5 a day or something like that.

Our results have been good.

Certainly the share has -- I don't have the exact figures in front of me.

The share has shifted a lot over three years in Seattle.

We will have 6.5 flights a day to Hawaii this winter.

I think that is a 60 or 65% share or something like that, but I don't know that we can comment on Hawaii or on Hawaiian's results.

That's fine.

I have been sort of reading the cruise liners up in Alaska are getting good pricing but weak volumes.

To me that represents a worst case scenario for the airline segment of the trip.

Are you feeling pretty optimistic as we move into the cruise season here you are seeing what you need to see in your Alaska cruise line markets?

Hunter, this is Joe Sprague from marketing.

The cruise lines pulled some capacity out of Alaska this summer, and we were aware of that many months ago.

There is some new airline capacity up there this summer as well, but I think we have adjusted to that, and adjusted to what we knew in advance was going to be softer demand in Alaska this summer.

On the flip side, we are actually seeing some strengthening in independent tourists, so the folks that are going up to Alaska separate from the cruise lines and seeing that in hotel occupancy and other indicators up there, so I think it has actually turned out as good as we could have hoped for this summer.

That's good.

If I could sneak in one more.

Help me understand a little bit this Delta code-share relationship.

Is Delta actually free selling tickets on your metal a good thing?

I know Delta wants to ramp up its reliance on the fee that you are feeding SeaTac.

Is that P&L accretive, is that a good thing that you're only collecting a portion of revenue or commission or if they do wanted to turn that up, would you it be better for you to have the seats to sell yourself?

Do they have the ability?

I know you don't want to talk with the specifics of the agreement.

Is Delta ramping up its reliance on you for feeding SeaTac a good thing for feeding your P&L.

This is Andrew.

The whole Delta relationship has continued to evolve.

As you have seen, we're flying to Atlanta now.

I think what we would say is that we found relationship to be a very positive one.

We have found that we have been able to work well with them to move our passengers that are in our markets of strength across the country and into the network and vice versa.

Also, the volume of passengers that they put on us up and down the West Coast I think is also helpful.

We need to continue to make sure we watch our revenue management and what we sell and what we don't sell and all of that complexity, but I think that today, I would say we're very happy with how things are going.

Okay.

I appreciate the color.

Thanks very much.

Good quarter.

Thank you, Hunter.

Your next question comes from Jamie Baker of JPMorgan.

Good morning, everybody.

Hi, Jamie.

Question, I guess for Brad on the main line network.

Regrettably, I am actually old enough to remember when you didn't fly to Mexico, and the network was much more seasonal obviously than it is now, and Mexico was obviously a great way to balance demand year-round, Boeing Next Gens, then made Seattle East-West flying a possibility so we saw more network shifts there, and obviously in last year so the Next Gens have been proven pretty capable to and from Hawaii, so I guess my question is what's left from here?

There are obviously a number of larger cities you don't serve in the lower 48, but should investors be thinking longer term about an additional fleet type and international flying at some point?

Is that simply the only maturation step that's logically left?

Maybe I can start, Jamie, on that.

I think there is much more we can do domestically at both companies, and we think that single fleet type is absolutely the way to go in terms of efficiency.

We love the 737-800 at Alaska and we think the Q400 is the right airplane for Horizon, so with that fleet, we think that there is a lot we can do, and the international part of this I think is going to be more domestic trips on international itineraries connecting to our partners, and we're really pleased to see Delta do the Beijing and Osaka, and who knows what else will happen off the West Coast to Asia, with all of our partners that we can connect to.

So there is no limit as we look out there to what we can do, and we are certainly are pleased with the results obviously, and we do like this S Curve notion that we have seen happen in Seattle and to some degree in Portland, and maybe there is opportunities for more of that, and in other words not just flying airplanes between point A and point B, but a strategy that focuses on a particular city and builds market share and presence, that gives us an advantage, and so longer term there is obviously more of that we can do.

And would you ever be tempted to export the current model off the West Coast to another focus area in the lower 48?

Or is the model just too heavily predicated on the West Coast dynamic that is are unique unto themselves?

I think it depends on the timeframe.

I think there is a logical sequence of things over many, many years, and I think there is just lots we can do and those are things we'll be talking about as Brad mentioned longer term strategic plan the next ten year plan will be looking at various opportunities.

All right.

Terrific.

Thanks very much and congratulations.

Thank you.

Thanks, Jamie.

Your next question is from Duane Pfennigwerth of Raymond James.

Good morning.

I wondered if you could share with us total capacity and competing capacity as you define it.

For the relevant markets for June and the September quarters.

This is Andrew, Duane.

Things are going to be a little tough for us going forward -- I think in the second quarter, the competitive capacity in our markets was down about 4% on the main line, and in Q3 and Q4 we expect it to be up about 2%.

Big reason for that is many carriers are annualizing their cuts.

Also, we have seen a lot of, I think 18% to 20% increase in capacity up to the Alaska long haul, or the State of Alaska this summer, so it is not huge, but they will increase frequencies here and there so about 2% of this is additional pressure on the network from other airlines.

Thank you for that detail.

Bearing that in mind, are you seeing that impact in your forward book yields?

We won't sort of comment on the yields per se, but what I think I will say is that as we look forward at our traffic and our loads, what we are seeing is that especially over the last six or eight weeks, we continued to see a 3 to 4 point increase in traffic booked over our capacity, both within the next 120 days and beyond, and also even as I look out into October, we're very happy with what we're seeing as far as how things are building, so right now unit revenue trends we're not seeing anything hugely alarming.

Thanks very much.

Duane, it is Brad.

I'd like to jump in.

As Andrew said, capacity looks like it is up 2% in our markets in the third quarter, but we're looking at a report right now that just shows competitive frequencies hub by hub, so Seattle, Anchorage, LA and Portland, and it is a stable as I can remember it being in a long, long time, city by city, there is a whole lot of zeros this report, so it feels like a pretty decent competitive environment that we're going to have the next little bit.

Thank you.

Your next question comes from Michael Linenberg of Deutsche Bank.

A couple questions here.

I guess with respect to some of the debt prepayments, Brandon, that you talked about, I think you said I think something like $50 million plus maybe in the last quarter or so, what -- what are you buying that back at par or are you actually getting a break and maybe even being able to buy that at discount?

Mike, it is Brandon.

I am going to let Jay Schaefer, our Treasurer, answer that one.

Great.

Michael, all of the debt that we're prepaying right now is all privately placed debt, so it is simple mortgage debt and we're prepaying it at par.

Is it relatively high coupon versus where the market would be for that type of debt for you today if you were to issue it?

Yes.

As you know, base rates are really low, but we did a lot of financing deals in 2009 as we became concerned with the weak economy and the capital markets in general, and credit spreads had really gone up, and so those are the deals that we're focusing on right now with this current tranche of prepayments.

Great.

Very good.

My second question, and this I think this sort of follows on what Bill Greene brought up about just your margins being so high.

And being attractive to competitors, particularly in some of the markets that I think are going very well for you, so you don't want to beat a dead horse here, but getting back to Hawaii, when I think about some of the capacity that could come into that market off the West Coast, that is markets that are going to be targeted by Allegiant and while the 757s they will bring on will be pretty large, lots of seats, maybe north of 200, my sense is that the markets they will look at are markets where they do pretty well in like Bellingham, Washington, which is close to you guys and may do things unique like Long Beach, for example, and when you think about competing against them, historically you guys have competed against everyone, and you have done very well and what when you think about a carrier like Allegiant coming into the market, what is your edge?

Is it the fact that you carry higher priced leisure passengers, you have the business mix, is it the Delta code, and what can you tell us about your ability to sort of fend them off, number one, and number two, you are competing with them in the Bellingham to Vegas market.

I believe you may have even up gauged the airplane in that market.

Maybe that's the laboratory here, the laboratory experiment.

How have you done in that market vis-a-vis them to at least give us some comfort that as they come in you will hold them off?

Mike, it is Brad.

The first thing I would say is carriers like Allegiant that make the transformation this Company has done and continues to do so important.

Low cost carriers are coming into our markets with very low costs, are a very real threat and why we have been doing everything we have been doing the last six or seven years and it's why we keep on this track going forward.

In terms of how we compete against Allegiant, Alaska Airlines has the lowest fares off the West Coast of the United States to Hawaii, and that's something that we're going to talk about and we're going to continue to promote.

We do fly to Honolulu, but we fly our biggest business to Maui and the outer islands, so I think that's something a little different for us.

You have 737-800, 157 seats, that can fly to almost anywhere on the West Coast to the four islands, and so it is a little smaller gauge airplane, which makes markets like San Diego or San Jose or Sacramento or Seattle or Portland work quite well, so we really like that asset, and Bill talked about the S Curve earlier.

We do have a lot of, in the markets where we're flying, we have a loyal base of frequent travelers.

Those are what we have going for us.

I don't think any of us here under estimate the threat of folks like Allegiant Air, so we're prepared to do whatever we have to do to compete against them.

This is Andrew.

The only thing I would add there, too, is the feeder network that we have to feed our Hawaii flights as well as the strength of our mileage plan, frequent flyer program, and our overall frequencies in all of our markets, versus the Allegiant model tends to be day of week type, and they do -- what we have seen is they do stimulate a lot of traffic.

Sometimes that's stimulated and not off of our network, so to Brad's point, we watch them very carefully and there is something we'll be continuing to study in the coming months.

Very good quarter.

If I heard Bill right, Bill, did you say this was the all time most profitable quarter ever for Alaska?

Is that absolute or margin?

That's on an absolute basis adjusted for the specials.

Great.

Great job, guys.

Thank you.

Your next question comes from Helane Becker of Dahlman Rose.

Thanks very much, operator.

Hi, everybody.

In terms of your code-shares on the West Coast, could you talk about how the American code works with respect to the Delta code, and what you're seeing there and have they come to you to talk to you about making more inventory available for their LA markets?

This is Andrew.

Essentially if you look at, even if you fly on Delta and look in their in-flight magazine you will see a lot of green lines over the West Coast and essentially American and Delta are using our West Coast network for their customers and passengers and in the case on both Delta and American, they do a lot of local market code-share up and down the West Coast so selling LAX, Seattle, Orange County, Portland and all of those, and we find that works very well for them and works very well for us and if anything helps strengthen the volumes we can put up and down the West Coast, but we have to work with them both, but specifically as they come to us or whatever, at the moment we just continue to work as we have always worked and really one of our main focuses at this time is make sure for our passengers this is not confusing, it's extremely seamless, and they see the benefits of type of arrangement.

Helene, this is Joe.

I might just add another benefit of the partnerships with American and Delta and the other partners we have is the frequent flyer reciprocity, the mileage plan benefits we have with multiple partners is really key for our customer base, because of having over twelve different mileage partners we can offer access to over 100 countries and something 706 different city pairs, so it is a powerful part of the whole alliance relationships.

That was going to be my follow-up question.

Thank you very much.

Your next question comes from Dan McKenzie of Hudson Securities.

Good morning, guys.

Thanks.

Given the I guess kind of the questions on competitive capacity, I wanted to circle back to it one more time.

My analysis is a little bit different than yours, Andrew, and I am not sure how you're defining it.

I am looking at direct and indirect competition or indirect through alternative airports.

I am seeing Virgin cut 18,000 seats or cut 15% of its capacity in the third quarter and cut again in the fourth quarter and on Southwest, I am seeing them cut 38,000 seats in the third quarter or 58,000 in the fourth quarter, so their capacity cuts actually accelerate, and I guess my question is what percent of the revenues are we talking about here?

Is this perhaps 30% of the revenues, 40% of the revenues that are impacted by this competitive capacity cuts and how material is that to I guess just in terms of revenue improvement year-over-year?

Dan, a couple of things.

Firstly, the modeling we use, maybe it is overly complicated.

Basically we look at where we fly and depending on which competitor we're looking at, and how significant that route is to our network, we sort of weight it across our network, so if we have a single frequency in a market and someone has big increase, that doesn't really affect our overall network that much, but that said, a couple of things.

We are seeing some stabilization or increase frequency in some of our markets from Southern California, but at the end of the day, we're seeing some up gauging and things going there, but nothing huge, just trying to think off the top of my head, there's some increased capacity that will be going into Mexico from Virgin off the West Coast.

We have seen JetBlue increase their gauging capacity out of Long Beach up to Seattle and the Pacific Northwest.

We have seen United and American come into Los Angeles, Reno, those types of things, so I don't know.

I think we're seeing modest sort of strengthening but nothing significant, but I am not seeing it hugely go down.

As far as our network, obviously Southwest is across our network in a pretty big way, I think about a third of our network we go head to head with Southwest somewhere.

Yes.

It changed a bit.

Dan, you followed us for a long, long time.

It used to be that Nevada, Arizona, Southern Cal and Bay Area were 50 or 60% of the network.

With the growth of transcon and mid-con and Hawaii, Mexico, State of Alaska which we have always had, those are less.

I think your intuition at 30, 40, 50% is probably pretty close to our exposure to those folks.

Great.

Thanks.

That will do it for me.

Your next question comes from Jim Higgins of Soleil Securities.

Good morning, everyone.

Most of my questions have been asked and answered.

Did you receive a refund of aviation security infrastructure fees in the second quarter?

No.

It is Brandon.

We did not participate in that lawsuit, so we didn't have any share of the refund that came.

Thank you very much.

Your next question is from Glenn Engel of Bank of America, Merrill Lynch.

Good morning.

Two questions, please.

First one, you touched on a little bit, but can you talk about how much capacity is up in the Alaska to 48 state markets versus last year, and how that compares with two years ago?

This is Andrew.

We're going to be coming up -- firstly in the quarter just done our capacity was down about 5%, and we're going to see about that number in the third quarter as well.

Off the top of my head, I think we're going to be about flat with 2008 capacity, but other competitors have increased.

Basically a lot of the competitors came back here and got out in 2009 and came back in 2010.

The long history on this as I recall was that every summer we had about what we're seeing today, and we had a little bit of a holiday from that last summer and it is back to where it has always been so no big deal on Alaska.

How much on a year-over-year basis is the Alaska capacity up including you and the competitors?

I am not sure we have that.

I don't have that offhand.

I am sorry.

Second question I have is on the flying, the transcon side flying, how has that performed relative to the system?

I guess how many frequencies do you tend to have in the market and what would you expect to have way down the road?

What would your ideal be for having frequencies in these East-West type markets?

Glenn, it is Brad.

You don't comment specifically on regions.

I think you can gauge from the way that we have grown transcon over the years that we have been happy with the results there.

Typically we are at one or two frequencies so our market shares in those markets is 15 or 20% if you had to average it, and we do see that as not a near term opportunity but maybe two or three or four years down the road if the economy comes back as a place we see further opportunity to grow.

What would be five, ten years down the road, where would you hope to be in terms of frequencies in these markets?

It's a really hard question to answer.

I guess you could look at something like our presence in Seattle, Southern California, as an example.

We have gone over 20 years from almost nothing there to having 50% of the share between the Northwest and Southern Cal, so our thinking about it would kind of be incremental.

Put some capacity in, get the capacity to work, make a little money and build on that and do more of the same.

Glenn, it is Brandon.

There is lots of benefits that come from adding frequencies as the market traffic can support it.

We offer more utility to our customers, it gives us an opportunity to improve productivity on each end of the flight.

It is something that we're seriously looking at, but we would only do that over the next few years as Brad said if the traffic can support it.

I might add that we're as sensitive about capacity increases as anybody out there, but given our small fleet size, one additional round-trip to the East Coast is essentially one airplane, and that's almost 1%, so over time, as we start looking at doing these things, you can quickly see how 3, 4, 5% growth a year really isn't very much, given the fleet size we have here.

Thank you.

Thanks, Glenn.

Your next question comes from Kevin Crissey of UBS.

Hi, guys.

Hey, Kevin.

Can you talk about Google's acquisition of ITA, what that might mean for you?

Kevin, this is Joe.

We do have a long partnership with ITA.

They provide the shopping engine for AlaskaAir.com website, and it has been a positive relationship, so of course this Google acquisition is fairly recent news, and we're studying that closely to see what it might mean.

I think there is some intrigue that that might even further strengthen ITA in terms of some of their research and development activities that could benefit us, and so like the rest of the industry, we're going to be watching that closely over next few months so see how that gets approved and how that moves forward.

Do you have an official stance?

You have opportunity to comment, right, on that with the Department of Justice, is that something that you have formalized yet?

We have not, and you're absolutely right, there will be a lot of industry comment with respect to that acquisition, but we have not formalized what our formal position would be on that yet.

Okay.

Can you talk about Allegiant going into Hawaii is about hotels.

They may make some money on cars, but it is about hotels and might make some money on the fare as well but I think it is also about hotels and car rental.

How do you do in that or how do you think your opportunities there, I guess?

This is Joe again, Kevin.

Actually, that's an area of big opportunity for us, especially on the ancillary side as we look ahead to what other opportunities we might have in that category.

We have an initiative to improve the shopping functionality for cars and hotel on our website and will be continuing that effort aggressively here over the next few months, and we have an existing infrastructure that reaches out and builds relationships with hotels and some of our key leisure destinations, so we have been working that very hard over the last three years.

We're excited about the partnerships that we have with hotel properties in Hawaii already, and as we sort of combine those partnerships with the better shopping functionality, we think we have a lot of opportunity in this area.

Those partnerships, I am sorry, just to follow it up, those partnerships are direct relationships with the hotels or you have an intermediary.

Both.

We have an intermediary to help with the sourcing of hotels for our website, and then through our Alaska Airlines Vacations efforts which is our inhouse tour wholesaler arm we have our direct relationships as well.

That's right.

Thank you.

Your next question comes from Steve O'Hara of Sidoti & Company.

Good afternoon.

Most of my questions have been answered.

I just had a question about the costs and maybe you addressed this.

I think you guys guided for slightly higher costs on the 16th of June or the 15th of June and I am just wondering what the difference was at the end of the quarter.

Hey, Steve, it is Brandon.

You're right.

On the main line we guided to $0.0785 to $0.0795 which moved up just a tick from our initial guidance during the quarter, and then it came down as you know and we ended up at $0.0779.

We had some favorable adjustments to our workers comp costs that helped us out late in the quarter there and then just generally good cost performance by all of our operating divisions in the month of June.

Secondly, in terms of the bag fee, do you notice any discernible change in terms of the markets maybe operate versus Southwest or JetBlue in customer behavior?

Do you lose any revenue premium that maybe you got before, based on your bag fee?

Steve, this is Andrew.

I suppose from a network and our own perspective I have seen no huge downside from this at all.

Okay.

Thank you very much.

Your next question is a follow-up from Hunter Keay of Stifel Nicolaus.

Thanks for taking my follow-up.

I appreciate it.

Bill, question for you as your chairman hat on for a second here, when we're talking about this cash deployment and let me frame this with the $50 million share buyback you authorized I think is incredibly differentiated, valuable for the share holders and I applaud it, but if you're thinking about the context of deploying more cash as you build more cash maybe than you expected, is there any reason why that maybe shouldn't be $100 million, and I hate to get greedy on this.

I know.

Right.

There is a good problem to have.

If you are thinking about driving ROIC and that's your probably highest cost of capital and invest base and two pronged effect like supporting the stock and driving earnings, et cetera, do you guide -- I don't want to you speak for the Board obviously but do you as Chairman view your stock is still currently undervalued at and could you maybe see upside in buying back more shares?

I am probably not going to take that bait.

I think this as Brandon said is something we're teeing up for the full board discussion.

It is a high quality problem and there is lots of alternatives, lots of opinions, and the guiding principle obviously is we're going to do what's best for shareholders over the long-term.

That's our business model.

We're going to shareholders understand that they deserve a return, it has been missing in this industry forever, and we're going to keep doing things that benefit our shareholders and our customers and employees along the way.

Hunter, it is Brandon.

There is no reason that you can't get to $100 million by having two $50 million offerings, and our board has a history of reauthorizing as we work through the authorizations that are on the table, our Board has a history of renewing those if the economic circumstances warrant.

Point well taken.

Point well taken.

I appreciate the color, guys.

Thought I would throw it out there.

Thank you so much again.

Thanks, Hunter.

I think that's it.

Okay.

Thanks for joining us today.

We look forward to talking with you again next quarter.

Take care, everybody.

Thank you for participating in today's conference call.

You may now disconnect.